Fraud And Errors of the Companys Financial Statement - Case Study Example

Audit Risk - Fraud and Errors of the Company’s Financial Statement Audit risk is the risk that the auditor expresses an inappropriate opinion because of intentional miscalculations like fraud and errors of the company’s financial statement. Identifying and assessing this risk is crucial in the audit process (Rittenberg, 2012, pp. 139). Three components help in evaluating the financial statement, including the inherent risk, control risk, and detection risk. The inherent risk looks at environmental factors such as the company’s background and considers if this would result in material error. The control risk looks at the ability of the internal controls to detect and prevent material error. Finally, the detection risk which analyses the risk that auditors’ procedures would fail to detect material error (Hall, 2013, pp. 691). Areas of Heightened Audit Risk Accsys Technology PLC is a chemical technology group quoted on the Alternative Investment Market (AIM) on the UK stock exchange. It develops and commercialises a range of transformational technologies that are based on the acetylating of wooden elements, such as particles, wood chips and fibres, and solid use for us as a leading, environmental sustainable, construction materials. Analysis of the company’s most recent financial statements indicates some anomalies that need further investigations. These areas include revenue, gross profits, and remuneration whose balances show a large positive difference in 2014 as compared to 2013. Revenue Material misstatements in the financial statements are often as a result of an overstatement or understatement of revenues. It is crucial for auditors to presume that there are risks in revenue recognition. From the quantitative analysis (Appendix 1) it is clear that the company’s total revenue had materially increased by 78% in 2014 as compared to that reported in the year 2013. According to the financial director, the increase had been attributed to a 61% increase in Acoya revenue because of an increase in sales to Medite. This increase of sales to Medite is because the company had finished its built up stock which it was still utilizing earlier. There was also an increase in license income from Solvary and other revenues such as the sale of acetic acid. According to the financial statements the increase in total revenue was as a result of an increase in revenues in the UK and Ireland by 183.70% (appendix 2). This was further explained by an increase in revenue generated from one customer who represented 43% of this revenue and exceeded 10% of the group’s revenue. This area creates an audit risk because in 2013 the revenue generated from a customer did not exceed 10% of the Group’s revenue. Further investigations need to be performed on revenue from the single customer to determine the reason behind its drastic increase. This is by looking at all documentation related to this customer and the journal entries that are related to sales to this customer. The process will determine if revenues have increased because overstated either by recording fictitious revenues or through premature revenue recognition. Gross Profits The company’s gross profit had increased by 131.80% in 2014 as compared to the amount recorded in 2013 (Appendix 1). According to the management, this is as a result of an increase in sales of Accoya, price increases, increase in license income, and improved operating income. However, this area is of increased audit risk because the amount of price increase that would verify its effect on revenue is not clear. The growth in the gross profit was also attributed to the increase in sales of Accoya. Increase in sales of Accoya is mainly because of a drastic increase in its sales in the UK. This is accredited to an increase in awareness and acceptance of the product, and because of a technical sales method that the company has been using over some years. However, the company has reported that it has no new distributors in the area and 43% of the sale has been to one customer. This shows the need to check the management assertion that there is increased product acceptance and yet there are no new distributors. Remuneration The company has come up with a new Long Term Incentive Plan (LTIP) based on employees motivational and retention concerns and the share option plan. The company is required to pay according to the UK regime for reporting executive pay because the company is quoted on Aim and is also cross-listed on NYSE Euronext. According to the financial reports, the company is committed to pay appropriately and avoid excessive levels that are not a reflection of the market. The long term incentive awards are not granted annually and have no formal way of determining the bonus levels (Accsys Technologies, 2014, pp. 28). This presents a challenge when determining the basis of the increase in the bonus for Paul Clegg, Hans Pauli, and William Rudge (Appendix 3) in 2014. According to the company’s policy, there is also no performance measure in determining benefits. Audit Procedure on Gross Profit According to ISA 315, external auditors have the responsibility to identify and assess the risk of material misstatement by understanding the company and its environment (Gray, 2007, pp. 213). The responsibility of auditors goes further from this general concept and demands for them to design and implement responses that would address any identified risk in the financial statement. This requires a substantive procedure on transactions and account balances to get sufficient audit evidence and reduce the audit risk to an acceptable low level. This process includes performing substantive tests that would help in determining misstatements and errors in the financial statement (Rittenberg, 2011, pp. 280). From the analysis of Accsys Technology PLC, there is a high audit risk in the gross profits. Considering the big increase in the gross profit by 131.80% in 2014 as compared to what was reported in 2013, there is a high likelihood that there was a material misstatement. To be able to reduce the risk, a number of substantive audit procedures need to be carried out. These include reading the trial balance and the journal entry, disclosures, analytical procedure, evaluating management assertions, and tests of balances. Reading the trial balance and the journal entry The first step is performing substantive procedures for all assertions related to this account. This is by looking at the material class transaction related to the increase in the sales made to the single customer, which attributed 43% of the revenue reported in the UK. This will involve looking at the trial balance done by the company’s accountant to confirm the amounts recorded in the income statement. Initial documentation and journal entries related to the customer will also need to be examined for accuracy of information provided. Evidence obtained from this procedure will help in assessing level of error and material misstatement. Disclosures Disclosures also need to be done on the price increase of products to determine its effect on the increase in the gross profits. It is not enough to trust the management’s claim that an increase in price resulted in the increase in revenue. Therefore, it is crucial to obtain evidence that will support this claim. It is crucial to also determine the terms of the sale to the individual customers to make sure that there is no channel stuffing. This is a situation where the company entices its customers to purchase more products than they need (Rich, 2012, pp. 216). This is usually done by companies at the end of the year to inflate their revenues. The customer can then return the extra product at the beginning of the next year and be fully refunded. Many customers accept to participate in channel stuffing so that they can get favourable purchasing terms in the future (Weygandt, 2010, pp. 683). Analytical Procedures When performing substantive procedures, it is crucial to go beyond performing the analytical procedures that involved examining analytical changes in subsequent periods (Basu, 2009, pp. 3.34). This process involves confirming the amount of revenue recorded by the company with the customer. This procedure is corroborative in nature because it will help to verify the percentage sale to the customer and the assertion made by management that the increase in sales is because of awareness, acceptance of the product, and a technical sales method that the company has been using over some years. This procedure will also involve tracing and performing tests on sales, cash receipts, and sales returns. Evaluating Management Assertions Test of balances resulting in the increase in the gross profit is crucial in determining the completeness assertion. This is difficult but necessary considering the drastic increase in sales reported. The process includes examining all contracts related to all revenues and expenses to be sure that all transactions that should be recorded have been recorded. It also includes confirming that all transactions recorded have occurred and that they have been recorded in the correct accounting period (Preinitz, 2010, pp. 20.17). Finally, this procedure involved confirming that all the transactions recorded as revenues and expenses are in their proper accounts and that an item has not been erroneously been recorded as revenue (Bragg, 2012, pp. 882). Tests of Balances Analytical procedure is also necessary in determining the accuracy of amounts recorded as revenues and expenses for 2014. This will also involve testing supporting documents for transaction to confirm entries. Inquiries from the company’s personnel may also be necessary to confirm balances. This process also involves looking at revenue recognition to make sure that the revenue expenditure has not been recorded as capital expenditure. This is crucial because the company can make the error to reduce expenses for the year so as to increase the gross profit. Conclusion Analyzing the audit risk is crucial before undertaking an audit procedure to enable auditors discover misstatements and errors (Loughran, 2010, pp. 67). Analysis of Accsys Technology PLC has high audit risk in its revenues, gross profit, and remuneration transactions. To reduce the audit risk, it is crucial to undertake substantive audit procedures that include testing balances, evaluating management assertions, requesting for disclosures, reading the journals and trial balance, and performing analytical procedures. Bibliography Accsys Technologies, 2014. Accsys Technologies PLC Annual Report and Financial Statements 2014. [Online] Available at: file:///C:/Users/D620%20Dell/Downloads/1224028_accsys_march-2014-annual-report-and-accounts.pdf [Accessed 05 03 2015]. Pp. 28. Basu, S. K. (2009). Fundamentals of auditing. Delhi, Pearson. Pp. 3.34 Bragg, S. M. (2012). Practitioner's guide to GAAS 2012: covering all SASs, SSAEs, SSARSs, and interpretations. Hoboken, John Wiley & Sons. Pp. 882. Gray, I. (2007). The audit process: Principles, practice and cases. London: Thomson Learning. Pp. 213. Hall, J. A. (2013). Accounting information systems. Mason, OH, South-Western Cengage Learning. Pp. 691. Loughran, M. (2010). Auditing For Dummies. Hoboken, John Wiley & Sons. Pp. 67. Preinitz, W., & Niedermaier, M. (2010). Intermediate Structured Finance Modeling: Leveraging Excel, VBA, Access, and Powerpoint. Hoboken: John Wiley & Sons. Pp. 20.17. Rich, J. S. (2012). Cornerstones of financial & managerial accounting. Mason, OH: South-Western/Cengage Learning. Pp. 216. Rittenberg, L. E., Johnstone, K. M., & Gramling, A. A. (2011). Auditing. Mason, Ohio, South-Western. Pp. 280. Rittenberg, L. E., Johnstone, K. M., & Gramling, A. A. 2012. Auditing: a business risk approach. [Melbourne, Vic.], South-Western Cengage Learning. Pp. 139. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2010). Financial accounting: IFRS. Hoboken, N.J: Wiley. Pp. 683. Appendices Appendix 1 Quantitative analysis 2014 2013 Percentage change Accoya wood revenue 29,293 16,555 76.90% Licence Revenue 1,134 553 105.10% Other revenue 3,085 1,714 80.00% Total Revenue 33,512 18,822 78.00% Total Cost of Sales (25,753) (15,474) 66.40% Gross profit 7,759 3,348 131.80% Appendix 2 Revenue by Geographic Area of Customers 2014 2013 Percentage change UK and Ireland 11,300 3,983 183.70% Benelux 8,822 6,842 28.90% Rest of Europe 7,501 4,611 62.70% Americans 3,376 1,585 113.00% Asia-Pacific 1,901 1,292 47.10% Rest of world 612 509 20.20% 33,512 18,822 Appendix 3 Directors’ Cash Bonus 2014 2013 Percentage change Paul Clegg 56 51 9.80% Hans Pauli 31 4 675.00% William Rudge 19 0 Gordon Campell 0 0 Patrick Shanley 0 0 Montague John ‘Nick’ Meyer 0 0 Read More