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Auditing Theory and Risk Assessment

Question:

Discuss about the Auditing Theory and Risk Assessment.

Answer:

Introduction

Auditing has been an essential practice in the business sector as well as other areas dealing with a lot of economic assessment. The capability of a corporation to assess its growth depends wholly on auditing performed within the firm. Most of the operation in the economic sector highly rely on the nature of auditing, therefore, various theories have then been developed to assist eliminate various risks and crisis in auditing (López and Peters 2012). These methods have been designed by world’s financial reporting framework institution such as GAAP and IFRS to guide auditing practices. Several policies have also been developed to assist auditors in making corrections on the risks which may face them during auditing.

The nature of auditing and commitment of audit team ensures the success of a company within the industry or global market. In the recent past, theories like going concern has been developed. Implementations and practice of these stipulated issues remain in the hands of auditors and the board of management of accompany. The scope of this paper investigates the application of these current issues in One.Tel Company in Australia. The company has been in operation in telecommunication industry since May 1995 after being launched in Sydney. The paper further discusses inherent risk in the company financial reports and the issue of ongoing concern.

List and discuss several factors that would have contributed to an increased subjective risk assessment at the financial statement level. Also, identify which of these factors may be identified during the strategic business risk assessment

Inherent Risk

Inherent risk is one of the audit risks managed under risks assessment. Audit risk involves three kinds of risks. These risks are an inherent risk, control risks and the detection risk.  Audit risk is considered as the product of the three risks shown above. It may be encountered during auditing performance which in this case is One.Tel Telecommunication Company. Inherent risk is, therefore, a component of the audit which comes as a result of material misstatement within the financial statement. Inaccuracy occurs in a company’s audit statement due misappropriate application of necessary control measures (Chung et al. 2012). Inherent risks arise mostly due to the error of omissions in the balancing of the company books of accounts. In the case of One.Tel Company, inherent risks may have arisen due to failures and poor application of the control measures.  The occurrence of failures due to inherent risks may be as a result of oversight and fraudulent practices. An increase in the inherent risks occurs due to some factors within the internal business environment.

Factors which affect inherent risk at the financial report level

Authenticity of Management

The increase in inherent risks in One.Tel Telecommunication Company may be as a result of the incompetence of the board of the Directorate. The company’s management is made of nine members having different powers and privileges. The board is comprised of five none-executive members forming up the majority of the board members. There are other four executive members having a full mandate to everything within the company (Coetsee 2010). The rate at which inherent risk is increasing in the One.Tel telecommunication company is high according to the provided statement. The members are obligated to a lot of duties including authorization of corporate and financial strategies, identifying and dressing issues of significant facing One.Tel as a company, reviewing and monitoring management processes and reporting mechanisms, supervising financial performance and appointment of the senior management team. The company has grown to a limit where the management team cannot meet all their obligations. The directors are more likely to hide their poor reputations, therefore, failing to produce meaningful statements during auditing leading to an increase in the inherent risk because of poor management.

Administration Understanding, Awareness and Fluctuations during the Period

The inefficiency in the management of the company as well as lack of knowledge facilitates inappropriate preparation of the financial report leading to an increase in the inherent risk. Once the auditor detects regular workforce turnover in critical management locations, the inherent risk rises because truthful personalities are likely to resign their executive positions rather than propagate some fraud. This mostly occurs when the company expands fast as reflected in the case of One.Tel Telecommunication Company (Herda and Lavelle 2012).

Uncommon Compression on Organization Management

There may be inducements for administration to misstate the financial report increasing the inherent risk. The incentives in can be either from the internal environment or the external environment (Kerler and Brandon 2010). The incentives may be cash flow problems, poor liquidity rationing, poor operating results due to management limitation and work overstretch and connection of management compensation pay schemes tied to share capital and earnings. This may lead to an increase in the inherent risk since management may be induced to misstate operating and financial statements to acquire some bonus.

Nature of the Kind of Business One.Tel is Operating

Various issues have been acknowledged in the business or industry in which One.Tel Company operates.  The company has a complex investment organization, which is an aid to increase inherent risk. The existence of related-party transactions such as the company shareholders would also increase inherent risk as the operations are not with the self-regulating party (Al Nawaiseh and Jaber 2015). The company has got capital share transactions which require a lot of financial know-how to audit since such operations are complicated. Telecommunication companies have probably recompenses until they inaugurate a standing, and a trustworthy income source will be inherently risky. Telecom industry is facing a challenge which requires a ompany in the industry to apply controls mechanism to be stable and remain relevant in the industry. New economies result in high inherent risk than stable economies.

Factors Affecting the Industry in which the Entity Operates

Variations in commercial and competitive environments would be anticipated to have a significant influence on the inherent risk of an entity like one.tel in the telecommunication industry. Factors such as imbalance in the revenue and growth in some telecommunication service providers may lead to a rise in the inherent risk during financial statement preparations.

Throughout risk assessment stage the company audit team goes through the risks identified like the inherent risk discussed above. The team or the auditor evaluates the factors of the risks through fair evaluation (Martin 2013). Evaluation of risks results into two types of risks which in this case is an inherent risk. The identified risk is a component of material misstatement of the financial statement motivated by several factors.  Factors relating to fraud can be identified during strategy development process whereas those factor that increase inherent risk due to fraud identifiable via the AU section 316.

Inherent risk factors that would have contributed to an increased inherent risk assessment at the account balance level

Accounts likely to Require Adjustment

In the case whereby the books of account require changes, the inherent risk can be high as a result of various errors brought forward. An oversight may occur leading to an increase in the inherent risk when the books of accounts are being adjusted.

Complexity of Underlying Transactions

If the deal during a trading period is complicated, it is likely that there will be an increase in inherent risk. In consideration of One.Tel Telecommunication Company, the books of accounts indicates complex types of transactions such as the shareholder's inequity, reserves and dividend may be difficult to understand leading to high inherent risk at the accounting level.

Conclusion Involved in Determining Account Balances

The kind of judgment made by the auditor during the process of balancing of auditors is likely to influence inherent risk. In case the account report on a given transaction may be induced by some factors within the company (Reichelt and Wang 2010). These judgments can be affected by the type of operation and the management pressure.

Susceptibility of Assets to Loss or Misappropriation

The susceptibility of the company’s assets to loss or misappropriations leads to increased inherent risk at the accounting level. During the transaction entries, it is evident that simple misappropriation of an asset result into accelerated inherent risk. For instance taking misplacement of an asset to liability may lead to an increase in the inherent risk (Herd and Lavelle 2014).

The Occurrence of Unusual and Complex Transactions, Particularly at or Near Year-End

The occurrence of significant transactions during the trading period has a possible increase the inherent risk (Skinner and Srinivasan 2012). When an unfamiliar transaction occurs precisely towards the end of a trading period, there are high chances of errors in the books of accounts. Such different operations may be a challenge to the auditor and accountants and may result in high inherent risk. When a transaction is challenging, auditors may perform wrong placement in the accounts thus increase the inherent risk.

Transactions Not Subject to Usual Processing

The rate of an increase in the inherent risk is high at the accounting level when we make transactions which require unfamiliar processing. In the event of such case the auditor of a business entity like One.Tel Telecommunication Company may make mistakes leading to an increase in inherent risk.

Whether going concern should be assessed as high, medium or low and identifying the factors for Rationale 

The GAAP’s reporting framework requires management to make a quick decision based on the issue of going concern. The ongoing concern builds on the auditors' assessment whether low, medium or high in correlation to inherent risk and control risk (Francis 2011). The detection risk during the evaluation is maintained at the lowest level to keep the audit risk at the recommended rate. Minimum detection risk can be accomplished through scope test enhancement. Due to the argument, it is evident that the going concern can be either high, medium or low based on the three type of risk. The issue of going concern in relation to One.Tel Company’s case can be considered to be high. Inherent in the company’s financial statement is deemed to be high since the company operates in a highly controlled industry. In this situation, the company’s going concern is considered to be high (Chang, Dasgupta and Hilar 2009). Other factors such as the detective risk and control risk are seen to be high according to the nature of the business entity.

 It is clear from the above discussion that the rate of going concern depends more on the kind of risks in the financial statement. In the event of low audit risk, the nature of going concern remains low whereas when the types of a risk is medium or high, the going concern is either low or high. Even though the assumption may be correct, it is hard to regulate the following circumstances that may lead to the continuous application of a going concern (Knechel et al. 2012). The nature of a going concern in accompany depends on the application of the stipulated financial framework. The nature of going concern should be assessed as either, small medium or high as seen in the perspective of audit risk. Other factors such as audit period, recommendations from the auditor, business environment, and management team also affect the going concern consideration.

Conclusion

It is evident that auditors may have identified most of the control risk factors but failed to report accurately due to both external and internal pressures. The majority of Australian auditors view most of the company’s risk factors control as a challenging task due to lack of auditors’ independence. Inherent risk factors can be monitored when to control various factors are put in place. Audit assessment theory deals with the inherent risk, control risk, and detective risk issues. The case of One.Tel Telecommunication Company reveals that auditors are more likely to deal with inherent risk during risk assessment as a result of limited number of directors.

References

Al Nawaiseh, M.A.L. and Jaber, J., 2015. Auditing subsequent events from the perspective of auditors: study from Jordan. International Journal of Financial Research, 6(3), p.p78.

Chang, X., Dasgupta, S. and Hilary, G., 2009. The effect of auditor quality on financing decisions. The Accounting Review, 84(4), pp.1085-1117.

Chung, J.O., Cullinan, C.P., Frank, M., Long, J.H., Mueller-Phillips, J. and O'Reilly, D.M., 2012. The auditor's approach to subsequent events: Insights from the academic literature. Auditing: A Journal of Practice & Theory, 32(sp1), pp.167-207.

Coetsee, D., 2010. A critical review of the effect of accounting for financial instruments on the accounting framework. Southern African Business Review, 10(1), pp.115-129.

Coetsee, D., 2010. The role of accounting theory in the development of accounting principles. Meditari Accountancy Research, 18(1), pp.1-16.

Francis, J.R., 2011. A framework for understanding and researching audit quality. Auditing: A journal of practice & theory, 30(2), pp.125-152.

Herda, D.N. and Lavelle, J.J., 2012. Auditor commitment to privately held clients and its effect on value-added audit service. Auditing: A journal of practice & theory, 32(1), pp.113-137.

Herda, D.N. and Lavelle, J.J., 2014. Auditing Subsequent Events: Perspectives from the Field. Current Issues in Auditing, 8(2), pp.A10-A24.

Humphrey, C. and Miller, P., 2012. Rethinking impact and redefining responsibility: The parameters and coordinates of accounting and public management reforms. Accounting, Auditing & Accountability Journal, 25(2), pp.295-327.

Iwu, C.G. and Xesha, D., 2011. Used Bookstore as a Vehicle for Improved Learning and Development: The Case of a South Africans Tertiary Institution.

Janvrin, D.J. and Jeffrey, C.G., 2007. An investigation of auditor perceptions about subsequent events and factors that influence this audit task. Accounting Horizons, 21(3), pp.295-312.

Kerler, W.A. and Brandon, D.M., 2010. The effects of trust, client importance, and goal commitment on auditors' acceptance of client-preferred methods. Advances in Accounting, 26(2), pp.246-258.

Knechel, W.R., Krishnan, G.V., Pevzner, M., Shefchik, L.B. and Velury, U.K., 2012. Audit quality: Insights from the academic literature. Auditing: A Journal of Practice & Theory, 32(sp1), pp.385-421.

López, D.M. and Peters, G.F., 2012. The effect of workload compression on audit quality. Auditing: A Journal of Practice & Theory, 31(4), pp.139-165.

Martin, R.D., 2013. Audit quality indicators: Audit practice meets audit research. Current issues in auditing, 7(2), pp.A17-A23.

Reichelt, K.J. and Wang, D., 2010. National and office‐specific measures of auditor industry expertise and effects on audit quality. Journal of Accounting Research, 48(3), pp.647-686.

Skinner, D. J. and Srinivasan, S. 2012. Audit quality and auditor reputation: Evidence from Japan. The Accounting Review, 87(5), 1737-1765.

Thompson, T.R., 1960. Problems of Auditing Computing Data: Internal Audit Practice and External Audit Theory Section 1: Internal Audit. The Computer Journal, 3(1), pp.10-11.

Unegbu, A.O., 2014. Theories of Accounting: Evolution & Developments, Income-Determination and Diversities in Use. arXiv preprint arXiv:1411.4633.

 

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