Accsys Technologies Plc Audit - Case Study Example

Case Study: Accsys Technologies Plc of Introduction Part A paper seeks to identify three areas of heightened audit risk relating to the audit of Accsys Technologies Plc’s financial statements for 2014. This paper will also explain in detail, using some quantitative analysis, why this researcher considers these areas as such. Part B of this paper will identify in detail and explain the reasons for the five substantive audit procedures that would be carried out to reduce the risk to an acceptable low level in relation to one of the areas selected in Part A . Part A The three areas of heightened audit risk relating to the audit of the company would include the following accounts from the financial statements: (1) Revenues, (2) Accounts Receivable and (3) Plant Property & Equipment (PPE). Management may want to inflate revenues to make the company look better than real for a number of reasons that may benefit their interests. This inference may sound relevant in view of consistent losses from operations by the company for the years 2013 and 2014. Further investigation reveals that losses have been actually there for at least the past five years (Reuters, 2015a). Related to the possible material misstatement of the revenues are the accounts receivable since the same are directly connected in most of the recognition of revenues in the books and to the seeming liquidity position of the company for the past five years despite having shown consistent loses for the past five years (Reuters, 2015b). One viable reason for continuing operations despite having losses is the protection of the employment of some key officer and personnel of the companies. Inflating revenues tries to show that management has intentions of maximizing wealth of shareholders (Arnold, 2004; Brigham and Houston, 2002; Brigham, & Ehrhardt, 2010). Revenues The company claims to have increase revenues by 78% from 2013 level and such increase may really be a big surprise. It is necessary to find as whether there is proper cut off in recording the proper revenues as of balance sheet day. Its 2014 Annual Report provides: “Total revenue for the year ended 31 March 2014 increased by 78% to €33.5m (2013: 26% growth to €18.8m)” (Accsys Technologies, 2015, page 6). The company gross profit margin was also reported to have increase from 18% to 23% from 2013 to 2014 (Accsys Technologies, 2015). There are different methods to inflate revenue as found by the US Securities and Exchange Commission, including the following: recognition of revenue on shipments that never occurred, creation of fictitious invoices, shipment of unfinished products, shipment of produce before customers wanted or agreed to delivery, recording of shipments to the companys own warehouses as sales and shipment to customers that did not place an order (Rittenberg, Johnstone, & Gramling, 2011; Palepu, Healy, & Bernard, 2007). Any of these could happen in the case of the company. The revenue accounts for 2014 increased by such a big difference compared to previous year. Management has all the reason to overstate revenues because for the past five years the company has been showing operating losses. To overstate revenues may be the only reason to sustain and to tell users that the company is still a game to play and that management can still turn things around. Receivables The need to audit receivables is closely related to possible overstatement of sales revenues due to many possible causes as explained earlier. Foremost of these would encompass inclusion of shipments to customers when there is not legal reason to do as the same are not part of the revenues but were made part. Its relationship with sales revenues should be carefully examined to either deny or support allegations about possible misstatement. PPE Evidence revealed that the company has poor profitability, and the possible cause of this has something to do with costing and valuation of its PPE. Overstating depreciation may come from non-existent PPE and this may explain such low profitability of the company. Moreover overstating deprecation has the effect in increasing cash inflows since the same is added back in to net profit in computing cash flow from operations. Part B The five substantive audit procedures for PPE to be carried out include the following: (1) comparing the clients PPE account balances trend with economic conditions and the industry trend; (2) comparing PPE account balances with depreciation and allowance depreciation accounts; (3) analytical procedures of ratio analysis; (4) analytical procedures of trend analysis; and (5) physical inspection of the assets and reconciliation with records. By comparing the PPE account balances trend with economic conditions and the industry trend, it is possible to observe inconsistency which may tell that something is really wrong. With PPE decreasing, it is more natural to expect a slowdown in the economy and the industry averages for revenues. In case of inconsistency the company may be actually improperly inflating its revenues or unnecessarily reducing PPE to reduce the level of expenses. By comparing the PPE account balances with depreciation and allowance depreciation accounts, a logical relation is normally expected among the accounts (Rittenberg, Johnstone, & Gramling, 2011). Increases in PPE should result in increases to depreciation for purposes of yearly income statements and the related allowance for depreciation should also increase on a yearly basis. Any inconsistency among the accounts should be subject to further verification because of the tendency of the management to window dress and have the company accounts look better than in reality. As can be verified from the summary of the accounts, PPE total for 2013 was €22.3 million, and it decreased to €20.7 million in 2014, while the related depreciation for 2013 and 2014 amounted to €2 million. The related allowance for depreciation or allowance for depreciation increase from €10.8 million to €12.8 million. On the surface there, was retirement or reduction of total PPE account balance and yet the depreciation did not decrease. The dates of possible retirement of PPE are interesting to be further analysed (Rittenberg, Johnstone, & Gramling, 2011). In using an analytical procedure of ratio analysis, it is important to highlight PPE asset accounts and accounts in the income statement particularly revenues and expenses other than depreciation (Higgins, 2007). The increased revenues from 2013 to 2014 as against the decline in the amount of PPE accounts balance for the same period invite inquiry. It is not normal to have decreasing asset when revenues are increasing. From the mind of an ordinary observer, increased revenues comes from increasing capital expenditure that should increase the total balances of PPE, but in the case of the company there is just simply an inconsistency that should be explained since it itself a possible source of material misstatement. Investors as users of information would like to see notes to financial statements explaining the reason for the inconsistency. They may perceive the same as lack of transparency if not sufficiency explained to them and they could lose their trust to the validity of information. In using analytical procedures of trend analysis, consistency of PPE with other accounts in the income statement and balance sheet as well cash flow is also sought (Johnson, et al, 2003; Kieso, et al , 2007)). This is more detailed than comparing earlier PPE with industry and economic factors as stated earlier. PPE changes should be compared with repairs and maintenance accounts. Decreases in PPE should normally be accompanied by lower repair and maintenance accounts unless there is proof that an increased amount of the latter is justified because of older equipment. Management may actually be spending abnormally higher repairs and maintenance cost than what is possible given the amount of PPE that company has. The industry where the company is in may be related with other industries which may be showing expansion which may contradict the behavior of management to slowdown in 2014 as shown by the decline in PPE account balance. While it may validate claims of increase revenues (Reuters, 2015c), the decline in PPE becomes a serious question that should be properly investigated. A claim of better management in the company despite lack of sufficient past experience of its key officer from their previous corporate affiliation may reveal many things that may not have been reflected in the Annual Report. Under this procedure, it is possible to know check capital expenditure plans in the near future in relation to past experience as a way to check reliability of recorded PPE (Rittenberg, Johnstone, & Gramling, 2011). Finally, under physical inspection of the assets and reconciliation with records, the power of good observation is required. Physical inspection of PPE against records would be needed to establish and verify the claimed existence of these assets. To check the records, there must be proof of ownership of these assets, such as certificates of title and that they are actually being used in business. These assets may be remote, but there must be an alternative way of looking for evidence and that the company is actually benefitting the same. Leased assets under a finance lease, where the company is the lessor, should be excluded. However, when the company is the lessee under a finance lease, the lease should be capitalized and form part of the PPE under IAS 17 (Deloitte, 2015). Conclusion This paper has identified the accounts of revenues, accounts receivable and PPE from the 2014 financial statements of Accsys Technologies Plc as areas of heightened audit risks based on the unusual changes that could be connected with management personal intentions. In order to reduce the risk to an acceptable low level on PPE accounts, this paper has discussed five substantive audit procedures that should be carried out including comparing clients PPE account balances trend with economic conditions and industry trends, comparing PPE accounts balances with depreciation and allowance depreciation accounts, analytical procedures of ratio analysis and trend analysis, and physical inspection of the assets and reconciliation with records. References: ACCA. 2012. Audit Procedures. Available at http://www.accaglobal.com/content/dam/acca/global/PDF-students/2012s/sa_nov12_f8_fau_audit_procedures.pdf. Accessed 6 April 2015 Accsys Technologies. 2015. 2014 Annual Report. Available at: http://www.accsysplc.com/wp-content/uploads/2013/09/March-2014-Annual-Report-and-Accounts.pdf. Accessed 6 April 2015 Arnold, G. 2004. The Financial Times Guide To Investing: The Definitive Companion to Investment and the Financial Markets. London: FT Prentice Hall Brigham, E. & M. Ehrhardt. 2010. Financial Management: Theory and Practice. Boston: Cengage Learning Brigham, E. and Houston, J. 2002. Fundamentals of Financial Management, London: Thomson South-Western Deloitte (2015). Leases. Available at: http://www.iasplus.com/en/meeting-notes/iasb/2015/february/leases. Accessed 1st April 2015 Higgins, R. 2007. Analysis for Financial Management, Eighth Edition. New York: The McGraw−Hill Companies Johnson, et al (2003). Financial Accounting. U.P.: Tata McGraw-Hill Kieso, et al (2007). Intermediate Accounting. New Jersey: John Wiley and Sons Palepu, K., Healy, P and Bernard, V. (2007). Business Analysis and Valuation: Text and Cases. Boston: Cengage Learning Reuters. 2015a. Accsys Technologies Income Statement for five years. Available at: < http://www.reuters.com/finance/stocks/incomeStatement/detail?stmtType=INC&perType=ANN&symbol=ACCS.L. Accessed 6th April 2015 Reuters. 2015b. Accsys Technologies – balance Sheet for five years. Available at: http://www.reuters.com/finance/stocks/incomeStatement/detail?stmtType=BAL&perType=ANN&symbol=ACCS. Accessed 6th April 2015 Reuters. 2015c. Accsys and Industry Data. Available at: http://www.reuters.com/finance/stocks/financialHighlights?symbol=ACCS.L. Accessed 6th April 2015 Rittenberg, L., Johnstone, K. & Gramling, A. 2011. Auditing: A Business Risk Approach. Eight Edition. Cengage Learning Read More