The Standard Statutory Audit - Essay Example

Requirement Prepare preparatory s to support presentations to Chan's that include: a) legal rules relating to the sta y audit - including the small companies exemption and corporate governance requirements. 10% The legal rules for the statutory audit include the international accounting standards set by the international accounting standards board. b) the nature, purpose and scope of the external audit and the difference between the statutory audit and the independent financial review. 15%. external auditing is characterized by the hiring of independent minded external auditor to give an opinion as to the fairness of the financial statement items. the purpose of external auditing is to give credence to the financial statement assertions prepared by the management of the company. the scope of the external audit is determine is to implement generally accepted auditing standards. The auditing standards pertain to the standard of field work, general standards, and standards of reporting. Financial reviews are not accepted as part of the financial statements. the statutory audit report is a must for the company in the presentation of their balance sheet, income statement and statement of cash flows. The standard statutory audit is characterised by an auditor performs normal auditing procedures to show that the financial statements are more credible than if no external auditor's opinion is attached. The statutory audit is implemented in order to prevent frauds and illegal acts. As proof,Enron's income statement was window dressed. The company had recorded sales transactions that had never happened. Consequently, these fraudulent transactions would translate to higher sales. Higher sales would give a higher net income. a higher net income would give us a higher net assets. a higher sales would generate a higher stockholders' equity. In addition, the company did not record some of its losses. Enron had fraudulently window -dressed by presenting these Enron losses as losses of its off -shore companies. as a result, the unrecorded losses resulted to a net income that is higher than what the real net income should be. Convincingly, Enron's income statement was window dressed (Fusaro, and Miller 2002, 107) Also, Enron and Arthur Andersen knew that recording fictitious sales and profits would increase stockholder investments. Enron and Arthur Andersen knew that recording fictitious sales and profits would increase stockholder investments. The senior management officers connived with the accounting officers of Enron to prepare the fraud -laden financial statement in complete violation the harmonization standards set by violating the international accounting standards accomplish this fraudulent goal. Clearly, Enron and Arthur Andersen knew that recording fictitious sales and profits would increase stockholder investments (Madrick 2002). urthermore, the WorldCom and Enron accounting scandals are two of the reasons that triggered the approval of the Sabarnes -Oxley Law. The company was a communications company that had risen to profitability during the 1990s. However, the company found its profitability had slowly declined in the early 2000s. This is the largest accounting scandal in history. The officers of WorldCom entered tried to window dress their stock market price. The company's stock market price had decreased because company profits started to decline. The officers, specifically CEO Bernie Ebbers and CPA Scott Sullivan had to prepare false financial statements indicating that their sale and profits were higher than the real sales and profits would show in order to stave the decline of its stock market share price Zekany, Braun, and Warder 2004). Similar to Enron, the company's external auditor, Arthur Andersen, did not comply with generally accepted auditing standards to prevent or curtail material misstatements of the income statement and the corresponding balance sheet. The WorldCom fraudulent activities occurred from 1999 to 2002 (Ettredge et al., 1). Convincingly, the WorldCom and Enron accounting scandals are two of the reasons that triggered the approval of the Sabarnes -Oxley Law (Stack 2003). Statutory audit includes : 1. understanding of business, 2 identify management controls, 3. are controls appropriate and effective, 4. assess residual risk and substantiate opinion. Further, Enron's liabilities were also window - dressed. Enron violated generally accepted accounting principles established in the United States and the International business scene. Enron's window -dressing occurred in this category when the company presented its liabilities in the balance sheet at a lower amount than what the actual liabilities figures should be(Chandra et la.,231). The company recorded many of its liabilities as the liabilities of its off -shore businesses outside the United States. This non - recording of the company's real obligations gave a false impression that its obligations to outside parties were lower than what the actual figures should be. As a result, this presented a better picture of the company than what the actual accounting figures should be. Clearly, Enron's liabilities were also window - dressed (Fox, 59). Explain: a) The purpose of the threshold placed on a single audit fee as a proportion of total audit fees. 5% The threshold fee on a single audit fee as a proportion of a total audit fee is done as a basis for the number of hours spent for auditing each every audit assignment. For example, assigning a large audit fee to work done on accounts receivable that is twice the amount assigned to audit of office equipment shows that the auditor must exert extra effort to the accounts receivable amount because there are large accounts receivables to be positively confirmed. b) An appropriate basis for audit fee setting and any issues you feel may arise through competitive tendering. 5% A good basis for audit fee setting is the per diem basis. Here, the auditors will be paid based on an hourly rate. Sometimes, the audit engagement includes a basic audit fee plus an additional hourly audit fee for work done in excess of the agreed time cap for each audit program (Citron, and Taffler 2004). Requirement 2 Discuss any matters you may feel arise from the information provided above. Your discussion should include consideration of : a) family links between auditor and clients. 5% The auditor must have an independent mind. The auditor's independence may be decreased if his wife or children are clients, suppliers, stockholders, or loan recipients of the company being audited. In this case, the auditor must beg off from the engagement and request that another auditor take his or her place. b) internal control systems and their effectiveness. 5% The auditor must determine if the internal control system of the company under audit will be able to deter any fraud or error to take place. A strong internal control system effectively signals the auditor that his audit program will be lesser in terms of time as compared to auditing a company where the internal control is not so effective in eradicating fraud and error. Frauds are intentionally made whereas errors are unintentionally made. 1. the audit expectation gap and the purpose of the letter of engagement. 5% The audit expectation gap is the amount of field work that the audit has to perform in return for earning audit fees. the letter of engagement sets forth in detail the specific audit procedures, scope, fees, and other related audit details that the client will help the external auditors retrieve. the auditors in turn will present his or her audit report regarding the financial statement assertions rights and obligations of the company. 2.2. Prepare the letter of engagement for the approval of the board of Chan's dated 25th august, 2008. 10% Adam, Smith & Co., External Auditors August 25, 2008 This engagement letter is to confirm our arrangements for our audit of your company for the period covering..... we will conduct our audit in accordance with generally accepted auditing standards. Our audit procedures will include gathering material evidences through physical observation, computing, vouching, validating, confirming and other related audit procedures. The audit program will center gathering sufficient competent evidential matter that are both valid and relevant on the determination of the fairness of the financial statements in terms of existence or occurence, completeness, rights and obligations, valuation or allocation & presentation and disclosure. Our examination will begin on October 1 to 5, 2008. Our initial audit fee is &500 plus &20 per hour in excess of the total audit time cap of forty hours. The objective of our audit is to determine if there are no material misstatements of the individual accounts enumerated in the financial statements prepared by your company. Our responsibility is to express an opinion on the financial statements whereas the financial statements are the audit client's responsibility alone. Very truly yours, Adam, Smith & Co., Accepted by Date: ------------------- Part 3 Assuming date is Oct 15, 2008. Based on Sept 30, 2008 FS given to auditor, additional information (appendix A and B). Requirement 3 a) Extract and analyse any information that you may feel relevant for the purposes of analytical review and audit risk (show computations). 15% Based on your financial statements presented to us, the top twenty percent of your accounts rank according to the largest amount to the lowest amount. This will be taken from the general ledger of each accounts in the balance sheet and income statement. This twenty percent will serve as a basis to determine whether more audit time will be spent on such accounts (Hollingsworth, and White 1999, 91). b) Explain the importance of dis -aggregation as part of analytical review. 5% Dis -aggregation is a very important auditing procedure included in the analytical review. Here, the audit staff will analyze each account title in the financial statements. Then, the percentage of errors or fraud found in each account title will be compared as a whole to determine if the entire financial statements are materially misstated or fairly stated. Next the audit staff will present their audit findings to the on -site audit leader for guidance and peer review. Lastly, the audit partner at the head office will sign the audit report after reviewing the audit findings of the on site (working in the client's premises) audit team (Power 1997, 63). The audit plan will take a risk -based approach and the following statistical risk assessment has been produced: audit risk 5%, inherent risk 25%, control risk 80%. a) list and define the four risk elements of audit (include evidences for each element.) 5% a1. criteria. audit time will be focused more on accounts that are inherently high audit risks. The high risk items include cash, accounts receivable and inventory. the inherently low audit risk items are buildings and large factory equipments. a2. condition. More audit time will be exerted to determine on the existence of rights of assets. For example, equipments that are fully depreciated but observed by the auditor to be still being actively used in the company's daily operations should be kept in the books under other assets. all research and development cash outflows should not be capitalized but expensed outright. a3. cause. The auditor must determine the possible causes of misstatements of assets, liabilities and capital. possible causes could be non recording of new assets or non recording of asset disposals. a4. effect. Only the top twenty accounts in the cash, accounts receivable and other financial statement accounts should be be audited first. Additional audit steps should be undertaken if glaring irregularities occur in one account to determine the extend of the fraud or error and its effect on the fairness of the financial statement items. b) calculate detection risk from the above data and explain the implications of the result. 5% detection risk = audit risk /(inherent risk x control risk) = 5% /(25% x 80%) = 25% 3. Being aware of Jean Marshall's internal audit aims for the organisation, a) Describe the circumstances where the external auditor may use the work of others as a means to obtaining audit evidence. 5% The external auditor may use the work done by the internal auditor or an expert in a field that outside the expertise of the chartered accountant. However, the external auditor must take full responsibility and not pin the blame for any unfavorable effect caused by relying on the internal auditor or outside expert. An expert in another field could be a doctor, engineer, computer programmer and the like. In short, the external auditor must verify through application of audit steps like confirmation and physical inspection to assured that the other person's work is reliable. b) Discuss the extent to which you might use Jean's work. 5% As external auditor, i will use all of Jean's internal audit work as a jump off point. I will scan her internal audit findings and choose twenty percent of the items she audited starting from the largest monetary amounts to the smallest. This will reassure me that i had done my part as an external auditor and will take full blame for any audit debacle because of my reliance on Jean's work (Whittington, Graham, Fischbach, and Ahern 2006). Works Cited Citron, David B., and Richard J. Taffler. 2004. The Comparative Impact of an Audit Report Standard and an Audit Going-Concern Standard on Going-Concern Disclosure Rates. Auditing: A Journal of Practice & Theory 23, no. 2: 119+. Hollingsworth, Kathryn, and Fidelma White. 1999. Audit, Accountability, and Government. Oxford: Clarendon Press. Power, Michael. 1997. The Audit Society: Rituals of Verification. Oxford: Oxford University Press. Whittington, Ray, Lynford Graham, Gretchen Fischbach, and John Ahern. 2006. Advancing the Audit Documentation Standard: Auditors Must Leave a Clear Record in Private Company Audits. Journal of Accountancy 201, no. 6: 64+. Chandra, Uday, Michael L. Ettredge, and Mary S. Stone. 2006. Enron-Era Disclosure of Off-Balance-Sheet Entities. Accounting Horizons 20, no. 3: 231+. Ettredge, Michael L., Chan Li, and Lili Sun. 2006. The Impact of SOX Section 404 Internal Control Quality Assessment on Audit Delay in the SOX Era. Auditing: A Journal of Practice & Theory 25, no. 2: 1+. Fox, Loren. 2003. Enron: The Rise and Fall. Hoboken, NJ: Wiley. Fusaro, Peter C., and Ross M. Miller. 2002. What Went Wrong at Enron: Everyone's Guide to the Largest Bankruptcy in U.S. History. Hoboken, NJ: Wiley. Geisst, Charles R. 2004. Wall Street: A History : from Its Beginnings to the Fall of Enron. New York: Oxford University Press. Gill, Lawrence M. 2007. IFRS: Coming to America What CPAs Need to Know about the New Global GAAP. Journal of Accountancy 203, no. 6: 70+. Glassman, James. 2003. Show Stockholders the Money. The American Enterprise, April/May, 16. Kinney, William R. Jr. 2000. Research Opportunities in Internal Control Quality and Quality Assurance. Auditing: A Journal of Practice & Theory : 83. Madrick, Jeff. 2002. Report of Investigation by the Special Investigative Committee of the Board of Directors of Enron Corp. Challenge 45, no. 3: 117+. Marlowe, Justin. 2007. Costs of Compliance with Generally Accepted Accounting Standards. Public Management, August, 17+. Penman, Stephen H. 2003. The Quality of Financial Statements: Perspectives from the Recent Stock Market Bubble. Accounting Horizons 17: 77+. Rittenberg, Larry E., Frank Martens, and Charles E. Landes. 2007. Internal Control Guidance: Not Just a Small Matter. Journal of Accountancy 203, no. 3: 46+. Surdick, John J. 2005. Accounting Principles. Issues in Accounting Education 20, no. 2: 218+. Thomas, C. William. 2002. The Rise and Fall of Enron; When a Company Looks Too Good to Be True, It Usually Is. Journal of Accountancy 193, no. 4: 41+. Read More