ACC331 Auditing and Assurance Services

Solution to question 1

Firstly, for the “Current ratio” which gets calculated as current assets on current liabilities and represent the liquidity position of a firm in meeting all its short-term liabilities in time, can be seen as increasing from 1.804 in 2019 to 2.132 in 2020 against the industry which have increased form 2.46 in 2019 to 2.55 in 2020. This proves that Brown is not enough liquid as compared to all the other firms in the market, however, the current ratio can be seen as increasing over the years and is above 1 at all times that means the company can meet its short-term liabilities on and its liquidity position is increasing over time. Secondly, the “Inventory turnover” can be seen as decreasing over the years from 3.927 in 2019 to 3.234 in 2020 against an enhancing industry average form 3.311 in 2019 to 3.696 in 2020 signifying a fall in the speed of inventory movement over the years against an enhancing inventory trend (Louwers et. al., 2018). Thirdly, the “Receivables turnover” for Brown shows a declining trend form 6.768 in 2019 to 5.64 in 2020 against a enhancing industry average trend form 5.358 in 2019 to 5.67 in 2020 signifying a inefficiency of the management in collecting all its receivables in time. The “Gross margin” can be seen as increasing over the years form 0.228 in 2019 to 0.2622 in 2020 against a decreasing industry trend of 0.285 in 2019 to 0.2622 in 2020 signifying a better profitability position of Brown and efficiency of the management in enhancing the gross profit of Brown over the years. The “Net profit ratio” can be seen as constant for Brown throughout the years at 0.027 against a constant industry standard of 0.045 which portrays that the all-inclusive profitability for Brown has been less as compared to the industry average. Lastly, the “Return on total assets” for Brown can be seen as increasing over the years form 9% in 2019 to 10% in 2020 against a increase in industry average form 6% in 2019 to 7% in 2020 which portrays that Brown has been generating better returns to its owners using the assets at its disposal as compared to the industry in general.

After a thorough analysis of the different important financial ratios for Brown and its comparison with the industry average, it can be said that there are some inherent and control audit risks that needs further investigation. Firstly, for Brown it can be seen that the inventory turnover has been decreasing along with decrease in collection of receivables as portrayed over the years yet there is an increase in Current ratio over the years signifying an increase in current assets or decrease in current liabilities (Eilifsen et. al., 2014). So, as per the trend for Brown over the years, the current assets are decreasing yet as per the current ratio, the current assets are increasing which is an “inherent risk” as well as, “control risk.” Secondly, the “Net profit ratio” can be seen as constant over the years, however, the “Return on total assets” can be seen as increasing over the years. The “Return on total assets” is calculated as “Net profit” on “Total assets.” So, as per the “Return on total assets” ratio, the “net profit should be increasing over the years. However, as per the “Net profit ratio” it is constant. This is an “inherent risk” as well as a “control risk” where the internal control failed to detect such a risk and needs further investigation.

Solution to question 2

The key strengths of the internal control functions at Richardson are as follows:

• There is proper separation of duties for the staffs working at Richardson, which is a big plus to its effective internal control. For instance, there are separate duties for cabinet makers, foreman, accounts payable clerk, accounts receivables clerk, secretary, banking clerk and five directors.
• Secondly, the major strength of internal control at Richardson is protection of tangible resources that is raw materials form wastage where it can be seen that the raw materials are only ordered by the foreman when the cabinet makers say that such stock of raw materials have been depleted.
• Thirdly, there is proactive identification of all maters including potential issues and taking necessary actions thereof. For instance, the foreman takes quotes form suppliers first, then places the order on call, gets confirmation of such order via E-mail and then prepares the “purchase order.” After preparation of the purchase order the sends one copy to the accounts payable clerk after keeping one copy for the warehouse as documentation (Akhmetshin et. al., 2014). He also actively checks all goods post its delivery by the supplier and tallies it with the delivery note then signs it and makes two copies of such delivery note and sends it to the accounts payable clerk.
• Thirdly, there is instances of accurate and prompt reporting by the designated staff. For instance, the accounts clerk passes prompt necessary journal entries to the supplier’s accounts for the amount which has been mentioned on the delivery note signed by the foreman after verification of goods received and then marks the delivery note as entered and also files it by the name of the supplier.

The key weaknesses of the internal control functions at Richardson are as follows:

• The first weakness can be seen in the ordering process of raw materials where the foreman orders the raw materials once he is notified by the cabinet makers that the stock of raw materials have been depleted without physically verifying the fact whether really that sock has been depleted or not thereby raising the fraud risk by a considerable level.
• The last weakness is that one of the Board of Directors, Joe runs the entire business and hence can be considered as a CEO. Therefore, as per the standard practices a CEO cannot be a board member as there arise problems relating to review of own work. So, this is the area where separation of duties is at risk and internal control risk arises.

The audit strategy for purchases at Richardson are as follows:

• First of all, the audit will be conducted as per the “Australian Auditing Standards” where the annual reports of the client, Richardson have been prepared as per the AASB standards.
• The reporting objective of the audit is in accordance to the conformity of the Richardson Ltd and will be communicated through the annual report.
• The key areas that require special attention or high professional judgement is the order placing procedure by the foreman which might include physical inventory count as well as observation and inquiry because the foreman does not verify the remaining inventory before placing the order for new inventory after being informed by the cabinet makers. Also, considerable attention must be placed on different businesses processes through observation and inquiry because one of the directors, Joe, controls the entire business process without having a separate employee as CEO. This is how all necessary audit evidences would be collected and audit opinion would be formed.

Solution to question 3

1. In the first test of accounts payable where a complete list of creditors was obtained at the first place and out of such list a random 14 suppliers were chosen as sample where their year end balances were traced back to the goods received notes and invoices so as to become sure that the goods arrived before the year end represents a “Substantive test.” While in the second test of accounts payable where the 18 creditor invoices were chosen as sample to examine that the discount condition as well as the price are approved and also checked by the managers of the purchase department or not represents the “Test of controls (William Jr, Glover & Prawitt, 2016).”
2. The key assertion which has been addressed in the first test identified above is the “Cut-off” which portrays that the transactions are to be recognized within the relevant and correct accounting periods only. The same has been done in the first test of accounts payable where 14 suppliers were chosen as sample so that their year end balances could be traced back to the goods received notes and invoices so as to become sure that the goods arrived before the year end. Whereas the assertions which has been addressed in the second test of accounts payable is the “Accuracy” and “Valuation” where the 18 creditor invoices were chosen as sample to examine that the discount condition as well as the price are approved and also checked by the managers of the purchase department or not and also to determine whether there are any errors involved in such pricing as well as calculation and correctness of discounts applied (Kharisova & Kozlova, 2014).
3. In the first instance where two out of the 14 suppliers which were selected revealed that the amounts were overstated, however, such amounts were of a relatively smaller amount and hence were accepted as no other material errors were detected. However, it is not reasonable to conclude such a statement as only 14 out of all the total creditors balances were tested and not all. So, there can be material number of overstated balances which can be detected in the total set of creditor balances and such an overstated balance in an accumulated way may be material. Whereas in the second case where 3 out of 18 invoices contained errors relating to discounts which have been applied still it was accepted as the discounts were immaterial. It should require further investigation as the total number of invoices of the suppliers may contain more errors relating to discounts and such figures may be material.
4. In the first test of accounts payable, “Inspection” of all invoices as well as goods received notes must be conducted. While on the second test of accounts payable, “Inquiry” into the management is to be carried out along with “Recalculation” of discounts if needed in some specific or eminent cases.

Solution to question 4

1. The two key account balances which are at risk are the “Accounts receivables” and the “Accounts payable (Zamboni & Litschig, 2018).”
2. The key assertions at risk for “Accounts receivables” are the “completeness” and “Cut-off”, while the key assertions at risk for “Accounts payable” is “Occurrence” and “Accuracy.”
3. Firstly, the “Account receivables” are at risk because one of the major purchasers of Rodan, “Pattison Ltd” who happens to be controlling 33% of the total sales of Rodan is facing financial difficulties and as a result is taking up to five months in paying the accounts owed to Rodan in place of the designated 30 days normal credit period. Rodan cannot afford to lose such a customer and as a result is suffering from intense liquidity crunch and has been taking lines of credit to maintain the cash flow. It may happen that Rodan may not receive the complete amount of accounts receivables or may not receive such owed amount in time that is within the same accounting period and may resort to misstatement in order to maintain the desired current ratio so that the debt covenant imposed on it by the ZSBC gets maintained at all times and this is why the completeness as well as “Cut-off” assertations are at risk (Knechel & Salterio, 2016). Secondly, the “Accounts payable” are at risk of material misstatement because when one of Rodan’s major supplier gone under administration, there was a shortage of raw materials and such shortage was met after taking of raw materials form another supplier and such raw materials were later reported to be of inferior quality by the production staff at Rodan. Therefore, the “Occurrence” and “Accuracy” assertion are at risk here because the Rodan management must be securing lower quality materials by paying higher price as well as there are doubt relating to securing of specific number of raw materials against which payments are being sanctioned.
4. The substantive tests for “Accounts receivables”, are “confirming accounts receivables directly from customers” and “review of the cash-receipts and bad debts write-offs (Rummell & Weickgenannt, 2020).” On the other hand, the substantive tests for “Accounts payable” are “Application of analytical procedures on payable balance” so as to ascertain the unusual increase or decrease and “verifying all balances of invoices received or delivery notes received and comparing it with the total amount of payables.” Lastly, “direct confirmation forms the creditor” can also be a handy option as a substantive test for accounts payables.

References and bibliography

Akhmetshin, E. M., Vasilev, V. L., Mironov, D. S., Zatsarinnaya, Е. I., Romanova, M. V., & Yumashev, A. V. (2018). Internal control system in enterprise management: Analysis and interaction matrices.

Appelgren, L. (2020). A survey of models for determining optimal audit strategies. Advances in accounting, 48, 100455.

Contessotto, C., & Moroney, R. (2014). The association between audit committee effectiveness and audit risk. Accounting & Finance, 54(2), 393-418.

Eilifsen, A., Messier, W. F., Glover, S. M., & Prawitt, D. F. (2014). Auditing and assurance services.

Kharisova, F. I., & Kozlova, N. N. (2014). Applying the category of «Assertions (or preconditions)» in audit of financial statement. Mediterranean Journal of Social Sciences, 5(24), 180-180.

Knechel, W. R., & Salterio, S. E. (2016). Auditing: Assurance and risk. Taylor & Francis.

Louwers, T. J., Sinason, D. H., Strawser, J. R., Thibodeau, J. C., & Blay, A. D. (2018). Auditing & assurance services. McGraw-Hill Education.

Rummell, J. E., & Weickgenannt, A. B. (2020). Planning for Substantive Testing at the Assertion Level: A Training Activity and Mini CasePlanning for Substantive Testing at the Assertion Level. Current Issues in Auditing.

William Jr, M., Glover, S., & Prawitt, D. (2016). Auditing and assurance services: A systematic approach. McGraw-Hill Education.

Zamboni, Y., & Litschig, S. (2018). Audit risk and rent extraction: Evidence from a randomized evaluation in Brazil. Journal of Development Economics, 134, 133-149.

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