Tiger Pride Enterprises - Literature review Example

Group Auditing Tiger Pride Enterprises Conventionally, in auditing, a component is a business activity for which the group or component management provides financial information to be included in the financial statements of the group. Group financial statements refer to the combined aggregated financial statements of the components that are under the control of the group. An audit that is conducted on the group’s financial statements is called the group audit. In this regard, various factors lead to the conclusion that the audit on Tiger Pride Enterprises constitutes a group audit (Journal of Accountancy, 2015). One, the Tiger Pride Enterprises prepares financial statements may be referred to as group financial statements since they are compiled by the four divisions each of which prepares its consolidated financial statements. Each of the four divisions prepares the financial statements for the business units it operates and then and then the four are consolidated and summarized as one by the Tiger Pride enterprise auditors. Notably, even though each of the four divisions operates and maintains its own records, Tiger Pride operates a centralized Information Technology system. Secondarily, the group engagement team that audits the component also serves as the group auditor and the component auditor. After every two years, an auditing team from the corporate offices audits the financial statements of all the divisions. Also, the financial statements of the various divisions consist of the various financial statements of different business activities within the division. The financial statements of Tiger Pride Enterprises include the financial information of more than one component and further include the analysis of each of the components as per the standards. The divisions of the Tiger Pride Enterprises are considered as components because they exist as legal entities and perform different operations each. Consequently, the financial statements for Tiger Pride Enterprises are group financial statements and hence the audit should apply is a group audit standard as Bagshaw (2013) highlights, because of the following reasons; one, the its divisions prepare consolidated financial statements which are compiled for the final overall statements, secondly, even though each of the divisions exists as a legal entity all of them are under common control, the Enterprise consists of the head office and more divisions which are managed separately and prepare separate financial statements which are reported to the head office, and the enterprise consists of components that are for financial reporting purposes. According to AU-C 6oo, an entity or business activity is a component for a group if the component management prepares financial statements those should be included in the financial statements of the group. Determining the kind of component, whether it is a business activity or it is a division is based on the accounting systems that used by the component. According to AU-C-600, A1-.A5, the identification of the type of the component may be gauged depending on the structure of the group and its financial reporting system (Journal of Accountancy, 2015). Further, financial information may be provided by different sections may be based on the parent and one of its subsidiaries, or the head office combining with its divisions, or a combination of both. Also, Bagshaw (2013) adds that the financial reporting of the group may be based on the geographic locations, the processes for different components, or their products and services. In this regard, for various reasons the conclusion is that the components of the group audits would be divisions and not the business units. This is because, for one, if the business units are used in the group financial auditing then it would not be a group audit as a group audit must consist of individual components. The respective business units for different divisions do not fit the definition of a component. One, they do not exist as legal entities of their own. Secondly, they are all managed by the divisions and hence the management of the business units is not independent like that of the divisions. Despite the fact that they prepare financial statements for purposes of inclusion in the division, the division cannot be termed as a group of its own. On the other hand, as per the statements provided, the divisions prepare reports for purposes of inclusion in the groups and hence this fits the conventional definition of a component. Moreover, the divisions exist as legal entities that are managed independently even though they are controlled by a head office. Therefore, a group audit for Tiger Pride Enterprises should include only the financial statements of the business units as its components. Collings defines a significant component as one that is of individual financial significance to the group with reference to some specific nature of circumstances (2011). In his case, this component may include significant misstatement to the group’s financial statements. Notably, the fact that a component is not material does not imply that the component is directly insignificant. In some cases, Budescu, Peecher and Solomon (2012) claim that a component may be of less material yet present a significant risk of misstatement of the financial statements of the group. For instance, the components that perform high-risk transaction such as the exchange of foreign currency, derivatives and hedging, alternative investments, components which are a going concern to the group, and others with complex financial arrangements. In this regard, it implies that one must not use the rule of thumb, may be of 25% of the assets, but should combine both quantitative and qualitative means. On the other hand, Flood (2015) observes that as the component’s financial significance increases, ordinarily the risks of misstatement in the group financial statements due to the component also increase. In this regard, for the Tiger Pride Enterprises, all individual business units with revenue of and over 5% of the revenues and whose income before tax of and over 5% of the group’s revenues and income before tax are considered as significant components. Other benchmarks include that for a component to be significant it must have 2% of the total fixed assets of the group and 2% of the total accounts receivable and inventory. The threshold is that for a component to qualify as significant must meet at least three of the above-mentioned benchmarks. In addition, other components shall be added which may pose significant risks to the group regardless of whether they meet the criteria of materiality described above or not (Stewart & Kinney 2012). Based on the above benchmarks and threshold, all the divisions, and various business units would qualify as significant components. Five percent of the total revenues amount to 545 millions of dollars, five percent of the income tax before tax would be $ 20 million, two percent of the fixed assets equals to $22.04 million while the inventory and accounts receivable benchmark of two percent would be $50 million. By this criteria, all the divisions meet the all the benchmarks and hence may be considered as significant components. Other business units that meet the above criteria may be found in the various divisions. Under Division A, the business units 1, 2, 3, and 4 qualify as significant components. In division B, the units 1 and 2 qualify as significant. For division C, the business units 1, 2, 4, 5, 6, 7 and 8 qualify as significant components while only unit 1 qualifies under division C. In addition to the above financially significant components, there are various other units that pose a significant risk to the financial statements of the group despite the fact that they are not materially significant. Notably, Business Unit A4 of division A has a significant risk of the financial statement of the overall group but it has already been included under material. In specific, Business Units 4, 5, 6, 7, and 9 of B, unit 3 of C and 4 of D have issues that significantly may lead to a misstatement of the overall group financial statements. In consideration of the units of B, unit four is incurring huge restructuring expenses that are leading to a significant loss that would lead to an increase of profits by $10 million if not accounted for. Therefore, eliminating it from the audit list would definitely lead to swell in profits by approximately $10 million and that would be a significant financial misstatement of the Tiger Pride Enterprises’ financial statements. As for unit 5 of B, it is involved in processes and further maintains complex derivative instruments that may lead to a gain of $25 million in the current year. In this regard, leaving out this unit may reduce the actual profits of the group by approximately $25 million which is a significant financial misstatement for the group. Unit 6 of B on the other hand is a going concern for the management as it has a history of making incorrect statements and the internal audit reports for the unit are very poor (Budescu, Peecher & Solomon, 2012). The new management in division B plus that Unit 6’s management is doubted by the management of the group in its ability and skills to run the unit adds to the significance of this unit to the financial statements of the entire group. Unit 7 of B also has similar issues as unit 6 especially regarding poor internal audit reports and hence is also financially significant. The Business unit 8 of B is not financially significant because of the cases of fraud it was involved in previously in order to meet the revenue bonus incentives were dealt with and assurance was made that indeed it was operating effectively. However, the Business unit 9 of B is financially significant because it is encountering severe market environment changes that have led to impairment charges on fixed assets and goodwill amounting to $60 million. Leaving out the $60 million will swell the value of the assets and hence this units audit is financially significant for the whole group. Furthermore, the management of the unit 9 has conceded that low sales are giving them cash flow problems and they may not be able to meet the assets’ overhead costs. Division C also has units that though materially insignificant, have financial significance due to the risks they pose to the financial statements of the group. However, unit 4 of C has significant risk but has already been included as financially significant due to its materiality. Unit 3, however, is included as financially significant because it is encountering low margin that is subject of discussions by the corporate management. Moreover, some of its goods have been returned as defective and the management has established that the top management of the unit may be pressuring the workers to the extent that they sell defective goods. Therefore, if the returned goods are not accounted for may make the audit report miss some important facts and also provide inaccurate estimates for the sales that may significantly affect the financial statements of the group of as a whole. It is important to decide whether the representative components selected on the basis mentioned above are sufficient and appropriate audit for the group. According to paragraph 28 of CAS 600, the auditor of the group is supposed to perform analytical procedures specifically on the non-significant components (Journal of Accountancy, 2015). Conventionally, the analytical procedures and transactions are basically done considering specific circumstances of engagement. Glover and Wood (2014) state that after doing the analytical procedures that the group auditor may conclude that the non-significant risks do not represent significant risks of material misstatement of the groups financial statements. In summary, before concluding that sufficient appropriate audit of the group may be based on the significant components, the group auditor has to consider the work that has been performed on the financial statements of the significant components, the work that has been done on the group-wide controls and its consolidation process, and also the analytical procedures that are performed at the group level. In the case of Tiger Pride Enterprises, there is a need to perform some specific analytical procedures on the non-significant components for various reasons. First, many of the divisions, that is Division A-C have many business components such that the business units summarized under one category do meet that benchmarks and the threshold that has been used as select individual financially significant units. This implies that as a group they meet the threshold benchmark and if left out of the audit they may pose a significant risk of misstatement to the overall group financial statements. Secondly, business units for divisions like D that are new even though they dont meet may materiality requirements for audit are should be considered to ensure that they are following correct accounting procedures. Furthermore, they by virtue of being new it imply that they don’t have any sufficient internal reports from which to draw conclusive conclusions regarding their procedure. Finally, some business units for which the management has special issues relating to it should also be further scrutinized to ensure that the corporate management measures are working correctly (Glover & Wood, 2014). Now that it is ascertained that the group financial statements risk misstatement if audited on the basis of the already chosen significant components, it is necessary to consider performing special procedures on the transactions and the accounts of the non-significant components so as to include more components of the audit. These actions are based on the paragraph 29 of CAS 600 which provides that the group engagement partner may decide to include a component auditor in the auditor’s report for the group’s financial information. To include the component however, the auditor must expressed permission from the component’s auditor, and that the report of the component auditor shall be presented with that of the auditor in the financial statements of the group. A 51 of the CAS 600 provides some factors that are to be considered in this process (Journal of Accountancy, 2015). Among others, auditor should consider the extent of evidence that may be obtained from the financial information of the significant components, newly formed components, effects of works performed by internal auditors in the components, whether the components are applying similar processes and systems and the effect of the controls of the corporate management to specific components. For the chosen components among the non-significant ones, the auditor shall conduct the following procedures or request the internal auditor to conduct them. One would be to audit the financial information of the components with regard to materiality. In this case, for the Tiger Pride Enterprises it will involve, for instance applying benchmarks and a threshold in a manner that will eliminate the possibility of material misstatement originating from the group. For instance, the auditor may apply the same benchmarks and threshold for the groups of business units within the divisions. Secondly, the auditor, or the internal auditor may decide to audit one or more of the account balances, disclosures, and different transaction classes. In this regard, as it concerns Tiger Pride enterprises, this will involve auditing the specific account balances and transactions of the financially significant components that will have been selected from the non-significant components. The internal auditor shall, therefore, present a report regarding how balanced the specific component account balances are and whether they truly represent the transactions of the component (Thomas & Wedemeyer, 2013). The review of the financial information of the selected components shall follow the component materiality assessment criteria as well as identify for auditing specific transactions that are have a to the financial misstatement of the component due to the nature of their transactions. In principle, the purpose of doing a risk assessment of the possibility of material misstatement is to design and implement mechanisms that will prevent the possibility of material misstatement in the financial statements of the group. When performing the procedures the auditor must ensure that they are sufficient and they provide a reasonable basis for identifying and assessing material misstatement risks. Notably, Thomas and Wedemeyer, (2013) summarize that material misstatements may occur due to error or fraud and they require that the auditor designs additional procedures for the audit. In general, the risk of misstatement may arise from external sources such as the industry environment of the component and its conditions, and also from internal factors that are specific to the company such as the nature of the company, the activities or processes of the company, the internal control of the company as it regards financial reporting. Consequently, the necessary procedures for the identification and appropriate assess of material misstatement risk should consider the company specific as well as external factors. One, the auditor should have an understanding of the component with their specific industry environment. The environment of the industry should be understood in terms of its regulatory framework, and other external factors such as how competitive the industry is, general economic conditions, the legal and political environment, and the applicable financial reporting framework. As it regards the nature of the company, the auditor should assess the organizational structure and the personnel in management of the company, the sources of funding for the component, the operating characteristics of the component, how the component earns its income, including the profitability of its key products and services and finally the relationship that the component has with its suppliers, customers, and the corporate management. Further, the auditor should also consider the financial relationships and transactions between the component and its executive officers. This process may involve doing through the compensation contracts between the executive officers and the component, looking at the filings of the company with the Securities and Exchange Commission, and any other regulatory agencies relating to the relationship and transactions with its executive officers (Glover & Wood, 2014). Secondly, Budescu, Peecher and Solomon (2012) advise that the auditor should also consider the application and selection of accounting principles as well as included disclosures for the component. In this regard, the auditor considers whether there are any significant changes that have occurred in the components financial reporting policies, accounting principles and the reasons for the changes. Further, the auditor shall consider the financial reporting competencies and skills for the specific components personnel, disclosures that relate to judgment on the determining of the estimates and assumptions of the management and any new financial reporting laws and standards to the component and how the component has adopted to such requirements. These considerations will enable the auditor to identify and assess misstatements that may be related to an omission, inaccurate disclosures and how the financial statements of the component conform to the financial reporting framework applicable. The auditor shall consider the above factors on the selected non-significant components that have been chosen on the basis of materiality. Upon identification of the components, the auditor should discuss with key engagement team members on the selection and accounting principles that are applied to the specific components as well as their disclosure requirements and the suspicions that the component may have a financial statement material misstatement due to error or fraud. For the new components, like the Business Units of Division 5 which are new, the misstatement may be due to an error while for unit 8 of Division B the misstatement suspicion is based on the history of fraud. References Bagshaw, K. (2013). Audit and assurance: Essentials for professional accountancy exams. New York, N.Y: John Wiley & Sons. Budescu, D. V., Peecher, M. E., & Solomon, I. (2012). The joint influence of the extent and nature of audit evidence, materiality thresholds, and misstatement type on achieved audit risk. Auditing: A Journal of Practice & Theory, 31(2), 19-41. Collings, S. (2011). Interpretation and application of international standards on auditing. Chichester: Wiley. Flood, J. M. (2015). PCAOB 8 Audit Risk. Wiley Practitioners Guide to GAAS 2015: Covering all SASs, SSAEs, SSARSs, PCAOB Auditing Standards, and Interpretations, 881-882. Glover, S. M., & Wood, D. A. (2014). The Effects of Group Audit Oversight on Subsidiary Entity Audits and Reporting. Available at SSRN 2117889. Journal of Accountancy,. (2015). Clarifying the standard for group audits. Retrieved 19 March 2015, from http://journalofaccountancy.com/issues/2013/mar/20126525.html Stewart, T. R., & Kinney Jr, W. R. (2012). Group Audits, Group-Level Controls, and Component Materiality: How Much Auditing Is Enough?. The Accounting Review, 88(2), 707-737. Thomas, W., & Wedemeyer, P. D. (2013). Clarifying the Standard for Group Audits: Impact of New Standard on Individual Engagements Will Depend on the Manner in Which the Practitioner Has Performed Group Audits in the Past. Journal of Accountancy, 215(3), 32. Read More