Audit and Audit Strategies - Assignment Example

Audit and Audit Strategies Name Institution Date QUESTION A Determining an Audit Strategy Factors that can affect preliminary assessment of inherent risk and control risk during an audit at Queen Island Dairy There are three risks that are associated with auditing and these are inherent risk, control risk and also detection risk. This is because since time immemorial audit has been following a risk based approach towards financial statements, there is always a possibility that there is a misstatement in financial statements and auditing dedicates itself to finding the nature, timing and tests as well as procedures to assess the misstatements in the financial statements. Inherent risk during auditing refers to the risk that an important financial misstatement will happen and the management of the business or firm takes to measures to control it. A detection risk to an auditor refers to the risk that a material misstatement has occurred in the financial statements of a business or firm but the tests or procedures established by an auditor to detect and assess those risks has not been able to identify those material misstatements. Control risk on the other hand refers to the chance that a misstatement in the financial statements of the business or firm has occurred which is very material but could not be prevented, detected nor corrected on time because of the nature of the accounting as well as internal control systems of the business or the firm (Statement of Auditing Standards, 2004). Looking at the definitions of the various risks associated with auditing, a few factors can be deduced that could affect the preliminary assessments of inherent and control risks during an audit at Queen Island Dairy: Inherent risk; In the assessment of inherent risk an auditor focuses mainly on the financial statements of the company looking at the account balances as well as the various classes of transactions that are material. Factors that should be considered which affect the preliminary assessment of inherent risk could include; the management’s integrity, the experience and knowledge or lack of experience and knowledge of the manager, changes in management systems during the financial period, unnecessary pressure on management, nature of the business, external environmental factors influencing the business operations, transactions that are complex in nature, nature of financial statements and their susceptibility to being misstated, level of judgment when dealing with account balances and nature of transactions among others (Houghton and Fogarty, 1991). Looking at Queen Island Dairy factors that will affect the assessment of inherent risks during the audit process will therefore be; lack of experience and knowledge in one of the managers (Jim Bannock) as well as integrity given that he makes decisions that affect the business without consulting his brother as well as other managers in the business especially in the sales department. Lack of communication on Jim’s part makes it difficult for the preparation of final financial statements since not all information is provided. Jim is also prone to making changes in the business such as making offering different prices for different customers on the same products. There is also lack of integrity because Jim barely makes time for the business given that he has another business to take care of outside the Queen Island Dairy though his side benefits from the Queen Island Dairy. There is a certain level of doubt when it comes to determination of account balances given that Bob Bannock may force the account and finance department to manipulate the figures to ensure that the business seems profitable. The kind of problems being caused by Jim to the business are very risky to the future of the business and the relationship of the business with various stakeholders so there is a chance that some information especially damning information brought about by Jim’s inappropriate behaviors may be omitted making it impossible to make proper judgment on the business’ progress. Control Risks; Factors that could affect preliminary assessment of control risks include; Jim does not conduct business transactions for Queen Island Dairy in accordance authorization of the business’s management. He offers different prices for different customers, he does not inform others of decisions he makes and also he does not make proper entries of the transactions he conducts. There is also the fact that transactions conducted by Jim are not promptly recorded and if they are they are not recorded in the right amounts and the proper accounts which makes it challenging when preparing the final financial statements. Other factors include; mistakes resulting from our nature as humans such as distraction, poor judgment, misunderstanding and also carelessness among others. Overriding of internal control procedures by either members or a member of the management team just as Jim Bannock has been doing (Statement of Auditing Standards, 2004). Explain how these factors would influence your choice between the predominantly substantive approach and the lower assessed level of control risk approach for sales, inventory and debtors. Tests of control for inherent risks and control risks are designed to avoid, detect as well as correct errors in financial statements that lead to misstatements. They are also meant to provide guidelines to how the internal operations are conducted and managed throughout the financial period. On the other hand tests for control risks for sales, inventory and debtors are designed to reduce detection risks so as to ensure that there is an appropriate balance in audit risks. They are also designed to verify the monetary value of sales, inventory as well as the debtors. They (control risks for sales, inventory and debtors) provide validity to transactions that are carried out in the business. The purposes of the tests are the ones that make it easier for a business to choose the substantive approaches compared to the lower assessed level of control risk approach for sales, inventory and debtors because they do not provide the desired results. QUESTION B Misstatement risk for depreciation What key assertions for the above accounts are likely to be affected? The main accounts to be affected by depreciation of an aircraft include; the total value of assets (fixed assets), cash and bank accounts to cater for maintenance costs and the depreciation account taking into account the decrease by 7%. However, these changes will affect both inherent and control risks for the company. This is because the airline will have to change its policies to cater to the Global Financial Crisis facing the airline among other changes such as new market entrants and also changes in depreciation figures may lead to misstatements for the airline if not well accounted for. Explain what evidence would be persuasive in this case? These changes will be evidenced by the changes in the final financial statements prepared by the airline company. These changes also increase the airline’s assets to be susceptible to misappropriated with the changes implemented by the company resulting from changes in the external environment (economic crisis). QUESTION C Importance of Internal Control Make a list of the potential problems that could occur in Powersys’s maintenance and Improvements program 1. Lack of integrity from the team charged with the responsibility of overseeing the maintenance and improvement programs. This could involve managers hiring people they favor although they may lack the knowledge and expertise for the project thus causing the program to fail and exposing the consumers of Powersys to more complications. 2. The team charged with the responsibility of overseeing the program may lack the necessary knowledge and skill set in the field of electricity distribution therefore face challenges when making reports or preparing financial statements for the program. 3. There are external environmental factors such as the state of the economy, political stability, the legislation of the region, natural calamities such as storms, earthquakes, floods, hurricanes and also drought among others that could hinder the progress of the maintenance and improvements program of Powersys. 4. The complex nature of the transactions or the works of maintenance and improvements in power distribution may force the team to consult with experts making the company incur more expenses for the program. 5. The program may run out funds during its implementation thus making it difficult to complete the program within the stipulated time frame because of lack of money to pay the laborers. This is made even more complex if the program is not generating enough profits causing potential investors to hesitate to offer financial aid for the program. 6. The program also faces the challenge of equipment malfunctioning which could even cause the death or deaths of some employees given the sensitive nature of electricity. If such happens the company will face law suits and even extra expenses of repairing the machinery which is very costly. 7. If natural calamities are to occur such as fires or hurricanes bringing down electricity poles, the company should have insurance but if not it will suffer great losses financially. The natural calamities will also paralyze the program and take the efforts of the company a few steps back in the areas affected by the natural calamities Suggest ways that good internal control over parts, equipment and labor could help Powersys avoid these problems Internal control systems refer to the established rules, policies and also procedures governing the management and operations of the company that assist in ensuring that the company can meet its goals and objectives of conducting the business operations in the most orderly and efficiently way possible, the workers follow policies set by the management, safeguarding the assets of the business, ensuring that fraud, errors and other malpractices do not occur and ensuring that financial records are done accurately and also on time among others. In general internal control systems ensure that the business is run as efficiently and effectively as possible with no hindrances (Waller, 1993). Therefore Powersys can ensure that operations of the program are conducted in accordance to the policies established by the management team. The team charged with overseeing the operations should also ensure that all transactions have been entered correctly in the right amounts, in the right accounts and in the right time. The management team of the maintenance and improvement program should ensure that they monitor the accessibility to all the assets of the company and the records of the assets match the existing assets and in the case of indifferences they should take notice and take the necessary measures to correct the indifference (Waller, 1993). There are other ways to ensure that the problems identified are avoided and these include; ensuring that the size of the program is manageable and also the methods of operations are not so complex that the management team faces challenges in running the maintenance and improvement program. The policies and regulations established by the management team should be reasonable and also flexible enough to allow changes that may occur to the labor force, equipment and parts during the financial period. The management team should ensure to communicate what is material and what is not material for the business so at to set priorities for the program. The team should ensure that what is most material should be given more attention than issues that are not material such as internal and external environmental factors, the assets and the operations of the program among others. The program should ensure sufficient communications of the internal control policies to all staff members as well as the management team especially if there are specific internal controls that the management team wishes to emphasize on (Waller, 1993). References Houghton, C.W., and J. A. Fogarty. (1991). Inherent Risk. Auditing: A Journal of Practice and , pp. 1-21. Statement of Auditing Standards, (2004). Audit Risk Assessments and Accounting and Internal Control Systems. Pp. 1-12. Statement of Auditing Standards 300. Waller, W, S. (1993). Auditor’s Assessments of Inherent and Control Risks to Audit Adjustments. Journal of Accounting, Auditing and Finance, pp. 459-484. Read More