Inherent Risk Task Essay Example

INHERENT RISK TASK

Inherent Risk Task

A Case of One.Tel Limited

Case Summary

One.Tel was an international telecom organization that was started in Sydney. The telecom service provider was well known for its international standard services that it provided to its subscribers. The range of telecommunication services that the company provided to its customers included international and domestic calls,
internet services, postpaid and prepaid service subscription, and GSM cellphone services. The firm’s corporate strategy aimed at growing sustainably in the global telecommunication industry by investing in the customer-centric initiative. In this regard, the company provided high standard and innovative telecom services at a relatively low price. Based on their financial report for the year ended 20 June 2000, the company reported total revenue of $678.2 million, with the Australian subsidiary being the highest earner.

A closer look at the telecommunication industry in Australia shows that the industry had been experiencing immense changes. The Australian telecom infrastructure is well developed based on the fact that it consists of a sophisticated and extensive digital network. Prior to the deregulation of the telecom sector in 1997, only two carriers existed in the market. Nonetheless, the industry has seen an increase of carriers now standing at 35 since deregulation. Among the players in the Australian market, Optus, Telstra, and Vodafone among are the dominant ones. The increased number of different sizes of service provider has increased the competition within the Australian market. Apart from the increased influx, the competition has also stiffened because most of the telecommunication services provided are common to all. Per se, finding a competitive advantage over the other companies is a difficult endeavor.

Apart from the external factor of the market, the company also has a unique management. Its board of directors is made up of nine members, of which four are executives while the others are non-executives. With the changes and growth in the telecommunication industry, it is required that they possess vital managerial competencies and experience. This is also important for the management handles significant functions such as the appointment of high-level managers and approves One.Tel’s financial plans and corporate strategies.

Auditing Risk

As it is with any organization, periodical auditing is important as it has a positive payoff of establishing the company’s current status and improves its operations (Reding, 2013). In addition to this, auditing process is important as it helps an organization achieve its strategic objectives through a disciplined and systematic model to assess and enhance the efficiency of risk management and governance process. In carrying out an audit, an auditor may be faced with the risk of offering an opinion based on financial reports that have been misstated. This risk is defined as the audit risk.

In the One.Tel case, audit risk is an essential part of the audit process based on the fact that the auditor is not in a position to verify all transactions comprehensively. Given the fact that the telecommunication industry in Australia has been growing, and the services being provided have increased it is evident that One.Tel Limited has many transactions taking place daily. Although it is possible to evaluate the transaction, the risk model of auditing is usually adopted due to its convenience.

The audit risk is usually considered from a top-down perspective. This means that the audit risk of One.Tel is undertaken by first considering the individual accounts and then followed by the assessment at the financial report level. In this regards, an independent auditor needs to know the kind of accounts or transactional class that may likely pose a risk associated to material misstatement. The identified accounts and transactional classes should be the center of focus for the auditor. As such, the top-down approach presents a more direct methodology for audit planning and testing. The detection and material misstatement risk are the two main constituents of the audit risk (Reding, 2013). In this regard, the risk of detection refers to the uncertainty associated with failure of the audit procedure to detect total or partial material misstatement.

While the material misstatement risk is associated with uncertainty due to misstatement prior the audit process, the later risk is closely associated with the business operations and the internal controls that exist within the firm (Gay & Simnett, 2015). In this regards, internal control is used to refer to procedures and processes that are utilized by the management to help them realize its objective of attaining normal and productive business operation. The risk of management is divided into control risk and inherent risk. Pertaining to this case study, the inherent risk of One.Tel will be discussed comprehensively.

Inherent Risk of One.Tel Limited

By definition the inherent risk of One.Tel Limited is the vulnerability of account or transactional class to total or partial material misstatement, on the assumptions that there are no associated internal controls (Gay & Simnett, 2015). In coming up with the audit plan, an auditor is supposed to evaluate the inherent risk at the financial statement stage. On the other hand, in coming up with the audit program, the auditor in charge is required to associate the assessment at the financial reporting level with the individual account or transactional class at the level of assertion. As such, in assessing the inherent risk of One.Tel Limited there it is worth considering influential factors at financial statement and account balance level.

Assessing Inherent Risk on the Financial Report Level

In the assessment of financial risk some factors dictate the assessment including:

Nature of One.Tel’s Business

One.Tel business is based on providing telecommunication services to their Australian subscribers. In order to achieve this, the company should be updated on the new technology being embraced in the telecommunication industry. Being up-to-date with the latest telecommunications services is not difficult because it is a subject of management decision and available funds. Nevertheless, the telecommunication business is usually faced with rapid technological dynamic. In addition to this, the nature of their customer base is one that has fickle client demands. The result of this is that One.Tel is likely to be faced with issues of brief commodity commercial life even before the commodity is obsolete. As such, One.Tel invests disproportionate efforts and other resources to commodities that have brief commercial life or may result in write-off obsolete and excess inventories. These responses to the obsolete and excess inventories are partially effective because it harms the company’s operational results and its financial status. With this nature of business, the inherent risk at, the financial report level is increased. Additionally, it is possible to identify this factor when evaluating business risk.

Influential Factors’ in the Telecommunication Industry

Before 1997, the telecommunication industry in Australia was extensively regulated. This fact made it possible for only two service providers to dominate the Australian market. Nevertheless, with the deregulation of telecom industry in 1997 many telecom companies have entered into the market. This means that the monopoly and dominance of the telecommunication companies for companies such as Telstra have reduced over the years because the emerging companies are bring competition for the Australian market share. Apart from the competitive market, companies are forced to offer quality telecommunication services at low prices. The low prices are used as a marketing strategy as most of the service providers offer almost the same services. As such, to differentiate their products from others, they have to adjust some aspects of the product which also includes the price. The competition and low pricing of products leads to low revenues per firm within the telecommunication industry. With this competitive and economic status, the inherent risk should be assessed as high. This factor can also be detected in the process of assessing the business risk.

Integrity of One.Tel’s Management

In the business community integrity is regarded as the key to success. This is because with integrity, issues that need to be solved are addressed openly and everyone is in a position to contribute their thoughts into the matter (Boynton and Johnson, 2006). Nevertheless, if the integrity of the management is questionable, there are various things ranging from the business operation and financial reporting that can go wrong. This may be detected by poor business practices that the management may or may have not put forth. For instance, the auditor may only be able to access particular people or information in the company. The lack of integrity thus increased the overall inherent risk.

Abnormal Stress on Management

In the business sector and any other institution, the management is in charge of decision making which affects how the business operates and revenue it earns (Boynton and Johnson, 2006). As such, this group of individual is used to the pressure that comes from various business stakeholders. Nevertheless, there are stressful events which are uncommon that may lead them to the intentional misstatement of the financial reports. For example, the pressure may come from cash flow issues, and poor liquidity condition and operation results (Ricchiute, 2006). As such, an auditor needs to assess if the management is working on normal pressure or abnormal. In the case, the stress is established as abnormal the inherent risk should be increased. Furthermore, it is worth noting that this factor can be detected in the process of evaluating business risk.

Level of Auditor — One.Tel Engagement

The engagement between the auditor and the company is influential in the assessment of inherent risk (Reding, 2013). It is pure psychology to trust someone when you get to know him or her for a long time. Based on this premise, if the auditor is to conduct an audit on a new client the level of inherent risk is placed high. However, with the second and continued auditing of the same client, the auditor results to reducing the inherent risk as time passes.

Assessing Inherent Risk at Account Balance Level

Findings of the Previous Auditing Works

In the assessment of the inherent risk it is also important to consider the findings of the previous works. If the Auditing done previously show that the company had issues of material misstatement, the discovered issues should take into consideration as there are uncertainties associated with the likelihood of repetitive misstatement. Accordingly, if the auditor find’s that One.Tel previous audit discovered misstatement in inventory pricing, the same issue is considered to have high inherent risk.

Uncommon Transactions

Uncommon or non-routine transactions refer to those transactions carried out by One.Tel that are not considered as part of its routine operational management. Additionally, this transactions takes place when huge withdrawals are involved (Reding, 2013). These may include writing-off assets and fire related losses. In order to record these transactions, One.Tel may not be in a position to do so because of the complexity and experience needed. This makes One.Tel prone to misstatement.

Transactions Requiring Judgement

Like most businesses, there reaches a time where the management of One.Tel will need to make judgments in the approximation and recording of a transaction, some of these transactions may involve new financial commodities and particular ones in the changing deal market (Ruhnke & Schmidt, 2014). In such a case, the judgement should be professional, therefore, relying on sophisticated decision-making and utilization of available information. Based on the level of professional judgement needed, the more likely one can make a material misstatement. Therefore, where professional judgement is needed the inherent risk also increases.

Related-party Transactions

Related-party transaction is a type of transaction that takes place between associated individuals. For instance, in this case study One.Tel (Australia) may engage in a transaction with its parent entity. In this case, the term of the transaction may be subjected to various conditions that promote misstatement (Ricchiute, 2006). As such, with this in mind all related-party transactions increase the inherent risk.

One.Tel’s Going Concern

The going concern is an important accounting assumption. Its significance is rooted in the fact that it depicts the possibility of a company to operating for a period that will make it possible to achieve its objective and settle all obligations (Ruhnke & Schmidt, 2014). In the case of One.Tel the going concern can be evaluated as low. One of the factors that influence this decision is the nature of telecommunication industry in Australia. With the increased completion the nature of future sales and earnings will be affected significantly. Additionally, there is a financial indicator in the balance sheet, where noncurrent assets are listed.

List of References

Boynton, W. and Johnson, R. 2006. Modern auditing. 1st ed. New York, NY [u.a.]: Wiley.

Gay, G. and Simnett, R. 2015. Auditing and assurance services in Australia. 6th ed. McGraw Hill Education.

Purvis, S. 2010. Auditing & assurance services. 1st ed. [Place of publication not identified]: Irwin Mcgraw-Hill.

Reding, K. 2013. Internal auditing. 1st ed. Altomonte Springs, Fla.

Ricchiute, D. 2006. Auditing. 1st ed. Mason, Ohio: South-Western/Thomson Learning.

Ruhnke, K., & Schmidt, M. (January 01, 2014). Misstatements in financial statements: The relationship between inherent and control risk factors and audit adjustments. Auditing, 33, 4, 247-270.