Auditing: Stage Coach Group - Case Study Example

Auditing- Stage Coach Group Stage Couch Group is an international transport company which operates trains, buses, trams, ferries and express coaches. The company was founded in 1980 in Perth; Scotland. Stage Coach Group provides smarter, greener and better value transport to over 3 million customers across the United Kingdom and North America. The company employs close to 33,000 employees. The company has three main divisions which include Rail, UK Bus and North America as a number of joint ventures. The success of the company is attributed to the strengths of the company. The company manages a portfolio of business assets and keenly looks on how to deliver value to its shareholders (Stage Couch Group Annual report 2012). This report will touch on the key areas of audit risk that have heightened in the audit report for the year ending 30th April 2012. The main sources of information will be the annual report, respective audit procedures and any other relevant sources. Areas of increased risk a) Revenue Stage Couch Group’s revenues are generated from the three main divisions (continuing operations) which include Rail, UK Bus and North America as a number of joint ventures. Revenue is a key area of concern as it is used in assessing the group’s overall growth and performance (Stage Couch Group Annual report 2012). As pointed out in the company’s annual report for the year ending 30th April 2012, the overall performance was as a result of increased sales in all the three divisions. The revenue increased by 7.76 per cent in 2012 from the 2011 financial team. There are times when the management of a company may misstate the revenue with the aim of impressing investors, the top level managers or the board of directors. The group recognizes revenue share amounts payable or receivable in its income statement at the same period in which related revenue is recognized. The revenue obtained from maintenance income and advertising incomes is treated as miscellaneous revenue by the company. The management of the company says that the company had performed well. However, the low percentage increase in revenue from 2011 to 2012 may be an issue of concern. A 7.76 % increase in the total revenue may be an indication of misappropriation and misstatements. This is a reason why the increase in revenue is an area of increased risk. Investor’s motive is to invest in a company that performs well and indicates growth. They get information of a company through the financial statements so as to make investment decisions (Stage Couch Group Annual report 2012). Therefore, if the revenue for instant does not indicate any growth, they will not invest in that particular company. Other times human error might occur when recording revenues or revenue may be recorded at the wrong time. This is another reason of concern on revenues. The audit procedure here is for the auditor to have an understanding of the company and the industry in which the entity operates so as to have a better assessment of the auditing procedures outcome. Audit procedures would also include vouching and verification procedures and analytical review of the financial statements. b) Cash When the company has enough cash, it means that its liquidity position is secure. Cash balances and receipts usually affect the profits of a business. Stage Couch Group cash balances decreased to ? 241 in 2012 from ? 358.3 thus this is a key area of concern that calls for scrutiny of internal controls to detect any error or fraud (Stage Couch Group Annual report 2012). The auditor uses analytical procedures as the audit procedure in detecting any fraud. He compares the cash balances with the projected cash and if the balances exceed or fall below the years expectations, tests of detail are performed. Cash is an area of concern because the management might overstate it to cover up on its liquidity position. c) Accrued receivables According to the 2012 financial statement, accrued receivables decreased to ?16.4 million in 2012 from ? 19.4 million in 2011 (Stage Couch Group Annual report 2012). An accrued receivable occurs when revenue is earned, but an invoice has not been issued yet to the customer. The reduction in accrued revenue means that revenue was earned but invoice was never issued. When an actual invoice is issued in the next accounting period, the entry is reversed. If not issued, the amount is accrued on a continuous basis. Use of accrued receivables is a vital area of concern as auditors pay attention to get justified answers. Therefore, one should not use accrued receivables if not in a position to justify clearly to the auditor the customer’s obligation to pay the accrued amount. This is a key area of concern which draws much attention to the auditor as he seeks justified explanations on the accruals. The auditor uses the feedback from the customers to reconcile the general ledger as the audit procedure. Customer’s feedback may either be positive or negative. d) Gross profit margins Gross profit margins are used in measuring the profitability of an entity and this reason why they are a key area of concern. According to the financial report in 2012, the gross profit margins increased by 9% in 2012 from 7% in 2011. The gross profit margin is an indicator of efficient utilization of resources such as labor and materials in generating revenue. The low rate in the change in profit margin indicates that the company is not efficiently utilizing its resources maximally. It also indicates that the company is unable to control inventory costs and production. Therefore, the higher the gross profit margin, the better as the company as it can retain some money to cover the operational expenses and left over on net the net profit. This is because for each sale, the company is in a position to retain a dollar. All these reasons explain why changes in gross profit margin adversely make it a key area of increased audit risk. For example, no accruals should be made where the business is offering services under a fixed fee contract since revenue is earned upon the completion of the project. Approval should also be made by the customer with regard to the project completion. This means that revenue is not earned prior to completion so there should be no accrual at that point. e) Gross profit Profit for the 2012 financial year was ? 238.5million, an increase of ?47.9 million from the 2011 financial year (Stage Couch Group Annual report 2012). The company recorded an increase in gross profit regardless of the increase in operating costs. This makes gross profit an area of increased audit risk as it may be subject to material misstatements to inflate the accounts. Audit procedures to determine the accuracy of the gross profit will include vouching of the books of accounts, test of controls and substantive tests. Section B Audit procedures for revenue Revenue has a cycle, and it is necessary to assess the degree of inherent risk associated with the cycle and perform tests to determine whether there is an error or fraud. The major processes in the revenue cycle include receiving customer orders, Authorizing credit terms and shipment, Confirming orders, Executing orders and Customer billing and recording the sale (Puncel 248). The inherent risk that might be associated with the revenue cycle can result from pressure by the management to misstate revenue or cut-off dates for particular dates during the financial trading period (Rittenberg, Johnstone and Gramling 843). The objective in auditing revenue includes: Ascertain the occurrence of revenue transactions. Establish the completeness of the revenue transactions Establish the accuracy of documents and records supporting revenue Determine the valuation of revenue Check whether the presentation and disclosure of revenue is adequate. For example disclosure of related party sales To increase the level of assurance that revenues are not misstated, analytical procedures, substantive tests and tests of control are to be performed. I. Analytical procedures Analytical procedure can also be performed on the revenue. These procedures entail running a number of financial ratios and making comparisons of these ratios to the industry benchmarks. The organization’s maximum capacity for sales is to be examined as part of the analytical procedures on condition that all the resources have been fully utilized (Rittenberg, Johnstone and Gramling 843). II. Test of controls Internal controls are mainly designed by the management. As a result, they highly depend on management’s adherence to high ethical standards and strong controls. Examples of tests of controls include ascertaining who accepts and approves credit sales, separation of duties such as filling out, recording of sales orders and shipping of goods, checking for documentation of cash receipts and depositing of cash, checking for appropriateness and authority to granting of discounts, sales returns as well as cash payments (Rittenberg, Johnstone and Gramling 843). III. Substantive tests The substantive tests help in finding any errors and misstatements that might have occurred during documentation or that are within the accounts. Such tests include checking the trial balance created at the end of each cycle by the accountant, circularizing debtors to confirm receivable amounts that they owe the company and evaluating the accuracy of the provision for bad debts by reviewing the company’s history. Substantive tests may also include tracing vouching and performing cut off tests on sales, cash receipts and sales returns (Rittenberg, Johnstone and Gramling 843). Documentation relating to a sample of the customer is examined including journal entries to ascertain the accuracy. Substantive tests for sales cutoff includes the Auditor selecting sample of sales recorded during cutoff period and vouches back to sales invoice and shipping documents to determine whether sales are recorded in proper period, Cutoff tests assertions of existence and completeness and Auditor examining terms of sales contracts. Cut off tests gives evidence whether revenue transactions have been recorded in the relevant accounting period. They are usually several days before and after balance sheet date. In addition, the extent of cutoff tests highly depends on effectiveness of internal controls. Substantive tests on Sales return cutoff include confirmation of documents on goods returned, date, description, condition and their quantities. The operating segments which contribute to the revenue should also be audited as follows: Audit of Rail, UK Bus and North America i. Audit of Rail and UK Bus The auditor reviews the adequacy of system controls, compliance with the required policies and operational procedures and recommends changes in policies, procedures and controls if necessary (Dube and Gulati 613). He also reviews, examines and reconciles the customer records, invoicing and contracts to ensure that they are accurate. Finally, the auditor reviews and analyzes invoices, rates, tariffs, call volumes, systems, taxes and lines. ii. Audit of North America Audit objectives of transport service entails verification of the legislation, physical security, security architecture, logical security and security policy. Legislation The auditor verifies whether relevant legislation has been followed like all transport laws (Dube and Gulati 613). Security architecture Here, the auditor checks on the appropriateness and completeness of the trains, buses, trams, ferries and express coaches (Dube and Gulati 613). He reviews the processes followed in the implementation of security in the company. The auditor also reviews the criterion used in choosing a firewall and firewall classes used in increasing security and functionality. The auditor reviews security required and technology used in addressing issues concerning security (Dube and Gulati 613). Physical security The auditor evaluates whether the trains, buses, trams, ferries and express coaches are physically present. He also determines whether these equipments are adequately protected against any hostile entry (Dube and Gulati 613). Logical security This involves checking whether company passwords are periodically changed, alerts are generates, passwords are encrypted and controls are in place to secure ingoing and outgoing connections (Dube and Gulati 613). Security polices The completeness of security policies is reviewed. For example system access controls, violations, confidentiality of information handling and general disclosure policy (Dube and Gulati 613). Conclusion There are a few aspects that one should put in mind before commencing the revenue process. First, it is extremely essential to understand the environment that the company operates in (Puttick et al 584). Therefore, an expectation on the total revenues and gross margin is developed based on economic indicators, market position and competitive environment. This also entails the auditor understanding the integrity of the management, financial pressures or condition of the organization and management’s incentives in achieving financial results. Secondly, one should identify and understand issues which prove difficult in the recognition of revenue. These issues are long-term contracts, potential for deferred or unearned revenue and bundled revenues. Works Cited D. P. Dube and Ved, Gulati. Information System Audit and Assurance. Tata McGraw Hill education. 2005, pg 613 George, Puttick, Sandy van Esch, Sandra Dawn Van Esch and S. P. Kana.The Principles and Practice of Auditing. Juta & company. 2008, P582, p583 and p584 Larry, Rittenberg, Karla, Johnstone and Audrey, Gramling. Auditing: A Business Risk Approach. Cengage learning. 2011, Page 843 Luis, Puncel. Audit Procedures 2008. CCH. 2008, pg 248 Stage Couch Group Annual report 2012. http://www.stagecoach.com/~/media/Files/S/Stagecoach-Group/Attachments/media/publication-financial-reports/ar2012.pdf. Accessed on 20th March 2013 Read More