Areas of Heightened Audit Risk - Case Study Example

Audit Risk and Audit Risk According to the IAASB, audit risk is the risk that the auditor will express an inappropriate audit opinion on the financial statements when they are materially misstated (Rittenberg, 2012, pp. 14). This risk is a function of detection risk and material misstatement. Audit risk has three components which include inherent risk, control risk, and detection risk. Inherent risk is the probability that fraud and material errors will enter the accounting system that is being used to develop the company’s financial statement (Gupta, 2005, pp. 224). Control risk is the risk that the company’s control system will fail to detect and prevent material misstatement (Rittenberg, 2012, pp. 142). Finally, detection risk is the risk that the auditor’s procedures will be unable to detect material misstatement. These components affect the quality of evidence collected to support the auditor’s opinion. The lower the audit risk, the higher the amount of evidence collected. Areas of Heightened Audit Risk Mobile Streams PLC is a mobile media company whose business activity involves the sale of content which are distributed on mobile devices (Mobile Streams, 2015). The company is engaged in selling mobile contents over the internet, provision of technical and consulting services, and selling mobile contents through mobile operator services (MNO’s). Three issues in financial statements of Mobile Streams PLC are likely to increase the audit risk of the company. These areas are revenue, trade creditors, and the going concern, which need substantive tests, including appropriate analytical procedure to verify that there are no misstatements or omissions in the transactions and balances (Millichamp, 2002, pp. 114). Revenue The revenue of the company shows an increase of 145% in 2013 as compared to what was recorded in 2012; however, it has decreased in 2014 by 10% (Appendix 1). This has resulted in a decrease in EBITDA by 86% in 2014 as compared to an increase of 157% that was recorded in 2013 and a decrease of the profit before tax of 97% (Quiry, 2011, pp.165). According to the company’s management, the decrease in the profits and revenues is attributed to the devaluation of the Argentinean peso. This has had a negative effect on the company’s performance because it usually gets 83% of its total revenue from this market. It is crucial to do a substantive procedure on this account to make sure that there is no fraud or misstatement that has led to such a big difference in the performance for 2014 as compared to the previous year. Trade creditors From the analysis of the financial statement, the company’s payable and the total current liability have decreased by 1% and 9% respectively while the cash has increased by 4% (Appendix II). This makes this account of heightened audit risk because the company may have tried to decrease its debt to make it easy to get additional cash (Sarngadharan, 2011, pp.70). There is also a high risk that the company might have recorded transactions in the wrong accounting period so that the financial statements look favourable. Going Concern ISA 570 (UK and Ireland) requires auditors to obtain sufficient evidence to support the directors’ use of the going concern assumption when preparing the financial statements (Kwok, 2005, pp. 27). They also have the responsibility to conclude if there is material uncertainty about the company’s ability to continue in a foreseeable future. A foreseeable future is usually 12 months after the preparation of the financial statements. Auditors also have the responsibility to consider if there are material uncertainties relating to the going concern of the company that needs to be disclosed (Everingham, 2007, pp.13). From the financial statement of Mobile Stream PLC, the directors of the company indicate their confidence that the company will be in existence for the foreseeable future (Mobile Streams PLC, 2014, pp.9). The company claims to be performing well despite the changes in the market and uncertainty in the economic climate of its markets. This is especially in the Argentina market where the government has imposed currency control. The currency in 2014 was devalued, resulting in the negative performance in the profits of the company. There is a high risk that management is blinding the directors and are not very concerned about the external factors affecting the performance of the company. The directors need to be careful by considering all the information about the company when assessing the going concern. According to IAS 1, management needs to take into account all information that may affect the future of the company, not limited to twelve months from the date of the balance sheet. The revenues of the company have decreased by 10% in 2014 as compared to the increase of 145% that was gained in 2013, which shows concern about the going concern. The company is continuing to develop its mobile internet services and mobile content in markets like Mexico and Brazil. It is crucial to consider the consequences of additional costs as a result of this expansion in terms of the working capital requirements. The revenues are already decreasing, and the company is already feeling negative effects the devalued Argentinean peso. It may be very difficult to get more funding through loan. If the company plans internally to raise the capital needed for this expansion, it is crucial to examine how this will affect its going concern. Audit Procedure for Revenue Under IAS 315, the auditor has the responsibility to identify and assess any risk of material misstatement in the company’s financial statement. This is by understanding the company and its environment, including its risk assessment and internal controls (Gray, 2007, pp. 435). From the analysis of Mobile Stream PLC financial statement, one area that presents a high level of audit risk is the revenues. This has decreased as compared to previous year, which has in turn led to a drastic decrease in EBITDA by 86% in 2014 as compared to an increase of 157% in 2013. Its shows cause for alarm on this account that required a risk assessment. Five substantive audit procedures will need to be carried out to reduce the audit risk to a level that is acceptable. These procedures will include; analytical procedure, checking the timeliness of transactions, confirming the authorisation of activities, and making sure that the transactions in the account exist and occurred. Analytical procedure Analytical procedure involves comparing the record values to the expectations and looking at fluctuation or differences in the information (Singleton, 2006, pp. 159). This process is crucial because of the difference in the company’s revenue performance in 2014 as compared to 2013. This involves looking at the sales invoices of the company to make sure that all the sales have been recorded correctly. This also makes sure that there are no instances where sales have been made but not recorded (Albrecht, 2012, pp. 435). Test sample of reconciliation also needs to be done between the daily sales reports to the sales invoices. This process also involves recomputing balances of sales invoices and examining evidence from the client for mathematical accuracy. This is crucial in making sure that sales transactions have been recorded in the correct amounts and that the account balance is accurate. This process also involves comparing the price and terms of sales in the sales invoices to what has been authorised in the price list for the different products being sold by the company. This helps in making sure that there were no sales that were done using unauthorised terms or prices, which would have negatively affected the sales revenues (Pickett, 2005, pp. 109). Accrued Income The second procedure that needs to be conducted on this account is looking for accrued income (Loughran, 2010, pp.68). This is income that has been earned and the company has the right to receive it but has not yet been recorded in the general ledger. This process involves looking at post year end receipt to confirm that they are allocatedto the correct accounting period. This procedure is crucial to ascertain that no revenue transaction has been recorded in the wrong periods because this would have an effect on the revenue balance for the period (Kiger, 1997, pp.271). For example, if sales made in 2014 were not recorded in the same year, this would reduce the sales revenue. Deferred Income Deferred income is usually unearned revenue or advanced payments that are recorded as liability in the company’s balance sheet. This is until the products have been delivered and services have been rendered. This reduces the amount of revenue recorded by a company. It will be crucial to check all the contracts with the customers, to account for all deferred income. Any income recorded as a liability after the contract period would negatively affect the revenues. Classification This process involves examining if transactions have been classified correctly. It is crucial to check if the sales invoices have been properly classified (Bragg, 2012, pp. 33). The process also involves examining a sample reconciliation of the sales invoices to the management report on daily sales, the posting, and the summarization. The aim of this is to make sure that there is correct posting of the customer’s accounts or the sales journal in the accounts receivables ledger, and also from the sales journal to the general ledger (Puncel, 2007, pp. 5.39). Existence and Occurrence This procedure involves examining if a transaction or event occurred or affected an account. A comparison of the company’s revenues in 2013 and 2014 shows a decrease of 10% in 2014 (Appendix 1). The management explanation for this decrease is that there was a devaluation of the Argentinean peso. They further explain that Argentina forms 83% of the company’s revenue making the effect more obvious in the total revenue for the year. This is an unusual item that has resulted in a significant variance in the net profit (Sadler, 1998, pp. 86). Further explanation is required on this item to confirm its existence. The management has already given its explanation so it will be the auditor’s responsibility to find another way of confirming this information (Konrath, 2002, pp. 303). This is by researching about the exchange rate of Argentinean peso to the Euro during the period. It will also involve researching about the modified regulations in Argentina regarding the international transfer of funds and how this has affected the company’s performance in 2014. This is especially crucial because the regulations were put in place in 2012 and, therefore, they are not expected to have a significant effect on the company in 2014 as compared to 2012 and 2013. This is unless the company was not in compliance with the regulations until 2014. Conclusion A general analysis of the company’s 2014 financial statement shows the need to perform substantive procedures in some areas. These including the revenue and the trade creditors’ accounts, and the management going concern assumption to reduce the audit risk to an acceptable level. This is by performing analytical procedures, confirming timeliness (Kiger, 1997, pp.271), authorisation, and classification of transactions, and confirming the occurrence and existence of transactions. Bibliography Albrecht, W. S. (2012). Fraud examination. Mason, OH, South Western, Cengage Learning. Pp. 435. Bragg, S. M. (2012). Wiley practitioners guide to GAAS 2012: Covering all SASs, SSAEs, SSARSs, and interpretations. Hoboken, N.J: John Wiley & Sons. Pp. 33. Everingham, G. K., Kleynhans, J. E., & Posthumus, L. C. (2007). Principles of GAAP. Cape Town, South Africa, Juta. Pp.13. Gray, I. (2007). The audit process: principles, practice and cases. London, Thomson Learning. Pp. 435. Gupta, K. (2005). Contemporary auditing. New Delhi, Tata McGraw-Hill. Pp. 224. Kiger, J. E., & Scheiner, J. H. (1997). Auditing. Boston, Houghton Mifflin. Pp. 271. Konrath, L. F., & Konrath, L. F. (2002). Auditing: A risk analysis approach. Cincinnati, Ohio: South-Western. Pp.303. Kwok, B. K. B. (2005). Accounting irregularities in financial statements: a definitive guide for litigators, auditors, and fraud investigators. Aldershot, Hants, England, Ashgate. Pp.27. Loughran, M. (2010). Auditing For Dummies. Hoboken, John Wiley & Sons. Pp.68. Millichamp, A. H. (2002). Auditing. London [u.a.], Continuum.Pp.114. Mobile Streams PLC, 2014. Mobile Streams PLC Financial Statements. [Online] Available at: file:///C:/Users/D620%20Dell/Downloads/1225454_ms_statement_jun2014.pdf [Accessed 09 03 2015]. Pp. 9. Mobile Streams, 2015. Technology. [Online] Available at: http://www.mobilestreams.com/technology [Accessed 07 03 2015]. Pickett, K. H. S. (2005). Auditing the risk management process. Hoboken, N.J: Wiley. Pp. 109. Puncel, Luis. (2007). Audit Procedures 2008. Cch Inc. Pp.5.39. Quiry, P., & Vernimmen, P. (2011). Corporate finance: theory and practice. Chicester, West Sussex, U.K., Wiley. Pp. 165. Rittenberg, L. E., Johnstone, K. M., & Gramling, A. A. (2012). Auditing: a business risk approach. [Melbourne, Vic.], South-Western Cengage Learning. Pp. 14. Rittenberg, L. E., Johnstone, K. M., & Gramling, A. A. (2012). Auditing: a business risk approach. [Melbourne, Vic.], South-Western Cengage Learning. Pp.142. Sadler, E., Hamel, A., Staden, M. ., & Smit, R. (1998). Auditing: A final approach. Kenwyn: Juta. Pp.86. Sarngadharan, M., & Kumar, R. S. (2011). Financial analysis for management decisions. Pp. 70. Singleton, T., Singleton, A., & Bologna, G. J. (2006). Fraud Auditing and Forensic Accounting. Hoboken, John Wiley & Sons. Pp. 159. Appendices Quantitative analysis Appendix 1   2014 2013 2012 Percentage change Percentage change   000s 000s 000s 2012-2013 2013-2014 Revenue 48,573 53,936 22,047 145% -10% Gross Profit 14,229 17,586 8,835 99% -19% Selling and Marketing Costs -7,872 -7,843 -3668 114% 0% Administrative Expenses -5,617 -4,565 -3153 45% 23% Trading EBITDA 740 5,178 2,014 157% -86%             Depreciation and Amortisation -36 -25 -209 -88% 44% Impairments -380 -334 -169 98% 14% Share Based Compensation -328 -18 0   1722% Operating Profit -4 4,801 1,636 193% -100%             Finance Income 170 0 2 -100% Finance Expense -13 -13 -2 550% 0% Profit Before Tax 153 4,788 1,636 193% -97% Appendix II Appendix II       Current Asset 2014 2013 Percentage change   000s 000s   Trade and other receivables 6494 8420 -23% Cash and cash equivalents 2964 2851 4% Total 9458 11271 -16%                 Current Liability       Trade and other payables 5340 5390 -1% Current tax liabilities 1668 2532 -34% Provisions 340 120 183% Total 7348 8042 -9% Read More