Auditors' Risks and Errors - Assignment Example

………………………………………………………………………….xxxxxx …………………………………………………………………….xxxxxx …………………………………………………………………………xxxxx ………………………………………………………………………..xxxxx @2013 Introduction Auditors work is to verify documents, examine them and do tests of details. In the process, it is their duty to detect fraud or error. However, the auditor can fail to detect any errors or fraud due to Audit risk. Audit risk is the risk which occurs when an auditor expresses inappropriate audit opinion due to material misstatements (Kumar and Sharma 2006). This report will discuss several audit problems which can impact the materiality of financial statements. Wentworth Brewster limited specializes with the manufacture of sports equipment. All the products are sold to specialist retailers and private member gym clubs. The company owns a large number of freehold premises than it generally requires. The surplus office is usually sub-let to three other businesses. All sales are on a credit basis and customers are authorized and credit checked by the credit controller before an account is being set up. Detailed records on stocks are also maintained. The audit risk areas for Wentworth relate to debtors, stocks, claims on damages and rent income. Debtors have been circularized and no evaluation on replies and follow ups on non-replies had been done. There was also a dispute from a particular debtor with regard to account balance. There were also slow-moving stocks whose valuation was questionable. Rental income had not been audited since it was argued that its amount was less than that of sales income. Finally, there were no provisions made for claims or contingency. The audit duration will be a period of one month and the audit team will from time to time visit the site to obtain information. Communication shall also be done via emails when necessary. Debtors The main purpose of circularizing debtors is to obtain evidence regarding the ownership, existence and value of debtors in the financial statement. Debtors are third parties and thus are considered to be an external source of information. Obtaining evidence from different sources or types especially from third parties increases the level of assurance (Kumar and Sharma 2006). Circularization is done by writing to debtors directly requesting them to confirm their account balances. Debtors’ circularization can either be positive or negative. In positive circularization, the debtors are required to respond whether they agree or disagree to the contents of the circular. In negative circularization, the debtor is required to respond whether they disagree with the contents of the circular. The major drawback of negative circularization is that in case the debtors fails to reply to the contents of the circular, the auditor assumes that he is in agreement with the contents of the circular. The auditor of Wentworth Brewster limited sent circulars to a sample of 30 debtors to confirm year end balances. There were replies and non-replies to the circular. Second request was done to non-replies where some debtors replied but five did not reply. One of the debtors who failed to reply had a zero balance while three of these debtors had balances ranging between ?5,000 and ?20,000. There were no follow ups done on these accounts. The fifth customer was a major customer, Multi-gym ltd and had a yearend balance of ?145,000. The audit senior had discussions with the credit controller of Wentworth with regard to this account as part of the follow up process. According to the credit controller, Multi-gym limited had disputes on a number of invoices worth ?95,000. The amount related to a model of rowing machines bought from Wentworth and Multi-gym disputed that the machines were inefficient as they kept on jamming every time. Upon the receipt of replies, the auditor is supposed to evaluate the replies to confirm whether the amounts acknowledged in the replies reconcile with the amounts appearing in the client’s ledger. In case of Wentworth Brewster limited, the auditor did not evaluate the replies. Any differences occurring are supposed to be investigated thoroughly. For non-replies, reminders are supposes to be sent of which the auditor did so but still there were non-replies. For non-replies an auditor is supposed to perform follow ups and alternative tests (Kumar and Sharma 2006). The auditor did not do so for the four debtors. The only follow up done was for the fifth debtor who had disputes with the company. The auditor is bound to carry out further audit tests. Previously, the auditor had ascertained that the internal controls are strong, thus the auditor will only carry out analytical review procedures on the debtors. Additional tests include: Agreeing cash received to the account balance Agreeing the details of the account balance to the debtors remittance advice Preparation of a more detailed analysis of the balance and ensuring that it consists of identifiable transactions. The occurrence of these transactions should also be confirmed. Preparing a final summary of the circularization results and drawing a conclusion. In the case of the fifth debtor who had a dispute, the auditor should obtain an analysis of the provision for bad and doubtful debts and scrutinize whether the disputed debt had been included in the provisions (Kumar and Sharma 2006). If not included in the provisions, the auditor should discuss with the management for their reasons. Stocks During audit stocks worth ?0.5 million out of ?1.6 million had been included in stocks of the prior year end. According to the auditor the stock are still in good condition and will continue to be recognized at full cost. The problem with these stocks worth ?0.5 million is their valuation and that they are slow moving goods. In case of slow moving goods, the auditor should investigate further by requesting a list of slow-moving stocks from the management and ascertain whether they have been adequately provided for. If the stocks worth ?0.5 million are not in the listing of slow-moving inventories, the auditor should hold a discussion with the management and evaluate the reasonableness of the assessment by management. The International Financial Reporting Standards (IFRS 2) requires stocks to be stated at the lower of cost and net realizable value (Gupta 2004). The audit senior confirmed that the stocks worth ?0.5 million continue to be recognized at full cost. The audit manager should not rely on the assumption of his audit senior and should go ahead and carry out further audit on their net realizable value. In performing the net realizable value audit, the auditor should inspect sales invoices subsequent to year end since this reflects the realizable value as at that date. In case there are no subsequent sales, sales completed close to the yearend can alternative be used. Upon investigation, if the net realizable value is lower than the cost, then the auditor should consider the net realizable value. Rent The problem with rental income is that there were no tests done since its amounts were smaller than that of sales income. Rental income might appear to be small but it might have significant amounts that might lead to material misstatements. Usually, an interim audit is designed to expedite completion of final audit. However, the results of an interim audit cannot be relied on since after the interim, uncertainties that can lead to misstatement of rent income can take place. Therefore, the audit manager should exercise professional judgment and carry out further audit work on rent income. The substantive tests aim at gathering information about the financial statement assertions which include: existence, occurrence, valuation, rights and obligations completeness, presentation and disclosure (Gupta 2004). The substantive tests help in finding any errors and misstatements that might have occurred during documentation or that are within the accounts. Claim for damages The main problem here is that Wentworth has been receiving similar claims from retail customers with regard to injuries customers have experienced. However, there is no provision or contingency made by the management of Wentworth with regard to the claims. A contingent liability is an obligation dependent on the non-occurrence or occurrence of one or more future events (Gupta 2004). The auditor should exercise due diligence regarding subsequent events using the guidance of ISA 560. ISA 560 requires that a provision be made in the financial statements for a contingent liability. Therefore, the audit manager should provide this in the financial statements. Where a contingent liability occurs through litigation and claims, the auditor uses guidance provided in ISA 502. This is the case of Wentworth. The standard requires the auditor to obtain external confirmation from attorneys regarding the claims and litigations. Therefore, further audit procedure involves asking the client to send a legal letter to an independent attorney to get information about pending litigations and a list of claims that the management feels may have a negative outcome. Conclusion The auditor uses professional judgment in assessing the audit problem areas since it is not easy to detect an error or fraud. Having discussed the major audit areas of Wentworth Limited, further audit procedures were suggested. If the further audit procedures prove to be a success, the financial statements will be free of any material misstatements. Therefore, the auditor will not qualify the audit report. A qualified report suggests that the company being audited has not adhered to the Generally Accepted Accounting Principles (GAAP) or the information provided was limited by scope (Kumar and Sharma 2006). A qualified report is thus not a good thing. Reference Gupta, K, 2004. Contemporary Auditing.Tata McGraw. Kumar, Ravinder and Sharma, Virender, 2006. Auditing: Principles and Practice. PHI Learning Limited. Read More