MAA705 Corporate Auditing Individual Assignment

1. Auditor’s report was signed by the audit partner John Yeoman.
2. Auditor’s report for the year ended 30^thJune 2017 was signed by PwC on 22^nd August 2017.
3. As per the auditor’s opinion the associated financial report of the company and the entities controlled by it is in compliance with Corporations Act 2001 and it includes –

• The report is complied with Corporation Act 2001 and Australian Accounting Standards
• The audit report gives true and fair view of the entity’s financial position and financial performance as on 30^thJune 2017 (com 2018).

The auditor provided unqualified audit opinion as according to them the audit is conducted in compliance with the AAS (Australian Accounting Standards). Further, they believe that audit evidences obtained by then are appropriate and sufficient to provide the basis for opinion (Blankley, Hurtt and MacGregor 2014)

Inherent risks

Inherent risk is risk of the material misstatement in the financial statement that arises owing to omission or error. It arises due to factors other than control failure. Generally, the misstatement arises due to lapse or absence of the controls that are separately considered while assessing the control risk (Coetzee and Lubbe 2014). Inherent risks are considered higher if higher degree of estimation and judgements are involved or where the transactions of the company are of complex nature.  Inherent risks found in case of WWW are as follows –

• Valuation of inventory – WWW is the manufacturer of precious metal studded wristwatches and pocket watches made of gold. 2 employees are engaged by the company who are specialized in making watches. However, due to age factors they are near to their retirement and the new generation are not so interested in this profession. Moreover, very few watchmakers are there who can match the expertise level of existing watchmakers. However, it is found that the classic watches of the company do not match with latest trends. WWW’s experience tells that inventories of the company do not become obsolete. Inventories are generally recognized at cost or market value whichever are lower (Makarenko and Yardanova 2015). However, if the inventories are kept idle it will not be possible for the company to record it in their book.
• Cash deposit – WWW follows perpetual inventory system and maintains the point of sale system in computer. However the cash payments received by the company are deposited in bank once in week as there is no bank in nearby location (Louwers et al. 2015).  However, chances are there for the misstatement of cash. Cash being highly volatile item it is always susceptible to embezzlement, misstatement or theft. As cash are not deposited on daily basis it will create inherent risk for the cash account and its records.
• Stock taking – Stock take for jewellery used to be carried out by the retail manager on monthly basis. However, owing to his bad health stock take became less frequent. Inventories shall be physically counted and matched with inventory register on regular basis (Contessotto and Moroney 2014). Therefore, it will create inherent risk to inventories as inventories are subject to misstatement, theft and wrong valuation.

Control risk

It is the risk related to material misstatement involved in financial statement generated owing to failure or absence in operation of the relevant controls of company. Each company shall have sufficient internal control measures for detecting and preventing errors or frauds. It is considered as high where the client company does not have proper internal control measures for detecting and preventing errors or frauds (Ruhnke and Schmidt 2014). Control risks found in case of WWW are as follows –

• Segregation of duties – as WWW deals with high value watches its inventories involve higher amount. Therefore, responsibilities of stock taking shall have been segregated between 2-3 people. The manager being only responsible person for stock taking his ill health significantly hampered the stock taking procedure (Melikhova and Nikolayenko 2017). It will lead to control risks over the company’s inventories.
• Reporting loss – As the company reported its first ever loss during the year 2018 chance is there that financial reports of the company is being misstated. The possibility is also there that the financial statement includes error or fraud that is not detected by the company or the auditor.
• Cash deposit – As the cash receipts of the company are deposited in bank once in a week chances are there that the amount of cash is misstated. Cash being highly volatile item it is always susceptible to embezzlement, misstatement or theft. As cash are not deposited on daily basis it will create control risk for the cash account and its records.

Internal control strength

Internal control is the organizational plan in which all the measures and method of the company are co-ordinated and adopted within the business for safeguarding the assets, checking the reliability and accuracy of the accounting data for improving operational efficiency and encouraging adherence to required managerial policies (Johnstone, Gramling and Rittenberg 2013). Internal control strengths found in case of WWW are as follows –

• To prevent the store against theft the company keep it locked. Therefore, the customers are required knock on the door to enter in the store. It will protect the store from theft.
• Watches of the company are kept in the locked display case and one spare copy is kept in back storeroom. Therefore, it will be convenient for the customers to search for their required items as it will not depend on availability of particular staff.
• At night all the watches are removed by the company from display cases and it is locked in safe. Further, the store has the facility of security alarm that is directed to police station. The alarm switch is kept on while last employee leaved from the store. It will provide additional security to the products kept in the store safe.

Component of audit risk

Audit risk states the risk that the auditor will provide incorrect opinion regarding financial statement. Audit risk is equal to inherent risk * detection risk * control risk. The audit risk is measured as product of assorted risks that can be encountered for the audit performance. For keeping the audit engagement risk lower than the acceptable limit, auditor shall assess the risk level associated with each audit risk component. Control risk arises due to failure of the existing control or absence of the control that leads to misstatement in financial statement. Detection risk arises due to failure on the part of auditor regarding discover of the material misstatement include in financial statement. Inherent risk arises through omission or error arises from the factors except the control failures. Therefore, the risks identified above as inherent risk and control risk can be justified properly for detecting valuation of inventory, Cash deposit and Stock taking risks as inherent risks and Segregation of duties, Reporting loss and Cash deposit risks as control risk.

Strategies to be adopted

• Stock taking responsibilities shall be segregated between 2-3 people. It will enable maintaining appropriate stock for the inventories so that any error or fraud will be detected in early stages (Hamova and Mel'nik 2016).
• Cash shall be deposited in bank on daily basis so that chances of misstatement or misappropriation cash will be minimized
• Inventories shall be removed from the stock and stock register when it becomes obsolete and valuation shall be made on the basis of cost or market value whichever is lower (Tarasenko 2015).
• As the company reported loss for the 1^sttime in 2018, all the items those led to loss or the amount of the items those significantly varied with last year shall be checked thoroughly.

Computation of planning materiality

Planning materiality refers to misstatement amount that are set by the auditors at the stage of audit planning on the basis of materiality with regard to the financial statement. Below mentioned are the quantitative factors used for computing materiality planning –

• 1% to 5% of the sales = $ (33,00,000*1%) = $ 33,000 to $ (33,00,000*5%) = $ 165,000
• 1% to 2% of total assets = $ (44,00,000*1%) = $ 44,000 to $ (44,00,000*5%) = $ 220,000
• 2% to 5% of the shareholders equity = $ (23,00,000*1%) = $ 23,000 to $ (23,00,000*5%) = $ 115,000

While calculating planning materiality the auditor may consider the highest amount from above. However, based on the case scenario the auditor can set the materiality level. In the given case, if the lower limit is considered then $ 44,000 that is 1% of total asset can be set as the level for planning materiality (Audsabumrungrat, Pornupatham and Tan 2015).

From the given case study it is found that Nick Leeson made $ 10 million of profit for the 1^st week of February 1995. This significant amount of profit caught attention of various other members in bank. Head of the Global Futures and Options Sales, Mike Killian was in view that if Nick makes same profit level through entire year it will be half billion dollar profit for the year. This professional attitude is known as professional scepticism. Mike was cynical about the fact that if one person is making more money as compared to rest of staff’s entire earning it may raise questions regarding the reliability of information. Professional scepticism shall be applied properly throughout the auditing procedure. It is the component of auditor’s general duty with regard to care that is applicable through the procedure of audit. This attitude includes questions in mind and critical assessment for sufficiency and appropriateness of the audit evidence. It includes 3 elements – auditor’s mindset, actions and attributes (Kim and Trotman 2015). It plays an important role in audit as it forms integral part of skill set for the auditor. It helps in appropriate exercise of the professional judgement especially in decision making regrading –

• Timing, extent and nature of the audit procedure that is to be performed for reducing risk to the appropriate level
• Drawing conclusions on the basis of audit evidence available.
• Whether required audit evidences are gathered and whether more evidences required for achieving the audit objectives as per the relevant standards on assurance.
• Evaluating the judgement of management (Chiang 2016)

It further improves the effectiveness of the audit procedure and its application. Further, it reduces the chances of selecting inappropriate audit methodologies, misapplication of audit procedure and misinterpretation of audit results.

Nick Leeson was the floor manager and at the same time he was the head of the settlement operations. Thus, he was in a position to settle his trades without considering the internal control of bank. Hence, his action will create self interest threat and self review threat as per APES 110 on the Code of Ethics for Professional Accountants. Self interest threat is created when financial or any other interest inappropriately influences the behaviour or judgement (Tepalagul and Lin 2015). On the other hand, self review threat is the threat that the member will inappropriately analyse the results of previous judgement or any service performed by any other person. For reducing the threat, Baring Bank shall segregate the duties properly. For instance, the settlement and trades related to Nick Leeson shall be reviewed by any other competent person. It will reduce the chances of misstatement and fraud (Fiolleau et al. 2013). 

Unqualified audit report determines that the entity’s financial statements are presented appropriately and fairly without any in compliance and exceptions to accounting standards. It is most common type of the audit report and it does not raise any question regarding the company’s financial statement. Unqualified audit report states that the financial statement of the company is financially sound and there is no gap between the audit expectation and performance (Czerney, Schmidt and Thompson 2014). This kind of report suggests that the identification of responsibilities with respect to expectation of the auditor reflects proper knowledge of the company regarding the audit procedure.

Unqualified audit report, the most common type of the audit report is the clean report that does not demand any modifications in the auditor’s opinion. Though the audit report received by the bank was of unqualified nature that indicated all the internal control and financial statement requirements were in place. However, there were some inherent risks that led to bankruptcy of the bank (Guiral Ruiz and Choi 2014).  Therefore, before issuing the unqualified audit report the auditor should have applied in depth knowledge associated with mindset, actions and attributes.

Reference

Amcor.com., 2018. [online] Available at: https://www.amcor.com/ [Accessed 30 Aug. 2018].

Audsabumrungrat, J., Pornupatham, S. and Tan, H.T., 2015. Joint Impact of Materiality Guidance and Justification Requirement on Auditors' Planning Materiality. Behavioral Research in Accounting, 28(2), pp.17-27.

Blankley, A.I., Hurtt, D.N. and MacGregor, J.E., 2014. The relationship between audit report lags and future restatements. Auditing: A Journal of Practice & Theory, 33(2), pp.27-57.

Chiang, C., 2016. Conceptualising the linkage between professional scepticism and auditor independence. Pacific Accounting Review, 28(2), pp.180-200.

Christensen, B.E., Glover, S.M. and Wolfe, C.J., 2014. Do critical audit matter paragraphs in the audit report change nonprofessional investors' decision to invest?. Auditing: A Journal of Practice & Theory, 33(4), pp.71-93.

Coetzee, P. and Lubbe, D., 2014. Improving the efficiency and effectiveness of risk?based internal audit engagements. International Journal of Auditing, 18(2), pp.115-125.

Contessotto, C. and Moroney, R., 2014. The association between audit committee effectiveness and audit risk. Accounting & Finance, 54(2), pp.393-418.

Czerney, K., Schmidt, J.J. and Thompson, A.M., 2014. Does auditor explanatory language in unqualified audit reports indicate increased financial misstatement risk?. The Accounting Review, 89(6), pp.2115-2149.

Fiolleau, K., Hoang, K., Jamal, K. and Sunder, S., 2013. How do regulatory reforms to enhance auditor independence work in practice?. Contemporary Accounting Research, 30(3), pp.864-890.

Guiral, A., Ruiz, E. and Choi, H.J., 2014. Audit report information content and the provision of non-audit services: Evidence from Spanish lending decisions. Journal of International Accounting, Auditing and Taxation, 23(1), pp.44-57.

Hamova, O.V. and Mel'nik, M.M., 2016. Ways to improve accounting and inventory audit. Scientific works of the Poltava State Agrarian Academy, 1, pp.173-179.

Johnstone, K., Gramling, A. and Rittenberg, L.E., 2013. Auditing: a risk-based approach to conducting a quality audit. Cengage learning.

Kim, S. and Trotman, K.T., 2015. The comparative effect of process and outcome accountability in enhancing professional scepticism. Accounting & Finance, 55(4), pp.1015-1040.

Louwers, T.J., Ramsay, R.J., Sinason, D.H., Strawser, J.R. and Thibodeau, J.C., 2015. Auditing & assurance services. McGraw-Hill Education.

Makarenko, A.P. and Yardanova, T.H., 2015. Development of a program of inventory audit. Naukovi pratsi Poltavskoyi derzhavnoyi ahrarnoyi akademiyi, 2(11), pp.40-48.

Melikhova, T.O. and Nikolayenko, N.S., 2017. Development of an inventory audit program to increase financial security of the enterprise. Ekonomika ta derzhava, 1, pp.51-55.

Ruhnke, K. and Schmidt, M., 2014. Misstatements in financial statements: The relationship between inherent and control risk factors and audit adjustments. Auditing: A Journal of Practice & Theory, 33(4), pp.247-269.

Tarasenko, A.V., 2015. Development of the Information Support of Inventories Audit within Machine Building Companies. Oblik i Finansi, 68, p.109.

Tepalagul, N. and Lin, L., 2015. Auditor independence and audit quality: A literature review. Journal of Accounting, Auditing & Finance, 30(1), pp.101-121.