Intense competition forced Tucker to modernize its products, and in doing so, it obtained a bank loan in January 2019. The long term debt was used to develop and introduce new products and a sophisticated computer-based control system that can be fitted to some of its products. The control mechanism eliminates the need to monitor and adjust the settings in the products manually. The new product was first shipped on September 1 st , and there are strong indications of its success. However, more information is still needed to determine its long term success.
Tucker must present to the bank a quarterly certificate of compliance related to the new loan to establish if it is in line with the covenant. At the end of June, the company recorded a loss to adjust its older inventory. Similarly, the loss helped in recognizing the impairment of older manufacturing equipment. The recorded amount can have significant effects on the annual auditor’s report. It is, therefore, critical to examine if there are material misstatement in the company’s quarterly financial statements and their effect on the annual auditor’s report. The analysis presents facts concerning the recorded information and any changes required to avoid adverse effect auditor reports at the end of the current financial year.
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Risk of Material Misstatement
It is a form of risk that arises if the financial statements of Tucker are misstated to some level. Reporting loss in the books of account to adjust the value of older inventory and to recognize the value of impairment for manufacturing equipment can lead to such risks. The books of account, in this case, will not represent an accurate picture of the state of affairs. It is therefore desirable for the company to assess the effect of such misstatements and whether they will increase the company’s risk.
While assessing the risk of material misstatement, the company must consider the inherent and control risks. Such action will determine whether the misstatement was as a result of fraud or an error. Control risk, on the other hand, cannot be detected or prevented by the internal controls of the company. Similarly, it is critical to establish the effect of misstatement risk on the financial statement of the company. A closer look at the financial statements of the company and the provide information shows that more evidence must be obtained through substantive procedures to reduce the overall audit risk.
Analysis of the Financial Statement
The inventory in the financial statement of the company dropped from 71 reported on 31 st March 2019 to 60 on 30 th June 2019. The values show a decline of 11, which is not the case in the previous quarter, where inventory increased from 70 on 31 st December 2018 to 71 in March 2019. Such changes affected the current assets, which declined by 12 from 161 reported in March to 149 recorded in June. However, there was a general decline since the December 2018 value was even higher compared to the Mach 2019 figure.
Changes in the inventory should affect the cost of goods sold and not the expenses of a company. An increase in the inventory of the company leads to more cost of goods sold, which reduces the gross profit and, ultimately, the net profit. On the contrary, a decline in the inventory will lead to lower cost of goods sold, increasing the gross profits; thus, it might also lead to more profits. However, the net profits can be affected by the company's expenses, and therefore attributing a loss to changes in the inventory alone can be misleading and does not present an accurate picture of the valid account of the company's operations.
Tucker recorded a loss to recognize the impairment of its manufacturing equipment. The financial statements at the end of the fiscal year should indicate the net book value of plant and equipment, and any loss from the impairment should be recorded in the income statement. It is prudent for the company to determine the carrying value of the equipment, and if it is lower than the book value, the difference should be reported as an impairment loss. Such loss should only be recognized if the carrying value cannot be recovered. The company can determine the value of the old manufacturing equipment if the total cash generated in its useful life is lower than the carrying amount.
The company should, therefore, determine the fair value of the old equipment and compare it with the book value. The difference should be treated as an impairment loss if the carrying amount is lower than the book value. The reported loss will reduce the company’s profits and also the value of the equipment reported in the balance sheet. Future depreciation should also be adjusted according to the book value of the plant and equipment.
The presented facts indicate that there are risks of material misstatement in the provided information. The risk can be attributed to the company’s action of recording a loss to cater for old inventory and impairment in the manufacturing equipment. It implies that the company must consider the effects of its operations and how they can affect the opinion of an auditor. The risk affects the income statement by reducing the reported profits and the balance sheet. The risk reduces the value of the inventory and manufacturing equipment. Similarly, it reduces the retained profits; thus, the entire statement of financial position will not reflect an accurate and fair view of the company’s situation.
There are financial statement level risks in this case since the reported amounts affect the financial statements as a whole. The company, for example, should have recorded changes in the inventory as a cost of goods sold, not an expense. Similarly, Tucker should only report the impairment loss in the old manufacturing equipment. The entire procedure should be audited to determine if there was fraud or it was an error from the company. The company should also follow the accounting standards while reporting its financials, and if there are any deviations, the same should be published in the management notes. Any transactions that affect the financial statements should be examined to ensure that the reported values reflect an accurate and fair view of the company.
Recommendations
It is critical to perform substantive procedures to determine whether there are material misstatements in the financial statements of Tucker. Similarly, the process will help in ascertaining whether the presented information reflects an accurate and fair account of the company's operations. By assembling the necessary support, it is possible to determine that there are no risks attributable to material misstatement. It will, therefore, be possible to give an opinion on the validity, completeness, and accuracy of the books of account of Tucker. The process will help in the detection of material misstatements in reporting a loss in the income statement to reflect the changes in inventory and impairment of the old manufacturing equipment.
Auditors should, therefore, test the transactions involved in recording the two items, their balance, and disclosure. They should also verify the financial statements and any information or notes provided by the management of the two issues. It is also critical to examine journal entries and the adjustments made by the company while recording such transactions. Auditors must, therefore, consider the related documents to establish that the appropriate procedure was followed. Similarly, the process should be reported to show that it was as planned. Likewise, they should make inquiries about such transactions, including physical observation of the manufacturing equipment and its impairment.
