Different Accounting and Financial Situations for Auditor - Case Study Example

Audit Name Course Name and Code Date Introduction The role of an auditor is to form an opinion on financial statements on whether it is free of material misstatement and reasons behind the misstatements: for example, due to error or fraud. At the conclusion of the auditing, the auditor can offer objective advice for adjusting the internal controls and financial reporting to maximise an organisation’s effectively and performance. Auditors are exposed to different financial obligations and the auditors have to make qualified decisions based provided information and experiences and skills of the auditor. The aim of the paper is to analyse different accounting and financial situations to determine an approach an auditor can employ to solve the issue or provide appropriate advice. Case 1 a. Purpose of Detect Controls Christ et al. (2012) state detective controls are formulated to detect and correct misstatements that have occurred or have been entered into the system. The advantage of detective control is easier and cheaper to perform and design. However, the negative of detective control is performing its duties after the fact (Tagesson and Eriksson, 2011). The absence of timely implementation of detective control means that it is difficult to identify the misstatements or remains in the accounts records for long periods. b. Importance of Both Types of Control It is crucial to have both types of control to tightening or reduce the chances of misstatements. The aim of prevent control is to ensure the misstatements are identified before occurring or preventing the issue before processing of the transaction. The importance of preventive control is timely and help ensure that the misstatements are not recorded from the beginning (Hammersley, 2011). However, the formulation and implementation of the preventive is costly but it is important to have both systems since the entire operational costs may be lower compared with fraud that may occur (Tagesson and Eriksson, 2011). Having both controls, it protects the accounting system from identifying error or misstatements before being recorded, while the detect controls correct inputs that were wrongly classified or entered and passed the preventive stage. It means the entire system has been strengthened through the increase of security measures and reducing the chances of risks. c. Assume Brown Industries Ltd Auditor’s Review Auditor’s Conclusion The auditor finds ineffective preventative systems in place or the entire process is ineffective. The aim of the preventive system is to address an issue before occurring but since it has occurred it means the system may be faulty or the procedural process is defective (Tagesson and Eriksson, 2011). For instance, the current approach requires authorisation by the credit manager in increasing the credit limit. The auditor may conclude the credit manager may have approved the increase in credit limits or the system was unable to detect the two transactions: maybe, there are even additional sales above the credit limit. Additional Evidence to Conclude the Prevent Control is Ineffective The following are some of the evidence the auditor has to consider: Checking processes and procedures in place – the auditor show reviews the control process and check the reasons contributing to exceeding the credit limits (Leung, Cooper and Perera, 2011). It includes following paper trail or movement of the transactions from the sales persons to releasing the products. The process enables identification of persons who handled the transaction and their respective contribution towards the fact. The role and contribution of different employees including management in control measures e.g. the credit manager – the credit manager have the overall responsibility of adjusting the credit limits (Omoteso and Obalola, 2014). The auditor has to engage the credit manager to determine whether the credit manager approved the transaction. If the credit managers affirm both transactions, it may mean the preventive control operates effectively. Historical analysis of Brown Industries Ltd with the customers who have exceeded the limit – the aim is to check all the transactions approved and above the credit limit. The aim is to determine whether the approval is routine and meets the policy in place and whether the credit manager played a role in authorisation (Omoteso and Obalola, 2014). It also includes sampling the data to understand overall sales behaviour and whether it meets other accounting objectives, and influence on accounts recording. Case 2 a. Analysis of Issues: Error or a Judgmental Misstatement The sales transaction is a judgemental misstatement. The transaction of $1,200,000 is large and affects the entire financial statements and has to be readjusted. It is a judgemental misstatement because the sales transactions should be reported as a transaction for the next year since the books are closed in June 2016 (Tagesson and Eriksson, 2011). The impairment of asset is an error and the management should have included the adjustments for the “drought-induced recession” or estimates for similar problems. Lin et al. (2011) advice the accounting process should be complete and query any transaction relative to impact to the financial statements. It is an error because it was not intentional, and there is a possibility after the drought, the value of the buildings would increase (Tagesson and Eriksson, 2011). The auditor should engage with the management and highlight the problem and inform on the overall impact to the transactions, and overall financial statements (Bowlin, Hobson and Piercey, 2015). The management will then propose the appropriate measures to address the issue. b. The Accounts Affected First part: sales transaction The balance sheet – it is a liability because the goods or services have not been offered. The argument is attributed to the proposal that the data should be recorded on 1st July 2016. Sales transaction accounts – the sales transactions has been misreported in that the period of sales is different to the actual delivery of the products and services (Omoteso and Obalola, 2014). Profit and loss accounts – the sales affects the profitability of an organisation since the more sales, it means more profits. It means the profit is overestimated and the accounts have to be adjusted to reflect the misreporting. Second part: impairment Balance sheet – the value of the assets are affected because the drought recession affected the value of the land and buildings (Tagesson and Eriksson, 2011). Income statement – the difference in reporting affects the profitability of an organisation since the impairment reduces the profits. c. Recommendations for Each Item For the sales transaction, updating the financial statements and transaction accounts is important. Update of the sales transaction accounts, the profit and loss accounts and the balance sheet should be updated (Omoteso and Obalola, 2014). Without updating these accounts, it affects the following year financial statements because the sales are attributed to a different financial period (Tagesson and Eriksson, 2011). In addition, the auditor has to provide notes about the issue to ensure the misstatement is not repeated in future transactions and accounts. For the impairment, Wood, Brown, and Howe (2013) opines that it is important to carry out testing for recoverability and determining the carrying value and fair value. The reason behind the decision is that the impairment loss is reported differently in the financial statements when compared with the approach taken in the test for recoverability (Tagesson and Eriksson, 2011). Instead of employing subtraction of future cash flow from the carrying value, it is imperative to subtract its fair value: the fair value refers to the current price or value of the asset (Omoteso and Obalola, 2014). These changes have to be reported on financial statements: income statement and balance sheet. On the income statement, the impairment should be reported on the operating income and expenses while in the balance sheet information should be updated through the use of fair value (Tagesson and Eriksson, 2011). Conclusion The efficiency and effectiveness of financial statements of an organisation lie in independent analysis and review. An auditor has the skills and experiences to review the financial statements and determine whether the financial and accounting records are documented appropriately. An auditor may find problems and shortcomings after reviewing the financial statements, and the auditor has the responsibility to provide objective advice. For example, the presence of different controls such as preventive and detective aims to report an issue before been recorded or highlight an issue after been reported. The management and accountants sometimes can inappropriately record or report financial activities such as impairments and sales transaction, and it is the role of the auditor to find the problem and provide advice on approaches to prevent the issue from happening again. Hence, an auditor is an important entity to an organisation because the individual provides objective advice and review of financial statements and accounting records. References Bowlin, K.O., Hobson, J.L. and Piercey, M.D., 2015. The effects of auditor rotation, professional skepticism, and interactions with managers on audit quality. The Accounting Review, 90(4), pp. 1363-1393. Christ, M.H., Emett, S.A., Summers, S.L. and Wood, D.A., 2012. The effects of preventive and detective controls on employee performance and motivation. Contemporary Accounting Research, 29(2), pp. 432-452. Hammersley, J.S., 2011. A review and model of auditor judgments in fraud-related planning tasks. Auditing: A Journal of Practice & Theory, 30(4), pp. 101-128. Leung, P., Cooper, B.J. and Perera, L., 2011. Accountability structures and management relationships of internal audit: An Australian study. Managerial Auditing Journal, 26(9), pp.794-816. Lin, S., Pizzini, M., Vargus, M. and Bardhan, I.R., 2011. The role of the internal audit function in the disclosure of material weaknesses. The Accounting Review, 86(1), pp.b287-323. Omoteso, K. and Obalola, M., 2014. The Role of Auditing in the Management of Corporate Fraud. In Ethics, Governance and Corporate Crime: Challenges and Consequences (pp. 129-151). Emerald Group Publishing Limited. Tagesson, T. and Eriksson, O., 2011. What do auditors do? Obviously they do not scrutinise the accounting and reporting. Financial Accountability & Management, 27(3), pp. 272-285. Wood, J., Brown, W. and Howe, H., 2013. IT Auditing and Application Controls for Small and Mid-Sized Enterprises: Revenue, Expenditure, Inventory, Payroll, and More (Vol. 573). London: John Wiley & Sons. Read More