A preliminary assessment as a part of the planning phase of Almond Limited’s audit has been completed. In the given memo, key account balances that are suspected of an increase in audit risk are identified, as well as factors that increase audit risk associated with these account balances. The key assertions at risk of material misstatement are then determined, and recommendations regarding specific audit procedures to address the risks are made.
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Three key account balances that are subject to an increase in audit risk are sales revenue, inventory, and accounts receivable. Specific attention should be paid to these major accounts as they may be manipulated by Almond Limited to enhance its financial performance. The impact of delay of several shipments of Almond milk by Australian customs will be primarily on recorded sales, which may drop by 20%, and related accounts. This is expected to contribute to an increase in inherent risk. There is a possibility that correct stock will not be received by Chinese customers, and orders will be incorrectly filled. In turn, Chinese customers may not provide full payment for the product received.
It is considered that the entry of a new competitor in the industry leads to an increase in the inherent risk. Since Tasty Milk started supplying Chinese customers with cheaper milk in terms shorter than Almond Limited, the company may face a serious problem.
It is thus possible to state that Almond Limited may overstate its sales revenue and record more receivables than customers owe (assertions — existence/occurrence). As a result, the short-term assets section will be not in line with generally accepted accounting principles (Chartered Accountants Australia and New Zealand 2019). It also should be mentioned that there is a risk that suppliers will change, and the company will need to abide by new standards (assertions — valuation).
Because of the appearance of the major competitors, there is a likelihood of rapid obsolescence of Almond Limited’s inventory, which may cause an inherent risk of incorrect valuation. The devaluation of the Australian dollar against the US dollar impacted accounts receivable (Gay and Simnett 2017).
Therefore, another inherent risk associated with foreign exchange transactions in US dollars and Australian dollars may lead to difficulty ascertaining the cost of purchase and incorrect creditor liability (assertions — valuation and allocation). Considering that the company transports its products overseas, there is a risk of theft, which is why inventory may be overstated in case thefts are not identified. Control risk may increase due to the company’s downsizing approach, which will lead to staff reduction and the subsequent segregation of duties. All three account balances identified maybe thus be affected by fraud and creative accounting practices.
Based on the assessment of key account balances that are exposed to considerable audit risk, it is possible to say that the audit plan aims to lower the detection risk. Given the high values of both control and inherent risk, minimization of detection risk will allow for reducing audit risk to an acceptable level. Specific audit procedures that are recommended to address the risks associated with each account identified include classification testing, completeness testing, valuation testing, and occurrence testing. These procedures need to be performed to ensure that transactions were classified correctly and none of them is missing from the accounting records. Also, the auditor should test whether assets and liabilities are accurately presented in the company’s balance sheet.
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Considering the detected risks surrounding Almond Limited, one could recommend the adoption of a substantive audit approach which involves covering large volumes of financial transactions without relying on information provided by management. The chosen methodology will require the auditor to neglect the internal control system of Almond Limited and conduct a detailed examination of financial information. Special attention should be paid to routine transactions, such as sales, accounts receivable, accounts payable, and inventory.
A particular benefit of the proposed practice is that it allows for minimizing risks which internal control system of the company could not detect. Before using a substantive approach, the auditor needs to make sure that he has obtained a thorough understanding of the company-level controls to learn the potential causes of misstatements (Kerr 2017). Then, it has to be checked whether the transactions selected have reliable supporting documents and if these documents have any errors.
There are several other substantive tests that an auditor can perform within the given approach. In particular, it is recommended to contact Chinese customers to ensure that accounts receivable balances are correct. It is also appropriate to check the validity of inventory valuation calculations to learn whether inventory was recorded at the lower cost and net realizable value. As highlighted above, the auditor may need to investigate the relation to fraud. Finally, provision for doubtful debts and provisions for inventory have to be carefully investigated by the auditor as areas of subjective judgment where creative accounting may take place.
Chartered Accountants Australia and New Zealand. 2019. Auditing, Assurance and Ethics Handbook. Milton: John Wiley & Sons Australia.
Gay, Grant, and Roger Simnett. 2017. Auditing & Assurance Services in Australia. 6th ed. North Ryde: McGraw-Hill.
Kerr, Rosemary, ed. 2017. Business Communication: A Handbook for Accounting Students and Graduates. Melbourne: Pearson Australia.