Preparation of Financial Statements in Compliance with Company Law - Assignment Example

Auditing Task Introduction The preparation of financial ments is in compliance with the requirements of company law. Different bodies provide the guidelines for preparing the financial statements. The reason for the framework for the preparation of financial statements is the difference in laws prevailing in different countries. In a bid to ensure conformity and uniformity, bodies such as the International Financial and Reporting Standards prepared rules and regulations that should be followed when preparing the financial statements (Foster & Greenawalt 1995, pp. 1-5). Precisely, the primary purpose of the accounting framework is to ensure that the users of financial information are provided with user-friendly information. This assignment seeks to present the concept of the audit, audit risk, and substantive audit procedures based on the case of Applied Graphene Materials PLC. Based on the company’s financial statements, first, three areas of heightened audit risk will be identified, and a quantitative analysis provided. Second, in relation to one of the identified areas in the first part, five substantive audit tests will be identified together their significance (Foster & Greenawalt 1995, pp. 1-5). Part A The company analysis can take two approaches. That is the providers of funds and the controllers of the funds. Funds are provided by stakeholders such as shareholders, creditors, and other entities. The categories of stakeholders that are responsible for the management of funds are directors and managers. From the statement, the providers of funds are different from funds managers. Therefore, fund providers require a report on how funds are being managed over a period, usually one year. However, the information contained in the financial statement may lack credibility for the following reasons: the information may contain errors; it may not disclose any fraudulent act; the information may be inadvertently or deliberately misleading; and the information may not disclose all the material information. It is a daunting task to prepare financial reports, especially for large companies with several subsidiaries that adopt different accounting practices. The process of consolidating the financial information of large companies such as Applied Graphene Materials PLC creates a breeding ground for multiple errors, fraud, and omissions. It is, therefore, the responsibility of the auditor to verify whether the company’s financial statements are free of error, fraud or material misstatement. That is, whether the information presents a true and fair financial position of the company. Therefore, an audit risk is the possibility that errors, fraud or material misstatement in the financial statement will go unnoticed during the period of the financial statement review. Based on the company’s financial statement, the basis of preparing the financial statement is the historical cost accounting convention, the framework provided by the European Union-adopted International Financial Reporting Standards, the IFRIC, and the Company Act 2006. However, regarding financial assets, liabilities and share-based compensation, the fair value method is applied. The application of crucial accounting approximations is a necessity regarding the preparation of financial information in compliance with the IFRS. The company’s management is also required to exercise professional judgment in the process of applying the accounting policies. Based on the financial statement, it is the responsibility of the company’s directors to ensure that the preparation of the financial statements conforms to the relevant regulations. Applied Graphene Materials PLC was audited by KPMG LLP (Annual Report: Applied Graphene Materials PLC 2014, pp. 30-32). The auditors confirmed the financial reporting framework adopted by the company (the applicable law and the European Union- adopted International Financial Reporting Standards). The auditors mentioned that the basis of preparing the parent company’s financial statement was the Company Act 2006. In their report, the auditors stated the following: first “the financial statement gives a true and fair view of the state of the Group’s and of the Parent Company’s affairs as at 31 July 2014 and of the Group’s loss for the year the ended” (Annual Report: Applied Graphene Materials PLC 2014, pp. 30)Second, “the Group financial statements have been properly prepared in accordance with IFRSs as adopted by the EU” (Annual Report: Applied Graphene Materials PLC 2014, pp. 30)Third, “the parent Company financial statements have been properly prepared in accordance with IFRSs as adopted by the EU and as applied in accordance with the provisions of the Companies Act 2006” (Annual Report: Applied Graphene Materials PLC 2014, pp. 30). Last, “the financial statements have been prepared in accordance with the requirements of the Companies Act 2006” (Annual Report: Applied Graphene Materials PLC 2014, pp. 30). The auditors report shows that the content of the financial statement of Applied Graphene Material PLC is accurate and valid. Based on the auditors’ opinions above, it is clear that the company’s financial statement is free of any material misstatement, thus present a true and fair financial position of the company at the end of the year 2014. However, the following three items in the financial statements are considered as posing a high level of audit risk: the revenues, cash and bank, and property plant and equipment. It is easier to manipulate the accurate value of the mentioned accounts. Thus, they are the areas of heightened audit risk. On that note, the appropriate audit procedures are bank confirmation, inspections, and inquiries. Based on the financial statement of Applied Graphene Material PLC, the revenues, cash and bank, and property, plant and equipment for the year 2014 were valued at £ 17,797, £ 2,972,930 and £ 308,581 respectively. For instance, if 2% of the company’s revenues were deferred revenues to be recognised in 2015, but were treated as income for the year 2014, the actual revenue was overstated by 2% (£ 355.94). Conversely, the loss would be understated by £ 355.94. That is, the current loss is £ 2,651,796, but the actual loss should be (2,651,796 + 355.94) = £ £ 2,652,151.94 (Annual Report: Applied Graphene Materials PLC 2014, pp. 36). Part B The primary reason for conducting a substantive audit procedure is to eliminate any doubt that the company’s financial statements are true and fair. Property, plant, and equipment are selected to facilitate the analysis of the substantive audit procedure to be conducted to reduce the audit risk to an accepted low level. The substantive audit procedures are as below (Rittenberg, Johnstone & Gramling 2012, pp. 534-560). First, the property, plant and equipment are recognized at the book value (the original cost – the accumulated depreciation or impairment loss). In order to verify whether the mentioned property, plant and equipment exist, the auditors are required to conduct a physical examination of the company’s assets. The specified assets are tangible and, therefore, they can be seen and touched. During the process of physical examination, the auditors are required to be thorough and check whether the assets are in a condition suitable for economic purpose and whether the depreciation or impairment costs are treated as is required (Rittenberg, Johnstone & Gramling 2012, pp. 534-560). Second, the auditors are expected to check the completeness of the property, plant and equipment. The process is conducted to ascertain whether all the physical assets are taken into account. That is, no case of unrecorded assets. Similarly, the auditors are required to confirm that no assets are recorded, but have no physical presence among the other assets. The appropriate audit procedure, in this case, is an inquiry (Rittenberg, Johnstone & Gramling 2012, pp. 534-560). Third, after the first and the second process, the auditors should check the legal ownership of the property, plant and equipment. In some cases, companies could avail the assets just to give the impression of the legal ownership, but rather, they are just in possession of them. In order to discover such action, the auditors are required to conduct both inquiries and general procedures to check whether Applied Graphene Materials PLC has the relevant documents that prove they are legal owner of the assets indicated in the balance sheet. In addition, the auditors should check the lease contract documents to verify the lessee and the lessor. In which case, the auditors are required to check with both the lessor and the lessee if the claimed lease contract is valid (Rittenberg, Johnstone & Gramling 2012, pp. 534-560). Fourth, the auditors should check whether the value of the property, plant and equipment is correctly determined. The mentioned assets are valued at their book value according to the annual report. The auditors should obtain the proof of the assets original cost and recalculate the depreciation cost or any impairment based on the procedure adopted by the company. After that, the new book value (carrying amount) should be determined based on the auditors’ calculations (Rittenberg, Johnstone & Gramling 2012, pp. 534-560). Last, the auditors should check whether the classification and the category of the assets are appropriate. The asset classification is crucial when it comes to the accounting treatments such as depreciation, impairment losses, and ascertainment of the fair value. In this case, the auditors should reperform the asset classification procedure (Rittenberg, Johnstone & Gramling 2012, pp. 534-560). Conclusion The three areas that are identified to pose audit risks are the revenues, cash and bank, and property, plant and equipment. Revenue misstatement results into profit misstatement, which is a material misstatement as shown in the qualitative analysis done above. The substantive audit procedures to be performed on the plant, property and equipment are a physical examination, inquiry, inquiries and general procedure, recalculation and reperformance. List of References Annual Report: Applied Graphene Materials PLC 2014, viewed 10 April 2015, http://www.appliedgraphenematerials.com/index.php/investor-relations/reports-presentations/ Foster, S.D. & Greenawalt, M.B. 1995, "Internal auditing education: A comparison across countries", Managerial Auditing Journal, vol. 10, no. 3, pp. 31. Rittenberg, L, E, Johnstone, K, M, & Gramling, A, A, 2012, Auditing: a business risk approach, Cengage Learning, [Melbourne, Vic.], South-Western. Read More