Audit Framework: Wind Farm Industry - Example

Audit Framework Edward Golbourne Ltd is a company specializing in the manufacture and installation of reception mastsand electronic components used in the industrial and domestic power generation and wind farm industry. The firm was founded in 2009 by Mr. Golbourne. The firm has 10 shareholders all of which comprises of two families namely; the Golbourne and the Powell families. The statutory audit , just like any other audit, is to determine an organization’s fairness and accuracy in its presentation of the financial position. This is majorly by carrying out an examination of the bookkeeping records, bank balances and financial transactions. After a well conducted consultation, the government aligned mandatory audit threshold for small companies. The small companies’ accounting threshold should meet 2/3 criteria for turnover, assets and employees in total. As a result, more than 36000 subsidiary companies would qualify to be exempted. More than 83000 subsidiary companies would also be exempted when all the following conditions have been fulfilled by the company; a) The parent undertakings must be established under the EEA state law. b) A unanimous agreement with the shareholders to dispense with an audit in any financial year in question must be reached. c) The parent must provide a statutory guarantee of all the liabilities outstanding attributed to the subsidiary at the end of the financial year. d) The company must be featured in the consolidated account constucted by the parent undertaking, which must be prepared in accordance with directive 83/349/EEC. This is the seventh company law directive. e) The parent must disclose the subsidiary’s use of the exemption in its consolidated accounts. f) The following documents must be filled by the subsidiary’s director at companies house on or before the filing date of the the subsidiary accounts. I. Written notice of the agreement in b) II. A statement by the parent that it guarantees the subsidiary company under a particular section of the act. III. The consolidated accounts and reports referred to in (d) and the auditors report on the accounts. g) The company must not be quoted within s385 (2) of the Companies Act. h) It is not an authorized insurance company, an e-money user, a banking company, a UCITS management company, a MiFID investment firm or carries on insurance market activity. i) It must not be a trade union or an employers association. The Nature and Purpose of the Audit. The purpose of this audit is to ensure that Edward Gobourne Ltd fully subjects to the legal and practical requirements of the statutory audit management and outlining the basis of the audit fees. Baring this in mind, specific objectives of the audit will be evaluated to determine the firm’s adherence to the statutory audit requirement. As part of the initial planning, an audit risk was conducted in an attempt to ensure the identification, evaluation and finally prioritization of the risks in line with statutory regulation adherence. The analysis was based upon examining the regulations, policies, manuals and the given standards governing the statutory audit. The criteria used in the audit was based on the identified risks. The methodology used was a comprehensive inclusion of data analysis, relevant documentation reviews and interviewing the specialists in the statutory audit field. Assurance Statement The conduction of this audit was subject to the requirements of the International Standard on Auditing (ISA). In our judgement, sufficient audit procedures were conclusive and evidence collected to back up the correctness of the conclusions reached are highlighted in the report. On a comparative note, the conclusions are based on the criteria occurance. Unlike an audit , which provides a reasonable as opposed to definite assurance that the financial statements have been presented fairly and in accordance with the (GAAP), a review is more inclined towards providing limited assurance that the financial statements lack any errors or dishonor the accounting rules as specified in the Generally Accepted Accounting Principles (GAAP) (Gwilliam, 2000). Most oftenly, a review is obtained when a party from outside, a creditor or example, needs a typical format of the financial information and requires assurance on the reliability of the information. A creditor will always require an audit to make a decision on whether to issue a loan to the company or not. However, for nonprofit organizations, there are many justifiable reasons for auditing beyond the creditor’s requirement. . By going trough the process of auditing, a higher level of accountability is assumed . Purpose on the threshold placed on a single audit fee. When total fees from an assurance client is a representation of a large portion of the total fee of the firm, the dependence n that client or even group of clients and the concern about losing the client may just result to a self-interest threat (The Code ED paragraphs 290. Page 213-214). Such threats may also be experienced when the fees generated from an assurance client represents a large portion of the revenue from an individual partner’s clients. Comparative positions. There is a 100% consistency of the position taken in that they all recognize the existence of a threat in case total fees borne by an audit client is a representation of the substantial fees of the firm. However the positions differ in that same jurisdiction also recognize that a threat might also be created by the significance of the fees attributed to a particular audit partner. Some threshold is also contained in the jurisdiction above which independence might be considered to be impaired. Therefore, for the above reasons, a specific threshold must be set because failure to this might lead to inconsistent application. For example if the fees represented a substantial portion or a similar type of description, significant differences in the interpretation might be realized. A 15% threshold is ideal and consistent with those jurisdictions which have established a bright-line threshold. Setting audit fees. In setting the audit fee, four attributes that affect the auditors effort should be evaluated namely; the exposure of the firm to fair value reporting, fair value measurement complexities, fair values recognitions and disclosures and usage of non-audit or external monitors in measuring the fair value. (Gwilliam, 2000). Firms with a significant proportion of operating assets reported at fair values might attract additional auditor efforts hence audit fee. This is as a result of incremental necessity in the confirmation of the fair values. However this firm can also require lesser efforts due to the fact that there would not be computation for depreciation and impairment testing. The role of complexity in the measurement of fair values is a reflection of the challenges met in the process of estimation. In consistency with the framework, we expect a higher auditor effort for in the estimation of fair value since complex estimation procedures are employed (Hackenbrack and Knechel 1997), for example lack of market derived input. The role of recognition versus disclosure, as defined by IAS 40, should be examined. For fair values that have been recognized, the audit fee is much higher than those which have been disclosed. This is so because the auditor spent more efforts in validating the information recognized in the primary financial statements. Finally, audit fees for firms recording recognized the fair value of assets on the balance sheet is relatively higher than those those disclosing the fair value at the footnotes. Either, we also predict a lower audit fees for firms that employs external monitors as part of the reporting process of the fair values. As a matter of concern, we recommend that in any case, the statutory auditor, firm or network must be in a position to demonstrate that theyre in no financial dependency existing in relation to a specific audit client and/or its affiliates. Family ties between the auditor and the client. The existence of a family relationship might influence the practice. Most of the activities are being handled by Chris and Powell. However Chris at times delegate his duties to David who is a brother to a colleague in the auditing firm, Bonny, Kuteszko & Co. In this case there is an indirect link and there is a high chance that the findings presented by this firm might not reflect the true and fair position of the Golbourne’s company. David is in a position to manipulate resources in his favor. Powell is the only signatory to check on the company, but she does so in consultation with David. This is quite a risky coexistence because it reflects that David also has an explanatory power in determining the financial authenticity of the company and being his brother works in the auditing firm, this act might as well be covered by influencing he auditing procedures. The Internal Control System. Most of the crucial services in the company are handled by the core owners of the company, Golbourne and Powell. They exhibit a personal commitment to the business and involves themselves in the day- to- day running of the business. This creates a more stable internal control system since they personally engage in the running of the company. However this does not mean that the internal control system is very effective since other factors have to be considered. The ability to manage such institution by the two families must be analyzed, the compensation plan of the employees must be upgraded and then a closer look to the employee motivational skills and training should also be taken. The internal control system of the company seems to be to some level effective. This is so because there exist a well-designed structure; who is responsible for what and who is accountable to whom. This tackles the problem of responsibility and accountability that may arise from the organization. However, there are threats posed in the operation of the company. The first threat is as a result of the family ties between David and the auditing firm. The relationship gives David an upper hand to conceal any mischievous behavior since the brother in the auditing firm can pull strings for auditors to overlook these acts. The second threat arises from the management of the company. This is because the company is run by two families each taking significant tasks in the company. Therefore the performance of the company is subject to a peaceful coexistence between the two families. The audit expectation gap. The audit expectation gap is basically the difference between the auditors’ actual performance and the what the general public expects of the auditors. In this case, the gap seems to be a significantly large one. The firms accounting facilities are incapable to handle the company transactions and as a result, we were forced to overlook some of the aspects which were either insufficiently accounted for or not accounted for completely. The family ties between David and the auditing firm also posed challenges as his brother was part of the team members who were carrying out the audit; any information extracted by the brother or any auditor affiliated to the brother and the family at large might not be true. This translates to a conflict of interest in the audit A letter of engagement  documents and confirms the auditors acceptance of the appointment, the objective and scope of the audit, the extent of the auditors responsibilities to the client and the form of any reports. Letter of Engagement For Audit Assignment for Edward Golbourne & Company with accounting period beginning from 25 th August 2012. The Directors of Edward Golbourne & Co. Dear Sirs, This is to appreciate and accept the instructions to be the auditors for your company and confirm the terms of our appointment. This engagement will commence with a review of the companys audit for the last financial year. As the directors, you are responsible in availing to us, all the companies financial records and/or any other records and related information including the minutes of all management and shareholders’ meeting. I/We confirm that I/We have read and understood the contents of this letter and agree that it reflects my/our fair understanding of the expected services. Signed…………………………………… Date……………………………………… For and on behalf of; Edward Golbourne & Co. Extraction and analysis Some of the financial statement items are subject to the auditor judgement. These items might result in different findings and portray the different position of the companies. These items are; a) The Accounts receivable. b) Depreciation. c) Assets (revaluation of assets) The way the above items among many others, would be treated depends on the accountant/auditor judgement and perspective. This is so because different methods and logistics are employed in order to arrive at the favorite answer. The merlin financial system is used to record accounts receivable in the accounts receivable module. This system is majorly used to monitor every suspense account, invoicing entering a payment, adjustments and interest and probably writing off bad debts when the need arises. In defining the audit, a risk analysis was undertaken in an attempt to identify, evaluate and prioritize the risks which are associated with the management of the accounts receivable. The analysis is subject to an examination of the accounting policies and standards governing the management of the accounts receivable. Relevant managers were interviewed in relation to the underlying subject. After an extensive evaluation, the identified risks were tabulated in terms of probability and relative effects on the departmental activities were also analyzed. Management of accounts recievable risk association matrix.     Low Medium High Impact High Invoicing problems   Insufficient control   Medium unauthorized write-offs ineffective measures of collection   Low Inefficient deposite management Non compliance to procedures at the end of the year. Non collection of interest on overdue a/c Unwritten off debts not collected. uncollectible debts allowances recorded wrongly.     Probability The conclusions are partially based on an analysis of data collected from the Department’s financial system. We conducted a review of files at the accounting offices. All the accounts receivable transactions for the 2010–2011 fiscal years were transfered from the financial system to carry out an analysis using techniques and tools that are computer-assisted. A risk evaluation and analysis was also carried out on the different depreciation methods employ. We tabulated our findings in terms of straight line method of depreciation vis a vis the accelerated method and defined the effect they would create on the different financial statements items. This is as represented in the table below. ITEM IMPACTED STRAIGHT-LINE ACCELERATED Earnings, Equity, Profit Margins Higher, as depreciation expense is lower in the early years Lower, as depreciation expense is higher in the early years. Current Ratio No impact because the current ratio relates to short-term assets. No impact because the current ratio relates to short-term assets. Total Pre-Tax Cash Flow No change. No change. Asset Turnover Lower, as asset values are higher in the early years. Higher, as asset values are depreciated up front. Debt-to-Equity Ratio Lower, as equity is higher driven by higher earnings in the early years. Higher, as equity is lowered in the early years with an elevated depreciation expense. Besides the above factor, depreciation is also subject to a number of assumptions. The element of depreciation can provide a better ground to commit fraud in the company if it so happens that the accountants are malicious. The depreciation expense charged is a function of the assumptions made about both the assets lifetime and what it might be worth at the end of that lifetime. Those assumptions affect both the net income and book value of the asset. Further, they have an impact on earnings if the asset is ever sold, either for a gain or a loss when compared to its book value. A risk analysis was also carried out on the choice of revaluation used by the company. An upward revaluation of assets was used by the managers in an attempt to communicate their knowledge about the reliability of the valued amount to the other stakeholders. This ended up presenting wrong figures of the values of asset translating to misinterpretation of the company’s financial position. Ratio Analysis. Ratios are used in an attempt to measure the performance and financial situation of a firm. The ratios were generated from the financial statements provided. The ratios can also be used to analyse trends and compare a firm’s performance to other firms. Among some of the ratios considered are; 1 Liquidity ratio. These ratios measures the firm’s capability to meet its short-term financial obligations. 1.1 Current Ratio. Current Ratio = Current Assets / Current liabilities. = 1080/550 = 1.96. 1.2 Quick Ratio. Quick Ratio = Current Assets – Inventory Current Liabilities = 1080 – 480 550 = 1.09. The firm registered a high current ratio. This is favorable to the creditors as it minimizes their risk level. However the ratio is quite unfavorable to the shareholders much of the assets are not utelised to grow the business. The firm also registered a high quick ratio. This means that the firm’s cash, accounts and notes recievable are sufficient to provide security for the liabilities without interfering with inventory. 2. Financial leavarage ratio. 2.1 Interest coverage ratio. = EBIT Interest Charges = 1100 / 90 = 12.22 The findings according to this ratio reflects a very high capability of the firm to pay interest on debt advanced to the firm. 3 Profitability Ratio. 3.1 Return on Assets ratio. ROA = Net income. Total Assets = 737 / 4480 = 0.1645 Based on this ratio, the firm exhibit a poor utilization of the firms assets. This is because a lot of assets are being utelised to generate a lower profit. This reflects on the inefficiencies in the management of firm and poor decision making techniques. Materiality Materiality is a concept used in auditing to denote the importance of a transaction, discrepancy or an amount. An audit of financial statements mainly enables auditors to give expression of an opinion as to the authentic ability of the preparation of financial statements, in all the material aspects; in conformity with a stipulated financial reporting requirements such as GAAP. Analytical procedures used in planning the audit generally use data aggregated at high levels. Furthermore the, the sophistication, extent and timing of the procedures, based on the judgement of the auditor varies extensively depending on the size and complexity of the client. The analytical procedures are a crucial part in an audit process and requires an evaluation of financial information data obtained by a study of plausible relationships in both financial and non financial data. This helps in the reduction of the audit risks. Risk elements of audit a) Audit risk- it is the likeliness that an auditor will express a wrong audit opinion in case of occurrence of material misstatement. Due to factors such as improper bookkeeping and affiliation with David to this auditing company, we declare a 90% confidence, reflecting a 10% risk level. b) Inherent risk is the possibility that material misstatements are contained in the financial statements. Our audit exhibited this level of risk but at a lower percentage because of a well defined internal control system. We noticed some discrepancies between the cash flow statements and the receipts for the same transactions. c) Control risk – this reflects a possibility that misstatement cannot be prevented by the internal control system. The audit experienced a part of the risk as we saw some leakages in the internal control system. The signatory to checks is in consultation with David who is affiliated to the auditing company. This increases the chance to commit fraud in the firm. d) Detection risk defines the Possibility that auditing test procedures will fail to detect material error or fraud from the statements. We were exposed to this risk as a result of insufficient bookkeeping since the firm accounting facilities are below its standards. Internal control system audit evidence Inspection We carried out an inspection which consisted of the examination of fixed assets, documents and registries. The inspection of registries and document provided evidence of a significantly variable degree of trustworthiness, following its nature and source and of the effectiveness of the internal controls for its processing. Three important categories of evidence of documentary audit, that provide different degrees from trustworthiness, are: evidence of audit elaborated and retained by third parties. Evidence of audit elaborated by third parties and retained by the organization and evidence of audit elaborated and retained by the organization. The inspection of tangible fixed assets provided evidence of reliable audit, with respect to its existence, but not necessarily to its property or value. Observation We carried out an observation procedure which consisted of observing processes or procedures carried out by others. Our observation of the count of inventories by personnel of the organization and the development of control procedures did contribute to our analysis of the ICS of Golbourne. Investigation and confirmation This consisted of analysis of information in and outside the organization. The investigations ranked from formal investigations directed in writing to third parts, to informal oral investigations directed to people within the organization. Some out the answers to investigations gave us data nonobtained previously and evidence of corroborative audit. The confirmation consisted of the answers to the investigation to corroborate information contained in the accounting records. For example, we looked for direct confirmation of accounts to receive by means of communication with the clients. Analytical procedures We carried out analytical procedures which consisted of the analysis of indexes and significant tendencies, including the resulting investigation of fluctuations and relations that are inconsistent with another excellent information, or that they are turned aside of the foretold amounts. Procedures of calculation The calculation procedures consisted of verifying the arithmetical source document exactitude and accounting records. A few discrepancies were discovered but a large portion of the arithmetic were significantly correct. These methods led us to conclude that the company’s ICS was to a greater extent effective. Use of the work of others to generate audit evidence An auditor can perform sufficient reviews of the other expert’s final reports to confirm that the specified scope in the audit charter, the reference terms or engagement letter requirements has been met; that some relevant assumptions previously used have been identified; and findings and conclusions are reported agreed upon by management. The management should to provide their own report on the audited entities, in acknowledgement of their systems of internal control primary responsibility. In such a case, the auditor should consider management’s and the expert’s reports together. In the engagement of an expert by another organizational part, the report of the experted may be relied upon. In certain cases this may minimize the need for an audit coverage even though the auditor lacks access to supporting documentation and work papers. The auditor should exercise caution in providing an opinion on such cases. Most of the information that we used came from the accounting department headed by Sean. We analyzed the information provided by him regarding the financial activities, control of payroll functions and wage payment and the dealings with the business bankers. This information was sufficient enough for the purpose of our audit though not to the full extent. The preparation of the projected profit and loss accounts and balance sheet provided us with a ground to measure the internal control system effectiveness by comparing the targeted performance to the actual performance. Evidently. This was an indication of an effective internal control system since the company was able to hit 90% of the targeted performance. Sean’s work contributed a lot in the process of this audit and the information he provided us with were verified to be true. This and other factors including our own judgement led us to conclude that Edward Golbourne & Co has a reliable accounting department and a general conclusion that it meets the requirements of statutory audit. Work Cited Gwilliam, D.R (2000), A survey of Auditing research, London, Prentice-Hall/ICAEW. Read More