Areas with Heightened Audit Risk in Abbey Plc - Essay Example

AUDITING Areas with heightened audit risk in Abbey PLC. annual report The current business world is very dynamic; it is unpredictable, volatile and fraught with risk. Businesses since the time of immemorial, have seen risk as an unavoidable evil, which should be mitigated or minimized at all costs. Abbey PLC. is not exceptional. As an auditor for the company, the three main areas with heightened audit risk are the audit of inventories, which include cash, fixed assets, and receivables. Secondly, expenses such as payment of salaries and creditors is another area, which the auditor should look at it closely. Thirdly, revenue recognition is another area where the company management can try to tamper with mainly to misstate revenues of the company (Amato, 2014, p. 2). Inventories should always be stated at the lower cost and the market prices or the net realizable value. The net realizable value is the amount that the asset can fetch as at the reporting date, less the estimated costs required to complete the transaction. These could include selling costs and overhead costs. The values stated in the inventories of Abbey Plc. in the annual report for the year 2014 should be tested adequately to ensure that they are the correct market values of such inventories. Fixed assets are critical items, which the auditor should ascertain and ensure that values attached to them are their correct fair values to be disclosed to the shareholders (Rittenberg et al. 2011, p. 626). Disclosing the values of the fixed assets in excess of their correct fair values would make the financial statements to be overstated; thus provide shareholders with a wrong financial position of their company. Trade and other receivables should be recognized and carried at the lower cost of their original invoiced value and the recoverable amount. In case the time value of money is material, receivables should be carried at the amortized cost. The company should make provisions in situations where there is some adequate evidence that the amount would not be recovered in full. The balances should be written off when the chances of recovery are assessed as being remote (Henning et al. 2007, p. 313). Adequate audit procedures should be done to ensure that the company did not make too much or too little provision to cater for trade and other receivables, which could not be recovered. Also, before writing off bad debts, all the relevant procedures should be followed since some managers may decide to write off debts, which could not be written off with the objective of hiding the correct amount of revenue collected by the company during a given financial year. Payment of salaries and other expenses incurred by the company is another area with heightened audit risk. This is because most companies declare more expenses than the actual expenditure with an objective of reducing the net revenue so as to reduce their tax burden. Besides, those taxed with the responsibility of making payments may use that opportunity to enrich themselves. The cost of sale and administrative expenses for Abbey PLC. was $84,563 million and $9,060 millions in the year 2014. The two values significantly reduced the net income to be shared by the shareholders (Gupta 2004, P.265). Therefore, the auditor should take the time to audit the two values since they are crucial in establishing an accurate financial position of the company. Audit risks are higher in the two elements since the procedures involved in recording them requires a number of authorizations from managers before they can be effected. The auditors can only minimize these audit risks using the correct audit procedures with a capacity to authenticate such transactions whenever they were incurred. How the company recognizes its revenue is another area with heightened audit risk. Accounting standards require that income be measured at the fair value of the consideration receivable (Karla M. Johnstone, 2014, p. 20). Revenue represents the value of services and goods supplied by the external customers and also include the intragroup sales net of value added tax. The management could be tempted to inflate revenues with an objective of trying to inflate the net earnings for the year. In most cases, an increase in the net earnings over the years could mean that the companys financial performance and position improved. In the year 2013, the revenue from continuing operation was $98,537 millions, but in the fiscal year 2014, the revenue was $114, 188 million (Abbey PLC. 2014, p. 4). The increase in the revenue in the two years needs to be audited adequately to ensure that the value was not only increased in the paper, but is an actual increase caused by improvement in the operations of the company in the year 2014. Other income such as finance income also needs to be audited adequately to confirm that the figures provided are the correct figures to be disclosed to the shareholders. Five substantive audit procedures to test revenue For many companies, revenue is among the largest accounts in the financial statements and is among important driver of a firm’s operating results. In auditing, under the public company accounting oversight board, revenue is an important account often involving high risks, which need special audit considerations. Historically, most of the fraudulent financial misstatement cases have mainly involved intentional misstatement of revenue. According to the study carried out in U.S (Public Company Accounting Oversight Board, 2014), 61% out of the 347 companies under study recorded revenue inappropriately by creating fictitious revenue transactions with the aim of presenting financial reports that impress investors. The revenue disclosed by Abbey PLC. in the fiscal year 2014 need to be audited adequately in order to test for revenue recognition, disclosures, and presentation. Revenue should be presented either gross or net of the actual amount. Therefore, the auditor should ensure that either way by which the revenue is disclosed, proper procedures are followed. Also, revenue disclosed should have been recognized in the correct accounting period. To audit the revenue of Abbey PLC., application of professional scepticism is needed. Professional scepticism is an attitude that includes critical assessment and a questioning mind of all the audit evidence. Analytical audit procedures are crucial to test revenue when they are correctly performed and designed. Analytical procedures are utilized as a substantive test to get evidential matter concerning assertions related to the account balances disclosed in the statements or the classes of transactions. The analytical procedures done as substantive procedures involve investigation of any significant difference from the expected amount and being able to obtain evidence regarding the management’s explanations of unexpected differences (American Institute of Certified Public Accountants 2012, p. 475). For the proper level of assurance for revenue to be achieved, appropriate substantive analytical procedures must be designed and performed (Public Company Accounting Oversight Board 2014, p. 23). The five substantive audit procedures that need to be carried out include the following; The nature of assertion to the revenue The auditor should come up with some of the assertions, which include; as the assessed risk of the material misstatement in revenue increases, the level of assurance required from the substantive procedures also increases. The needed assurance may be provided through combining substantive test of details and substantive analytical procedures. The lower the level of assurance given by the tests of details, the greater assurance is required from the substantive analytical procedures (Karla M. Johnstone 2014, p. 34). All the different types of revenue being received by Abbey PLC. should be assessed to determine the level of risks or misstatements, which are expected from the revenue. The extent of substantive audit procedures should be determined, such that in case of the revenue with high chances of being misstated, an adequate substantive test should be carried out. The Predictability and Plausibility of the Relationship The substantive audit procedures should also involve the comparison of the figures and ratios recorded in the financial statements and those ratios and amount which the auditor expects. The auditor should use the past financial statement and the budgeted amount and ratios as the baseline for determining the amount of revenue, which is expected to be disclosed to the shareholders. The auditor develops these expectations by identifying and utilizing the plausible relationship which is reasonably expected to be able to exist based only on the auditor’s understanding of the firm and its business environment (Public Company Accounting Oversight Board 2014, p. 27). For instance, the rate of increase in revenue disclosed by Abbey PLC. between the year 2013 and 2014 should be compared with the budgeted rate of change in revenue between the two years. The auditor should also go an extra mile by comparing the increase in revenue with those of other firms operating in the same industry with Abbey PLC. This second substantive audit procedure in revenue helps a lot in identifying any misstatement since any increase or decrease must be accompanied by substantive evidence. Checking the reliability and availability of data Before using the information obtained from the substantive audit procedures, the auditor should test the operating and design effectiveness of the controls over the financial information utilized in substantive audit procedures. Also, the auditor should perform other procedures to be able to support the accuracy and completeness of the underlying information. The auditor must also be able to assess the reliability of data by considering the condition under which they were gathered, as well as considering the source of such data being used. The auditor should ensure that the data, which is being used to test revenue must have been developed under a reliable system with enough control being put in place. Precision of the expectation The auditor’s expectation should be very precise to be able to provide the needed level of assurance; thus any variation may be treated as material misstatements in the revenue. The precision of the auditor’s expectation depends on other things, which include the auditor’s consideration and identification of the factors which greatly affect the amount being audited and the level of detail of the data employed in developing the expectations. For instance, revenue may be significantly affected by the volume, product mix, and prices. Each of these is determined by some factors, and the offsetting factors may obscure any misstatements in the financial statement. The expectations developed at detailed level have greater chances of detecting any misstatements of any given amount than to the broad comparisons. The monthly amount will be more effective than the annual amounts. Also, comparisons by line or location of the business will be much more effective than the company-wide comparisons. Therefore, the monthly revenues of Abbey Plc. for the last three years should be compared than comparing the annual total revenue of the three years. Any disagreements in the comparisons will call for further audit procedures in order to reduce the audit risk. Threshold for investigation The auditor should be able to consider the amount of the variance from the expectation which can be accepted without any further investigation. This is mainly influenced by the materiality and must be consistent with the level of assurance required from the procedures. To determine this threshold level for Abbey PLC., it involves considering the possibility that the combination of the misstatements in particular account balances could aggregate to unacceptable levels or amount. Therefore, the auditor’s threshold should not be too high or too low for the auditing objectives to be achieved. Reference Abbey Plc., 2014. Annual Report 2014. Annual Financial Report. Dublin: Abbey Plc. Abbey Plc. Amato, N., 2014. Seven risk areas for the 2014 audit cycle. Journal of Accountancy, 2 (1), pp. 1-10. http://journalofaccountancy/news/2014/dec/audit-cycle-risk-areas.html American Institute of Certified Public Accountants, 2012. Analytical Procedures. AU-C Section 520, 15 December. Pp. 1-22. http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-C-00520.pdf Gupta, 2004. Contemporary Auditing. McGraw-Hill: Tata McGraw-Hill Education. https://books.google.co.ke/books?id=neDFWDyUWuQC&pg=PA265&dq=auditing+for+expenses&hl=en&sa=X&ei=r4ktVeOtNcLeaqTJgagN&redir_esc=y#v=onepage&q=auditing%20for%20expenses&f=false Henning, K., Kinney, W. & Küting, K., 2007. Internal Audit Handbook: Management with the SAP®-Audit Roadmap. Berlin: Springer Science & Business Media. https://books.google.co.ke/books?id=R8kzyri7ULwC&pg=PA313&dq=auditing+for+trade+receivable&hl=en&sa=X&ei=zYotVbnzPMLhaK2RgbAB&redir_esc=y#v=onepage&q=auditing%20for%20trade%20receivable&f=false Karla M. Johnstone, G. A..L.E.R., 2014. Auditing the revenue cycle. Business Journal, 2 (5), pp. 1-105. http://www.mccc.edu/~horowitk/documents/Johnstone_9e_Auditing_Chapter9_PPtFINAL.pdf Public Company Accounting Oversight Board, 2014. Matters related to auditing revenue. Staff audit practice alert NO. 12, 9th September. Pp. 1-33. http://pcaobus.org/Standards/QandA/9-9-14_SAPA_12.pdf Rittenberg, L., Karla, J. & Audrey, G., 2011. Auditing: A Business Risk Approach. Boston Massachusetts: Cengage Learning. https://books.google.co.ke/books?id=VADFaaGgwb0C&pg=PA626&dq=Auditing+inventory&hl=en&sa=X&ei=mYgtVY2IBILSaPycgOAD&redir_esc=y#v=onepage&q=Auditing%20inventory&f=false Read More