MA611 Auditing

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MA611 Auditing

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MA611 Auditing

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Course Code: MA611
University: Melbourne Institute Of Technology

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Country: Australia

Question:

Results of analytical procedures
1 Get financial reposrts for last 3 years (2 sets of financial reports)
2 identify 06 areas which you have unusual balances by using 5% – 10% rule (simple comparison)
3 Applying analytical procedures
Ratio Analysis
for internal data
for industry data
Simple Comparison
4 How reliable is data in this company?
5 Expected results
– What to expect in the particular business?
– Consider Inherent Risk of company/ business
– Consider entity’s objective and strategies
– and any other related business risks that may result in a risk of material misstatement
6 Evaluating results
7 How the results of analytical procedures would influence the audit planning?

a) Can we classify them as “Significat risks”?
b) Key assertion at risk
c) Preparing substantive audit procedure for 01 account balance
d) Practical internal control to mitigate that risk
a) can include,

– the risk of fraud
– relationship to recent significat economic, accounting or other development that require specific attention
– complexity of the transaction
– involvement of significat transactions with related parties
– degree of subjectivity in measuring related financial information
– whetehr significant transations are unusual or outside the normal course of business for the entity

Answer:

Introduction
Auditing Standard ASA 315 is associated with the accountability of the auditors to distinguish and calculate the risks of material misstatements in the financial statements of the company. It is executed through understanding the nature of the entity and its internal environment comprising of its internal control mechanisms.The main aim of the auditor is to track the risks pertaining to material misstatements which can be due to fraud or error in the financial reports of the company. Their job is to ascertain the assertion levels through comprehending the nature of the orgnzation and its environment comprising of the internal control systems of the company. It provides the basis for designing and applying the reactions to the assessed risks of material misstatements (Griffith, Hammersley  & Kadous, 2015). 
In this regard, the auditor shall evaluate if the information gained from the client is relevant for recognizing the risks of material misstatements. The risk of material misstatements pertains to the risks which could affect the going concern aspect of the company. So, in this report, the various aspects of analytical procedures would be applied to analyze the risk of material misstatements of CSL Pharmaceuticals, Biotechnology & Life Sciences along with discussing the inherent risk of the company in the context of various factors. Lastly, the risk of material misstatements at the assertion levels shall be evaluated by applying audit procedures to address those risks. The internal control procedures shall be applied to mitigate the risks.
Results of Analytical Procedures
Simple Comparisons for the last three financial years
As it is seen from the annual report of the company, the following changes for FY 2015-2016 is being noted hereunder (CSL Limited, 2016):

Particulars

2015(US$ Million)

2016(US$ Million)

% Change

Net Profit after tax

1379.0

1242.4

9.91%

Property , Plant and Equipment

1841.3

2389.6

29.78%

Intangible assets

926.9

942.6

1.70%

Total assets

6401.0

7562.7

18.15%

Total Liabilities

3654.1

4995.5

36.71%

Changes in equity

2746.9

2567.2

(6.54%)

In the Financial Year 2015-2016, the change in net profits   after tax is about 9.91% which is considered to be material in pharmaceutical industry. It should not be more than 5% in publicly traded companies. The material change in property is 29.78% which is also abnormal as with change of 9.91% of net profits, there is a change of 29.78% in property. The change in the intangible assets is 1.70% which is considered to be normal. The total change in net assets is 18.15%   while the change in liabilities is 36.71% which is double the % change in assets. This matter is considered to be material. There is a negative change in equity which means the amount of net assets is decreasing. So, shareholders should have a closer look at the company before investing their money.
As it is seen from the annual report of the company, the following changes for FY 2016-2017 are being noted hereunder (CSL Limited, 2017):

Particulars

2016(US$ Million)

2017(US$ Million)

% Change

Net Profit after tax

1242.4

1337.4

7.65%

Property , Plant and Equipment

2389.6

2942.7

23.15%

Intangible assets

942.6

1055.4

11.97%

Total assets

7562.7

9122.7

20.62%

Total Liabilities

4995.5

5958.9

19.28%

Changes in equity

2567.2

3163.8

23.24%

The net profit is increasing by 7.65% and the value of property and plant is enhanced by 23.15% which are considered to be more than tolerable misstatements. The intangible assets are more than 11.97% and the total assets are increased by 20.62% while the total liabilities are increased by 19.28%.  The accounts are considered to be material misstatements. The 23.24 % changes in equity are considered to be material. The auditors should ascertain the auditing risk such as inherent risk and control risk in evaluating the statements.
Ratio Analysis for the last three financial years for internal and industry data 

Particulars for the year

Ratio(2015)

Ratio(2016)

Ratio(2017)

Industrial Analysis

Debt /Equity

1.33
 

1.95
 

1.88
 

2:1

Current Ratio

3.57

2.78

2.84

1.32:1

Quick Ratio

1.69

1.21
 

1.25
 

0.85:1

Return  on Equity

50.20%

48.40%

42.27%

17.10%

Source : CSL Limited( 2015,2016,2017)
As the objectives of the company is to save the lives of people and to safeguard their health. It wants to earn its reputation as a trusted and reliable global leader. So in pursuance of these objectives, there is some inherent risk such as the inventory becoming obsolete and expiring drug patents of the company. The state of fluctuating economy and availability of financing are another factors. Lastly the misstatements relating to the previous period may also impact the   current financial statements (Gramling, Johnstone & Rittenberg, 2012). 
The business risk pertains to risks of being outperformed by the competitors and manufacturing and supply chain risks pertaining to challenges in the continuity of the processes and the quality of supply having a negative impact on the results of the business. The other risks are research and development risk and business combination risk associated with lack of compatibility of the business combinations with the strategies of the company.
The audit decisions would depend upon analyzing the expected results from the industry data .The expected results are evident from the tables that debt-equity ratio is 1.88 which is not  as  per  pharmaceutical industry the ideal  debt equity ratio is 2:1 .The current ratio is  2.84 :1 which is more than the ideal ratio of 1.32:1  in the pharmaceutical industry.  The quick ratio is 1.25 which means that the company is in a better liquidity position.  It is also more than the ideal ratio of 0.85   in the pharmaceutical sector. The return on equity is 42.27% which is above an average in the industry which is delivering a ROE of 17.10% over the last few years.
The audit planning regarding the material misstatement pertain to obtaining proper audit evidence to ensure that there are no errors or frauds committed and the financial statements are free from them. They should analyze the    internal controls approved by the company for ensuring the sufficiency of capital so that the company can continue its operations. The inherent and control risk might be assessed by the auditors through evaluation of the evidence and performing procedures of risk assessment by considering the characteristics of the disclosures and accounts in the financial statements. The auditor reduces the detection risk by performing substantive procedures.
Risk of Material Misstatement (Inherent Risk) at the Financial Report Level
The inherent risk of the company would be assessed through the five factors viz.

The integrity of management (directors): The auditors should adopt professional skepticism which pertains to a critical attitude towards verification of the integrity of the management. They should not assume it to be dishonest or honest. It means that they should not accept the representations given by the management without proper evidence. They should verify the representations with other sources.

They should evaluate the reasonableness of the management representations in the context of other proofs. In case of any contradictions, they should investigate the causes and the reliability of the representations should be deliberated. They should verify if the letter of representation is signed by the authorized person.

Management (Director) knowledge, experience and changes during the period:  The inherent risk can be evaluated by examining the experience and knowledge of the management and changes occurred in the last financial year.  The inexperience management may impact the preparation of the financial statements of the company. The auditors should examine if there is any risk posed to the assets created out of the sources of the shareholders.Furthermore, they should verify proper procedures are in place to eliminate , correct and detect the frauds and errors (Griffith et al.,2015).

They should evaluate the preparation and presentation of the books of accounts preserved by the company.  They should update themselves with the knowledge of the business of the client and comprehending the critical areas.

Unusual pressure on management (directors): The unusual pressure on the management might pressurize it to misstate the statements like the industry facing failures or a company lacking amount of capital to continue its operations.At the level of account balances and transaction levels, the financial statements are likely to be susceptible like the accounts requiring adjustments in the preceding period or those involving intensity of estimation. The inherent risk in the judgment pertains to determination of the account balances. The susceptibility of assets to misappropriation or loss such as those assets which are highly desirable or movable like cash. The completion of unusual or complex transactions which are near to the end is likely to susceptible to inherent risk.
Nature of the entity’s business: The nature of the business of the entity such as probable obsolesces of technology and the products or services. The complication of the capital structure and the significant related parties can pose an inherent risk. Additionally, geographical spread of production facilities and the number of locations  can be the  factors contributing to inherent risks.

The auditors should evaluate the appropriate management and supervisory employees at various designations within the company with reference to the documentation like procedure manuals and flow charts to evaluate the inherent risk. The auditors should evaluate the major classes of transactions of the operations of the entity and the ways such transactions are initiated. They should verify the significant records, accounts and supporting documents to evaluate the risk (Cannon & Bedard, 2016).

Factors affecting the industry in which the entity operates: The factors affecting the industry in which the entity operates pertain to various economic factors and competitive conditions which are evaluated by ratios , financial trends and fluctuations in the technology, demands of the consumers and accounting practices which are common to the industry. The characteristic , technique and degree of the processes which are performed by the auditors should obtain an apprehension of the accounting and internal controls along with evaluating the complexity and size of the entity and its material considerations.

The internal controls involved and the nature of documentation and assessment of specific risks should also be verified by the auditors. They should also observe the activities of the entity and its operations (Meliyev, 2017).
Risk of Material Misstatement (Inherent Risk) at the Assertion Level

 

Specific account balance No.: 1
Total assets

(a) Explain why the account

The assets are exposed to material risk of misstatements as it may be possible that they existed but have not been mentioned  in the ledger accounts of inventory.

balance is at significant risk

It has also been studied that the materials which are not found can be marked as missing by the auditor.

of material misstatement.

While examonation of the materials , it is found that they were not on the locations on which they were stored.

 

 

(b) Explain the key assertion

The key assertion of existence should be implemented to the assets. It is related to the assumption that balance of the assets as stated in the financial statements really exists at the end of the accounting period (Mihaela  & Iulian,2012).

at risk of not being valid.

 

(c) Detail one (1) relevant substantive audit procedure substantive audit procedure to address the assertion at risk as identified in b) above.

The analytical procedures to verify the assets of the company and examine if the financial records match the physical counts should be applied by the auditors.The auditor should review the processes for counting methods to determine the efficiency (AICPA, 2017).

(d) Detail one (1) relevant

The auditor should implement the internal procedures for counting of the assets. They should count some of the assets and match the quantity  with the amounts to be recorded by  the counts of the company (Bowlin, Hobson & Piercey, 2015).

practical internal control that

 

would mitigate the risk in

 

relation to the assertion at

 

risk, as identified in b,) above.

 

 

 

 

 

Specific account balance No.: 2
Property , plant and Equipment

(a) Explain why the account

The risk of materiality in property, plant and equipment can be doubt in the accurate recording of the assets and for the appropriate period. The depreciation charges are valid or not or if they are properly calculated and recorded should also be amount to a material risk of misstatement (Deloitte, 2018).

balance is at significant risk

 

of material misstatement.

 

 

 

(b) Explain the key assertion

The accuracy and valuation of the figures of the property and plant should be proper and it should be based on the proper valuation of assets, balances of equity and liability ( AICPA,2017). 

at risk of not being valid.

 

 

 

(c) Detail one (1) relevant

The adoption of substantive test of control for scrutinizing the balance of fixed assets to verify their historical costs and classification of financial statements (Budescu, Peecher & Solomon, 2012).

substantive audit procedure

 

to address the assertion at

 

risk, as identified in b,) above.

 

 

 

(d) Detail one (1) relevant

The internal control procedure should pertain to the separation of ledgers for each asset with different useful life and salvage value. They should have periodic evaluations of the existence of the plants and note their location (Peytcheva,2013).

practical internal control that

 

would mitigate the risk in

 

relation to the assertion at

 

risk, as identified in b,) above.

 

 

 

 

 

Specific account balance No.:3
Total Liability

(a) Explain why the account

The liabilities can be posed to the risk of material misstatements regarding the provisions and contingent liabilities. It  would result in a possible outflow of  monetary resources  of the company. It is possible that the necessary provisions are not recognized  or the liabilities and expenses are not properly disclosed in the books of accounts.

balance is at significant risk

 

of material misstatement.

 

 

 

(b) Explain the key assertion

The assertion of Completeness pertains to the risk of not recording the liabilities by the company. The auditor has to verify all the transactions  made by the company (Zhang, Pawlicki, McQuilken & Titera, 2012). 

at risk of not being valid.

 

 

 

(c) Detail one (1) relevant

The substantive test of balances would be applied in this case. The appropriate classification of liabilities  would be determined. The financial statements would be verified for their disclosure (Glover & Prawitt, 2014).

substantive audit procedure

 

to address the assertion at

 

risk, as identified in b,) above.

 

 

 

(d) Detail one (1) relevant

The internal control policy should relate to the application of a well-documented policy on the liabilities specially the contingent liabilities and allocation of entries to their appropriate accounts (Knechel & Salterio, 2016). 

practical internal control that

 

would mitigate the risk in

 

relation to the assertion at

 

risk, as identified in b,) above.

 

 

 

Conclusion
Hence to conclude it can be said that the findings and issues of the company were that the material misstatements were found in the changes in  net profits , assets, liabilities and assets were considered to be material , so the relevant  substantial procedures , internal controls and key assertions are being applied  to mitigate the risks .
References
AICPA (2017). Analytical Procedures. Retrieved September 16th    , 2018 from https://www.aicpa.org/research/standards/auditattest/downloadabledocuments/au-c-00520.pdf 
AICPA. (2017). Audit guide: Audit sampling. NY: John Wiley & Sons.
Auditing and Assurance Standards Board (2013) .Auditing Standard ASA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment. Retrieved September 16th    , 2018 from https://www.auasb.gov.au/admin/file/content102/c3/Nov13_Compiled_Auditing_Standard_ASA_315.pdf
Bowlin, K. O., Hobson, J. L. & Piercey, M. D. (2015). The effects of auditor rotation, professional skepticism, and interactions with managers on audit quality. The Accounting Review, 90(4), 1363-1393.
Budescu, D. V., Peecher, M. E. & Solomon, I. (2012). The joint influence of the extent and nature of audit evidence, materiality thresholds, and misstatement type on achieved audit risk. Auditing: A Journal of Practice & Theory, 31(2), 19-41.
Cannon, N. H. & Bedard, J. C. (2016). Auditing challenging fair value measurements: Evidence from the field. The Accounting Review, 92(4), 81-114.
CSL Limited( 2016). CSL Limited Annual Report 2015-2016. Retrieved September 16th    , 2018 from https://www.annualreports.com/HostedData/AnnualReportArchive/C/ASX_CSL_2016.pdf 
CSL Limited( 2017). CSL Limited Annual Report 2016-2017. Retrieved September 16th    , 2018 from https://wcsecure.weblink.com.au/pdf/CSL/01896392.pdf 
Deloitte (2018). Audit Readiness (4) – Property, Plant and Equipment. Retrieved September 16th    , 2018 from https://www2.deloitte.com/ng/en/pages/audit/articles/financial-reporting/audit-readiness-4-property-plant-and-equipment.html# 
Glover, S. M. & Prawitt, D. F. (2014). Enhancing auditor professional skepticism: The professional skepticism continuum. Current Issues in Auditing, 8(2), P1-P10.
Gramling, A. A., Johnstone, K. M. & Rittenberg, L. E. (2012). Auditing. Canada : Cengage Learning.
Griffith, E. E., Hammersley, J. S. & Kadous, K. (2015). Audits of complex estimates as verification of management numbers: How institutional pressures shape practice. Contemporary Accounting Research, 32(3), 833-863.
Griffith, E. E., Hammersley, J. S., Kadous, K. & Young, D. (2015). Auditor mindsets and audits of complex estimates. Journal of Accounting Research, 53(1), 49-77.
Knechel, W. R. & Salterio, S. E. (2016). Auditing: Assurance and risk. NY: Routledge. 1-100.
Meliyev, I.I.(2017). Impact of Audit Planning On Audit Quality: Case Study Of Local Audit Firms In Uzbekistan. International Journal of Economics, Commerce and Management,5(11),379-385.
Mihaela, D. & Iulian, S. (2012). Internal control and the impact on corporate governance, in Romanian listed companies. Journal of Eastern Europe Research in Business & Economics, 2012.  DOI: 10.5171/2012.676810
Peytcheva, M. (2013). Professional skepticism and auditor cognitive performance in a hypothesis-testing                   task. Managerial Auditing Journal, 29(1), 27-49.
Zhang, L., Pawlicki, A. R., McQuilken, D. & Titera, W. R. (2012). The AICPA assurance services executive committee emerging assurance technologies task force: The audit data standards (ADS) initiative. Journal of Information Systems, 26(1), 199-205.

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