Auditing to James Cropper Plc - Case Study Example

finance and accounting al Affiliation) Key words: Audit procedures, assertions PART A Financial ments are auditedto test if they depict a true and fair view of the respective company. Some areas are prone to high audit risks. In relation to the audited reports of James Cropper Plc 2013, the following were the areas prone to such risks; Inventory According to the statement of financial position, the group’s inventories amounted to £11,848,000 as at 30.03.13. Closing inventories had reduced from £12,361,000 from the previous year. Inventories are highly vulnerable to audit risks. In the normal course of trading, the net realizable value of stocks is based on the management’s judgment. Inventory should be inspected to indicate its status. An allowance/provision is made for obsolete or slow moving stock. Provisions are based on current conditions, past practice, and aged inventory facts available to management. The inventory balance is a material item on the statement of financial position, which has a direct impact on profit. This balance should indicate how costs are apportioned to the different elements of inventory. Auditors ought to carry out a recalculation of the inventory balance so as to confirm the assertion of valuation and allocation. High inventory movements create the risk of misstatements of this account balance. If accounting records are not properly maintained, the audit for inventories can become complicated. Raw material and employee benefit cost Raw materials and employee benefit costs amounted to £33,754,000, and £20,296,000 respectively, for 30.03.13. They had both decreased by £1,679,000 and £383,000 respectively, from the previous accounting year. Raw materials are the basic element in the inventory cycle. Auditors may need to inquire why the amount of raw materials and consumables used reduced. This inquiry requires the accounting records from the supplier in respect to the purchased materials. Raw materials indicated in the accounting records may not be in existence. A company may include raw materials that they do not have the right and obligation to own. An inspection of raw materials by the auditors is necessary so as to satisfy the assertion of existence. Accounting records may include a misstatement of the value of raw materials. An understatement of raw materials and employee benefit costs lead to an overstatement of the period’s profit. Auditors need to investigate whether the raw materials and employee benefit costs exist, and that their actual amounts confirmed. Employee benefit costs may not be valued and allocated accurately. Such errors pose as areas of audit risk. Their existence, value, occurrence, and allocation must be clear to reduce cases of audit risk in this category. Retirement benefit/actuarial losses Retirement benefit liabilities-actuarial losses amounted to £3,382,000. Assumptions used in the calculation of the Group’s retirement liability have the biggest impact on the company’s financial statements. Assumptions include; inflation assumptions, and the amount of pensionable salaries. These assumptions may not be accurate and may lead to audit risk. Questions to be raised when performing an audit on this category include; Do retirement benefits exist in the company? Did actuarial losses occur? How did the retirement benefits compare to those of previous years? How were the actuarial losses valued and allocated? How many employees were eligible for retirement benefits? Auditors need to identify the number of eligible participants in the retirement benefits scheme. Audit procedures should match the retirement benefits with the eligible participants to establish the existence of such amounts. Retirement benefits/actuarial losses are prone to audit risks due to their sensitivity and vulnerability to negligence by the directors when preparing financial statements. Receivable/Payable All companies operate a debit and credit plan. The respective amounts need to be indicated in the financial statements as they have a huge impact on a company’s profit. These areas face high audit risks due to misstatements. Accounting records might fail to indicate the treatment of discounts on trade receivables and trade payables rendering such records ambiguous. Auditors may raise queries about the valuation and allocation of receivables and payables, which would slow down the audit procedure. Directors may overstate receivables or understate payables to improve the company’s image. They may also understate receivables and overstate payables to reduce the amount of profit to be taxed. Judgment is required in estimating the collectability of trade receivables. Judgment is also required on the provisions made for bad and doubtful debts. The criterion for this provision must be established to reduce cases of ambiguity and bias. Auditors need to ensure that all items in the receivables and payables are casted appropriately from the accounting records to indicate their existence and occurrence. Cash and PPE Cash and cash equivalents for James Cropper plc amounted to £2,249,000, and £21,219,000 for property, plant and equipment. It is usually a company’s policy to depreciate categories within property, plant and equipment over their estimated useful lives. The points of consideration for this policy are; the method of depreciation to be used and the estimate of the useful life applied to each category of asset. The estimate of the useful life of an asset determines the annual depreciation charge. Variations in asset lives could have an effect in the realized profit through an increase or decrease in the depreciation charge. The statement of cash flows should clearly indicate all activities that involve cash, which must be reflected in the statement of financial position. In the case of property plant and equipment, auditors should obtain a clear valuation of all elements in this category and ensure that the values match up with those in the statement of financial position to test their occurrence. Auditors should also confirm the current condition of the property to test their existence. Cash and cash equivalents should be realizable so that their existence can be valid. PART B Various audit risks are inherent in the valuation of inventory. Detailed audit procedures are required to mitigate these risks. Audit procedures include; observation, recalculation, inspection, enquiry and confirmation, and analytical procedures (Georgiades, 2006). Audit procedures, more often than not, are determined by audit objectives. An audit on inventory requires that inventory reflected in the accounts represent a complete listings of materials, products, and supplies owned by a company. The audit should also indicate the location of such materials, that is; are they in transit, physically at hand, or stored at external locations as at the balance sheet date. This would indicate their existence, completeness, and the rights and obligations of the company to own such material. Inventory listings should be accurately compiled and valued according to generally accepted accounting principles. These values should be properly reflected in the accounts to show that valuation and allocation were conducted in an accurate manner. Inventory classification in the statement of financial position should be proper. Various disclosures also need to be made, which include; assigned inventory, methods used to value inventory, and the major categories of inventory (Georgiades, 2006). Different audit procedures are used to test different assertions. For example, auditors should observe a sample of physical inventory to ensure that the inventory recorded on the financial statements actually exist. This would confirm the assertion of existence of inventory as an asset in the financial statements. A physical observation of inventories can be conducted using separate inventory observation programs. This method would test the assertion of existence, occurrence, and right and obligation inherent in the inventories. An auditor should use the results obtained from physical observation of inventory to enquire from the management on the valuation procedures used. It is the right of every auditor to access all the relevant information regarding the audit. The management has a mandatory obligation to answer any queries raised by an auditor. Enquiring from the management and other relevant third parties would ease the audit task and eventually reduce audit risk to an acceptable level. An auditor must recalculate and test the clerical accuracy of the company’s physical inventory summary, which ensures that comparisons for test counts recorded during the observation to the physical inventory summary are traced. Recalculating and testing enables an auditor to perform an inspection of the count sheet control numbers obtained during observation to those used to compile the inventory summary. Any missing or added count sheets would be identified, which would require an explanation from the management. After a recalculation, inventory listings should be inspected for obvious decimal slides. Decimal errors may seem immaterial, but would have effects on the total figures when such errors recur in almost all items of inventory. Inspecting inventory listings ensure that they are complete and all items recorded relate to the balance sheet date. Physical inventory summary should be reconciled to the ledger account balance, and inspected to ensure that all items are incorporated. An analytical procedure aims at eliminating cases of overstatement and understatement of inventory (Kayadelen, & Quick, 2010). This procedure involves a comparison of current; gross margin percentage, inventory turnover, unit costs of inventory, extended inventory value, and manufacturing costs with those of previous years. Analytical procedures tests assertions which potential misstatements would not be apparent from an examination of the detailed evidence. Other procedures may not have the capability of establishing misstatements as they do not compare the current period with the previous period. Auditors consider the level of assurance they want from substantive testing for a particular audit objective and decide which other procedures that can provide that level of assurance. Analytical procedures may be time consuming when comparing numerous tag control numbers to the inventory summary. A scanning procedure can perform such comparisons in an accurate and time saving manner. Computer audit software can be used to audit computer-generated audit summary. Such software is used to test mechanical accuracy. Audit procedures are diverse and are dependent on the audit objectives. Audit objectives, as discussed above, aim at testing all the assertions inherent in inventories. Therefore, audit procedures are successful if they effectively indicate the existence, occurrence, valuation, allocation, rights and obligations, accuracy, cutoff, and completeness of inventory. References Assessing and responding to audit risk in a financial statement audit. 2006. New York: American Institute of Certified Public Accountants. Georgiades, G. 2006. Audit procedures 2007 ed.. Chicago, Ill.: CCH. ISSAI - International Standards of Supreme Audit Institutions. n.d.. Introduction. Retrieved March 25, 2014, from http://www.issai.org Kayadelen, E., & Quick, R. 2010. Management explanations and the effectiveness of analytical audit procedures. Darmstadt: Techn. Univ. Darmstadt, Inst. für Betriebswirtschaftslehre. Read More