Origin Energy Limited Major Audit Risk Areas - Case Study Example

Origin Energy Limited Major Audit Risk Areas By student’s name Course code+ name Professor’s name University name City, state Date of submission Table of Contents Executive Summary 3 Introduction 4 Nature and Purpose of the Audit Process in a Company 4 Audit Risk 6 Origin Energy Audit Risk Areas 8 Liabilities Arising from Non-Compliance with Regulatory Standards 9 Understatement of Liabilities Arising from Lawsuits 11 Manipulation of Financial Statements and Results 12 Auditing Procedures to Verify Account Balances 13 Conclusion 14 References 15 Executive Summary An Audit risk is a risk that the auditor may unintentionally fail to modify his opinion appropriately on financial statements that are materially misstated. Through an audit risk assessment, an auditor is able to identify the high potential areas that can cause material misstatements in financial statements of a business. This report focuses on Origin Energy as a case study to highlight the audit risks in the company. Origin Energy is the leading retailer of gas and electricity in Australia. The report identifies three audit risk areas and provides a discussion on the possible impacts of such audit risk areas on the company. Introduction Origin Energy Limited is the leading supplier and retailer of gas and electricity in Australia and also a major energy provider in New Zealand. The company is involved in a range of energy-related operations such as the exploration, production, generation as well as the sale and supply of energy to businesses and households in Australia. The company offers a range of energy solutions to its customers that include a variety of renewable energy solutions such geothermal, solar and wind energy (Origin Energy 2017, 1). The purpose of this report is to look at the major audit risk areas affecting Origin Energy Limited and specifically in the preparation of its financial statements and other auditing procedures in the company. The report looks at how these audit risk areas affected the auditing of the company in the preparation of its 2014 annual report which contained information of the financial position of the company. Nature and Purpose of the Audit Process in a Company The making of economic decisions whether in a business or society has to be based on available information related to such a decision. Whether or not a bank will issue a loan to business, for example, depends on the information available on the previous relationships between the bank and the business or the availability of information on the financial condition of the business. The financial condition of the independence at such a time can be revealed by looking at the financial statements of the business among other factors. For the bank to rely on such information, it must be reliable due to the procedures used to prepare such information and the integrity and correctness of the making such a report or both (The Institute of Company Secretaries of India 2014, 321). One of the ways to verify such information is to have a verification process such as an audit by independent persons. Such verified or audited information can then be used in the decision-making process based on the assumption that the information is reasonably accurate, complete and unbiased. Auditing is defined as the process that involves examining the accounting records of a business with the objective of establishing whether such records correctly and completely reflect the transactions undertaken by the business and the financial condition of the business (The Institute of Company Secretaries of India 2014, 321). It involves the systematic examination of the books of accounts of a company or business in order to determine the correctness of the books. An audit is usually conducted by an independent person or group of persons who have the requisite qualifications to conduct such a process. The work of the auditor is to look at the profit and loss account of the business in order to ascertain that the profit or loss recorded is a true reflection of the business transactions. Further, the auditor also looks at the balance sheet of the business to ascertain that the state of affairs as stated in such records are correct. The auditor must be satisfied as to the authenticity of such records. At the end of the process, the auditor is required to prepare a report showing that the financial statements reveal the true and fair position on the state of affairs of the business. (Karen 2013, 7) To achieve this goal, an auditor must inspect, scrutinize, compare and review vouchers evidencing the transactions made on behalf of the business and also examine any correspondence and minute books of directors and shareholders to establish the correctness of the books. Companies and business usually have internal auditors to help the management in the making of the financial statements of the business. However, there are times when the owners or shareholders of the company need assurance that the financial statements prepared by the management are reliable. The shareholders normally vest the control of the business or company in the hands of the management. This means that the financial statements are also prepared by the management. As a result, the shareholders would want an assurance that the information presented to them relating to the financial position of the company is correct (The Institute of Company Secretaries of India 2014, 330). It is worth noting that in most companies such as Origin Energy Ltd, there are audit committees that are there to assist the management in fulfilling its responsibilities. The audit committee helps the management in ensuring that the company complies with all the laws, regulations and standards set for the industry (Origin Energy 2015, 2). However, since the audit committee acts as an internal structure, the shareholders may still require the services of an external auditor to verify the information prepared by the management and the audit committee. The process of selection of the external auditor is conducted by the audit committee to ensure that they have the required qualifications (Origin Energy 2015, 2). Audit Risk Audit risk is defined as the risk that an auditor has expressed an inappropriate audit opinion when there is a material misstatement of the financial statements. It is the risk that the auditor may unintentionally fail to modify his opinion appropriately on financial statements that are materially misstated (American Institute of Certified Public Accountants 2008, 1667). Through an audit risk, an auditor is assured that material misstatements are detected. Audit risk is important to the audit process due to the fact that auditors do not and cannot check all the transactions conducted by a business. There are many transactions that are conducted on behalf of a business especially for large companies such as Origin Oil which make it impossible for auditors to look into each of these transactions. The risk-based approach is, therefore, necessary to minimize the chances of giving an incorrect audit opinion. The audit risk approach is meant to ensure that the audit work is conducted in an efficient manner using effective tests in audit risk assessment. The audit risk approach requires auditors to direct audit work to the key areas where there are risks of likely errors in transactions and balances which may lead to a material misstatement of the financial statement of a business (ACCA 2009, 1). The concept of audit risk is closely associated with that of materiality in the audit process. The concept of materiality recognizes that there are matters or transactions that are more important in ensuring a fair presentation of the financial statements than others. In the process of performing an audit, therefore, an auditor must be more concerned with the matters that either individually or in aggregate are material to the financial statement (American Institute of Certified Public Accountants 2006b, 1647). The concept of materiality is supposed to ensure that the auditor incorporates the needs of users of accounting information in preparing the audit. The auditor must focus on the matters that have the potential to affect the accuracy and completeness of the financial statements. This concept materiality is also important in risk audit. An auditor must conduct audit risk assessment on those areas that are material to the financial statement. The auditor, therefore, must conduct an audit risk assessment on the material matters or operations of the business to rule out any errors that may cause financial misstatements (American Institute of Certified Public Accountants 2006b, 1647). One of the important processes in conducting an audit risk is identifying the areas that should be considered based on their perception of high risk. The management must, therefore, identify the areas that are at high risk through conducting an evaluation of the business (McGraw-Hill Higher Education 2012, 130). The audit risks identified can be of three types namely inherent risk, control risk and detection risk. Inherent risk refers to the risk of a material misstatement occurring in the financial statements which arise due to errors arising from factors other than the failure of controls. The inherent risk may occur where there is a higher degree of estimation or judgment involved or where the business transactions are complex. Control risk refers to the risk of the occurrence of a material misstatement in the financial statements arising due to the absence of relevant controls in a business. A business must have internal controls to detect and prevent fraud and error (McGraw-Hill Higher Education 2012, 132). The lack of such controls creates the potential for the occurrence of control risks. Detection risk, on the other hand, is the risk that the auditor may fail to identify a financial misstatement in the accounting information. An auditor is, therefore, required to apply the requisite audit risk assessment procedures in order to detect such risks. To identify these risks, an auditor has to plan adequately for the audit. One of the steps necessary in the planning stage of an audit is the acquisition of sufficient knowledge of the entity including information on the risk of material misstatement. The acquisition of such knowledge also ensures that the auditor understands the entity and its environment or industry. Such information is necessary for ensuring that the concept of materiality is applied. The auditor is able to identify the material areas that have a high risk to ensure that they are considered to avoid any misstatements in the financial information (McGraw-Hill Higher Education 2012, 133). Origin Energy Audit Risk Areas Origin Energy’s major risk areas are discussed in view of their 2014 financial statements. This is because there were key events that happened during that year which should have been accounted for in the preparation of financial statements. The audit risks facing Origin Energy are connected to some of the business risks facing the company. Although business risks are different from audit risks, such risks may greatly contribute to audit risks. Some of the major audit risk areas in Origin Energy in relation to the 2014 financial reports and their current financial statements include the liabilities arising from non-compliance with standards in the oil and gas sector, understatement of liabilities arising from lawsuits against the company and the manipulation of financial statements and results to cover up non-compliance with regulatory standards (Standards Australia Limited 2015, 4). Liabilities Arising from Non-Compliance with Regulatory Standards A 2014 internal group audit of Origin Energy Limited revealed that oil and gas division standards were unsatisfactory. In the internal audit report of the company, it was revealed that the management allocated inadequate resources into the compliance division leading to regulatory breaches (Origin Energy Limited Internal Audit Report 2014, 1). These regulatory breaches were not logged onto the internal system of the company hence losing track of its responsibilities. A whistleblower who was a former compliance manager at the company revealed how the company management tried to cover up the compliance issues at the company. Due to such non-compliance, industry and environmental regulators have been inspecting the company’s oil and gas sectors. An inspection of the Lang Lang facility in Victoria revealed that the plant was releasing higher amounts of toxic chemicals that were allowed under the license granted to the company (Butler 2016a, 1). The potential outcome of this non-compliance issue is the rise in the fines and other statutory charges arising from the breach of the standards. The Victoria Environmental Protection Agency had already found the company non-compliant which further raises the fines and charges (Butler 2016a, 1). There is also the potential that the plant may face closure until the management is able to guarantee that the emissions will be within the required standards. Such closure, however temporary, may lead to excessive costs to the company. Due to these extra charges, the expenses of the company are bound to lower hence affecting the profit and loss account. The audit report was released in February 2014, yet such risk areas and costs were not factored or considered. Figure 3: Outcome of the Control Environment Assessed as Unsatisfactory Audit Overall Rating Scope Area Scope Area rating Issues raised Issues raised Issues raised Issues raised Severe High Medium Low Regulatory Compliance Unsatisfactory Governance, policy and direction, management accountability, responsibility and awareness Needs Improvement - 1 - - Regulatory Compliance Unsatisfactory Management system, processes, reporting, and programs organization, resourcing, training Needs Improvement - 8 - - Regulatory Compliance Unsatisfactory Monitoring and improvement program Needs Improvement - 1 2 - Total - 10 2 - Source: Origin Energy Limited Internal Audit Report 2014, p.1 Understatement of Liabilities Arising from Lawsuits The finding of the non-compliance against Origin Energy also arose as a result of the information released by the then compliance manager Sally McDow. The compliance manager was later bullied and sacked for refusing to take part in the cover-up of the compliance issues facing the company. The sacking and bullying of the compliance manager led to a lawsuit against the company. This further adds to the costs against the company arising from the compliance issues. Due to the nature of the suit against the company and its attempt to cover up the whole issue it is likely that the total liabilities arising from the lawsuit were understated. The impact of such understatement of the liabilities means that there were material misstatements in the financial statements in 2014 and the preceding financial years as a result of any delay in the completion of the suits. Such costs were not factored in cash flows for 2014 (Butler 2016b, 1). Figure 2: Origin Energy Statement of Cash flows 2014 Year Ended 30 June 2014 ($Million) 2013 ($Million) Change($Million) Change (%) Cash and cash equivalents at the start of the period 308 358 (50) (14) Cash flows from operating activities 2,227 1,642 585 36 Cash flows used in investing activities (3,314) (1,515) (1,799) 119 Cash flows (used in) from financing activities 1,002 (188) 1,190 N/A Net increase in cash and equivalents (85) (61) (24) 39 Effect of foreign exchange rates on cash 5 11 (6) (55) Cash and cash equivalents at the end of the period 228 308 80 (26) Source: Origin Energy Annual Report 2014, p.13 Manipulation of Financial Statements and Results The findings of the internal group audit revealed the fact that the oil and gas sector was non-compliant with the standards and regulations set for the industry. After the release of the audit report the company made efforts to conceal these findings. The cover up of the compliance issues affecting the company means that there were also hidden costs incurred that were hidden from the auditors. These figures have a potential risk of leading to materially incorrect financial statements (The Institute of Internal Auditors Australia 2016, 3). It is worth noting that the cover up was done by the management which means that there was also the potential for manipulating financial information to hide the costs for the non-compliance issues facing the company. The audit report led to the start of an investigation into the company by the Federal government through the accounting from Ernst and Young. The company instructed its employees not to cooperate with the audit form. This shows that there were widespread and potentially dangerous compliance and financial failures that the company was trying to cover up. Such cover-ups potentially led to the manipulation of financial information. This means that there were financial and operational activities that were not indicated in the financial and operating highlights of the company (Origin Energy Annual Report 2014, 9). Figure 1: 2014 Financial and Operating Highlights Year Ended 30th June 2014 ($Million) 2013 ($Million) Change Statutory Results External Revenue 14, 518 14,747 (2) Statutory profit 530 378 40 Statutory earnings per share 48.1 34.6 39 Items excluded from underlying profit (183) (382) (52) Underlying Results Underlying profit 713 760 (6) Underlying profits per share 64.8 69.5 (7) Underlying EBITDA 2,139 2,181 (2) Final dividend per share- unfranked 25.0 25.0 - Ordinary shares on issue at year end (million shares) 1,104 1,098 1 Operating cash flow 2,227 1,642 36 Source: Origin Energy Annual Report 2014, p.9 Auditing Procedures to Verify Account Balances Due to the above major risk areas, there is potential for material misstatements in the financial record of the company. To verify the account balances and the financial statements of the company an auditor must maintain professional skepticism in gathering and evaluating the audit evidence (CPA Australia 2015, 1). One of the key steps in the planning stage of the audit process involves having the auditor familiarize with the business and its environment. An auditor will, therefore, take notice of the compliance issues affecting the company and the cover-up attempts by the management of the company. Such information means that the auditor will treat all financial information submitted to him with skepticism looking out for possible error and omissions. Such an approach means that the auditor will assign specialists and the more experienced staff to supervise and scrutinize the financial information and reports. This also means that the auditor will use further audit procedures in order to unveil the discrepancies in the reports (American Institute of Certified Public Accountants 2006a, 1782). Through this approach, the auditor is able to verify the account balances presented to him and ensure that there are no potential risks of errors. The auditor must also perform test control to understand the internal control environment of the company. The cause of control risks, as discussed above, is the lack of proper internal control mechanisms to prevent fraud and other errors. Due to the fact that the management took part in the cover-up of the compliances, the auditor must proceed on the assumption that there was manipulation of financial information. As a result, one of the approaches related to treating all information in a skeptic manner is by testing and evaluating the internal controls of the company (Financial Reporting Council 2000, 5). An evaluation of the internal controls will help the auditor to know whether the auditor can have confidence in the internal controls. Such testing of the internal controls will also help the auditor to decide whether the audit evidence generated internally is reliable. Once the auditor has done the testing, if the internal controls are reliable, he can proceed to rely on the information, and where such controls are not reliable, the auditor can proceed to scrutinize the company documents afresh to ascertain or find out the correct position of the company. Conclusion Audit risk enables an auditor to identify the areas that pose a higher risk for errors that can lead to misstatements in the financial statements. An audit risk assessment is, therefore, necessary identify the audit risk areas where the auditor can focus on to avoid financial misstatements. Origin Energy conducted an internal audit in 2014 that revealed that the company had not complied with the standards and regulations set for the oil and gas sector. Following these findings the management tried to cover up the non-compliant issues without success. As a result of such actions three audit, risk areas emerged. The report shows that an auditor’s approach to information on high-risk areas with skepticism and the testing of controls can help verify the correctness of the account balances. References American Institute of Certified Public Accountants 2006a, Performing audit procedures in response to assessed risks and evaluating the audit evidence obtained, American Institute of Certified Public Accountants. American Institute of Certified Public Accountants 2006b, Audit risk and materiality in conducting an audit, American Institute of Certified Public Accountants. American Institute of Certified Public Accountants 2008, Understanding the entity and its environment and assessing the risks of material misstatement, American Institute of Certified Public Accountants. 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