Importance of External and Internal Auditors in Reducing the Errors in the Financial Statements - Essay Example

INTRODUCTION: There is a saying that accounting is the language of business. This is definitely true because the different users of the financial statements need them for their decision making activities. However, some scrupulous accountants and /or company officers are serious in their scheme to present financial statements in clear deviation from international accounting standards. The company is then required by many of the financial statement users to present an external auditors report to add some credibility to the amounts stated in the financial statements. The following paragraphs explains the importance of external auditors as well as internal auditors in the reducing or even eliminating the errors and frauds that stain the financial statements. The first step that the auditors do is to base their audit programs on the inherent risk of each item listed in the financial statements . This topic will further be explained in the following paragraphs(Courtney, Briggs,2004, p139). BODY: Part 1 40%. Collect and analyse information on non-financial aspects of inherent risk like, for example, company: Qantas Airways http://www.corporateinformation.com/Company-Snapshot.aspx?cusip=C036P1730 The company is owned by stockholders. Stockholders can invest their hard earned money in Qantas Airways Ltd. by just visiting the Australian stock exchange and paying for the number of shares of stocks pegged at the hours stock market share. Products. Qantas Airways Limited. is engaged in the transport of air passengers and cargo. The company provides international, domestic as well as internal or regional transport of air passengers and cargo In Australian airspace as well as outside Australia. The company also is engaged in other business activities aside from ferrying human beings from one corner of the world to another. The other financial activities include subsidiary investments in QantasLink and Jetstar. The company is also engaged in the business of inflight catering as well as holiday and travel activities. The income statement for the past three years shows: REFERENCE: http://au.finance.yahoo.com/q/abs?s=QAN.AX The above income statement shows that the expenses generated for the year ended June 2007 was 12,756. And, the expenses generated for the year ended June 2007 was 11,593.50 Plus, the expenses generated for the year ended June 2007 was 10,757.70. The inherent risk of this accounting item is that one or more of the accounting staff could recorded an expense in the journalisation stage of the accounting process when there is no right for such recording to occur. Generally accepted accounting principles and international accounting standards states that expenses should be recorded only if the corresponding use of an asset has also occurred. In addition, the accountant could have recorded an expense such as salary expense giving the impression that an employee had been paid. However, the truth of the matter is that the accountant or the owner pocketed the amount equal to the salary expense. In the same manner the accountant could have recorded an expense such as representation or entertainment expense in the accounting records even though there is no official receipt to vouch for the validity of such expenses. In addition, the accountant could have recorded the expenses for the year ended June 2007 as such in error. This shows that there is an inherent risk in the recording of the expenses amounting to over 12,756 Australian dollar for the year ended June 2007. In addition, the accountant could have recorded the expenses for the year ended June 2007 as such in error. This shows that there is an inherent risk in the recording of the expenses amounting to over 12,700 Australian dollar for the year ended June 2007. In addition, the accountant could have recorded the expenses for the year ended June 2006 as such in error. This shows that there is an inherent risk in the recording of the expenses amounting to over 10,000 Australian dollar for the year ended June 2005. The above income statement shows that the earnings before interest taxes and DA generated for the year ended June 2007 was 2,409.70. And, the earnings before interest taxes and DA generated for the year ended June 2006 was 2,053.20 the earnings before interest taxes and DA generated for the year ended June 2005 was 2,221.70. The inherent risk of this accounting item is that one or more of the accounting staff could intentionally no record a revenue transaction in the journalisation stage of the accounting process when there is no right for such recording to occur. Generally accepted accounting principles and international accounting standards states that revenues should be recorded only if the corresponding use of an asset that includes riding the Qantas airlines has actually occurred. In addition, the accountant could have recorded an expense as revenues in errors giving the impression that a new customer had sold an airplane seat for the journey to Adelaide. However, the truth of the matter is that the accountant or the owner pocketed the amount equal to the revenue that had not been recorded. In the same manner the accountant could have recorded an expense such as representation or entertainment expense in the accounting records even though there is no official receipt to vouch for the validity of such expenses. In addition, the accountant could have recorded the expenses for the year ended June 2007 as such in error. This shows that there is an inherent risk in the recording of the expenses amounting to over 12,756 Australian dollar for the year ended June 2007. In addition, the accountant could have recorded the expenses for the year ended June 2007 as such in error. This shows that there is an inherent risk in the recording of the expenses amounting to over 12,700 Australian dollar for the year ended June 2007. In addition, the accountant could have recorded the expenses for the year ended June 2006 as such in error. This shows that there is an inherent risk in the recording of the expenses amounting to over 10,000 Australian dollar for the year ended June 2005. The income statement above also shows that the pretax profit for the year 2007 amounted to 1,032.10 Australian dollars. This is a good picture of the company. In terms auditing, there is an inherent risk that the company accountant or bookkeeper would have erroneously recorded a revenue even though they are fictitious. There is also a strong possibility that the expenses which have been recorded are really lesser than the real amount paid or incurred. Further, the balance sheet of Qantas Airways Limited for the same three year period shows: The above balance sheet and income statements are presented here because all audit programs start with the viewing of these two financial data as a basis for determining the time alloted to each account indicated above. REFERENCE: http://au.finance.yahoo.com/q/abs?s=QAN.AX The balance sheet above states that the cash balance is 3,362.90 as of June 2007. And, the cash balance is 2,902.00 as of June 2007. Also, the cash balance is 206.30 as of June 2007. Cash is the most inherently risky of all the items shown in the balance sheet. Cash can easily be stolen. The cashier can just pocket the amount and lie by state that he or she had given the customer an excess change of fifty Australian dollars or more. Also, the cashier who is also the accountant can write off the customers accounts receivable amounting to one thousand Australian dollars. Then, the cashier can profit from his or her fraudulent act by bringing home the money paid by the customer to zero out his or her accounts payable to the company Qantas Airways limited. The accountant can also fraudulently collude with management to show that the cash balance in the balance sheet amounting to 3,362.90 for 2007 when in fact the real cash balance is only 2,200. And, The accountant can also fraudulently collude with management to show that the cash balance in the balance sheet amounting to 2,902. for 2007 when in fact the real cash balance is only 2,00 Australian dollars. Also, The accountant can also fraudulently collude with management to show that the cash balance in the balance sheet amounting to 206.30 for 2007 when in fact the real cash balance is only 100. The balance sheet above states that the total current assets balance is 3,362.90 as of June 2007. And, the cash balance is 2,902.00 as of June 2007. Also, the cash balance is 206.30 as of June 2007. Some inventory items that form part of the current assets is a highly risky account in the balance sheet. Some of the dishonest employees of the company could easily place some of the inventory items that are small inside their pockets and fraudulently bring them home. Some employees who are tied up with large debts at home would be tempted to steal some high value items from the office of Qantas airlines to sell them and pay the dishonest employees personal overdue personal debts. A more daring employee would even place airline company spare parts in one small box and connive with the security guards at the exit gate to illegally smuggle out of the Qantas inventory building to sell them and divide the profit of their loot after the stolen items will be sold. In addition, the employees at the administration office would use the bond papers, pentel pens, folders and other office supply items to do their sons or daughters assignments. The dishonest employee would also use the office computers to search information for his or her personal use like chatting with skype, visiting pornographic sites, applying for jobs elsewhere, downloading software for personal use, playing online games, or just simply watching movies or trailers of movies during office hours. The internal auditor must set up an internal control system that would prevent or reduce the dishonest acts discussed above. One internal control system that the external or even internal auditor would be able to do is to recommend to management that the internal technology people ban computer sites that would not be beneficial to management. These sites include the pornographic, games, friendster and the like. The internal auditor can set up an internal control system where only authorized person can use the office computers. One such internal control system to use of passwords and security guards to allow only the authorized persons to enter the office and use the computer and other office equipments and office supplies(Coram, Ng, and Woodliff 2004) The auditor should also recompute and validate the Property Plant and equity for it has also inherent risks. The balance sheet above states that the property, plant and equipment balance is 20,823.80 Australian dollars as of June, 2007. And, the property, plant and equipment balance is 19,766.20 Australian dollars as of June, 2007. Also, the property, plant and equipment balance is 19,216.20 Australian dollars as of June, 2007. The inherent risk of the property plant and equipment is not as strong as the inherent risk of cash and the small office assets. The external auditor can inspect the airplanes the other properties like the office buildings to determine if some of the items listed under them are still what they purport to be. For example, the external auditor will have to determine if some of the equipments are equal to their book value. Book value is arrived at by deducting the accumulated depreciation from the historical cost of the building. Likewise, the external auditor will have to physically inspect the property, plant and equipments to determine if the amount stated in the balance sheet is realistic (Cunningham 2007). The intangible assets that excludes goodwill should also be audited because it also has an inherent risk. The intangible assets amount that excludes goodwill of Qantas is 233.10 Australian dollars as of June 2007. The intangible assets that excludes goodwill amount of Qantas is 233.10 Australian dollars as of June 2007. The intangible assets amount that excludes goodwill of Qantas is 233.10 Australian dollars as of June 2007. The inherent risk of this accounting item is that the scrupulous company accountant could have been instructed by one or more fraudulent company officers to record the intangible assets as well as the annual amortizations of the intangible assets amount that is in complete defiance of international accounting standards. The international accounting standards are based on the official statements of the international accounting standards board headquartered in the United Kingdom. Generally, all the accounting items listed in the balance sheet, income statement and statement of cash flows are imbued with inherent risks. However, the degree of inherent risk varies depending on the accounting item itself and a case to case basis because different companies have different accounting and auditing internal controls (Gul, and Tsui 2001, 71). Part 2 40%. Collect and analyse information on the quantitative aspects of inherent risk. The inherent risk of Qantas Airways Limited are generally focused on cash because it can easily be stolen. The auditor should not focus too much time on rights of the company in terms of ownership of the buildings and airplanes because it is very difficult to steal an airplane or a building. An airplane that is stolen by an unscrupulous pilot or a hijacker could easily be traced to its unauthorized destination through the use of many audit evidences. One such audit evidence is the inquiry from the radar tower as to the destination and current location of the hijacked airplane. The buildings can easily be traced to its owner with the gathering of evidences to prove rights or obligations like the purchase documents proving that there indeed was a sale of the building or aircraft to Qantas Airways Ltd (Carey, Simnett, and Tanewski 2000, 37). Inherent risk is the possibility of a material misstatement of an assertion before the determination by the external auditor of the strength or weakness of the internal controls being put into place by Qantas Airways Ltd. The company external auditor must focus more time on items that are inherent risks. These inherent risk items include the inconsistent profitability of the the company in relation to the profitability ratio of the entire Australian airline industry. Likewise, the external auditor must exert extra efforts on financial items listed in the financial statements that border on operating results that are clearly influenced by economic factors. These economic factors include inflation, gross domestic products, micro economic factors as well as the macroeconomic information. The external auditor must also spend time validating the fairness of the financial statements in terms of going concern theory. This theory states that a business, like Qantas Airways Limited will continue to exist and perform its normal day to day operations of ferrying air passengers and cargo from a location within Australia to destinations within Australia as well as destination in the any of the member states of the European Union, the United States, other major destinations in the Asian time zones and other places. Also, the company must focus on the auditing items that are considered audit risk for the simple reason that the prior audits gave evidences that there were anomalies, errors or frauds discovered happening. Likewise, the external auditors must consider the some of the items enumerated in the balance sheet and income statement if the external auditor discovers while performing the current audit that one or more of the line and staff employees are proven to be erroneous in the preparation of the balance sheet income statement and statement of cash flows. Worse, some of the officers and men of Qantas may be engaged in fraudulent activities. If this occurs, then the audit period must be increase to determine the extent of the fraud or error. The external auditor must focus on items that have difficult audit trails. Likewise, the external auditor must consider as inherent risks the financial items that are difficult to compute. One example of this item is the bad debts expense and the allowance for bad debts. The accountant or manager can abuse these two accountant titles to make it appear that amount paid by the customer has been reduced by ten percent and charged to allowance for doubtful accounts. The accountant or manager then illegally pockets the amount equal to the allowance recorded. Also, the external auditor must consider as inherent risks the financial assets, liabilities, capital, revenues, costs and expenses that appear to be doubtful in terms of valuation of such items. Part 3 20%. Draw on the research and analysis in parts 1 and 2 to write a memo* to the Audit Partner about specific areas of risk that are important to the Audit. Do not discuss specific audit procedures in this memo, only areas of risk that require special attention in the audit. May 18, 2008 To Partner ......, Based on the research done on Part one and Part two above, it is highly recommended that you must must equally give special attention in his or her audit program or procedures equally to all the items mentioned as inherent risks above. For emphasis, please start your inherent risk audit with cash, revenues and airplane inventories. For, these items are the three hottest items in terms of the possibility of errors or, in worse situations, fraudulent recording in the balance sheet, income statement and statement of cash flows. From : Me.... CONCLUSION: Accounting is the language of business indeed. Surely, there are different users of the financial statements need them for their decision making activities. Evidently, some scrupulous accountants and /or company officers are serious in their scheme to present financial statements in clear deviation from international accounting standards. Clearly, the company is then required by many of the financial statement users to present an external auditors report to add some credibility to the amounts stated in the financial statements. Undoubtedly, the external auditors as well as internal auditors are required by financial statement users to be instrumental in reducing or even eliminating the errors and frauds that stain the financial statements. Unquestionably, the first step that the auditors do is to base their audit programs on the inherent risk of each item listed in the financial statements. Conclusively, the audit program must be tailored to erase or eliminate doubts brought about by the inherent risk of each of the financial statement item discussed above. Works Cited Carey, Peter, Roger Simnett, and George Tanewski. 2000. Voluntary Demand for Internal and External Auditing by Family Businesses. Auditing: A Journal of Practice & Theory : 37. Coram, Paul, Juliana Ng, and David R. Woodliff. 2004. The Effect of Risk of Misstatement on the Propensity to Commit Reduced Audit Quality Acts under Time Budget Pressure. Auditing: A Journal of Practice & Theory 23, no. 2: 159+. Cunningham, Lawrence A. 2007. Securitizing Audit Failure Risk: An Alternative to Caps on Damages. William and Mary Law Review 49, no. 3: 711+. Gul, Ferdinand A., and Judy S. L. Tsui. 2001. Free Cash Flow, Debt Monitoring, and Audit Pricing: Further Evidence on the Role of Director Equity Ownership. Auditing: A Journal of Practice & Theory 20, no. 2: 71. Courtney, Briggs, Financial Management, Elsevier Australia, 2004 International accounting standards, retrieved May 19, 2008 http://www.iasplus.com/standard/standard.htm Qantas financial statements, retrieved May 19, 2008 REFERENCE: http://au.finance.yahoo.com/q/abs?s=QAN.AX Corporate Information, retrieved May 19, 2008 http://www.corporateinformation.com/Company-Snapshot.aspx?cusip=C036P1730 Read More