The three primary qualitative factors that affect an auditor's judgment of materiality include the magnitude of occurrence, the likelihood of occurrence, and the company's value creation factors (financial or non-financial). The auditors often judge materiality around the item types relating to the social, financial, and environmental matters. Auditors assign higher materiality for items with higher likelihood and magnitude than when they have a low magnitude or likelihood. Moreover, auditors assign high materiality when the item is financial than when it’s non-financial. In the judgment of materiality, magnitude is more influential than the likelihood of items. The magnitude and likelihood are more linked to financial items' materiality than to social and environmental items. The auditors would consider the three factors because they directly affect a company’s overall risk and financial results hence ideal for determining materiality.
Alternatives to Audit Risk Equation
Auditors can rely on research, data, and the 5-prong assessment to mitigate audit risk besides the audit risk equation. For example, Choplogic Inc. has internal auditors using two-dimensional enterprise risk management (ERM). Using this method, the company's internal auditor prioritizes potential risks and ranks their likelihood of occurrence. The company further relies on research to conduct external scans and checking data from sources such as transparency international on the corruption perception index, information on the major accounting firms, and risk compliance firms. In other firms like Minot global, auditors use the 5-prong procedure in mitigating audit risk. The procedure involves an analytical review of unusual transactions, audit inquiry with relevant persons such as accountants, observation through the physical confirmation of stated items, inspection through verifying documents, and re-calculations to detect any differences between audit and client works.
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Week 6 Question: Management and Internal Control
The Scenario of Deficient Internal Controls but No Material Weakness
The Lubtex Ltd Company has reported deficiencies in its internal controls, particularly in its general information controls of user access and program change management. The company reported that the affected technology systems support its financial reporting system and plan to report material weakness. However, the firm has materiality of 5% of its pre-tax net income that is difficult to envisage. It’s unlikely that defects in the company’s user access and program change management could lead to a 5% cost of the pre-tax net income error. It fails to satisfy the definition of a reasonable possibility for it to qualify as a material weakness. The amount of misstatement cannot be prevented or detected on a timely basis. If the deficiency were detectable on a timely basis, it would affect the audit plan in the design and operation control measures as it would constitute a control deficiency.
Accounting Scandals
Some of the recent accounting scandals include the Carillion and the Ted Baker scandals, both of which happened in 2018. In the case of Carillion Construction Company, the firm collapsed, having a debt of £ 1.5 billion (Oncioiu et al., 2020). The KPMG accountants responsible are accused of hubris, greed, and carelessness that led them to rubberstamping and misrepresenting the business coupled with conflict of interest. The Deloitte and KPMG auditors missed to notice or report red flags of £1 billion pension deficits and aggressive accounting at the company. Internal controls such as strategic risk management and auditor accountability would have helped the firm understand the risks and avoid failure properly. In the Ted Baker luxury clothing company case, KPMG provided expert witness services to Ted Baker in a London lawsuit. As a result, KPMG was fined £ 2.1 million for misconduct on Ted baker’s financial statements of 2013 and 2014 (Oncioiu et al., 2020). Internal measures of avoiding working with firms that have a conflict of interest in the business and scrutinizing external auditing would have helped prevent the case of substandard auditing provided by KPMG
Week 7 Question: Audit Risk and Fraud
Concealing Financial Fraud from Auditing Firms Using Technology
Balico Investments, a company that offers electrical energy goods and services, has liabilities that are worrying and raise more questions than answers. Since the firm is due to be audited, the accountants, technology department personnel, and managers collaborate to hide this information from the auditors. They devise a plan to hide the liabilities and inflate earnings. The firm makes bogus sales receipts and invoices for products that don’t exist and digitally alters the appearance of the receipts, invoices, and financial statements to trick the auditor and make the company look profitable when it’s not. They additionally accrue fictitious income at the year with forged journal entries, recognize sales of goods not shipped, inflate sales, accruing projected sales not yet occurred, and understate receivable allowances (Arens et al., 2016).
Remedy for Auditing Firms in Reducing Exposure to Risk
Auditing firms can minimize exposure to technology conceal financial fraud using ERP, continuous monitoring behavioral analysis, digital analysis, and data mining. ERP and constant monitoring will help eliminate errors in financial systems that aids in the misuse of assets. Auditors’ should be on the lookout for blandness in communication messages among potential conspirators and check for unusual content. Data mining will help auditors analyze and provide useful feedback for easy interpretation.
Audit Procedure
Figure 1 : Account balance sheet (Adapted from Figure 5 on the website MyAccountingcourse.com, 2020)
The best audit strategy to audit Paul’s Guitar Shop Inc.’s balance sheet would be using the four main steps of current auditing assets, fixing asset audits, undertaking investment audits, and auditing liabilities. In the first step, the auditor will audit cash balances, bank balances, and account receivables. The auditor will check depreciation for each asset, its sale value, and profit/loss balance values shown in the sheet in the second step. Step three will involve checking investment sources, while the final step will be for auditing accounts payable, outstanding liabilities, and bank loans. The procedure is ideal is it ensures that each item on the balance sheet is fully audited.
Week 8 Question: Internal Controls and Sampling Strategy
Auditing Sales and Collections of a Merchandising Company
The management could manipulate earnings through big bath accounting and capitalization practices. Internal procedures to prevent or detect such manipulations include separation of duties, standardized financial documentation, and physical auditing of assets. The physical audits will ensure that the documented information on cash, inventory. Tools and materials match with the actual and thus deter managers from manipulating figures. Standard financial documentation will ensure that each is documented as it happens with a transition, such as inventory receipts and travel expense reports submitted timely to prevent future manipulations.
Sampling in Auditing
The advantage of stratified sampling in auditing is that it covers a high degree of representatives of strata. The method is, however, time-consuming and tedious. Random sampling is advantageous for is accuracy in making selections using a random number generator. Auditors can easily draw accurate conclusions on recorded accounts when using random sampling. The method is disadvantageous when it comes to the time required, as it’s time-consuming. The best way to sample accounts receivables is by using random sampling. Random sampling is most suitable for accounts receivables as it’s the most theoretically correct.
References
Arens, A. A., Elder, R. J., & Beasley, M. S. (2016). Auditing and Assurance Services. Pearson Education, UK.
MyAccountingcourse.com. (2020). Balance Sheet . Retrieved November 13, 2020, from My Accounting Course: https://www.myaccountingcourse.com/financial-statements/balance-sheet
Oncioiu, I., Ștefan, C. M., Radu, V., & Burlacu, G. (2020). The Effect of Accounting Manipulation on Business Performances. Management of Accounting Standards for Sustainable Business Practices , 168-177.doi/10.4018/978-1-7998-0178-8.ch008.
