Auditing Assignment — Identify risk
The lack of authorization from the central purchases departments means that the inherent and control risk are affected. According to Gay and Simnett (2012) inherent risk arises from the client’s characteristics which may lead to material misstatements. The inherent risk is particularly present in this case because Tech Ltd has given its superstores in Australia freedom to make their own purchases as well as manage their transactions with the suppliers. This is regardless of the fact that the company has a central purchases department that should cater for all its purchase from suppliers. The control risk, on the other hand, refers to the risk that material misstatements may not be prevented as well as detected by internal control practices (Simnett and Gay, 2012). The internal control practice is that the company has a central purchases department but since this department does not control the purchases of the superstores the internal control risk is high.
The inherent and control risk that are present in this situation mean that the groups of accounts affected include the statement of financial position and the group income statement. The auditors will focus on these two main accounts because the statement of financial position will have information about the creditors who are the suppliers as well as the inventory; there is a high likelihood that these elements have misstated. The other accounts that the auditors will focus on include the purchases, sales, inventory and the creditor’s accounts. The purchases account will help the auditors identify the amount of purchases made by the company but the risk in this case is that each of the superstores may misstate their purchases so as to give a good picture to the parent company. The sales account, on the other hand, will give the auditor information about the amount of sales made by the company but the risk is that each superstore makes its sales distinctly.
From the information given in the case, it is clear that the auditor cannot rely on the central purchases department of Tech Ltd because each superstore works distinctively without the control of the department. The auditor should address these risks by testing controls as well as carrying out substantive tests. The test of controls should be to determine if the central purchases department controls the purchases made the superstores. The substantive tests, on the other hand, should involve tests of transactions and balances (Gay and Simnett, 2012). The auditor should ensure that the client provides information about purchase transactions o each superstore with the suppliers. This will in turn help the auditor deal with the inherent and control risk in this case.
The inherent risk is affected to a significant extent in the case of Pluto Ltd. The company sales are likely to reduce due to the enhanced competition and the fact that its generator is expensive. The company may misstate its sales to represent a picture that it is still competitive; the company has an internal process that does not ensure continued improvement of its products leading to inherent risk. According to Gupta (2005), inherent risk can also arise from the lack of integrity on the part of management. The CEO of Pluto Ltd lacks integrity because he is planning to make some of the employees redundant; this will be done just to benefit the company not regarding the employees who are primary stakeholders.
The inherent risk that is affected in this case means that the auditor will have to focus on several books of account. The auditor will have to focus on the production account so as to understand the number of generators produced. This will inform the auditor about the basis of the pricing strategy the company uses. The auditor will also have to focus on the sales account to get information about the number of units sold, compare it to the remaining inventory. Moreover, the auditor has to focus of the inventory account to establish if the difference between the units produced and sold is represented. The auditor also has to focus on the salaries account to establish which employees are likely to be made redundant.
The audit plan will be affected by the inherent risk because the auditor has to learn about the internal activities of the company before the audit process begins. The auditor has to get information from the CEO, the production as well as sales manager. For the auditor to address the inherent risks has to adopt a substantive approach in dealing with the risks. The auditor has to examine the production schedules to ascertain the number of goods produced. Moreover, the auditor has to also examine the sales account to examine the number of generators sold. The employee schedule should also be examined by the auditor to examine if some of them some of them have already been made redundant.
The inherent and control risks are significantly affected in this situation. The integrity of the CEO in this case is questionable and this gives rise to inherent risks. The other situation that makes this case inherent is the pressure from the management to the internal auditors. The new internal auditing team has also made recommendations for improvement which have been frustrated by the CEO. Moreover, the internal controls put in place to prevent the inherent risks have not worked in this case. For example, it is clear that the CEO has made withdrawals from the business but not made any disclosures. Moreover, the control risk also arises because the accountant has also been adjusting the financial statements before presenting them to the Australian Tax Office.
The statement of financial statement and the income statement are affected in this case. The income statement is used by the tax office to determine the amount of tax payable by a company but the accountant has been misstating the income generated by the company. Moreover, the statement of financial position will help the auditor identify of the drawings made from the company have been accounted for effectively.
The auditor in this situation cannot rely on the internal controls set by the company since they are ineffective and have led to material misstatement. The auditor in this case has to address the risks by testing controls and taking a substantive approach. According to Johnstone, Gramling and Rittenberg (2015) the substantive approach to auditing is effective when the auditor wants to respond to material misstatement in group accounts. The auditor should also test each transaction represented in the final group accounts that were presented to the auditor. The testing of each transaction will give the auditor a chance to establish an audit trail and unearth any material misstatement.
Gay, G & Simnett, R 2012, Auditing and Assurance Services in Australia Authors, 5th edn, McGraw-Hill Education, Australia.
Gupta, K 2005, Contemporary auditing, Tata McGraw-Hill, New Delhi.
Johnstone, K, Gramling, A & Rittenberg, L 2015, Auditing: A Risk Based-Approach to Conducting a Quality Audit, 10th edn, Cengage Learning, Boston MA.