Components of Audit Risks - Assignment Example

Q.1 List and discuss several factors that would have contributed to an increased inherent risk assessment at the financial report level. Also identify which of these factors may be identified during the strategic business risk assessment. Ans. Inherent risk is one the three components of audit risks where the other two are control risks and detection risks. Inherent risk is the susceptibility that an account balances or class of transactions could be materially misstated, either individually or in aggregate with other balances or classes of transaction assuming that there lies no related internal control among the same. There are several factors which contribute to increased inherent risks both at the financial reporting level and at the level of accounts balances and transactions. The factors which contribute to increased inherent risks at financial report level for One Tel has been discussed in details as under Lack of integrity of management When the management lacks integrity they are more likely to present a more poor picture and reputation of their business in the business community. Lack of integrity are usually indicated by factors such as management’s attempts to limit the access of its auditors to people or information and thus not depicting a true and fair dealings of all transactions entered by the organization during a business cycle. One Tel in the past has shown great signs of lack of integrity in the management and are responsible for monitoring financial statements which arises the susceptibility that the financial statements may be materially misstated. Further they also appoint the senior management team which further increases the inherent risk. Management Experience, Knowledge and Changes during the Period Inexperience management with lack of complete knowledge about the industry factors and business may affect the correct preparation of financial statements. Further when the auditors observe frequent personnel turnover in significant managerial positions it further increases the inherent risks as honest managers are more likely to resign their managerial post rather than involving in any type of fraud or material misstatements. One Tel. has limited managerial experience with huge powers in their hand, further the company has experienced material misstatements in the past and even has threat to its going concern issues which increases the inherent risks at financial reporting level. Unusual pressure on management Management may be lured to make misstatement in the financial statement owing to many reasons like. Frequent cash flow problems, Liquidity problems owing to financial feasibility of the business. Operating performance and results of the company are significantly poor. When management compensation schemes are linked to earnings or share price, there is always an incentive for management to materially misstate the financial statements with regards to their own personal interest of obtaining the bonus. One Tel. has high inherent risks owing to the fact of low yield strategies deployed by the management which has lead to liquidity problems and poor operating performance in comparison to its rivals. Further the generous incentives offered for its new customers could not be sustained in the small Australian market which had a large number of mobile phone providers. The company also had cash flow problems mainly in investing activities which increases the inherent risks to considerable extent. Nature’s of entity business It is a known fact that while telecom companies have potential advantages and until the company successfully develops and establishes a reliable and reputable source of income along with customer loyalty they will be inherently risky. Further complex capital structure and related party transactions boost up the Inherent risks to a considerable extent. One Tel. Has high level of inherent risks at the financial reporting level as the company has been offering telecom services to its subscribers at a price which is lower than what the company has been paying. Business strategies developed by the company are heavily relied on the strategies operated by Telstra and Optus who are their competitors and has much lower operating cost than what is for One Tel. Factors affecting the business in which the entity operates. Changes in the external environment and economic and competitive conditions can significantly lead to increase in the inherent risks. External factors which could lead to increase in inherent risks can be A rapid change in the inventory which becomes obsolete at a quicker pace. Expiring patent risks lead to increase in inherent risks due to rising competition and competitors offering similar products and services. The general economic growth of the economy in which the entity operates affect the degree of inherent risks. Interest rates and its associated financing factors. When a company faces problem in meeting its short term cash payments or loans with interest rates similar or a bit lower than its revenue generation. One Tel. has rising risks of patents and copyrights. Further the company operates in the telecom industry of Australia which is largely dominated by Telstra, Optus and Vodafone with 35 different carriers trying to develop their own switching and networks thus involving intense competition. One Tel. on the other hand charges no access fee, no minimum call spend with contracts having no fixed terms which might ensure loyal customers for the company which would stay with the company and thus leading to an increase in inherent risk (Carey and Simnett, 2006). Strategic business risk assessment is the process of identifying, assessing and managing the potential risks in the firm’s business strategy employed by the organisation. The inherent risk factors which could be identified during the strategic business risks assessments by One Tel. are as follows. Unusual pressure on the management in terms of liquidity problems, uncertain cash flow, operational performance of the company with regards to competitors etc. Macro environmental factors in which the business operates which includes rising risks of patents and trademarks obtained by One Tel. and are likely to be expired soon. The growth of the company in terms of growth of telecom industry in Australia is much lower owing to the fact of high competition. Any related party transactions entered by the company during the financial year. Dependence on larger telecom firms like Telstra and Optus for problems related to switching and networks, which makes the company dependent rather than operating independently. Risks arising from the nature of relationship with other telecom partners Pervasive telecom risks such as technical competency required by the staff and employees. Q-2 List and discuss several inherent risk factors that would have contributed to an increased inherent risk assessment at the account balance level. Ans. Just as there are several inherent risk factors which contribute to an increased inherent risk at the financial reporting level there are many inherent risk factors which leads to increase in inherent risks at the account balance level. The same with regard to One Tel. has been discussed as under. Susceptibility of material misstatements in the financial recording particularly in transactions relating to sales, purchases, accounts receivable and accounts payable. Complexity involved in underlying transactions. The management involves a high degree of judgment in determining the account balances during the final preparation of the financial statements. With development of technology the company deals with many transactions which are not subjected to ordinary processing but involves a high degree of e-commerce related to the same. There is occurrence of unusual and complex transactions particularly at or near the end of financial year. The company has a history of making inventory pricing errors. Management lacked the confidence to estimate provision for doubtful debts as accurate or near to accurate in its past performance (Brown and Caylor, 2006). The company has high amount of accumulated losses which may be as a result of overstating cash reserves (Brown and Caylor, 2006) The company has purchased licenses during the year which has resulted in negative cash generation from investing activities which contributes to a significant level of inherent risk at account balance level for cash assertions, particularly in relation to existence or occurrence and completeness. High amount of cash balances further makes it susceptible to thefts, as there may be probability of numerous kinds of fraudulent schemes involving cash which may have been borne out. Inherent risks at account balance level transactions may involve susceptibility of assets loss or misappropriation of assets. Thus, we see there are numerous factors which lead to increase in inherent risks at the account balance level. Q-3 Do you believe that the area of going concern should be assessed as high, medium or low? Identify the factors that are the basis for your decision. Ans. Going concern assumption is of key importance for any company. It assumption believe that the company will remain in business for the foreseeable future. Under the going concern assumption, assets are valued on a basis that the same will be used for conducting the business in future years and liabilities are classified and recorded in the financial statements as current or non-current on the basis that the company shall clear off the dues as and when they become matured in future years to come thus ensuring a smooth flow of business and its operations (Bhagat and Bolton, 2008). There are various factors depending on which the going concern of an organization can be rated as high, medium or low. The same with regards to One Tel. has been discussed as under. One Tel. has seen a major collapse in the year 2001 when previously the company was one of the fourth largest telecommunications company in Australia with a customer base of over two million and operating in eight countries is now just a small competitor in the Australian Telecommunications industry (Brown and Caylor, 2009). Hence we can sense a major cut on the market coverage and business of the company which certainly poses serious threat on the going concern assumption of One Tel. Market factors and financial conditions of the company highlight the company’s inability to handle the increasing competition in the Australian Telecommunications industry. One Tel. is characterized with negative cash flow generation from operating activities which clearly indicates a low rating in terms of its going concern assumption. The company has experienced a loss of major markets, franchise, licenses, suppliers and key customers which has led to accumulated losses for the company posing threat to its going concern assumptions. There are indications of withdrawal of financial support from many lenders in future years to come. One Tel. has invested huge amount in purchase of licenses. Further with higher competition, low market share and declining profits or rather accumulated losses there are low chances of the company emerging as market leader again (Agrawal and Chadha, 2005). Hence posing serious threat to its going concern issues. One Tel has major debt repayment falling due, part of which is paid this year hence refinancing might be necessary for the company to continue its existence in the telecommunication industry of Australia. The debt-equity ratio of the company does not present a strong financial stability of the company for future years. The company has large sum of accounts payable which clearly indicates short-term payment for the company in near future years. Australian telecommunication market has been over flown with a large number of small telecommunication company of which many has failed in the industry with almost similar structure and comparable operations as seen in One Tel. thus posing a threat to the going concern assumptions of the company. One Tel. in the past has shown signs of its inability to comply with loan agreements or to pay their creditors within or on the due date. Hence is a considerable probability of the company indulging in similar activities in future years which affects the going concern of One Tel. to a considerable extent. Thus, on a closer note of the above mentioned factors relating to going concern assumptions, it can be concluded that the area of going concern for One Tel. can be assessed as low which implies a serious threat on the running of the business in future years. References Agrawal, A. and Chadha, S. (2005). Corporate Governance and Accounting Scandals. The Journal of Law & Economics, 48 (2), 371-406 Bhagat, S. and Bolton, B., (2008). Corporate Governance and Firm Performance. Journal of Corporate Finance, 14 (3), 257-73. Brown, L. and Caylor, M., (2009). Corporate Governance and Firm Operating Performance. Review of Quantitative Finance and Accounting, 32 (2), 129-44. Brown, L., and Caylor, M., (2006). Corporate Governance and Firm Valuation. Journal of Accounting and Public Policy, 25 (4), 409-64. Carey, P. and Simnett, R. (2006). Audit Partner Tenure and Audit Quality. The Accounting Review, 81 (3), 653-676. Read More