Audit Risks Facing Havelock Europa PLC - Essay Example

Audit Risks Facing Havelock Europa PLC Introduction Havelock Europa Plc is a UK based company that provides interior design services to its clients who include major banks, construction companies, school authorities and retailers. After going through their financial statements for the year ended 31st December 2013, several areas of heightened audit risk are observed. Audit risk refers to that risk that auditors are not likely to observe due to some error or fraud (Lewin 2010, p. 218). The auditors are likely to issue an unqualified opinion although some inherent risks exist but cannot be easily identified. The following are the five main areas of high audit risk that face Havelock Europa Plc. Payroll The Company is said to provide equal opportunities to all employees for growth, training and career development regardless of age, sex, ethnic background or religion. They also consider the disadvantaged in the society and give them opportunities where they fit. In case an employee is disabled on course of duty, the company makes reasonable adjustments to accommodate such a member of staff. However, this information cannot be proved. According to the financial statements issued, it is hard to establish whether employees are remunerated fairly. Consolidated accounts make it difficult to establish whether employees from various subsidiaries are compensated fairly. The total number of employees for both 2012 and 2011 are given as 649 and 731 respectively, but the exact month when the new employees joined is hard to establish (Havelock Europa Plc 2012, P. 63). It is not sensible to assume all the new employees joined at the beginning of the year. Wages and salaries for the whole year are given, but auditors will be unable to determine the numbers of hours worked overtime that is usually not fixed. There is also likelihood that some of the employees being compensated exist only in books, the auditors may be unable to meet all employees especially those who do not work in the parent company (Porter et al 2008, p. 90). Non-current Assets and Inventories The financial statements presented show the values of noncurrent assets and inventory for both years (2011 and 2012). Non- current assets are reported on their deemed cost because any other value can only be an estimation (Havelock Europa Plc 2012, p. 82). The cost of the asset is then adjusted for depreciation every year using a specified formula. The risk arises in that the formula is only estimation and the auditor cannot be certain about those values. The notes to the financial statements also reveal the expected lives of both the tangible and intangible assets (Havelock Europa Plc 2012, p.90). This lives can easily change and cannot be relied upon, for instance, a change in technology may reduce the expected life of office computers significantly. Other non-tangible assets such as motor vehicles can suffer damages changing their useful lives completely. The notes also reveal that land is not depreciated meaning it is reported at its original cost. The risk associated with this is that the land is likely to appreciate and thus the value reported may not be the best reflection of its value. To report inventory, the company uses the lower of either its original cost including the conversion cost or the realizable value after selling the inventory. The market can affect the selling price of inventory easily depending on the forces of demand and supply. Sales Revenue From the consolidated income statement, it can be observed that revenues for the year 2012 have increased significantly compared to the one reported for the year ended 2011. The revenue increased from £96,925,000 to £92,462,000 (Havelock Europa Plc 2012, p.71). However, the auditors may be unable to determine precisely whether the total revenue reported related to the year 2012. The list sold may have been purchased in the previous year which means the matching principle applied in accounting have not been adhered to. According to the notes published together with the financial statements, revenues are recognized when earned and not necessary when cash is received (Rawindara & Sharma 2011, p. 500). Some of the amounts reported as revenue may not yet be received, if the customers fail to pay, the accounts receivables will be written off. Customers may also discover that the list they purchased was of low quality or even obsolete and decide to return them back to the business. If such a situation happened, it will mean the amount of revenue reported was not a true reflection of revenue collected. The auditors are likely to identify the various sources of revenue but proving the revenue has been earned is hard especially at the time of reporting. Principle Risks and Uncertainties The Company entered into loan covenants with the lenders relating to earnings before interest and tax, cash performance and audit cover (Havelock Europa Plc 2012, p. 34). Failure to meet these requirements, the lenders, will demand immediate repayment of all amounts owed. Although the forecasts show the business is in a position to meet this covenants, there are many external factors that can lead to losses making it impossible to meet the covenants (Rittenberg et al 2012, p.380). Periodic monitoring is not an assurance of detecting the loss on time. There are some significant losses that occur when least expected. The business has a seasonal element with a peak in the middle and second half of the year. There is a likelihood of the company being unable to meet the excess demand during peaks. Although the management deals with this by doing planning, the actual demand may exceed the planned. Customers are also employing procurement strategies that will help them purchase at the lowest possible cost (Havelock Europa Plc 2012, p.39). The company is also forced to procure inventory at lowest possible cost to meet the needs of their customers. The risk of taking this measure is that the company may end up procuring inventory of low quality compromising their ability to satisfy customer’s needs. Health and Safety The directors of the company recognize the importance of keeping employees and other stakeholders free from danger. The company has ensured this by training employees, appropriate instruction, refresher training and guidance to maintain and improve the competence level of employees (Havelock Europa Plc 2012, p.44). The statements published reveal otherwise because the number of accidents suffered in 2012 by employees in the course of their duty exceeds those reported in the year 2011. The indication is that either supervision or training of employees is not thorough. The auditors may not be able to note this because there may be accidents that occurred and never reported especially in the subsidiary company. There are also minor accidents that happen on the course of duty but because no one suffers an injury, they are ignored. If the trend continuous, the number of accidents reported in the year 2013 may be higher that affect the business negatively. One of the significant negative consequences of failing to take health and safety measures are higher turnover of employees. References List Havelock Europa PLC (2012). Havelock Europa Plc Annual Report 2012. Havelock Europa PLC, London Lewin, A. (2010). A Student’s guide to auditing. New York, Kaplan Publishing Foulks Lynch. Pp 217-245 Porter, B., Hatherly, D. & Simon, J. (2008). Principles of external auditing. Chichester, England Hoboken, NJ: John Wiley. Pp 89-104 Rawindara, K. & Sharma, V. (2011). Auditing: principles and practice. New Delhi, PHI Learning Privated Limited. Pp 453- 516 Rittenberg, L., Johnstone, K. & Gramling, A. (2012). Auditing : a business risk approach. Melbourne, Vic, South-Western Cengage Learning. pp 379-384 Appendices Property, plant and equipment Property, plant and equipment is stated at cost or deemed cost less accumulated depreciation and net of any accumulated impairment losses. Certain items of property, plant and equipment that had been revalued under UKGAAP on or prior to 1 January 2004, the date of transition to Adopted IFRS, are measured on the basis of deemed cost, regarded as being the fair value at the date of transition. Land is not depreciated. For all other property, plant and equipment, depreciation is calculated on a straight-line basis to allocate cost less residual values of the assets over their estimated useful lives on the following bases: – Freehold and long leasehold buildings 50 years – Plant and equipment 3 - 10 years – Fixtures and fittings 10 years – Motor vehicles 4 years Assets held under finance leases/HP contracts are capitalised and depreciated over their expected useful lives on the same basis as owned assets or, where shorter, over the term of the relevant lease. Other intangible assets Other intangible assets acquired by the Group are stated at cost less accumulated amortisation and net of any accumulated impairment losses. The cost of intangible assets acquired in a business combination is the fair value at acquisition date. The cost of separately acquired intangible assets, including computer software, comprises the purchase cost and any directly attributable costs of preparing the asset for use. Amortisation of other intangible assets is charged to the consolidated income statement on a straight-line basis when the asset is available for use so as to allocate the carrying amounts of the intangible assets over their estimated useful lives as follows: – Computer software 3 - 5 years – Brands 10 years – Customer relationships 4 years – Contracted customer relationships 4 years – Order backlogs 0.5 years – Non-compete clauses 2.5 years – Design rights 10 years Read More