Auditing Theory and Practice

Executive Summary of Auditing Theory and Practice

The report on the auditing measures of Boral Ltd (ASX code - BLD) and Coles Ltd (ASX code - COL) has disclosed the major areas of risks and the factors that can affect the going concern concept of the company. The report also analyzes the possible areas of concern for the two companies and how does it impact the quality of the financial report.

Table of Contents

Audit risk and Planning.

Key inherent risks.

Audit Procedures.

The following substantive audit procedures can be followed at Boral and Coles Ltd for the above mentioned inherent risks.

Analytical review on the financial statements.

Audit Procedures.

Responsibilities/liabilities of the auditors against an inappropriate audit opinion.


Audit Risk and Planning

Key Inherent Risks

As per ASA 315, identifying and assessing the risks of material misstatement, the inherent risks of the case companies are discussed below:

  1. Boral Ltd: In the audit planning phase, the following key inherent risks has been identified:
  • Environment and Weather: Boral Ltd is engaged in the business of manufacturing and supplying construction and building material, it is one of the major industries that negatively affected due to extreme weather conditions. Also Boral is subjected to high levels of health, environment and safety regulations and laws, which could results in losses and liabilities.
  • Human Intervention: During late December 2019, Boral identified financial irregularities in its North American business, involving misreporting in inventory levels and associated raw materials and labor costs in its Windows factories.

An auditing and forensic investigation determined that finance personnel manipulated financial and accounting statements to artificially increase the profitability and financial-health of the American Window’s business. The misconduct occurred for more than a period of 20-month till the end of October 2019.

  • Macroeconomic Disturbances: The economy of Australia especially building material industry has been highly relied on the economy of China, which is going through huge slowdowns due to trade war between USA and China and majorly due to the Corona Pandemic, for which the world economy faced huge negative consequences and Australia is no exception (Groomer and Murthy 2018).
  1. Coles Ltd: In the audit planning phase, the following key inherent risks has been identified:
  • Cybercrimes: Coles is a retailing giant and is also digitally visible. The cybercriminals in the digital world targets companies in the retailing industry like Coles in several ways. Like they can launch phishing scams which are sophisticated and difficult to track. Through these scams, the hackers convince company’s unwitting customers, employees, etc to share their personal information which might include national identification numbers and even credit card informations.
  • Supply chain risks: In the past 10 years or so, the risk management for supply chain has emerged as a big challenge for the companies engaged in the business of retailing. It can be defined as customers always wanted to receive its purchased products at any time and at any place they want. Therefore, it is required for Coles to meet its customers’ demands while remaining highly competitive.
  • Operating Balancing and Cost Productivity: this inherent risk is related to increase in the operating costs of the company. It requires the management to increase the overall efficiency of the operational structure along with implementation of cost cutting measures. Also, it is required to maintain a balance between the ongoing increment in the operating costs, the efficiency in operational structure while maintaining the quality of the products.

Audit Procedures

The following substantive audit procedures can be followed at Boral and Coles Ltd for the above mentioned inherent risks

  1. Physical inventory valuation: This process is related to the counting of stocks physical by making personal visits at the location sites where the goods are stocked. It is require by the auditor to properly pre-schedule this type of audit processes to avoid inconvenience that can occur in the business activities. The auditing team is also required to instantaneously investigate if any differences have been observed amongst the recorded figures and the physical count made by auditor (Groomer and Murthy 2018).
  2. Reconciling valuation of inventory to the general ledger: The auditing team is required to check the valuation of inventory after completing the physical counting of inventory with the sales books and purchase book (or records) of the company. A basic check includes calculation of the ending inventory by considering the beginning inventory (or ending inventory for previous financial year), the sales records and the purchase records. The formula is:

(Net purchases + Beginning inventory) – Net Sales = Ending inventory

(All figures in numbers or quantities)

It ensures discrepancies in inventory valuation can be identified and proper rectification can be implemented. The discrepancies that can occur due to some human error, machine error or sue to any other reason. For the case of Boral Ltd, the auditing team is required to crosscheck the inventory previously counted with the sales records and purchase records.

  1. The auditors are required to gain an understanding about the nature of the type of every material of commercial income. The effectiveness of relevant controls are required to be checked in the auditing procedures which are related to the measurement and recognition of amounts related to these arrangements
  2. A comparison analysis can be conducted for various arrangements against previous financial year(s). An analysis can also be conducted for ageing profiles and the areas where material variances have been identified upon obtained sustaining evidence.
  3. The audit procedure can include inquiry of the overall Group of companies including business category managers, procurement management and supply chain managers to identify existence of any side arrangements or non-standard agreements.
  4. At Coles, the auditing team created a sample of agreements with supplier and made an assessment about whether appropriate agreements and supporting documentation for measurement and recognition of rebates for Financial Report 2019, included an amount assessment recorded after and before the balance date.

Analytical Review on The Financial Statements

As per ASA 315, identifying and assessing the risks of material misstatement, the inherent risks of the case companies are discussed below:

Coles Ltd: In the planning phase, the following areas of concern or comfort have been identified after reviewing the financial statements of the two companies:

  • AASB 16 Leases: AASB 16 for Leases is applied on the Coles Ltd from July 2019. This is a new accounting standard implemented by AASB and its adoption is extremely complex and difficult due to the requirement to apply its necessities to:
    • The prevailing commitments, which includes embedded lease arrangements;
    • The volume of the leases (operating) that are held by the company; and
    • The projections applied by the managers while determining the ways to apply the main requirements of AASB 16 such as the impact of lease options.
  • Inventory existence: Coles reported inventories of $1,964.7 million for the FY 2019. After analysing the balance sheet (the Consolidated Statement of Financial Position), it was found that inventories are one of the most important balances, which is typical for a company in retail business. Also, the inventory verification procedure of the company seems to be extensive and the company conduct it on a routine basis around the financial year. The stocks are held at various locations all around Australia and stored at multiple distribution centres and stores.
  • Demerger of the Coles Ltd from Wesfarmers Lt and related accounting: During FY 2019 (November 2018), Coles Ltd finished the procedure of demerger from Wesfarmers Lt (aka Wesfarmers). It has resulted in various consequential events that involve complex financial reporting and accounting implications, as follows:
    • Execution of transitional service agreements amongst Coles and Wesfarmers, and a few subsidiaries of Wesfarmers
    • Office works, Target, and Kmart gets deconsolidated and transfer is made to Wesfarmers
    • Coles and its subsidiaries takes exit from the tax consolidated group of Wesfarmers. Now, there will be no income tax liability for Coles related to periods as a part of such tax consolidated group
    • Execution of agreements for new debt facilities

Boral Ltd: In the planning phase, the following areas of concern or comfort have been identified after reviewing the financial statements of the two companies:

  • The complexity of auditing forward looking estimates used to support carrying values that are inherently subjective and require a significant level of judgement to assess;
  • The variation in market demand and synergies for building products and average selling prices across countries that create a risk that business forecasts, which are the basis for the assessment of recoverability, may not be achieved;
  • In addition to the above, the Group recorded an impairment charge of $195.6m against the investment in the Meridian Bricks JV, increasing the sensitivity of the model to small changes in the assumptions.

Audit Procedures

  • Boral Ltd: The audit procedures that could be followed includes
    • assessing the appropriateness of the Group’s determination of CGUs and groups of CGUs used for impairment testing, considering management’s internal reporting and monitoring and the requirements of the accounting standards;
    • assessing the integrity of the value in use models used, including the accuracy of the underlying calculation formulas;
    • comparing the forecast cash flows contained in the value in use models to Board approved forecasts and considering the impact of past performance of the Group versus previous forecasts as an indicator of risk in future forecasts;
    • considering the sensitivity of the models by varying key assumptions, such as forecast growth rates, terminal growth rates and discount rates, within a reasonably possible range, to identify those assumptions at higher risk of bias or inconsistency in application;
    • comparing the economic assumptions such as industry growth rates to external sources;
    • checking the consistency of growth rates with the Group’s strategy and our experience of the economic environment in which the Group operates;
    • assessing management’s terminal value assumptions by considering the impact of alternative assumptions and assessing the impact on the present value calculation;
    • assessing the adequacy of the related disclosures against the requirements of the accounting standards;
  • Coles Ltd: The audit procedures that could be followed includes
    • AASB 16: We assessed the analysis of the expected financial impact of the new standard and the accounting policies, estimates and judgments made in respect of the products and services of the Group. We selected a sample of lease agreements to determine the appropriateness of the judgments applied
    • Physical inventory valuation: This process includes the physical counting of stocks in hand by personally visiting the location of stocked goods. The auditor needs to schedule such audit process in advance in order to avoid any inconvenience that can arise to the daily business activities. The auditor also needs to immediately ask for explanations about any differences observed between physical count and the recorded figures as per the reports presented by the management of the company

Responsibilities/liabilities of The Auditors Against an Inappropriate Audit Opinion

An audit is an inspection of the financial statements and operations of a company by an independent entity. The auditing process is primarily directed to determine the financial health of the company and whether the company is making true and fair disclosures. In the report, there was a discussion where the big fours failed in fulfilling their professional and ethical duties and responsibilities (Chang, 2017). The world’s largest accounting firms have been globally criticized including ASIC due to deterioration in their audit quality, not fulfilling their professional duties and conflict of interest.

The KAMs as per ASA 701 of AUASB committee requires an auditor to include all the relevant and significant information associated with forming an opinion in the auditor’s report. The opinion should be based on the best possible judgment of the auditing team regarding the importance of the audit matter while making a valid decision. The most important purpose of ASA 701 is towards presenting the stakeholders of the company with transparent and fair disclosures so that the stakeholders can make accurate decisions in relation to the company (Auditing and Assurance Standards Board 2019).

When a company acquires another company, then an auditor needs to account various other substantial audit matter mainly related towards valuation of assets and depreciating and amortizing them and check for impairments if required. The auditor also needs to consider the provisions for such audit procedures applied by the acquiring company. Therefore it represents the Key Audit Matter Communications that becomes of the audit report.

Since the capital structure and position statement (balance sheet) of the company witnesses substantial changes and the investor remains one of the main stakeholders which require reports of the material changes in the company so that he can make appropriate decision.

The main disclosure that must be made as per the provisions of ASA 315 which are related towards identification and assessment of material risk while valuing and recognizing the intangible asset (Federal Register of Legislation 2019).

The important disclosures are as follows:

  • The asset’s cost of acquiring
  • Asset’s residual value (or the salvage value) of the asset
  • Method of depreciation and amortization of the asset.
  • Appropriate method of valuation.

Reference for Auditing Theory and Practice

Auditing and Assurance Standards Board. (2019). Pronouncements.

Boral Ltd. 2020. Annual Report (2019).

Brown, N.C., Pott, C. and Wömpener, A., (2014). The effect of internal control and risk management regulation on earnings quality: Evidence from Germany. Journal of Accounting and Public Policy, 33(1), pp.1-31.

Cohen, J., Krishnamoorthy, G. and Wright, A., (2017). Enterprise Risk Management and the Financial Reporting Process: The Experiences of Audit Committee Members, CFO s, and External Auditors. Contemporary Accounting Research, 34(2), pp.1178-1209.

Coles Ltd. (2020). Annual Report 2019.

Federal Register of Legislation. (2019). Details: F2009L04079.

Groomer, S.M. and Murthy, U.S., (2018). Continuous auditing of database applications: An embedded audit module approach. In Continuous Auditing: Theory and Application (pp. 105-124). Emerald Publishing Limited.

Junior, R.M., Best, P.J. and Cotter, J., 2014. Sustainability reporting and assurance: a historical analysis on a world-wide phenomenon. Journal of Business Ethics, 120(1), pp.1-11.

Quadackers, L., Groot, T. and Wright, A., (2014). Auditors’ professional skepticism: Neutrality versus presumptive doubt. Contemporary accounting research, 31(3), pp.639-657.

Stubbs, W. and Higgins, C., (2014). Integrated reporting and internal mechanisms of change. Accounting, Auditing & Accountability Journal, 27(7), pp.1068-1089.

Zhang, J., Yang, X. and Appelbaum, D., (2015). Toward effective Big Data analysis in continuous auditing. Accounting Horizons, 29(2), pp.469-476.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Auditing and Assurance Assignment Help

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