The Audit of the Multinational Listed Company ABC Ltd - Essay Example

 The Audit of the Multinational Listed Company ABC Ltd Abstract The audit of the multinational listed company ABC Ltd is fraught with irregularities. A few test checks reveal the weakest possible internal control, a breeding ground for frauds and even for unintended mistakes. The Australian accounting standards have been converged with the IFRS so that the multinational company such as this one having overseas operations will ensure uniformity in account treatment and avoid distortions to mislead investing public. The fact that the overseas unit’s of the entity under audit and the major shareholder have the same auditors M/S XYZ Ltd makes the audit more burdensome to ensure that there is no compromise in the audit. (1) Materiality level based on 2008 estimates ($’000) Sales Revenues for both the years are required for comparison and examining rate of the profits earned in 2008 in relation that of 2007. Audit notes for the previous year 2007 are required to check continuity and track down the trend. Current Assets Increase in inventory levels $ 35,724 and receivables $38,971 need to be compared with the increase in the sales revenue for the year 2008. Non-current Assets Abnormal items representing loss on sale of investments $ 17,050. Details of investments and sale are required to check against market value that prevailed at the time of sale and reason why they had to be sold at loss should be ascertained. There has been an increase of $ 77,318 in property, plant and equipment and $ 76,737 in brand names and a decrease of $ 13,595 in investments. The increase in the value of property, plant and equipment needs to be physically verified with reference to the relative purchase invoices and a comparison with market rates conducted. The increase in brand names also needs to be physically checked with new brand names acquired or it should be ascertained whether increase has been due to revaluation of the brand names. Policy regarding treatment of brand names in the balance sheet has been separately dealt with. As regards decrease in investments, it should investigated, the reason for there being no correlation with the loss reported and the decrease. Whether the values reported in the balance sheet represent cost of acquisition or market value has also to be ascertained. Current Liabilities The increase in creditors and borrowings represents an amount of $ 186,041. This is to be ensured against any possible inclusion of proforma purchase invoices without corresponding entry in the value of inventories. Policy regarding payment based on proforma invoices without receiving stocks has also been separately dealt with. The break up details of provisions is required to ensure whether previous year’s pattern has been followed this year. Besides the reason for the decrease of $ 48,631 needs to be obtained. Non-current liabilities The net increase of $ 44,240 in total non-current liabilities should be analyzed. While there is increase in creditors and borrowings, provisions have reduced. Whether there is under provision of liabilities to avoid possible reduction in profits or liabilities have been terminated requiring no further provisions, need to be ascertained. Net Assets Net asset has a net increase of $ 30,310 reflected by net increase as much in shareholders’ equity. This year substantial dividend has been paid to the tune of $53,274, the reason for limited increase in the equity. (2) Memo to Audit partner M/S XYZ & Co who have performed audit of this company’s (ABC Ltd) overseas operations are the auditors for another U.S Company who is major share holder (49%) in this company. The U.S. Company’s brand names have been purchased by ABC Ltd. Hence care should be had to ensure that value of the Brand names reflected in the balance sheet is worth that much. Whether purchase price has been converted into shares or share capital has been separately received in cash needs to be ascertained. As the auditing firm XYZ Ltd who happens to be the auditor for the major shareholder has performed the audits of ABC Ltd’s overseas operations, it should be ensured the major share holder company has not exercised influence on the auditing firm. (3) Procedures for verification of carrying value of brand names Brand names are intangible assets which AASB 138 defines as the ones that are identifiable, under the control of the entity under the audit and having future economic benefits. Thus the brand names as intangible assets shall be recognized if it can be ensured that they bring economic benefits to the entity and cost of the brand names can be measured. The auditor should obtain the list of brand names with individual values aggregating to the value shown in the balance sheet and also ensure that the entity has assessed probable shelf-life of the brand names as intangible assets. The auditor shall look for possible wrong inclusion of internally generated brands, mastheads, publishing titles, and those arising from internal research which AASB prohibits. Hence these items if included in the value of the brand names must be eliminated. As provided by the AASB 138 in Table 1, if the brand names have been separately acquired, the recognition should be at cost comprising of purchase price including import duties and taxes paid if any and net of trade discounts and rebates. The cost incurred such as employee cost, professional fees, and expenses for testing the assets’ effectiveness can also be part of the purchase price. If the brand names have been acquired as a result of business combination, fair value at the acquisition date shall be recognized. As it has been claimed that all the brand names have been acquired from the major share holder, the question of exceptional recognition of internally generated brand names as intangible assets does not arise. AASB also provides for amortization of intangible assets in a systematic manner for a pre-determined period of finite life of such assets subject to being derecognized or classified as held for sale as per AASB 5 relating to Non- current Assets held for Sale or Discontinued Operations. AASB108 also provides for review of amortization period at the end of every reporting period. Residual value is assumed as zero except when there is a commitment by a third party to purchase the brand name at the end of its life or if there will be an active market at the end of the asset’s useful life, residual value can be accordingly determined. The above factors are to be considered when auditing intangible assets consisting of brand names subjected to amortization. The AASB also provides that there is no need to amortize an asset if it has an indefinite useful life. But as per AASB 136, it will be subjected to impairment testing every year or when ever there is an indication that there has been impairment. The AASB states that an asset shall have an indefinite life when there is no foreseeable duration over which the asset is capable of generating cash flow for the firm. However AASB 108 states that there shall be review every year of the circumstances justifying the indefinite life criteria failing which change shall be made to arrive at a definite life. The brand names if derecognized and disposed of, the loss incurred if any can be recognized in profit and loss account on the occurrence of the de-recognition. If there is profit on disposal, it should not be recognized as revenue. Hence the auditor when dealing with brand names intangible assets should ensure disclosures for the finite or indefinite life of the assets concerned. There should be a disclosure of rate and method of amortization in case of assets having finite life. There shall be disclosure of gross carrying value, and accumulated amortized amount along impairment losses both at the beginning and end of the period. In the income statements, the brand name amortization if any shall be mentioned. The auditor should also ensure that reconciliation has been made from the carrying value at the beginning and at the end of the period in question. The auditor shall obtain from the entity the reasons justifying the indefinite useful life in case of assets not subject to amortization. If the brand names have restricted title or have been pledged as securities for liabilities, the fact should be mentioned in the audit report. (4) Reasons for disagreement with non-amortization The specific reasons have been provided for in the AASB 108 for reviewing indefinite life of the brand names. It is mandatory to review every year to ascertain the condition justifying the continuance of the indefinite life period of the brand names. Thus the auditor can give a qualified opinion for the brand names for which there were no sales for the year or continuously for certain years or for which there has been any litigation pending in the court. In principle also it can be argued that when tangible assets themselves are subjected to depreciation even if there is no apparent wear and tear, there is no reason why intangible assets of brand names having indefinite life can not be amortized. It can be argued that amortization can be resorted to in such cases for retaining profits to provide for future acquisition of brand names. The amortization by no means will be against the interests of the entity except for the purpose of valuation of the firm. This can always be offset as an off-balance sheet item in the entity’s financial statements. Since amortization avoids drifting away of funds, the auditor can qualify his opinion against the indefinite holding of the brand name in the balance sheet. (5) Audit strategy for stock valuation assumption at retail outlets AASB 102 deals with accounting treatment of inventories. It requires inventories to be valued on item by item basis at the lower of the cost and net realizable value. The cost includes purchase price, import duties, transportation and handling costs after deduction of trade discounts if any. If the net realizable value is lower than the cost so computed, then lower one shall be adopted. AASB 102 provides for retail inventory valuation by estimating their sale value minus gross margin. This is uncumbersome and easy to adopt and easy for verification. Stocks of all the retail outlets shall be planned to be verified at a time simultaneously so that no duplication of stocks can take place. Once physical quantity is ensured, valuation of the same can be done by adopting previous sale price reduced by gross margin. (6)Testing of company’s internal control 6(i). 2% of the test checked invoices could not be found in the records and another 2% was not initialed and approved for payment. It is quite possible that the invoices not found in the records might have been misplaced. If the relative stock has been received and accounted for in the inventory account, it can be allowed and duplicate invoice be obtained authenticated by the company. It is also possible that stock might not have been received but the invoices might have been paid which fact indicated possible fraud within the company. It is also possible that payments made to such invoices are outstanding as debtors unreconciled in the balance without being squared up for want of invoices resulting in also understatement of purchases. Further, for the two invoices not initialed and approved for payment, it could be due to non receipt of stocks and they may either be proforma invoices or possible inclusion of them in accounts for claiming payment by fraudulent means. Hence it should be checked whether they have been already paid. However 4% of the test checks as irregularity is sizeable and hence it could be concluded that internal control system is not effective. 6(ii) Again 4 out of 120 cards have been found altered with quantity delivered. Possibly it must have been short accounted so as to make room for pilferage. This is quite a serious one and of significant percentage indicating a weak internal control. 6(iii) One supplier’s invoices alone are being paid on proforma basis before supplies are received but accounted as purchases through proper entries in the creditors ledger. This is dangerous on two counts. One, the supplier if does not deliver the goods after payment, there is no check in place. In the test checks also not all such instances can be found out. Secondly if invoice are accounted in the purchases by entry through creditors ledger, it will result in overstatement of expenses and understatement of profits at a give time. This is again a weak internal control. This practice should be immediately stopped and any such proforma invoices for which goods have not been received should reversed in the relevant year under audit. 6(a) This fact of missing invoices, accounting of unauthenticated invoices in the inventory account is a serious pointer to the weak internal control and also an indicator that similar practices may be in vogue in respect of other expenditures of the profit and loss statement. Hence the auditor will do well to choose a range of continuous period and subject all items to check without exceptions. If it results in more revelations, then the auditor can conclude that the internal management is not effective and manned by possible fraudulent persons. Cash also may be affected by similar inadequacies. 6(b) The fact that the practice of proforma invoices being accounted and paid before receipt of supplies has not been discontinued in spite cautioning of the same in the previous year shows the deliberate attempt on the part of the internal management to favor a particular supplier which can lead to undesirable consequences. Hence the supplier should be blacklisted and the official involved should be transferred. If the supplier happens to be a monopoly source and he can not replaced, strict instruction should be given to record payment as advance payment debiting his account and purchase account debited and his account credited only after his goods are received and proper tax authenticated invoice is obtained. It is also quite possible that the supplier is trying to evade tax payment and such instances of proforma invoices being paid also will not be allowed by the income tax authorities leading to severe penalties on the entity. 7(i) & (ii). The weakness in the system is that there is no output in the batch update program leaving it open to manipulation at any time before payroll is prepared. Besides, common password and user ID have a potential for misuse by the payroll staff by altering the records of some of employees who may pass on some benefits to the payroll staff for helping them. Hence in order to avoid possible manipulations, output should be taken as and when inputs are keyed in so that it will not give room for payroll staff to make changes to the records even if ID and password are common. Secondly, if the ID and passwords are unique to each payroll staff, it will effectively prevent them from making changes in the payroll rates in an unrelated employee’s records. But to prevent the payroll staff from altering the pay rates of their own allotted employees, the payroll rates should be arranged to be entered by the HR Manager which should not be capable being altered at the lower levels. Bibliography Australian Accounting Standards (AASB post-2005) retrieved October 8, 2008 Read More