Objective of Auditing and Audit Procedures - Article Example

Auditing 4-61 a. Potential Audit Risk Associated with Observation The following are the potential audit risks associated with physical observation of different equipments and observation during audit examination of manufacturing and distribution sites of the client. 1. The third production line which is considered to have served its useful life needs to be evaluated for its value and recognition in the company’s machinery records. Also it needs to be assessed for safety issues and other problem areas like cost of production and output. 2. Machinery which is idle and placed outside needs to be assessed for its inclusion in fixed assets and depreciation amount charged. 3. Disposal of waste chemicals and there proper storage needs to evaluated for any hazards and risks. 4. At the distribution point there are numerous potential risks including incorrect recording of machinery dispatches, values, stock positions etc. Furthermore, the distribution center is disorganized which may allow theft, damage or continued mismanagement causing problems for the company. 5. Also products which are outdated are not disposed off which may require assessment of their value and existence in company’s books. 6. Products which are on hold in transition phase needs to be store properly to avoid machinery damages and losses. Also records should be assessed to determine their relocation and inclusion in the current stock if they require repairing. 7. The automated receiving of goods can have potential risks in situations where the product received is faulty and is not according to the required specifications and thus requires to be sent back. In this way the production can be delayed or affected in other ways by rejection of products. 8. The issue of receiving input material for client’s major production line could be considered as inadequate and material misstatement could result because there is not recording of material inflow, use, rejection and disposal after the manufacturing process. 9. Warehouse management and accounting is weak where access to warehouse is not limited and the security is feeble which could be breached at any time. The non-existence recording system of ins and outs of the warehouse could result in material misstatement. b. Audit Adjustment for Knowledge of Risk SAS 89 Audit Adjustments requires auditors to inform audit committees regarding issues which they consider are subject to material misstatement and allows auditors to make adjustment to their proceedings if there is knowledge of risk which is material and is likely to affect the outcome of the audit (Ratcliffe). From the observations made at different facilities including manufacturing, distribution, transition and warehousing several issues could be identified which could have material effect on the outcome of the audit. In this situation the auditor must consolidate his / her findings and report to the audit committee to inform them regarding the issues and possible misstatements in the financial records which could impede the outcome of the audit. Furthermore, SAS 89 requires auditors to ensure that only those issues should be raised to the audit committee which are relevant to the terms and coverage of audit agreed upon in the engagement letter at the time of the commencement of audit. This therefore limits auditors’ responsibility to the issues raised during observations. Auditors should also seek acknowledgement letter from the management that material misstatements in records and procedures identified are in their knowledge and require their approval for further investigation (Ratcliffe). Risk assessment procedures should be devised by auditors in order to assure that these risks are fully covered and disclosed in their report. From the above observations the auditors can modify their approach as follows to ensure that the audit is able to give an unqualified opinion: 1. The assessment of the third line machinery requires audit to get external evaluation of the machinery to assess its value and workability. This would therefore require an upward or downward change in the value or even if proven hazardous recommendations would be made to replace machinery. 2. Idle machinery placed out requires auditor to examine the fixed assets register and in particular machinery ledger to ensure that this machinery is included and is disclosed in the company’s financial statement. 3. Procedures for disposing waste chemicals and ensure that risks associated are managed properly by the company and finally their inventory records should be monitored. 4. Internal controls are distribution points are weak which suggests that the auditor may carry out physical examination of stock and trace the movement of inventory and dispatch. 5. Inventory count of outdated stock should be carried out and ensured that they are properly stored and recorded at their disposal value. 6. The machinery in transit should be examined for any damages and evaluated if there is any risk in the process and the value of this machinery in transit should be reported accordingly. 7. The automated receiving of inventory may have to be checked for internal controls in the system. The access to the computerized system has to be evaluated whether system breach is a risk. There are various other audit procedures which the auditor could carry out to examine the entries into the system, report generated, supplier relationship and pricing etc. 8. Weaknesses in the controls over incoming materials can cause serious problems and the auditor can suggest improvement in the procedure to manage purchase properly by examining the company’s requirements, purchase orders, suppliers invoice and documentation from receiving department. All materials and spare parts should be tagged and properly recorded in material sheets. 9. Weakness in the management of warehouse highlights lack of controls which could lead to major problems for the company. The auditor can carry out inspection of different procedures involved in the warehouse management. This would require member of audit committee to work along with the auditor to ensure that new procedures can be devised to improve the management of inventory and prevent accidental losses or thefts. The records of inventory can be checked by physically examining the stock and ensuring that all stock is tagged and maintained. The modification in audit procedures after initial observations does not mean that further alterations are not possible. However, the management and the audit committee of the company needs to be informed and written approvals should be sought in order to ensure that responsibility could established and improvements could be identified and documented. 9-77 a. Confirmation Information The company has extended credit facility through various arrangements. In order to seek confirmation from customers the assistant should acquire the following information from them; 1. A copy of letter of credit to ascertain their liability and to evaluate the terms and conditions for the borrowed amount, interest rate and repayment. 2. Schedule of repayment, copies of payments from the customer to the company and confirmation of outstanding balance. 3. Purchase orders, delivery orders, invoices, receiving of equipment, installation and other documents may be requested for confirmation. 4. If the customer receives maintenance service from the company and payments are made in this respective then confirmation regarding these can also be requested. b. Objective of Auditing and Audit Procedures The objectives of auditing notes receivables include gathering sufficient information in regards to the following management assertions about their presentation and disclosure: 1. Occurrence, rights and obligations: This objective determines the existence of obligations on behalf of the customers and ascertains who is responsible for the repayment of notes. In addition to this it also determines the outstanding balance, income and other terms and conditions from the arrangement (Arens, Elder and Beasley) 2. Completeness: This assertion must be determined by gathering evidence which ensures that the balance of notes payable coincides with the ledger accounts and physical examination of notes document held by the company. 3. Valuation and allocation: The valuation methods used by the company to determine the book value of outstanding notes receivables should be assessed for their accuracy and consistency. Notes receivables can be valued using two different methods that are either at face value or present value of notes receivables. The method of valuation selected should be disclosed in the financial reports and respective discount factor used for determining the face value. 4. Classification and understandability: This ensures that the notes payable are classified according to their terms of obligations and are identified as short term or long term. Also it requires allocation of the current part and non-current part of notes receivables and includes them in the financial statements accordingly. The current element constitutes of interest cost which should go in the income statement. Furthermore, it means that the auditor should ensure that the disclosure in the financial reports is understandable to the users to derive decisions based on it. The objectives of audit are to ascertain the achievability of the above assertions when auditing notes receivables account. These assertions cover different aspects of accounting, reporting and assigning title to the notes receivables. The audit procedures should ensure that all assertions are satisfied in order for financial statements to be reflective of the accurate amounts, interest income and ownership. The assistance should carryout additional audit in lieu of notes receivables by physically examining notes available and receive confirmation from the holders regarding their obligation, outstanding amount, repayments and interest amount. Furthermore, they should be compared with sales ledger and find corresponding sales amount and determine the allowed amount. Furthermore, performing calculations to determine the value of note receivables is required. In addition to these if the company has entered into a finance arrangement with a financial institution then the documentation pertaining to the arrangement should be examined to understand the terms and conditions and in particular the ownership and risks of the notes receivables. The assistant should recalculate the present value of notes receivables and assess whether the cost of capital the company is using appropriate rate for discounting future cash flows. Finally their disclosure in the notes to financial statements should be examined for their accuracy and completeness. c. Differences Explanation The difference in the reported notes receivables and physical examination of notes may be due to the reason that the company has settled $25,000 worth notes receivables and the payment has been received fully for this amount. Also notes receivable is a promise in writing and the difference in the amounts can be due to some other arrangement between the company and the debtor. Furthermore, it can be due to the effect of price changes on assets held during the period. Also it may be due to the increased interest cost charged on the notes receivables which increases the amount due from the debtor (Delaney and Whittington). In addition to these there are other possibilities to the difference between reported notes receivables and physical notes. This could be due to the reason that the company has pledged notes receivables worth $25,000 with a bank seeking short term finance against it. Notes receivables are similar to accounts receivables which are assets of the company and could be acceptable to financial institution for extending short term loan and in returns the title of ownership and mark up transfer to that financial institution. These types of arrangements involve higher mark ups as risk is transferred from the company to the financial institution. However, this should have been reflected in the records which the company maintains for its notes receivables. This could be confirmed from the bank with which the company maintains its accounts and if there are any discrepancies in that arrangement they should be presented in the audit report for written explanation by the audit committee. Furthermore, the company could have given the notes receivables to some collecting agency which could be a bank to collect the outstanding amount. In this arrangement the title of notes receivable is transferred to the collecting agency which on behalf of the company collects the outstanding amount from problematic debtor and the company itself has not established debtor collection department. Finally, it may be possible that notes receivables worth $25,000 are settled by the debtor but the settlement is not recorded in the books as yet which could lead to a difference between the book value and the physical count of notes receivables. Works Cited 1155 Arens, Alvin A., Randal J. Elder and Mark S. Beasley. Auditing. New York: Prentice Hall Business Publishing, 2008. Delaney, Patrick R. and O. Ray Whittington. Wiley CPA Exam Review 2009: Financial Accounting and Reporting. New York: Jon Wiley Publishing, 2009. Ratcliffe, Thomas A. Understanding SAS No. 89, audit adjustment. 1 April 2000. 12 September 2009 . Read More