Audit Risk: Havelock Europa PLC - Essay Example

Finance and Accounting Audit Risk: Havelock Europa PLC Audit Risk: Havelock Europa PLC Audit risk refers to the risk of an inappropriate audit opinion by the designated and assigned auditor when financial statements are materially misstated (Rittenberg, Johnstone and Gramling, 2012). However, it may be of two types that is either at financial statement level or at assertion level, risk at financial statement level means that overall financial statements are adjusted for window dressing while risk at assertion level means that it affect certain class only (Collings, 2012). As for as financial statements of Havelock Europa PLC are concerned it is worthwhile to mention that profit in current year raises questions about reliability of its financial statements (Zack, n.d.), Here is the evaluation of financial statement and key ratios that show risk, Income statement analysis: 2013 2012 % % Gross profit ratio 12.5 11.2 Operating profit ratio 12.5 2.6 Finance charge to sales 5.4 8.2 Statement of financial analysis: Decrease in inventory by £1107000 Decrease in debtors by £7814000 Increase in loan by £237000 Decrease in trade payables by £7584000 During the financial year 2013 the company posted a profit of £283000 which was a loss of £345000 during the last financial year, which provide that corroborative evidence that financial statement might be materially misstated, following are the risk areas: Inventory/Accounts Payable: As clear from income statements figure sales during 2013 has been decreased by £2872000 amount, due to which closing stock should have risen but amount shown in statement of financial position show quite opposite figure that show decrease in inventory, which is a high risk area as both evidence regarding inventory show opposite position, further decrease in accounts payable by such large amount need detailed analysis of this area in order to reduce audit to an level. Because as stated by the company that it measure its inventory on lower of cost and NRV i.e. net realizable value, so all these assertions need detailed substantive testing because all these amounts involved in them are material, therefor as per materiality concept of audit auditor should carry out detailed substantive testing in this area in order to reduce audit risk to an acceptable low level. Employees Benefits Revised: As revised employee benefit has been adopted from 01 January 2013, which has heavy financial impact for the group defined pensions scheme, where net interest income or expense is calculated using the discount rate used to measure the expenses, it is an establish fact whenever new policies are adopted than it is presumed that the risk of material misstatement in them would be high due to either an honest mistake of facts or an intentional misstatement, further changes in retirement benefits decreased by £3293000 which is 11.6 times of the net profit,( 283 ), further as it a policy that’s why control risk is also high in this area as well. Further a lot of actuarial calculations are involved in them that also need detailed substantive testing, e.g. assessing estimates whether they are reasonable and consistent, but due to significant changes in the amount of employee retirement benefit scheme for audit purpose it is a high risk area due to its more vulnerability to a misstatement. Debtors/Accounts Receivable: Sales is the only figure that show profit or loss, means higher the sale higher would be profit and vice versa, as sales fig is also material therefor it is always a high risk area for the auditor because if this fig is misstated than it would affect many other assertions as well and as a result this risk would be affect overall financial statements, so using materiality concept auditor should maintain high professional skepticism while dealing this area, as this area is also highly vulnerable to misstatement e.g. in cash sales there is risk that sales may not be recorded, further debtors has been decreased by £7814000 amount which is material amount and it means high volume of receipts has been made this year which is a high risk area because there may be risk that receipt may be embezzled (ICAP, 2015). Substantive Procedure for Inventory: As closing inventory of the Havelock Europa show an amount of £1107000 which is a material amount in respect of its sales and net profit, therefor detailed substantive testing is required in this area of financial statements because this year financial statements provide a profit fig of £283000 which were a negative fig as compared to last year, so for an auditor this turnabout from a loss to a profit have high audit concern and therefor need detailed substantive testing for all material areas of financial statements, here we would perform some substantive testing in order to validate the inventory figure in the financial statements, these substantive procedure are designed to establish the assertions that have been made by the management of the company, which include existence, completeness, rights and obligations, valuation, and presentation and disclosures, 1 Existence: To check the existence of inventory at given date following are the substantive audit procedures: Observe the inventory count, and also performing some count as well to verify the count procedure by the auditor, as auditor observe the count procedure at client so he should perform these procedure as well When internal control are good company may also perform periodic count but it is good at year end, because in periodic count a lot of adjustments are required in order to reach year end figure While observation all significant inventory item should be observed, keeping in view materiality concept of, Review the plan for inventory count, as if there is deficiency in count plan then the whole process of inventory count is useless Test count by auditor should include: Observing that employee are following the plan Assuring that all item counted are tagged Confirming that tags and summary sheets controlled and reconciled Watch for empty boxes and obsolete inventory items Establishing cut off by proper evidences. 2 completeness: Whether inventory count contain all item that are owned by the entity, it is responsibility of the auditor to establish that all inventory owned by the client and are counted, Performing analytical procedure ( that include trend analysis, ratio analysis, comparisons of current year info with prior year info ) to verify, Inventory turnover ratio to assess average Vertical analysis i.e. inventory to total assets Budgetary expectation Examining nonfinancial information like weight etc. Executing purchase and sales cut off test that means establishing that sale and purchases are recorded in relevant accounting periods, no sales or purchases are recorded wrongly this can be confirmed by reviewing year end close sales and purchases documents, 3 Rights and Obligations: Whether inventory is owned by the client, does the client is lawful owner of right and obligation of the asset and liabilities shown in financial statements, Checking the recorded purchases with underlying documents( e.g. purchase requisition, purchase order, store record, ) Evaluate the goods consignment Evaluate client correspondences Examining trade debtors and purchase documents Sometimes inventory of supplier is on return basis or the company hold inventory which is lawfully transferred to the customer hence this assertion need to be addressed so that only those item appear on financial statements which are the exclusive rights and obligation of the company 4 valuation/Allocation: Whether inventory is valued according to given framework that is IFRSs, further to assess that management representation regarding inventory valuation is correct, as stated in note to accounts that company value its inventory on lower of cost and NRV ( sales price less cost of completion and estimated cost necessary to make sales ) basis as per IAS 2 (Epstein, Jermakowicz & Epstein, 2008), so high professional skepticism is required from auditor in this area as it involve detailed analysis about each inventory item so that no item is either overvalued or undervalued, Comparing replacement cost with recorded cost, and examining vendors price list to establish if recorded price is less than current prices Perform inventory turnover ratio, as result obsolete inventory would be revealed if this ratio is very small We can also establish inventory fig from current sale prices, 5 presentation/disclosures: Whether presentation of inventory and related accounts are appropriately presented and disclosed, That inventory is valued at lower of cost and NRV Carrying amounts is properly classified Any write down is properly expensed out Cost of inventory is properly recognized as expense Further sufficient disclosure is also required about slow moving and obsolete inventory item, and on financial statements it is properly classified as cost of sales. Conclusion: The purpose of audit of financial statement is to make them free from material misstatement so that users of financial statements like management of the company and other those concerned with these financial statement can make an effective decision on the basis of these financial statements, as for as Havelock Europa PLC is concerned where company show a profit of £283000 for the year ending 2013 (£345000 loss in 012) ,this huge shift in amounts is a matter of concern for the auditor that whether it show actual position of the company or just window dressing for some stack holders, therefor use of substantive audit procedure are required to establish that these financial statements are free from material misstatements, for example in establishing that inventory valued in statement of financial position is a correct value auditor need to go through all above stated procedure by verifying each assertion of account balances. And in the same way auditor has to address other material changes that may affect the materiality of financial statements, References Zack, M. (n.d.). Article for Audit and Risk. Retrieved from http://www.iac-recruit.com/articles_upload/articles/article-for-audit-and-risk-by-malcolm-zack.pdf Rittenberg, L. E., Johnstone, K. M., & Gramling, A. A. (2012). Auditing: A business risk approach. Melbourne, Vic.: South-Western Cengage Learning. Collings, S. (2011). Interpretation and application of international standards on auditing. Chichester: Wiley. Epstein, B. J., Jermakowicz, E. K., & Epstein, B. J. (2008). Wiley IFRS policies and procedures. Hoboken, N.J: John Wiley & Sons. ICAP. (2015, February). Audit and Assurance. Retrieved from http://www.icap.org.pk/wp-content/uploads/students/srbook/caf92015.pdf Read More