Acc707 Auditing and Assurance

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Question 1

Part A

Inventory, also known as merchandise, is defined as goods that business holds with the sole purpose of selling to customers. Risk aversion measures the degree of uncertainty that lies outside the utility class (Epstein, 2004). Key assertions which are at risk related to inventory of Computing solutions an auditor to familiarize themselves with the company and with its environment. In this way, an auditor will assess the existence of any material misstatement due to error or by fraud (ISA 315.3). Moreover, it also helps in determining scope, timing, duration of the audit procedures that are important in getting adequate evidences to control the risks.

Managing inventory transactions of a company involves some assertions during an audit. Five assertions of management include occurrence tests, completeness, authorization, accuracy and cutoff. Clients find difficult to sell the items after promotional and branding packages and the return of items back to supplier is also difficult.  The evidence can be done by an auditor through inspecting the contract terms with the suppliers in order to determine if any return provision of items exist. Also, an auditor must inspect inventory record to evaluate if there are any obsolete products as items are held for longer time.  Physical inspection is also necessary to search the inventory that is out-to-date (back of the shelves and dust appearance).

Obligations and rights for the inventory as some items are held on the basis of consignment. In this case, authority remains with supplier until audit client sell it. Items are returned back to suppliers if not sold because they were purchased and therefore, must be included in client’s inventory record. The evidence exists with the auditor who should inspect contract terms with supplier. Also, inventory inspection can be done to evaluate if items held on the consignment are incorporated in inventory balance (by mistake). It is therefore essential for client and staff to properly follow internal control and authorization procedures while handling the inventory transaction. Hence, disbursement of inventory is approved by management.

Another risk is due to occurrence of those items which are purchased from the suppliers are not received & sold items not removed from the inventory record. It is how actually an inventory took place and to test it requires inventory purchases & vouch to obtain requisitions & receiving reports. The evidence exists with vouch items being held in inventory for supplier invoices. Also, notice client stock-take and implement test counts to show inventory record by clients.

All overhead and direct costs must be accurately recorded. The overall drop in inventory from 5.2 to 3.8 times in one year indicates that inventory conversion to sales has decreased. This is due to returns of previous inventory packages. Movement of inventory to 6 new houses and an increase of closing inventory to 22% implies valuation risk. Also, turnover ratio is less which means that the rate of inventory turnover is quiet slow. It is therefore essential that costs are accounted properly to ascertain losses. There are chances of inventory overstatement due to fictitious transactions.

Part B

Substantive procedure refers to detecting of material misstatements at assertion level. It includes test details, disclosures, balances and several analytical procedures (Messier et al., 2008). It identifies material issues and evidences for inventory assertions that identifies risk issues and balance level.

To check an authority assertion, it requires a sample of inventory and material requisitions & bills of lading for proper authorization. An audit procedure that can be performed with respect to valuation is vouching the asset cost to purchase invoices & impairment calculations to substantiate assertion. As per AASB 102, it is essential to lower costs and valuation of items. Also, the cost which is not directly related to production cost must not be included in inventory cost. Some valuation techniques for inventory cost includes AVCO and FIFO etc. which provides justification for cost. Comparison to market prices of recorded costs, treatment of overhead and freight charges and testing for inventory allowances and layers are some of the ways to warrant (Kramer, 1975). Thus, valuation & allocation is a difficult task due to complexity of Work in process and finished goods. Schedule of raw materials, WIP and finished goods must confirm accuracy of balance & agree to financial statements and trial balance. Setting up new product costing systems shows that auditor is lacking control over the inventory. Due to sophisticated products, numerous assumptions are rooted into decisions of allocation cost of labor, machinery hours and raw material.

And for existence & cut off, it is necessary to track goods which are received and generate dispatch notes along with invoice. In this way, an accurate record of received inventory is made before the year closes. Select sample for year-end of finished goods & review post-year of end sales invoice to discover if NRV (Net Realizable Value) is above the cost or below. Another way by which auditors can resort is through deep examination of company’s policies and procedures for halting item receipts in warehouse during inventory count to accurate counting of inventory items. Furthermore, shipping transactions and sample analysis of last receipts will also help in substantiation of assertion risk (Leung et al., 2007). Auditor can review calculations for the equivalent units and recalculate inventory valuation. Also, review aged reports of inventory an identify slow moving items and discuss how these items can be written down.

Part C

Communicating key Audit Matters is an effective tool for audit of the financial statements. It says that the most important items encountered are likely to be communicated charged with the governance (Gimbar et al., 2015). The audit standards are made in accordance with legislative environment and audit quality. Auditing standards provides application of material regarding communication of KAM in independent auditor’s report. Matters which require auditors concern are mainly of high-risk misstatements which requires careful operation. On all matters, an auditor must determine significant areas of the entity & communicate it in key audit matters under separate section.

The rational and requirement for Key Audit Matters is because of decision framework which is specified for auditors in reporting material substances. It is to strengthen governance of company by communicating with the matters. Examining all matters and then selecting appropriate ones is important for audit as company’s financial is the most concerned matter. It is also stated that exception to determination of key matters are made where effects of matter could disaffirm benefits of public interest via contracts. Hence, it can be said that Key Audit Matters is the subjective decision to all the auditors with respect to an entity and an auditor is responsible for maintaining the confidentiality of its client matters (Cordoş & Fülöp, 2015).