HI6026 Auditing Fundamentals Assignment Sample

Audit, Assurance and Compliance

1. Dear Nayan,

It was very great meeting you after so long time. We discussed the basics of auditing profession and you had your obvious concerns and questions about auditing. Since, you are not from this profession, so these concerns are really obvious. The most important point I would like to let you know is that it is never possible for an auditor to provide absolute assurance as to books of accounts and financial statements of the auditee. Auditing is defined as “independent examination of financial statements of an entity and such examination is conducted with a view to express an opinion thereon” (Basu, 2010). An auditor provides only an opinion or reasonable assurance on the books of accounts of the auditee, but an auditor is never in a position to provide absolute assurance.

An audit implies only reasonable assurance as to financial statements not being materially misstated, not absolute assurance (Kramer, 2009).

Normally, reasonable assurance is a substantial level of assurance relating as to financial statements being free of material misstatements, but it can never be absolute assurance. The reasonable assurance does not mean that there is not even remote possibility that material misstatements in the books of accounts will not be prevented or detected on timely basis

Reasonable assurance is determined based on factors specific to the engagement.

There are some inherent risks in the audit process such as use of judgement in establishing estimates, degree of uncertainty and complexity of transactions, use of sampling techniques in conducting audit procedures and practical limitations to obtain sufficient audit evidence. That’s why auditor is not able to provide complete assurance

The concept of ‘professional scepticism’ is also very important in auditing. I would like to discuss about this as well as you were concerned with the possibility of company managers misrepresenting the facts or hiding the facts from the auditor to save themselves.

‘Professional scepticism’ is useful at all the stages of the audit. Auditor should pay attention and be proactive to the possibility of existence of contradictory audit evidence and being able to assess assumptions and judgements critically and transparently and always be ready to challenge the management if necessary (BPP Learning Media, 2017) Professional scepticism is the foundation of audit profession which every auditor needs to maintain.

However, the fact that auditor should use professional scepticism does not mean that auditors should assume that managers are always trying to mislead the auditors. Hence professional scepticism is not the same as assuming that managers are always trying to deceive auditors

Hope above clarifies your concerns

Regards

2. a) The following may be the ethical problems in this case

• Auditor’s independence may be impaired in case of significant amount of unpaid fee from the client as unpaid fee may be equivalent to debt due from the client which leads to possibility of impairment issues for the independence of the auditor.

• Since the other partner, Ball is about to sign the Audit report despite the fact only 10% of overdue fee has been paid there may be a secret arrangement of Ball with the client wherein Ball has agreed to the clean audit report in return of some financial gains. It is just a possibility not conclusion.

b) The following may be done to address above issues

• Ross and Associates should insist the client for payment of overdue audit fee before issuance of the audit report for the current year

• Still, if fee remains unpaid even after issuance of audit report, Ross and Associates may consider hiring a professional auditor who was not involved the audit engagement to provide suggestion or review the audit procedures performed.

(a) Materiality is a Convention in auditing and accounting. This concept is used in relation to importance and significance of an amount, transaction or discrepancy. Determination of materiality depends on professional judgement of an auditor. An information is considered material if omitting it or misstating it impacts decisions of users taken based on the financial statements.

The material misstatements may be both qualitative and quantitative.

 Quantitative factors: The following are the examples of quantitative misstatements which may be material:

• 5% to 10% of sales revenue
• 2% of total assets
• 2% of Gross Profit
• 5% of net profit
• 5% of shareholders’ equity

Qualitative factors: The following are the examples of quantitative misstatements which may be material

• A small illegal payment may be material as it may have adverse consequences to the client
• Potential effect of misstatement on company’s policy
• Misstatements involving breach of regulations, laws as it may lead to penalties for an organisation

(b) At the time of planning for the audit, auditor considers the factors due to which financials become materially misstated. The auditor’s initial evaluation of materiality related to balances of certain accounts and certain transactions, facilitates to determine audit procedures that can help control audit risk by decreasing it to an acceptably low level. There is an inverse relationship between materiality and audit risk. Higher the risk, lower the materiality level and vice versa. This relationship between materiality and level of audit risk is used by the auditor in determining the nature, timing and extent of the audit procedures.The thresholds of quantity are used for determining the materiality of the item or aggregate of items.

The information provided in the question impact the auditor’s assessment of preliminary materiality in the following ways.

• With effect from January of the current year, firm is consistently defaulting in supplier’s payments and delaying payments to suppliers even in the excess of suppliers’ normal credit terms. Hence, there is high possibility of some supplier accounts being misstated. Hence, auditor must change the assessment relating to preliminary materiality level pertaining to suppliers’ ledger.
• Cash flow problems in the last two years may lead to potential risk for the company to operate as going concern. Hence, auditor needs to consider this for making assessment of preliminary materiality.

4

• The going concern assumption is of paramount importance at the time of preparation of the financial statements. This assumption assumes that entity will continue operating for foreseeable future and hence the financial statements are prepared assuming that the entity will be able to convert its assets into cash and pay off its liabilities in the normal course of business.

In case there is potential risk to going concern assumption, the entity may not be able to realise its assets or pay off its liabilities and would be experiencing significant problems in its cash flows

The following are auditor’s responsibilities for going concern assumption

• Auditor must assess the risk to going concern at the stage of planning the audit itself. This assessment may be carried out with the help of analytical procedures
• Obtain sufficient appropriate audit evidence supporting that going concern assumption used by the management is appropriate while preparing financial statements.
• To assess whether there is a material uncertainty about the ability of the company to continue as a going concern. This responsibility exists even if the management has not made any specific assessment regarding this.
• To include appropriate disclosures in the audit report when there is significant potential risk as to client’s ability to continue as going concern.

• There are several examples of events or conditions that individually cast significant doubt about the going concern assumption such as

• The position related to net liabilities or net current liabilities
• Withdrawal of financial support by lenders
• Negative operating cash flows
• Adverse financial ratios
• Significant dilution in the value of assets
• Inability to pay creditors/suppliers on due dates and as per credit terms
• Non-Compliance with the loan agreements.
• Suppliers insisting on cash on delivery transactions instead of credit transactions
• Shortages of critical supplies
• Intentions of the management to liquidate the entity

The following events or conditions may cast significant doubt client’s ability to continue as going concern

• Significant cash flow problems since 2016
• Inability to pay suppliers on due dates
• Suppliers changing payment terms from credit to cash on delivery

5.

Audit procedures that should have brought the above items to the auditor’s attention:

1. Cut off procedures
2. Ascertaining the status of litigations, claims etc against the company from the legal department or legal advisors
3. Inquiry with the management for significant events affecting the company after the reporting date
4. Inquiry with the management for significant events affecting the company after the reporting date

6.

References for Auditing Fundamentals

Basu, 2010. Fundamentals of Auditing. Noida: Pearson Education.

BPP Learning Media, 2017. ACCA P7 Advanced Audit and Assurance(UK). s.l.:BPP Learning Media.

Kramer, 2009. Financial Statements Demystified. Noida: McGraw Hill Education India Pvt. Ltd..

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