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ACC707 Auditing And Assurance Services

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ACC707 Auditing And Assurance Services

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Course Code: ACC707
University: Kings Own Institute

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Country: Australia


While assessing the risk of material misstatement and determining the appropriate response with regard to the inventory of Computing Solutions Limited (Computing Solutions) for the 30 June 2018 audit, you become aware of the following information:
(i) The best-selling computer presentation package has been experiencing a high level of returns owing to suspected software problems
(ii) Based on closing inventory, inventory turned over an average of 5.2 times in 2017 and 3.8 times in 2018
(iii) Computing Solutions moved its inventory from a central warehouse to six new regional warehouses in March 2017
(iv) Inventory on hand at end of year represented 22 per cent of sales in 2018 and 18 per cent of sales in 2014
(v) Computing Solutions has recently won a tender to supply a large government department with various products. In order to win the tender and prevent competitors from gaining a foothold in the public sector market, Computing Solutions agreed to supply the items at 10 per cent below their cost price. The first shipment is due to be delivered to the government department in the middle of July 2018.
(a) Identify and explain the two key assertions at risk in relation to inventory
(b) Identify and describe two substantive audit procedures that you could perform in response to each risk identified above
(c) Explain the requirement of ASA 701 Communicating Key Audit Matters in the Auditor’s
Report and the rationale for this auditing standard. Determine if the above matters are key audit matters, providing full rationale for the determination. If it is determined that they are Key Audit Matters, provide the disclosures which are required in Key Audit Matters Section of the Auditor’s report as required under ASA 701.


Audit Assertions
Assertion simply means a claim made by someone about something. The Audit Assertions are claims and representation made implicitly or explicitly accountable for the preparation of the financial statements and their transparency and viability.They are also referred to as the Management and Financial Statement Assertions. The auditors rely upon a variety of assertions made by the management regarding the business. There are different elements based on which the assertions of the financial statements are tested and those include completeness, appropriatness, accuracy, obligations etc.These assertions play a vital role in audit of the financial statements as it helps the auditor in understanding various issues related to the financial statements and also resolving the same.
1 a) Key Assertions at Risk

Valuation:Inventories are the major assets of the company and hence it is important that they should be valued accordingly.According to the standards of accounting the inventories are valued at the lower of cost or net realizable value. The values also provide that surety must be obtained that no abnormal wastage has been included in the valuation of inventory. It is provided in question that Computing Solutions Limited is the seller of computer presentation package, so there are high chances that the inventories are become obsolete (Das, 2017). In a fast growing world where the technologies are upgrading on a daily basis, products are ought to get outdated within a very short span of time, which results in impairment of their value rapidly.
Rights and Obligations:The assertion of rights and obligations is a elementary assertion that all the assets and liabilities included in a financial statement belongs to the company delivering such financial statement.  (Belton, 2017). The practice followed by Computing Solution in regard to the inventories is that it moves the inventories from the chief warehouse to six regional warehouses, which involves risk to rights and obligations assertion. Since there are outside parties involved like consignee, when goods are on consignment, insurance companies, transporter, when the goods are in transit. So, the risk is high in relation to this assertion, hence, the clear understanding of rights and obligation assertion is very significant in this case.

1 b) Substantive Audit Procedures: The activities which are done by the auditors to notice the material misstatement or fraud at the assertion level are known as substantive audit procedures. For valuation risk: In case of inventory, the auditor is required to observe the physical count of the inventory, which should be done periodically. The auditor should analyze the procedures used for inventory count by discussing the counting procedures and observe the count as the same is being done. In case of multiple inventory storage locations, the auditor should test the inventory in those locations where the amount of inventory is noteworthy and also ask for confirmations of inventory from the guardian of the warehouse. The auditor should reconcile the inventory count to the general ledger and also do physical inventory count to those of general ledger (Kim, et al., 2017). In case there are items in the inventory the value of which is unusually high, then the auditor is likely to ensure that they are valued correctly by investing more time in the physical count of such inventory. The inventory must be valued at the lower of cost or net realizable value, the auditor is required to ensure the same by comparing a selection of inventory’s net realizable value with their recorded cost. The review of the closing stock should be done by the auditor with more diligence as it is valued at the closing date and risk of inflation or deflation is high in such case.
For rights and obligations: The auditor should review the purchase records to ensure the ownership rights of the inventories that are stored in the warehouse lies with the company and not with the suppliers or the assigners. In case of inventory that is on consignment, the auditor should review the consignment agreement to verify the ownership rights, also in case of insurance, the auditor should review the insurance policy (Jefferson, 2017). Basically wherever there is involvement of third parties the auditor should check the corresponding legal documents like agreements, to verify the ownership rights, as the risk involved in such cases are high.
1 c) The Auditing Standard ASA 701, Communicating Key Audit Matters in the Independent Auditors Report, was issued by AUSB pursuant to the disclosure requirements of the key audit matters by the auditors in the audit report. The main purpose of disclosing requirements of the key audit matters by the auditors is to bring more transparency and more insight to the audit report of a financial statement. As per ASA 701, the auditors are required to identify the key audit matters that require significant audit attention; these are required to be disclosed as a separate heading, clearly stating the reasons for determining the matters as key audit matters, their significance in audit along with related risk (Grenier, 2017). The auditor is to mention in detail the substantive audit procedures and substantive analytical procedures followed by the auditor in the audit of such key audit matters. The auditor is required to state such details in simple language avoiding the use of very technical terms in order to make the shareholder understand, since mpost people are not accustomed to technical auditing terms (Goldmann, 2016).
The valuation of inventory can be considered as a key audit matter since the level of complexity involved is high. The valuation and recording of inventory requires a lot of prudence on the part of the management (Sithole, et al., 2017).
The disclosure required in relation to key audit matters, as per ASA 701 are: 
The auditor should first describe the key audit matter with the help of a suitable heading in a separate section of the audit report under “Key Audit Matters”. The auditor should describe the key audit matters in reference to the related disclosures in the financial statements and state what are the audit procedures that have been undertaken by the auditor of the company. The auditor should clearly mention his observation on such matters in the audit report.
In case where the auditor, based on the circumstances and facts of the audit of any entity, considers that there are no key audit matters , a statement should be provided by the auditor separately, in a section to this effect under “Key Audit Matters”.
2) Intellectual property rights are legal rights that protect the creation or innovation of new ideas by people or company. These are intangible assets like, patents, copyrights, trademarks. The intellectual property rights became a commonplace in the majority of the world in the 20th century (Trieu, 2017). With growing technologies and more innovative ideas coming up bringing about advancement in the world, the intellectual property rights have became a very major asset for a company. The intellectual property rights are governed by the intellectual property law, the main purpose of which is to encourage the creation of large varieties of intellectual goods.
2 a) Key assertions at risk

Valuation:There are mainly three methods for the valuation of intellectual properties, firstly, cost method, which can either be based on historic cost or replacement cost, as historic cost is the cost of creating an intellectual property. Secondly, market based method, which can either be based on the market price compatibility or on comparable royal rate; thirdly, the economic based method, which is the most preferred method of valuation, this method requires quantifying of cash flow or royalty fees to intellectual property and then capitalization of future cash flow (Werner, 2017). Different companies use different method of valuation depending upon their valuation requirements.
Rights and Obligations:There are several types of intellectual property protection like patent, trademark. Copyrights, etc. Different intellectual properties provide different rights to the owner; say rights provided in patent are not similar to those provided in copyrights (Farmer, 2018). The ownership of a copyright belongs to the person who actually created it. This right is required to be registered with law in order to claim its ownership, unless it is registered with the law and the legal ownership is established by the law, the intellectual property rights cannot be recognized in the books as assets. There are complexities involved in such rights, creating greater risk on assertions.

2 b) Substantive audit procedures: Substantive audit procedures refer to the collection of data by the auditor during the audit process for audit evidences. Substantive audit procedures help the auditor in confirming that there are no material misstatements in the financial statements and that the financial statements are free from any material discrepancies . (Erik & Jan, 2017). The general categories of activity included in substantive audit procedures are:
Testing the various  classes of transactions, account balances and disclosures;
Examining the various  journal entries, assumptions and adjustments made during the preparation of the financial statements
Verifying that the financial statements and the notes accompanying thereto are in agreement to the underlying accounting records.
In case of intangible assets the substantive audit procedures involves that the intangible asset exists by reviewing appropriate documentation like legal documents; determining the ownership rights of the intangible assets belongs to the company and where acquired, the auditor should check the purchase agreement; the auditor should assess the useful life of the intangible asset, which if finite, then amortization policy and amortization expense should be reviewed; the management should be inquired  in regard to the carrying amount of the intangible asset, whether recoverable (Choy, 2018).
2 c) According to the Auditing Standard ASA 701, Communicating Key Audit Matters in the Independent Auditor’s Report, the auditor is required to disclose in its audit report the key audit matters. Key Audit Matters, also known as KAMs, are those matters, , are of most significance to the financial statements and are needed to be highlighted by the auditor. The main purpose of communicating the key audit matters in the audit report is to bring more transparency in the financial statements (Arnott, et al., 2017).
In order to determine the key audit matters, the auditor requires determining the matters which are most important to the users of the financial statements, the level of complexity involved in regard to any matter, the matters in which there are high chances of misstatements.
In view of the above, it is evident that the valuation of the intellectual property rights may be considered as a key audit matter, since it involves high level of complexities and the chances of misstatements are also high. Also, the proof of existence of certain intangible assets can never be completely reliable.
The disclosure required in relation to key audit matters, as per ASA 701 are: 
While reporting the key audit matters the auditor should give a proper explanation of the key audit matter and why is it so considered. The key audit matters should always be disclosed under a separate head in the audit report. Along with the description, the auditor should also disclose its significance to the entity and how it affects the financial statement (Alexander, 2016). The auditor should also provide a description of how the key audit matters have been addressed by the auditor in the audit report along with the auditor’s reply and approach, with a brief description of the audit procedures performed that would state that the company is free from any kind of misstatements
Hence based on the audit assertions it can be said that the company should see that all the key disclosure requirements with respect to financial statements of the company. It is important that books of the company should be properly audited and the audit report should be on point so that shareholders and stakeholders are able to take important decision based on the same.
Alexander, F., 2016. The Changing Face of Accountability. The Journal of Higher Education, 71(4), pp. 411-431.
Arnott, D., Lizama, F. & Song, Y., 2017. Patterns of business intelligence systems use in organizations. Decision Support Systems, Volume 97, pp. 58-68.
Belton, P., 2017. Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat International ltd.
Choy, Y. K., 2018. Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis. Ecological Economics, p. 145.
Das, P., 2017. Financing Pattern and Utilization of Fixed Assets – A Study. Asian Journal of Social Science Studies, 2(2), pp. 10-17.
Erik, H. & Jan, B., 2017. Supply chain management and activity-based costing: Current status and directions for the future. International Journal of Physical Distribution & Logistics Management, 47(8), pp. 712-735.
Farmer, Y., 2018. Ethical Decision Making and Reputation Management in Public Relations. Journal of Media Ethics, pp. 1-12.
Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business. Financial Environment and Business Development, Volume 4, pp. 103-112.
Grenier, J., 2017. Encouraging Professional Skepticism in the Industry Specialization Era. Journal of Business Ethics, 142(2), pp. 241-256.
Jefferson, M., 2017. Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland. Technological Forecasting and Social Change, pp. 353-354.
Kim, M., Schmidgall, R. & Damitio, J., 2017. Key Managerial Accounting Skills for Lodging Industry Managers: The Third Phase of a Repeated Cross-Sectional Study. International Journal of Hospitality & Tourism Administration, , 18(1), pp. 23-40.
Sithole, S., Chandler, P., Abeysekera, I. & Paas, F., 2017. Benefits of guided self-management of attention on learning accounting. Journal of Educational Psychology, 109(2), p. 220.
Trieu, V., 2017. Getting value from Business Intelligence systems: A review and research agenda. Decision Support Systems, Volume 93, pp. 111-124.
Werner, M., 2017. Financial process mining – Accounting data structure dependent control flow inference. International Journal of Accounting Information Systems, Volume 25, pp. 57-80.

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