Risk-Based Audit Methodology - Assignment Example

Question one; Risk based Audit methodology Risk based audit is the process as well as method that focus on control often considered as the key expertise that works as the problem with approach is unfolded, the approach audit process is directed by focusing in those areas of the financial statement that might contain material misstatement either by errors or omission as an effect of the risks encountered by the business. The importance of risk-based audit is as a result client-focused; starting with the goals of the activity that is audited by focusing on the risks of attainment of the objective as well as the procedures to minimize risk (Alvin A Arens, 2013). Risk based-audit is consequently an evolution instead of revolution, even though the outcome realized can be apparently in their magnitude. The main area auditor focuses is the control. Adapting the risk based audit As per the business situation and nature of the audit process, every audit process depicts a diverse threat and risk and thus there is no single approach to auditing that guarantee perfect audit result and opinion. According to ISA 315 on ascertaining and appraising the risk of material misstatement by comprehending the entity and its environment provides that an auditor must take on a risk-based audit approach to performing auditing. In so doing, it commands practitioner to make risk appraisal of material misstatement in the financial report and assertion levels based on relevant understanding of the firm as well as its environment inclusive of internal controls. Auditing must therefore performing the top down audit approach where he assess the risk by focusing on an entity and its environment since the approach commands practitioners to identify the daily risk encountered by the business, to establish the impact of the risk might have on the financial statement as well as plan their audit procedure so as to facilitate the recognition of risk as well as the appraisal if the effect it will have on the financial statement. Risk are classified into ;Financial risk such as the cash flow risks, compliance risk such as the breaching the laws and regulation risk as well as the operation risk such as the employee risk as well as loss of data risk Risk based audit is an approach that focuses on identifying the probable risk that a company might face or the threat that might affect the business operation in the near future. Under this approach, an audit places more emphasize on risky areas that are susceptible to fraud or threat and perform and an in- depth audit test in order to ensure that the threat or risk is identified as well as appropriate audit conclusion provided in order to ensure that the risk is minimized (Get Through Guides, 2007). Detection risk is the risk that the procedure adopted by an auditor will fail to detect risk or material misstatement in the books of account and thus auditors employ their judgment in establishing levels of appropriate inherent risks well s control risk, specifically the auditor’s input rarely the appropriate detection risk permited.inn reality, auditors control the entire level of audit risk that they are planned to assume on a specified audit task by merely establishing the nature and extent of the procedure as well test to be performed but as well by distributing an appropriate level of audit resource to the task. The formulae for Audit risk therefore is Audit risk= {Inherent risk*Control risk*Detection risk} It can observed from the above audit risk formulae that the percentage of risk values is appraised for both inherent risk and control risk and thus the acceptable audit risk, a defined level of detection risk might set as and consequently the extent of commanded substantive procedures might assessed. Despite the level of at which audit risk is set, detection risk has a proportional connection with the financial statement risk (Griffiths, 2012). The lower the financial risk, the higher the detection risk as Well as the lower the level of comprehensive audit test, it must be realized at the time the identified level of detection risk is set, an auditor might employ manual tables as guide to right sample size to be examined. The conclusion is that, after setting the key test for risk based audit approach to auditing; his net thing is to consider audit planning as well as documentation where the risk-based auditing is adopted. The auditor adopting this approach must therefore place more emphasize on the risk that might affect the business as well as ensure that an audit opinion is not misleading. This a risky type of audit approach since, it employees a comprehensive audit approach as well as using substantive audit test in order to ensure that there is no material risk that affect the books of account of the business as result, an audit need to be extra cautious in this type of audit approach in order not to mislead users of the audited financial report (Harrer, 2008). An expert with wide background in auditing specifically the risk based auditing will be required to employee this approach since, the method command the use of audit risk formulae that consider the detect ion risk, inherent risk as well as control risk is developing and audit risk as well as interpreting the outcome of the report clear prior to making an audit opinion. It therefore commands the use of audit risk technique that are complex such as understanding the inherent risk, control risk as well as identifying such kind of risk in the financial report and generating a conclusive audit opinion form the statistics generated from the audit risk formulae. the risk therefore was good since, it identifies risk and threat that business will face in its daily operation as well as providing an opinion as to the best approach to get such risk as well as guarantee business going concern assumption. The users of the financial statement majorly place more emphasizes on the audited financial report since, it provides and assurance as to the reliability and consistency as per the accounting standards and auditing disclosures. The auditors are held acceptable for any material loss that will be incurred by the users of the financial statement after placing reliance on the unqualified audit report provided by the auditors. Performances The ratio analysis depicts that the company performance is improving. The stock turnover ratio is increasing which signify the increasing trend in the level of goods sold while the amount of credit sales as depicted by debtors turnover is declining this regards, the business cash management is improving since, the amount goods sold on credit is reducing while the level of stock turnover is improving. As a result, the working capital management of the business is improving (Harrer, 2008). The earnings per share to shareholders are improving which implies that the business operation is expanding in terms of reported net profit and retained earnings. the increasing per share depict s strong liquidity position of the business since, the amount of retained earnings as reserve is increasing every year which is a good indication that the present and anticipated future business performance is improving and consequently the venture is viable. Additional information that is helpful in assessing the company financial position In order to place full reliance on the company ratios in ascertaining the financial position, additional information on the ratio must be executed. In this regards, I will perform the following to gain additional information in order to substantiate the reliability and balance of the ratios in order to provide conclusive evidence about the company’s present and future business performance. Two B. Audit procedures to get additional information Substantive test Since the company is reporting a decrease in the current ratio from the year 2011 to 2015. As an auditor, I will perform the substantive test in inventory and cash department in order to ascertain the adequacy of the company’s internal control over cash and inventory. Cash department is a high risky area that is susceptible to fraud and hence a test of detail will be performed. the decline in the level of current asset to current liability implies therefore that the management might be having a weak working capital since, the level of, liabilities is increasing each or fraud might be perpetrated by fraudulent employees (Larry Rittenberg, 2009). as a result, to substantiate the accuracy of the ratio analysis, I will perform test of detail such as an audit trail in order to track the inventory stock as well as to guarantee efficiency and effectiveness in recording, I will as well as check the asset register in order to corroborate the correctness of the list of asset bought and disposed in order to get a clear understanding of the trend in return on asset in order to develop an audit opinion as to legitimacy of the declining trend. Issuing debtors and creditors circularization letter It can be observed that the debtors turnover trend is declining which implies that the level at which credit sales is made is declining and thus it depict that the cash sales is increasing. Hence, an audit test should test on the debtor to substantiate the debtors balance. This is possible by issuing debtors circularization letter in order to confirm the accuracy of the account balances before placing reliance on the value of the debt owing. Performing cutoff test will help in identifying the possibility of frauds since, the cutoff procedure will aid in checking on the accuracy of the balance before and after the balance sheet date. The test procedure is important since, it will provide a clear understanding of the company state of internal controls well as the level of audit risk that an auditor will be exposed in concluding on the relevance and adequacy of the company’s books of accounts. Performing test of detail on Issued Capital The issued capital would be examined by inspecting the sum increased in the present financial year through raising extra equity capital. An audit test is performed on the amount raised inform of equity capital and investment employed in the additional funds raised. The audit test performed on issued capital is because, despite having a high reported retained earnings, extra capital raised would be audited by examining the equity capital employed by the company. Question two C. Aspect of the company that should receive more emphasis. Inventory Inventory is acceptable to fraud since; goods in the store must be less as compared to actual figure documented in the annual report due to errors, fraud, or poor inventory system. As a result, I will places more emphasis in this department in order to gain more audit in-depth understanding of how inventory are documented, accounted for as well as the approach of issuing goods in store (Pickett, 2006). This will provide a clear understanding of inventory system as well as help in concluding on the effectiveness of internal control over stock as well as providing conclusive evidence on the reliability of inventory. Cash department Cash department is a risky place since this is the centre of acknowledging cash receipt as well as data entry is made. in this regards, I will perform in-depth analysis of this department in order gain a deeper understanding of the system of recording in order to ensure that there exit effective internal control over cash as well as provide an assurance that the internal control over cash is working and that the report can be fully be relied upon in making a conclusive audit evidence. Cash department is risky since, it will affect the profit margin of the company as well s the opinion on the company profitability hence, a strong internal control over cash must be implemented in order to provide an assurance of the legitimacy of the cash sales in providing audit opinion on the company present and future performance. Depreciation In understanding the book value and written down the value of the asset, depreciation must be deducted. Depreciation of fixed asset poses a threat since if a correct rate of depreciation is not applied, the books of account will be misleading since the set will be undervalued either but fraudulent employees or by mistake. this is an area that is extremely vulnerable to fraud since, the rate of depreciation can be changed in order to provide false information about the value of asset at end of the balance sheet as a result, I will perform audit trail in order to get a deeper knowledge of the exiting rate of depreciation as well as checking the accuracy, consistency and reliability of the rate application in order to get assurance of the applicable rate as well as the value of asset at end of balance sheet date. This is important since, the written value of the asset will affect the return on asset ratio, and thus it will be misleading inn concluding on the liquidity position of the company. Question three Purpose of internal control Internal control is a procedure that is influenced by top executive as well as other individual staff and those charged with governance to create a justifiable assurance concerning the attainment of goals in the reliability of financial statement and reporting. Internal control of any organization is appraised depending on the plan size, nature as well as whether the plan outsources external service providers and the size of and experience of the department accountable for financial reporting. Control must be based be on a unique and risk result method to guarantee excessive in areas with low risk. Prior to adopting an internal control system. The cost of creating and maintaining the control system must be appraised while taking into consideration of implementing the internal control and not having Internal control serves the following function in an organization Existence or occurrence Asset and liabilities must be existing in the business every financial period as well as it must be well documented and accounted for at the time of occurrence. The internal control therefore ensures that the existence of asst a liabilities must be existing in the firm as well as properly accounted for in the year Completeness The internal control over completeness places more emphasis on the entire transaction by ensuring that account is accounted in the financial statement. The internal control ensures that there is completeness in recording and transaction and are fully reflected in the final books of accounts. Presentation and disclosure All transition must be documented and accounted for and every specific component of the financial statement must precisely be classified, described, and disclosed. The control object must be distinguished from every plan’s financial statement assertion. Control goals involving the plan’s financial statement assertion .The board of directors is accountable le for ensuring that there is an effective internal control system put in place and seen to be working in the organization. The board must set up relevant policies on internal control as well as regularly assure itself that appropriate processes are functioning efficiently to supervise the risk to which the business is exposed and that the system of internal control is efficient in minimizing the risk to an acceptable level Strength and weakness of porcine solution pty internal control Strength The company depicts a strong internal control since; there is a coordinated system of recording where a transaction follows protocol before it is paid. It can be observed that there is proper documentation as well as stamping of the invoice before being guaranteed for payment. the account clerk enters the data and stamp the final copy which provide an evidence as to existence of goods supplied, this is a strong internal control over cash and stock which provides and assurance as to the system of internal control existing in them business. there is thus completeness, accuracy and consistency in recording which implies therefore that the accounts are in compliance with books of account which further provide assurance in placing reliance on the company system of internal control and financial report since there will be no over statement or understatement of books of account. Weakness. Since goods received are first inspected and acknowledge by the director, there is risk of fraud since, the director is the final in the business and may manipulate the recording in order to give false information about the amount of goods received. The account clerk is just a junior person in the company will thus record what has been given by the top-level executive devoid of judging its legitimacy. It can as well be observed that there is no departmentation as well as a delegation of duties and responsibilities. Under normal circumstance, the goods received must be acknowledged by the inventory department personnel and not the manger in order to ensure that goods in the store are properly document. This therefore process some weakness in the business, which will be an ideal for the executive to perpetrate frauds since, there is weakness in the internal control over inventory. in this regards, the business ensure that there is an effective delegation of duties as well as assigning responsibilities and duties to every department in order to ensure that there is effective internal control, system. Assessment of internal control and its effect on Audit Approach A depicted by the above issues in the internal control of the porcine solution, the audit approach will follows an in-depth analysis such as use of audit trail to check for existence of any frauds that might be perpetrated due to weakness in the internal control. The audit approach will be comprehensive and will as well as consider visiting the company during the stock take in order to ensure that the system of recording is efficient and reliable and as well as to confirm for completeness in recording by substantiating the balance in the store and the actual amount documented in the financial statement. The audit procedure will ensure that the relevance of delegation and accountability is fully functional and seems to, be followed so as to ensure that the company policy is fully adhered with. As a result, the audit approach for porcine solution Pty will be detailed and comprehensive in order to check for any material misstatement, as well as confirm the consistence of recording in the books of account as well as there is precise posting in order to get an assurance of the completeness in transaction and recording before giving a final audit opinion. Reference list Alvin A Arens, P. B. (2013). Auditing, Assurance Services and Ethics in Australia. Sydney: Pearson Higher Education AU,. Get Through Guides. (2007). F8 Audit & Assurance(Intl) - Study Text. Get Through Guides. Griffiths, M. P. (2012). Risk-Based Auditing. New york: Gower Publishing. Harrer, J. (2008). Internal Control Strategies: A Mid to Small Business Guide. London: John Wiley & Sons,. Larry Rittenberg, K. J. (2009). Auditing: A Business Risk Approach. New york: Cengage Learning. Pickett, K. H. (2006). Audit Planning: A Risk-Based Approach. New york: John Wiley & Sons. Read More