One Tel Company Inherent Risks - Case Study Example

Case Study: One Tel Company Name: Unit Name: Lecturer: Date of Submission: The inherent risk is one of the elements in the audit risk model. The other elements are control and detection risk. The overall audit risk entails the product of all various risk encountered during the audit engagement. The inherent risk is material misstatement in the financial statement emanating from error or omission due to factors other than the failure of internal controls (Botica Redmayne, 2012). The assessment of inherent risk involves analysis of client’s business on how it is susceptible to the financial statement assumptions to material misstatement. The auditor does not have control over the actual level of inherent risks since they are independent of auditor’s assignment (Botica Redmayne, 2012). The ASA 200 restricts the definition of inherent risk to a material misstatement of financial reports and account balances (Botica Redmayne, 2012). Therefore, inherent risk involves assessment of business strategies, business environment and the approach in which financial reporting and recording of account balances. The ‘going concern’ entails the determination of continuity of the discussions in the foreseeable future (Fiedler, 2005). The assumption demonstrates company’s ability to meet current and future commitments, objectives and obligation when they fall due. The analysis of One Tel Company case study will give an insight factors that contributes to inherent risk and extent of the impact it has on the company. Also, the analysis of the case study provides the level of inherent risk in influencing the going concern and classification as either low, medium or high. Factors that contributed to increased inherent risk assessment at the financial report level. The factors that would have contributed to an increase in inherent risk assessment at the financial reporting level includes limited managerial experience, strength and transparency of corporate governance, global operation, competitiveness in the telecommunication industry, the difference in accounting standards and jurisdiction. The analysis of the above factors is as discussed below; First, the strength and transparency of the company’s corporate governance are in question since the company failed to adapt to the changes experienced in the industry. The corporate governance risk has an immense impact on the shareholders objective i.e. wealth and profit maximisation. The weak corporate governance attracts the chances of directors to fail to act in the best interest of shareholders of the firm (Fiedler, 2005). There is an agency relationship between directors and shareholders guided by the corporate governance structure. The company’s corporate structure should be monitored and evaluated continuously and thus encourage complacency regarding charting the way forward for the company. The one Tel Company must ensure that the strength of its corporate governance is checked to reduce the impact of inherent risk arising from poor stewardship. The increase of the composition of the board of governance for One Tel Company will mitigate the risk. The current composition of five non-executive and four executive board members is inadequate. The poor governance increases the strategy execution risk since there his limited control in executing company objectives. Companies fail from lack of strength and transparency regarding the corporate governance i.e. the collapse of Enron Bank due to failure to spot and tame aggressive trading by its chief finance officer (Henriques, 2001). Also, several banks experienced financial difficulty during 2007/2008 global financial crisis due to the failure of corporate governance in implementing due diligence procedure in advancing loans. The policies and regulation have been put in place to guide and improve the strength of corporate governance by government i.e. Sarbanes-Oxley Act of 2002 by US government. Therefore, corporate governance risk reduction is paramount for the One Tel. Secondly, the limited managerial experience for the company operating in telecommunication industry exposes the company to high inherent risk. The managers are supposed to portray high competence in discharging their day to day duties as well as advising top management on how to manage industry dynamism effectively. The competence of managers plays a crucial role in the implementation of a robust internal control system within the company which can detect and adjust as per the change in business environment (Gay, & Simnett, 2010). Therefore, One Tel should ensure that its managerial team has required and sufficient experience in telecommunication industry to enhance business continuity and competitiveness in a rapidly changing business environment. The ability to develop and implement sound strategies determines company’s future since customers’ preference is dynamic. Kodak and Nokia companies are a good example of the companies that failed as a result of an inability to maintain its market share due to failure to adjust to technological changes and thus increase exposure of strategic risks. Therefore, failure to increase the number of the experienced managerial team might impair the going concern of the company despite its current position as the leading and monopoly dominant in the telecommunication industry. One Tel Company needs to tackle the issue to minimise exposure to strategic risk and plunging into Kodaks and Nokia situation. Thirdly, the global operation increases inherent risk due to high complexity in accounting for the financial reports. According to Fiedler (2005), the international business faces several foreign risks which include translation, transaction and economic risks. The translation risk arises in the determination of the exchange rate to be used in converting the financial report to home currency. Therefore, unscrupulous employees can use the complexity of exchange rate in translation to defraud the company. The operation in different regimes increases the inherent risk that arises from different laws and regulations. The violation of the laws and regulation result in a high penalty or shut down by relevant bodies thus loss of investment. On the other hand, transaction risk arises from purchase and sale of goods or services with companies in different currency zones i.e. loss incurred as a result of appreciation or depreciation of the home currency in respect to foreign currency depending on the nature of the transaction (Fiedler, 2005). The risk arises from the fact that the company is exposed to the risk of currency fluctuations since it carries out business in regions with different currencies such as UK, France, Netherlands and Hong Kong. The complexity encourages the misrepresentation of the financial reports and illegal activities. Consequently, the company would consider using hedging tools such as derivatives to minimise the impact of transaction risk. However, the derivate is complex instruments which confuse finance and accounts personnel in accounting since their value is derived from underlying assets. The Enron Bank collapse due to the aggressive trading of derivative instruments and thus led to massive loss of money on energy-swap (Henriques, 2001). Also, Lehman Brothers Holdings, Inc failed due to the same problem of aggressive trading on derivative instruments. Also, the company regulation significantly varies in several countries and thus recording tax and other government obligation might attract financial reporting misinterpretation. Fourthly, the competitiveness of the telecommunication poses a high inherent risk The deregulation of the industry in 1st July 1997 increased the number of competitors and pulling out of major companies who used to lease company’s infrastructure. The industry has more than 35 carries who have given the company competition. The case study shows that the industry has seen a constant growth but does not correspond to revenue growth due to greater competition, price reduction and lower revenue per company. Also, the company moved from profitability of $9.1million in 1999 to loss of $282.1million in 200. The reduction in profitability has an enormous impact on the future of the company since lower margin or loss limits the company ability to meet commitment and obligation as they fall due (Hardy, 2015). These expose the company to high inherent risk since profitability enables the company to expand and remain as a going concern. Lastly, the global operation exposes the company to use different accounting standards which increase inherent risk during the consolidation of financial reports. Therefore, One Tel Company should adopt uniform accounting standards to reduce material misstatement during the consolidation of the parent and subsidiary financial reports. The material misstatement imparts wrong decision by investors, creditors, and other users since they are the biggest users of financial information (Hardy, 2015). According to the analysis above, it is noted that the more profound factor that subjects the company to high inherent risk is limited management experience and weak corporate governance structure. These two factors are involved in study future economic trends of the industry and formulating strategies that ensure that One Tel is responsive to changes in the business environment of telecommunication. These inherent risk factors are identified at the strategic business risk assessment since it is involved in the formulation of long-term plans of the company. The inherent risk factors that would have contributed to an increased inherent risk assessment at the account balance level The international operation of the company would have resulted in increased inherent risk at account balance level (Vallabhaneni, 2013). The management of several branches creates an avenue of fraudulent employees to steal from the company due to lack of close management. Also, the difference in currencies and accounting standards increases the susceptibility misrepresentation of account balances and hide the malpractices in company branches. Therefore, the confusion created by posting account balances posted to final books of account and thus failure to provide a clear picture of the financial performance and position of the company. The complexity in posting balances during the consolidation of the financial statement would have resulted in increased assessment of inherent risk at account balance level (Vallabhaneni, 2013). The unscrupulous employees can take advantage of the complexity for personal interest and thus defy the agency relationship between the management and shareholders. For example, the aggressive trading in Lehman Brothers Holdings, Inc and Enron case was as a result of the complexity of financial reporting. The complexity gave fraudulent directors a chance to hide malpractices until a point where the company was unable to meet its day to day operation due to liquidity problem (Henriques, 2001; Hera, 2010). Therefore, One Tel Company needs to develop a strong and clear accounting system to reduce malpractices. The weak accounting system increases inherent risk facing the company during the posting of account balances. The company recorded a loss of $282.1million from the previous profit of $9.1million for the consolidated statement. The discrepancy in reporting would have resulted from window dressing which entails posting of understated debtors balances to hide dismal performance of the company. Lastly, the high volume of the transaction recorded by the company would have increased the assessment of high inherent risk in posting account balances (Law, 2008). The company ability to monitor and review each transaction for its branches in more than six countries is not possible and thus weak accounting system can employees an opportunity to post wrong balances without getting noticed by the parent company. Therefore, One Tel Company should work on improving internal controls on its accounting system to enhance the effectiveness of counter check mechanisms. Going Concern Assessment The going concern assumption is auditor’s opinion that the company can meet its commitments, obligation as they fall due in the foreseeable future (Vallabhaneni, 2013). The assessment of internal factors affecting the financial reporting and account balances shows that the going concern of One Tel Company at a medium level. The company profitability has significantly reduced despite the growth of telephone users and thus showing that competitors are eating on company’s market share. Therefore, the company is on the verge of losing its position as the market leader in the telecommunication industry. However, the company still has an opportunity to improve its strategies to regain the lost market share, reduce cost operation and reducing currency risks through the effective use of hedging tools. Despite the loss, the company has positive cash flow which shows that company can meet its obligation and maintain reasonable liquidity (Law, 2008). The company needs to improve on the following factors to improve rating of its going concern; Improve the company’s accounting system to reduce errors when posting account balances and financial reports. Increase the number of competent managerial team to ensure that the company remains competitive and innovative. Use hedging tools and educate its account and finance department on relevant standards governing its recognition, measurement and reporting. Employ uniform accounting standards in parent and subsidiaries to reduce confusions and chances of material misstatements. Reference: Botica Redmayne, N. (2012). Essentials of Auditing, Assurance Services & Ethics in Australia: An Integrated Approach20121Essentials of Auditing, Assurance Services & Ethics in Australia: An Integrated Approach. Massey: Massey University 1st ed. Journal Of Accounting & Organizational Change, 8(1), 120-122. Fiedler, B. (2005). Student guide to accompany auditing and assurance services in Australia (1st ed.). Frenchs Forest, N.S.W.: Pearson Education Australia. Gay, G., & Simnett, R. (2010). Auditing assurance and services in Australia (1st ed.). North Ryde, N.S.W.: McGraw-Hill Education. Hardy, K. (2015). Enterprise Risk Management (1st ed.). San Francisco: Jossey-Bass. Henriques, D. (2001). ENRON'S COLLAPSE: THE DERIVATIVES; Market That Deals in Risks Faces a Novel One. Nytimes.com. 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