Why Auditor Should Plan Audit Work Well - Assignment Example

AUDIT Introduction In order to have an appropriate basis upon which an opinion will be expressed in regard to the financial statements, an auditor is required to plan his audit work well and implement it in order to obtain a reasonable assurance whether or not the financial statements are free of any material misstatement arising from errors or fraud. According to the Public Company Accounting Oversight Board’s (2015) findings, the reasonable assurance is obtained by an auditor by reducing the audit risk to an appropriately low level. The auditor achieves this by applying due professional care in addition to obtaining sufficient audit evidence. In the course of the financial statements audit, an auditor is subject to the audit risk and he/she commits it if his/her audit opinion is inappropriate. This arises where the financial statements are materially misstated, making them be presented unfairly and fail to conform with the applicable financial reporting framework. To this extent, this paper aims at identifying the possible audit risks as presented in the case of Cupcake Co and the possible actions that the auditor is likely to take in each case. It will also discuss the benefits that accrue from conducting a risk assessment at the planning stage of the audit. Possible audit risks Risk of theft According to this paper’s analysis, Cupcake Co is likely to suffer the loss of cash through theft. As presented in the case, the company keeps a sufficiently large amount of cash for the purposes of giving back change. The internal control of Cupcake Co has failed in its control over the cash, making it susceptible to improper diversions, as well as being misused. From the case, there was no separation of duties in cash handling. When such a case subsists such that a single department or individual is entrusted with both asset custody and their record keeping, there is a potential risk of frauds, in that, such assets can be stolen. In addition, accounting records falsifications to hide events can be done. In such a scenario, the management would have difficulties in holding a specific employee accountable in case errors or fraud is detected. To respond to this audit risk, the auditor can ask the management of Cupcake Co to state the internal controls they use to control their cash. The auditor will seek clarification on whether duties are segregated in the handling of cash. The auditor can also perform some analytical procedures such as the prevailing trend in the cash balance relative to the previous year’s balances. Risk of wrong recording of the property, plant and equipment There could be an audit risk arising from the likelihood that Cupcake Co expensed the purchase of the fixtures and fitting and the new store in its income statement. Given that these purchases are of capital nature, a huge amount of money must have been used. Therefore, charging this amount into the income statement would have been a contributing factor as to why the company made huge losses. This is irrespective of the recession that was experienced in the Bakeryland during the financial period ending 31ts March 2015. The wrong recording of fixtures and fitting and the new store could be as a result of lack of arithmetic and accounting controls. The absence of these controls makes transactions to be recorded in a manner that is inconsistent with the Generally Accepted Accounting Principles (GAAPs’) requirements. If Cupcake Co committed these mistakes, it becomes difficult to ascertain the right account balances. To respond to this risk, the auditor can ask for the relevant documents and records that were involved in the acquisition of property, plant and equipment for inspection. The inspection entails examining documents or records, both internal and external, in electronic form, paper form or any other media. The auditor can also go further and ask for the fixed assets schedule to ensure that they were captured after the purchase. The auditor should also review the income statement’s expense items to ensure that these capital expenditures were not expensed. Lack of trail This paper established several activities to be taking place in the company’s chain stores. There is a risk that some necessary documents to support these transactions could go unissued. This would have compromised the core roles played by accounting records such as capturing the economic essence of transactions, as well as providing audit trails of economic events. Cupcake Co should maintain the audit trail because such information would assist it in its day-to-day operations because its employees would be able to respond to its customers’ inquiries by indicating the prevailing status of transactions in process. Additionally, it assists external auditors in the course of their financial audit because they need to verify some transactions by referring to the financial statements, ledgers, journals and source documents. The auditor can respond to this by requesting for the relevant books of original entry and tracing them to the final statement. Besides having them, the auditor can seek for external confirmations from other parties to certify that indeed a given transaction took place and the amount ties. Misappropriations risk From the presented case, this paper has established that there could be an audit risk arising from the likelihood of misappropriation of products. This form of fraud would have occurred because this paper did not learn about the rotation of duties, and, therefore, the firm’s personnel continued to work in the areas they were first assigned. As a result, if there are any existing irregularities, they will continue as there is no one to report them since there are no personnel taking over from these duties. The auditor can respond to this risk by asking the management to issue their control measures concerning the inventory handling. In addition, the auditor can go ahead and establish the extent to which the duties are rotated and the objectivity of the involved parties. Risk of omission Through this study, this paper has established that there lacked an independent verification of transaction that Cupcake Co engaged in. Even though there was the assertion that its inventory records were updated on a daily basis in order to reflect the delivery, as well as the use of ingredients, and later the production and dispatch of the finished goods, there lacked an individual who directly took part in the verification of transactions. The record update work could have been left in the companys Storeroom Managers office without any other party that plays an oversight role over it. This could give rise to clerical mistakes such as errors of omission, misrepresentations, and misappropriation frauds. It is, therefore, vital that Cupcake Co institutes independently check procedures over the flow of its inventory, which will enable it to assess an individual’s performance, the integrity of the inventory control system, as well as the correctness of the accounting records. To verify that indeed, the right recording was done, the auditor can recalculate some of the recorded amounts. The recalculation would involve checking the accuracy of mathematics as contained in the documents or records. The auditor can also sample out the material costs and seek for external confirmations. The auditor can inquire with a view to gathering the relevant information from knowledgeable persons, especially the respective customers who confirm their amounts with the recorded ones. Litigation risk The results of the case analysis in this paper established that there is the likelihood of an audit risk arising from litigations. From the presented case, Cupcake Co has been served with a letter from its primary customer, Stayrose Co on breach of their agreement. According to Stayrose Co, Cupcake Co has been supplying it with cakes prepared using flour from non-organic suppliers instead of those prepared using organic ingredients only. The auditor would respond to this by inquiring from the management whether the claims as suggested by Stayrose are true by giving evidence that they use organic ingredients. The auditor can also gather some information on the same by asking the suppliers to offer information about the type of ingredients they supplied Cupcake Co with. The benefits of conducting a risk assessment at the planning stage of the audit Through audit planning as required by ISA 300, an audit reaps enormous benefits. ISA 300 requires an overall strategy for the audit to be established, planning for the audit to be done, reducing audit risk to acceptably low levels, and planning for the engagement in a manner that it will be performed effectively. The first benefit of audit planning is that the auditor obtains an understanding of the client. The understanding is in terms of the objective, scope and the audit report, the staff to be involved and the remuneration. The second benefit arises from the development of an overall audit strategy. The auditor develops an overall audit strategy at the start of the engagement, and which he can amend or update if required in the course of the audit exercise. Through the overall audit strategy, the auditor develops an effective response to any risk of material misstatement. In addition, the overall audit strategy will guide the auditor in deciding the resources to be required. According to Burke’s (2015) study, the overall audit strategy covers resource availability and how they will be used, preliminary risk assessment and the need to test internal controls, setting of materiality, important dates to be observed, and the nature of the engagement. The third benefit is that the auditor can understand the business of the client and its industry. This is because the nature of the business and the industry dictate the business risk affecting the client and the risk of material misstatements in the financial statements. After understanding these risks, the auditor uses this knowledge to establish the audit evidence he deems sufficient and appropriate on which to offer the audit opinion. The fourth benefit is that the auditor evaluates whether there is a need for an outside expert. If an auditor is faced with an event that requires special knowledge, skills and experience to give audit evidence, the auditor does so after considering the professional qualifications, reputation and experience as well as the experts objectivity. References Burke, A., 2015. Audit Planning and Risk Assessment - CPA Ireland. [Online] Institute of Certified Public Accountants in Ireland Available at: HYPERLINK "http://www.cpaireland.ie/docs/default-source/Students/Study-Support/P1-Auditing/introduction-to-audit-planning.pdf?sfvrsn=0" http://www.cpaireland.ie/docs/default-source/Students/Study-Support/P1-Auditing/introduction-to-audit-planning.pdf?sfvrsn=0 [Accessed 29 April 2015]. Public Company Accounting Oversight Board, 2015. Auditing Standard No. 8 - Audit Risk. [Online] Available at: HYPERLINK "http://pcaobus.org/Standards/Auditing/pages/auditing_standard_8.aspx" http://pcaobus.org/Standards/Auditing/pages/auditing_standard_8.aspx [Accessed 29 April 2015]. Read More