Auditing and Assurance Services - Assignment Example

Auditing In conducting their audit assessments, auditors are faced with various risks. The risks that are susceptible to the business despite the controls put into place are referred to as inherent risk (Louwers 36). Auditors have to assess this kind of risk before making their final audit report. Revenue & collection cycle, the acquisition & expenditure cycle, and the production cycle are all faced with the inherent risk element. There are some similarities in the inherent risks associated with the following cycles: In all the cycles, the inherent risks may result from the complexities that are involved in the process. In the case of R & C cycle, there could be problems in when to recognize the revenues without inflating receivables. For A & E cycle, there could be complex transactions expenses that cannot be classified with precision. Similarly, production cycle is faced by the complexities in method to use in valuing stock and goods produced. Secondly, the inherent risks in all the three cycles would affect both the balance sheet and income statement of the business. R & C cycle may either increase or reduce the receivables and cash and this would at the same time affect the income reported by the business. Inherent risks in A & E cycles affects the expenses reported thus affecting income statement. Likewise, wrong valuing of stock affects the inventory value in the balance sheet and also closing stock which alters the income reported. In all the three cycles, the inherent risk is increases by the fact that there are external parties’ dealings. These parties include the suppliers, debtors, and creditors. Fraudulent actions of these parties increase the inherent risks. In as much as there are similarities in the inherent risk in the three cycles, there are also some differences. Inherent risks in these cycles differ because of the differences in the nature of transactions involved. In R &C cycle, the asset involved is cash, A &E also involves majorly cash asset while and production cycle inventory is at risk. The three cycles are also characterized by different accounting standard requirements (Louwers 53). The manner of recognizing receivables is different from that of valuing stock or purchasing materials in the production cycle hence making their inherent risk different. R $ C cycle is entails the determination of the business debtors and the amount they owe to the business. The relevant department has to identify all the debtors and examine the credit period agreement. They then make the claims for the money and adjust their debtors’ balances. Source documents include sales order, credit application, customer order, and shipping notice. Some of the controls for the R& C cycle include separation of functions in recording, reconciling, and authorization of transactions. Physical controls, information processing controls, and analytical review can also be adopted to mitigate the risks involved (Louwers 45). A & E cycle involves the activities of making purchases after receiving purchase requisition from the different departments. Suppliers are then chosen through a bidding process and the purchase orders prepared. The good or services are then received after approval and the assets or liability recorded. The final process entails the payments of the cash after receiving the invoice. The controls established include physical checks, segregation of duties, performance reviews and information processing controls e.g. comparing goods received with the purchase orders (Louwers 68). Some of the source documents includes purchase orders, goods received notes, purchase invoice and payment vouchers. Production cycle involve the determination of production plan accompanied by the actual production. The cycle will then aim at calculating standards to detect deviation and take corrective actions. Overhead costs are then charged to the cost centers. Production cycle requires segregation of duties of authorization, custody, and reconciliation. Physical controls on stock involving restricted access and performance reviews are necessary for control purposes. Source documents include production schedules, material purchase invoices, and stock records. The explanation of extended procedures will be based on the revenue and collection cycle. There are instances in which the procedures are extended to ensure reduction in risks. Where there is a likely possibility of teeming and lading i.e. where the debtors are overstated to hide cash receipts that have been misused, the auditors or management may decide to mail debtors directly to allow them confirm their balances (Louwers 75). Management may also decide to vouch specific debtors account where there is suspicion of wrong entries or when the debtors amount are very large and can therefore cause material losses to the company. Extended procedures can also be conducted on the revenue and collection cycle to determine whether the bad debts allowed are correctly computed. This would entail recalculating the debtors balances with an intention of confirming the balances or when the management doubts the qualification of the employees in managing debtors records. Extended procedure of analytical review can also be done in cases where there are significant variation in the debtors value between two financial periods. The management in doing this will be interested in detecting any anomalies and getting explanation for the big variations. The three cycles are susceptible to errors and fraud. The revenue and collection cycle faces the fraud of teeming and adding where cash receipts are not recorded to hide cash misuse. There is also the error of wrong computation of bad debts and errors of wrong entries. These errors will either understate or overstate receivables hence impair the quality of the financial statements. Moreover, the acquisition and expenditure cycle faces the risk of overstating the costs and expenses. Third parties like suppliers can collude with employees of the firm to have equipments overstated hence compromising on the quality of equipments. Expenses can also be understated to hide losses and low profits posted by the business. Production cycle as well faces the error of misstatement in the quantity of materials used in the production of goods. The cycle is also susceptible of fraud of concealing and understating the output to serve the personal interest of the employees. The fraudulent actions involve collusion with other people from various departments. In preparing financial statement, management has the obligation of providing information to external users. This information must be tested for reliance and acceptability purposes. Management assertion relates to the occurrences of transactions, disclosure, valuation, accuracy, and completeness. In the case of R & C cycle, the assertions can be tested by doing a test of completeness to determine if all transactions are captured in the financial statement. Accuracy can also be tested by recalculating the figures and amounts while presentation can be checked by confirming whether receivables have been reported (Louwers 83). With regard to A & C cycle, the documents of ownership should be verified to check whether the purchases bear the name of the company. At the same time, expenses can be checked by verifying the receipts that were issued and their authorization. Finally, management assertion on production cycle is necessary to determine the accuracy of output recorded and the efficiency of the process. These can be verified by doing a comparison between the set standards and the actual production. Valuation checks can be done by ensuring that all the costs incurred in production are summed and the required margin incorporated. The assertions of disclosure can be checked from the posting made on the financial statements of the company. If well verified, third parties can place reliance on the information for investment purposes. In conclusion, the revenue and collection cycle, acquisition and expenditure cycle and the production cycle plays immense roles in the financial statements preparation and determines the nature of the audit reports. Inherent risks should be considered when conducting audit assignments and necessary audit controls institutionalized to ensure reliance on financial statements. Work Cited Louwers, Timothy J.. Auditing & Assurance Services. 4th ed. New York: McGraw-Hill Irwin, 2011. Print. Read More