Developing an Audit Plan for Yarram & District Health Service - Case Study Example

Developing an Audit Plan for Yarram & District Health Service Executive Summary Yarram & District Health Services is an organization that has committed itself to providing quality health care for its customers. This audit plan aims at developing a framework that will facilitate the formulation of an audit opinion on the organization’s financial statements and whether they represent an accurate position on the financial standing of the institution as a whole. As auditors, we are guided by the auditing standards (ASAs) developed by the Auditing and Assurance Standards Board in conducting audits (AASB 2011). In particular we are guided by ASA 315 which requires that we; (a)    Perform risk assessment procedures to obtain an understanding of the entity and its environment, including its internal control; (b)    Establish the susceptibility of the entity’s financial report to material misstatements, including those due to fraud; (c)     Understand specified aspects of the entity and its environment, including its internal control components; (d)     Assess the risks of material misstatements both at the financial report and assertion level; (e)     Identify significant risks and assertions where substantive procedures alone will not be sufficient; (f)      Communicate with those charged with governance or management material weaknesses in the design and implementation of internal control that have come to the auditor’s attention; and (g)      Outlines all the relevant documentation. It is in compliance with this standard that we set out this plan to outline ways in which we shall achieve the above requirements. First and foremost, the understanding of the entity and its environment, which is a key part of the audit, shall lay the groundwork for the development of this plan. Information on Yarram & District Health Services has been obtained from the company’s website and publications which exist in the public domain such as its annual report and financial statements. This information is vital in enabling us to understand where the entity stands in relation to its industry, market environment, competitor’s etcetera. The next part outlined in this plan is an assessment of the entities internal controls. Information for this has been derived solely from the entity’s reports (YDHS Website 2011). Internal controls enable us to determine whether the organization has set measures to address various risks related to its operations or financial position. In particular, we look at corporate governance to give us a general picture of how the organization is managed and the kind of structures that have been put in place to address risks of fraud or error. These structures may include audit committees, internal auditors, fraud managers etc. after assessment of internal controls, we plan to analyse the organizations compliance with good corporate governance principles and recommendations as prepared by the ASX Corporate Governance Council (ASX 2011). Another vital part of the audit plan is the assessment of risks of material misstatement in YDHS’s financial statements. Here, we are particularly concerned with the account balances, classes of transactions and disclosures that we have obtained from the entity’s 2009-2010 financial statements. Using analytical procedures, we plan to identify the material classes of transactions, account balances or disclosures that are susceptible to these risks of material misstatement. In particular, we plan to rely on the movement of account balances from prior year and the audit risk model to ascertain these risks, the relevant assertions and where they are most likely to attach. Finally, after the assessment of risks, we plan to rely on substantive procedures to develop responses to these identified risks of material misstatement. In particular, we shall use tests of details and substantive analytical review (SAR) to determine whether certain account balances are materially misstated. Where necessary we shall develop expectations and compare these with recorded amounts in the financial statements. Sample sizes on which to perform these substantive procedures shall depend on our computation of performance materiality and/or the materiality of particular balances e.g. those that are historically prone to risk or those above the clearly trivial threshold. Introduction This audit plan shall rely on the guidelines developed under ASA 315. This audit standard requires auditors to understand the entity and its environment, analyse the entity’s internal controls, assess risks of material misstatement and develop responses to these risks. The audit plan shall therefore be organized under the following subtopics; 1. Understanding the Entity and its Environment 2. Understanding Internal Controls 3. Assessing the Risks of Material Misstatement 4. Developing Responses to Assessed Risks 5. Conclusion Using this framework, we shall be able to comply with set standards while at the same time develop a proper plan which shall enable us formulate an audit opinion on the accuracy or fairness of the financial statements prepared by YDHS for the financial year 2009-2010. Audit Plan 1. Understanding the Entity and its Environment As auditors, we are required to familiarize ourselves with the organization in terms of knowing its structure, history, operations and its standing within its market or industry. We shall therefore discuss this topic as hereunder; a. Brief History of YDHS Originally known as Yarram and District Hospital, YDHS began operating on the first of January 1912. However, it was only in 1917 that it admitted its first patient. The hospital changed its name in 1993 as a reflection of its growth to a greater organization capable of availing multi-purpose service and its ability to serve a wider community. YDHS currently operates under the DHS program for Small Rural Health Services. It provides a wide range of primary health care services. YDHS has a bed capacity of 50; 20 acute beds, 15 for high-aged care and the other 15 for low-aged. It has also acquired a nearby care hostel with a bed capacity of 30 (Stone 1997). b. Organizational Structure YDHS has a structured organizational chart where ultimate authority rests with the board. Under the board are four sub-committees each tasked with different responsibilities and an executive which is headed by a director. Fig 1 shows YDHS’s organizational chart. c. Operational and legal structure Since YDHS falls under the Department of Health Services, it is obligated to follow certain statutory and policy requirements so as to provide quality health care to the community. The health centre therefore offers both private medical and community service in a balanced manner. One of the policy requirements that YDHS has to adhere to is that of competitive neutrality. This means that YDHS has to offer its services at a much friendlier cost than that offered in the private sector. To achieve this, the health service ensures that it provides its services at an affordable cost and also ensures that it outsources for services in a competitive manner. Another policy requirement is that of providing community service. YDHS has met this policy by providing community support services such as screening programs, sponsorships and direct participation in community activities. YDHS has also to adhere to strict legal guidelines. One such important guideline is directive 4.5.5 which requires that the health service has to comply with the set risk management standard. The service also has to adhere with other statutory requirements especially those to do with health and occupational safety such as the Building Act of 1993. Additionally, YDHS adheres to employment laws such as the Whistleblowers Protection Act of 2001 and the Equal Opportunities Act of 1995. YDHS is also mandated to provide information to its clients under the Freedom of Information Act of 1982 and it has nominated an administrative officer for this purpose. The organization is also required to disclose financial information as under the Financial Management Act of 1994. d. Industry and economic conditions YDHS is a local rural health services provider. Since it falls under the DHS, much of its regulation falls under government policy. However, the health service has to compete with other private institutions. Much of YDHS’s revenue comes from government partnerships/grants, donations, fundraising mechanisms as well as from its private services. 2. Understanding Internal Controls YDHS seems to display a good sense of corporate governance. This is because of the health services adherence to statutory requirements as well as the principles of good corporate governance. According to Lipman (2006), "Good corporate governance helps to prevent corporate scandals, fraud, and potential civil and criminal liability of the organization." The Corporate Governance Council of the ASX lists eight principles of good governance (ASX 2011). These are: 1: Lay solid foundations for management and oversight 2: Structure the board to add value 3: Promote ethical and responsible decision-making 4: Safeguard integrity in financial reporting 5: Make timely and balanced disclosure 6: Respect the rights of shareholders 7: Recognise and manage risk 8: Remunerate fairly and responsibly YDHS meets the first three principles by having a good organizational chart where there is a clear flow of authority and accountability. The Board is assisted by subcommittees such as internal audit, investment, medical appointment and quality improvement. These subcommittees provide sufficient controls through advising the board on critical matters and also ensuring that there is fiscal discipline and strict adherence to proper financial reporting standards. The health service seems to have met the requirements of principle 4 and 5 by making their financial statements publicly available and presenting them according to the set financial reporting standards. YDHS has a quality control co-ordinator under the Director of clinical services who is responsible for managing risk. The health service in its disclosures has also made available information from its clients on the quality of service they receive as well as the number of medical incidents that occurred throughout the year under review. YDHS seems to have a good risk culture especially in their adherence to directive 4.5.5 requiring them to maintain strict risk management standards. On the risks of fraud, YDHS seems to have set controls by having an internal audit committee answerable only to the board as well as having external auditors. YDHS has also ensured that it has set mechanisms to remunerate and keep its staff motivated. It has also set controls through confidential audits which enable it to find out the staff satisfaction rate. 3. Assessing the Risks of Material Misstatement The risks of material misstatement in YDHS’s account balances have been identified through the examination of their financial statements and disclosures as well as through an analysis of their internal controls. For each Material Disclosure, we need to consider whether factors exist that may increase the risk of misstatement. This includes a consideration of whether there are conditions or events that specifically increase the risk of fraud or error, as well as an assessment of the risk that fraud or error may cause the Disclosure to contain material misstatements. We also inquire of appropriate levels of management about any fraud or significant error that has been discovered. Our research into the incidences of misstatement enables us to recognize factors that may increase the risk of misstatement, and we use these factors to identify risks. The following points have been considered in assessing risk for these disclosures. Whether the disclosure: 1. Contains significant transactions with related parties 2. Has related deficiencies in internal control, especially those not addressed by management 3. Has changes in the related information technology environment 4. Has past misstatements, history of errors or a significant amount of adjustments at period end 5. Contains significant amount of non-routine or non-systematic transactions including intercompany transactions and large revenue transactions at period end 6. Contains transactions that are recorded based on management’s intent (e.g., debt refinancing, assets to be sold, and classification of marketable securities) 7. Contains application of new accounting pronouncements 8. Contains accounting measurements that involve complex processes 9. Has events or transactions that involve significant measurement uncertainty, including accounting estimates 10. Has pending litigation and contingent liabilities (e.g., sales warranties, financial guarantees and environmental remediation). 11. Contains transactions or events recording significant adjustments 12. Contains complex transactions or events for which we believe there is a high risk of error 13. Contains transactions or events that are subject to an unusual degree of Management involvement or that produce direct or indirect benefit to Management 14. Contains transactions or events that are outside the normal course of business for the Entity 15. Contains transactions or events that exhibit characteristics that raise concerns about the possibility of illegal payments 16. Certain assets and liabilities may represent a risk of material Misstatement owing to their value and liquidity. 17. Has improper reconciliation and review between the general ledger accounts and supporting records In addition to identification of risks, we also need to identify which account balances have significant risk. As part of our risk assessment, we shall determine whether any of the risks identified are, in our judgment, a significant risk. In exercising this judgment, we shall examine the effects of identified controls related to the risk. In exercising judgment as to which risks are significant risks, we shall consider at least the following: • Whether the risk is a risk of fraud • Whether the risk is related to recent significant economic, accounting or other developments and, therefore, requires specific attention • The complexity of transactions • Whether the risk involves significant transactions with related parties • The degree of subjectivity in the measurement of financial information related to the risk, especially those measurements involving a wide range of measurement uncertainty • Whether the risk involves significant transactions that are outside the normal course of business for the entity, or that otherwise appear to be unusual. We have assessed risks of material misstatement for YDHS by examining the movement of account balances in the operating statements and the balance sheet. We have also assessed these balances according to their susceptibility to fraud and misstatement. The following are the five account balances that have a risk of material misstatement due to fraud or error. ACCOUNT BALANCE RISK LEVEL REASON REVENUE Significant Revenue may be overstated owing to addition of a new revenue category under ‘specific purposes income’ with a balance of 2,471,326 dollars. This category does not exist in prior year and there is no explanation for it. EXPENSES Not Significant Depreciation expense seems to be overstated since it has increased to 1,316,651 from 411,956 yet there is no correspondingly huge variance in the assets balance. RECEIVABLES Not Significant This accounts balance is inherently risky owing to its nature. The organization though non-profit may overstate this balance to appear to be fiscally healthy so as to attract more grants and donations. CASH/BANK Not Significant Cash is inherently susceptible to misstatements mainly due to fraud. YDHS has several revenue streams including donations for which we do not find adequate controls. PAYABLES Not Significant YDHS may understate this account balance so as to attract may donations and grants. 4. Developing responses to assessed risks Having identified the various account balances with a risk of material misstatement, it is our duty as auditors to develop responses that will address these risks. The kind of responses will depend on the nature of the account balance, the level of risk ascertained and the auditor’s judgement. We shall address these risks through substantive procedures as follows; a. Revenue Since this account balance seems to have a significant risk, we shall perform more comprehensive substantive procedures on it. This shall require us to sample more items and to send confirmations especially for the balances that fall under the category of “specific purposes income”. These substantive procedures shall enable us develop a level of assurance as to the accuracy of the account balance. b. Expenses We shall test the depreciation expense through substantive analytical review. This entails developing an expectation by computing back the expense based on the value of assets added or disposed during the year and prior year account balances as at year end. Using the organization’s depreciation rates, we shall be able to ascertain whether the figure recorded for depreciation is accurate. c. Cash/Bank Owing to the nature of this account balance, we shall determine the accuracy of the account balance by sending confirmation letters to the relevant banks. We shall also perform substantive tests on unpresented and uncredited cheques if any. d. Receivables We shall test this account balance through a test of details. This shall involve sampling and examination of supporting documents. Where possible we shall send confirmations to debtors to ensure that their balances agree with those of YDHS. e. Payables We shall also test this account balance through a test of details. This shall involve sampling and examination of supporting documents. Confirmations shall be sent to creditors to ensure that their balances agree with those of YDHS. Conclusion We believe that this plan shall enable us meet our professional obligations as per the relevant ASAs as well as enable us form an opinion as to the fairness or accuracy of the financial statements prepared by YDHS. Appendix Fig 1: YDHS’s Organizational Chart (YDHS 2011) References ASX Corporate Governance Council (2011) Corporate Governance Principles and Recommendations with 2010 Amendments- 2nd Edition. Available at http://www.asx.com.au/documents/about/cg_principles_recommendations_with_2010_amendments.pdf (5 October 2011) Auditing and Assurance Standards Board (AASB) (2011) ASA 315-Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement. Available at http://www.comlaw.gov.au/Details/F2006L01372 (5 October 2011) Lipman, Frederick (2006) Corporate Governance Best Practices. London: John Wiley Stone, Peter (1997) Splendid Isolation: a history of the YDHS. Sydney: Ocean Publications Yarram and District Health Services (YDHS) (2011) Annual Report: 2009-2010. YDHS Website. Available at http://www.gha.net.au/Uploadlibrary/405135197YDHSAnnualReport2010.pdf (5 October 2011) YDHS Organisational Chart Read More