Auditing and Assurance Services Assignment 2009

Subject Code: CO5118

Subject Name: Auditing and Assurance Services

Subject Co-ordinator: John Howarth

Student Name: Xinyu Chen

Student ID: 11906467

Due Date: April 25th 2009

Table of Contents

Financial..............................................................................................................3
Operating.............................................................................................................4
Others..................................................................................................................5
1. b) Additional Information ....................................................................................5
2.Substantive Procedures to Address the Key Audit Assertions
................................................................................................................................6
2. a) Trade Debtors ............................................................................................7
2. b) PC inventory
.............................................................................................................................8
2. c) Returns Provision........................................................................................9
2. d) Operating Revenue
...........................................................................................................................10

3. What Effect Would this Information Have on the Audit?...................................12

References............................................................................................................13
Appendix A: Charts...............................................................................................14
 1. a) Factors Indicating a Going Concern Problem
What are the key factors that indicate that the company may have a going
concern problem?

‘Going concern’ means that an entity can pay for its debts when they are due,
and continue in operation without any intention or necessity to liquidate or wind up
its operations. Generally, there are three factors that contribute to a firm having a
going concern problem: financial factors, operating factors, and other factors (From
CPA website).

Financial

Factor Analysis
Net liability or net current liability position?
For ABC, net liability was 58,513
in 2001.
Inability to pay creditors on due dates? More unlikely to pay money to
creditors
Inability to meet with the terms of loan More likely not to meet the terms
agreements of loan agreements

Inability to get financing or basic new Maybe ABC has a problem to

product development or other investments finance its investments due to a
bad financial position
Adverse key financial ratios Debt ratio was 1.64 >1, which
means ABC has more liability than
assets.
Negative operating cash flows From the income statement, we
can conclude that ABC has
negative cash flows
Substantial deterioration in the value of More than 50% value of plant and
assets which used to generate cash flows equipment depreciated.

Arrears or discontinuance of dividends ABC probably has an inability pay

dividends to its shareholders due
to its negative equity.
Debtors or other creditors withdraw money Not illustrated that debtors
withdrew money in the article.
Over reliance on short-term debt to fund Not mentioned in the article.
long-term assets or fixed-term borrowing
approaching maturity without repayment
Change from credit to cash-on-delivery Not mentioned in the article.
transactions with suppliers
Operating

Factors Analysis
Loss of key management not Not mentioned in the article.
replacement

Loss of a major market, license, ABC loss PC market.

franchise, or majority suppliers

Labour difficulties or shortage of Not mentioned in the article.

important supplies

Lack of strategic direction ABC’s strategy is now to sell Modems

and Spares.
Deficiencies in the governing team Yes, there are deficiencies in governing
team, such as managers intently
treated tax loss as assets
Lack of variety of products to reduce ABC only produces three different type
risks of IT products. This is not enough
variety of products to reduce risks.
Difficulty to prolong industrial Not mentioned in the article.
relationships

Deficiencies in management No deficiencies in management

information systems information systems.

ABC has some plans for its

Unplanned development of business development of business, for example
its future market only focuses on
Moderns and Spares.

Uninsured disaster No uninsured disaster happened in

2001.
Others

Factors Analysis
Lack of sufficient back-up and recovery Not mentioned in the article.
capabilities for key financial information
systems

Other same industry of entities failures Not mentioned in the article.

A key product obsolete due to rapidly ABC not did very well in the PC market
technical developments since rapid technological
developments.were introduced
Undue impact by a market dominant From ABC’s perspective, its PC sales
competitor have been put out of the market as an
undue impact by competitors.
It is expected that legislation or Not mentioned in the article.
government policy.adversely affects the
firm
ABC not meeting capital or other ABC met with capital requirements
statutory requirements

1. b) Additional Information
What additional information would you obtain to evaluate this problem?

I would obtain additional information listed below to evaluate the firm’s going
concern problem:

 Evaluating Management’s Assessment

 According to going concern assessment, review management’s future
actions
 Gather audit evidence to make sure that there exists a material
uncertainty
 Obtain written representations about future actions from management
 Obtains audit evidence to prove that the management’s plans are
workable
  Obtain additional available facts or information from managers, who
relied on certain dates to assess the going concerning problem
 Discussing the entity’s recent interim financial report

2. Substantive Procedures to Address the Key Audit

Assertions

Assume the audit partner has concluded that the company is likely to
remain a going concern. Describe the substantive procedures to be
performed to address the key audit assertions for the following balances:

Trade Debtors, PC Inventory, Returns Provision, Operating Revenue and

Amount Owing to Parent Entity.

There are some key audit assertions for the following accounts, for
example: Existence and occurrence, valuation, rights and obligations,
presentation and disclosure.
To address these assertions, the auditor will most likely need to perform
some standardised audit procedures such as risk assessment procedures
supplemented by further audit procedures to shape control tests and substantive
tests, because risk assessment procedures do not provide sufficient and
appropriated audit evidence.
Firstly, the auditor should perform risk assessment procedures. After this,
the auditor can conclude that ABC Pty Ltd has poor internal control, since
management is keen to classify significant tax losses as an asset to improve the
financial position. There is a risk of management override of internal controls and
high risks of material misstatement at the ABC’s financial report and assertion
levels. Therefore, the auditor can hardly use the internal resources to reach an
opinion about the debtors account.
Secondly, the auditor should perform control test due to the fact that there
may be system changes this year, event though ABC has a strong control in
accounting systems for debtors, inventories and general ledger functions in prior
years
Lastly, substantive tests can be conducted by one or more of the following
ways: Inspection of records or documents, observation, inquiry, confirmation,
recalculation, reperformance and analytical procedures. The auditor should
examine each of these in turn.
2. a) Trade Debtors

Assertion Procedures Application

Existence and Ask ABC’s debtors to confirm the After the audit, the
Occurrence existence and amount of their company had $9,133,000
indebtedness to the client debt
Valuation 1. Test of transaction processing and Two of ABC’s largest
reviews of contracts can addressed debtors have gone into
the sales and receivables liquidation. Therefore,
transactions initially recorded at their ABC only can get 50% of
correct value these debts from
insurance company, but
2. Determining the reasonableness
only if they provide
of the provision for doubtful accounts
sufficient evidence. On
to address whether ABC will likely
the other hand, it shows
collect the outstanding receivables in
that the company under
a timely fashion
value its trade debtors
from the note 3.
Rights and 1. Review all arrangements that ABC Not sure whether the
Obligations sells its account receivable to banks company has sold its
or other financial institutions, while accounts receivable to
making sure that they still take banks or other financial
responsibility for collecting the institutions.
receivables.
2. Make inquiries and review the
minutes of the board of directors’
meeting for indications of discounted
receivables
Presentation 1. Confirmations from banks and Not applicable.
and financial institutions
Disclosure 2. Review of loan agreements,
board of directors’ minutes and the
receivables trial balance
3. Inquiry of management
2. b) PC inventory

Conclusion
Assertion Procedures
All of ABC recorded
Existence and 1. Review ABC’s physical inventory procedures
inventory exists.
occurrence 2. Observe the ABC’s count of annual physical
inventory. Perform test counts of the observation
and trace to the company’s compilation of
inventory
Completeness 1. Perform year-end cutoff test. Review the Not all of ABC’s PC
purchase and sales journal that record just inventory has been
recorded on the reporting
before or after year end
date
2. Make inquiries to managers about the
existence of goods on consignment or lied in
outside warehouses
3. Ask managers about the company’s policy for
expected return allowance. Review receipt of
transactions during a selected period of time.
Rights 1. Test disbursement and Review supplier 1. All of the recorded PC
invoices to make sure that proper title is inventories actually
belong to the company.
transferred
2. The company controls
2. Review the company’s sale contracts to the rights to the PC
determine whether the customers has rights to inventory.
return PC. And how the company recognize sale 3. ABC customers have
revenue if the contract included the goods rights to return PCs
return.
The company
Valuation 1. ABC uses an appropriate valuation method
undervalues its PC
2. Ask production and warehouse staff about the inventory.
existence of obsolete inventory
3. Find obsolete inventory. Trace obsolete items
to the inventory compilation and decide whether
they are correctly classify as obsolete items
4. Test inventory cost
5. Test the probability of obsolete inventory that
should be written down to market value
ABC established an
Disclosure 1.The inventory valuation method used
allowances for returns of
2.inventory policy about returns and allowances PCs
2. c) Returns Provision

Assertions Procedures Application

Occurrence and 1. Check the company’s sales ABC had a provision for
Rights and contract to determine that goods returns
Obligations acceptance of returns are included
in warranty provisions
2. Approve acceptance of returns
Completeness 1. Perform year-end cutoff test. Note 9 shows that 2%
Review the Returns provision of returns provision is
journal entries that were recorded not recorded on the
just before or after year end company balance date
2. Make inquiries to managers
about how they grant credit
warranty work related to returned
goods

Classification 1. Ensure proper classification of No application

and goods and determine that the
Understandability return goods are not reshipped as
if they were new goods
Accuracy and 1.Value returned items for which ABC had established
Valuation full credit has been granted $480,000 returns
provision for Modem
2. Determine the potential
items. However, the
obsolescence or defects in the
company has only used
goods returns and similar goods
up 17% of this provision
held in inventory.
until October 2001.
2. d) Operating Revenue
Assertion Procedures
Existence and 1. Trace sales invoices to
Occurrence customer orders and bills of
lading
2. Scan sales journal for
duplicate entries
Completeness 1. Trace bills of lading to sales
journal
2. Account for sequence of
sales invoices in sales journal
3. Perform analytical
procedures
Valuation and 1. Verify accuracy of sales
Accuracy invoice and agreement of sales
invoices with supporting
documents
2. Trace sales invoices to sales
journal or customer’s ledger
Application
All of ABC’s sales invoices
occurred and absolutely no sales
journal were double recorded,
since the number after audited are
bigger than unaudited.
From the Note 1, we can see that
audited Modem sales account
increased 44%, audited Personal
computer sales increased 60%,
and audited Other increased 64%.
All of these figures show that ABC
only recorded some parts of sales
invoices in its sales journal and not
all of them, which lead to the failure
in completeness.
The numbers listed above illustrate
that the company under valued its
operation revenue. Further more,
This means that the company has
not valued operation revenue
accurately.
2. e) Amounts Owing to Parent Entity
Assertion Procedures
Confirmations with recorded
payables
(This procedures provided a
high degree of reliability,
Completeness however not used frequently
since ABC have adequate
control over disbursements
Testing subsequent
disbursements
Analytical review of related
expense accounts
(This procedure is only used understatement of expenses.
when ABC has a low control The auditor may perform the
risk, no red flags, or even
violates debt covenants, yet accounts payable if
still can maintain its working understatement likely happened.
capital)
Year-end cutoff tests
Review of contracts for
purchase commitments
(long-term contracts to
purchase inventory at fixed
price or at a fixed price add
inflation adjustments)
Applications
The Auditor can send
confirmations to the parent entity
requesting a statement of open
account items, and afterwards
the auditor may reconcile the
parent entity confirmation with
the accounts payable trial
balance of ABC company.
The auditor may select a sample
of cash disbursements made
after the end of 2001.
Afterwards, the auditor can
examine this sample and decide
whether the disbursements are
for goods applicable to last year.
If so, the auditor can ask
management why management
did not record liability in the
previous year.
Determine if the accounting date
indicates a potential
above two procedures to test
Determine whether the company
timely recorded accounts
payable and whether the
company intentionally misstated
the accounting records in order
to understate liability or
overstate inventory.
Examine contracts to determine
penalties associated with
default and assess the ABC’s
estimate of the probability of
contract default or losses.
3. What Effect Would this Information Have on the
Audit?
Assume you were given the following information:

The parent company has advised local management that should ABC not
show a turnaround to profits for the year ended 31 December 2002 it will
proceed to wind up local operations early in 2003.

The first question illustrated that ABC had going concern problem. The
company had unhealthy financial position in 2001. The parent company will
proceed to wind up local operation early in 2003 if ABC still loses money at 31
December 2002. The auditor should recognise how ABC deals with its going
concern problem and either ignore or try to change it.
If the auditor implements the control test at the end of year 2002, he or she
can determine that the company have poor internal controls, inadequate capital,
dependence on limited product offerings, technology subject to obsolescence
and instability of future cash flows. However, the company’s financial
performance improved a lot. This indicated that ABC was a high-risk company
because of fraudulently manipulating its financial dates and increasing the
engagement risk due to higher control risk, inherent risk or environment risk. This
may result in ABC having higher motivation to misstate the financial statement.
Therefore, the auditor should use more reliable evidence, such as that listed
below:
1) Use External evidence (bank confirmation) rather than internal evidence
2) Obtain evidence by the auditor himself, and avoid evidence provided from
the entity
3) Use documentary evidence and written representations instead of oral
representations
4) Use original documents as audit evidence rather than using photocopies
or facsimiles
The auditor should identify areas that are likely to be misstated as well. The
company more likely will overstate key accounts related to its good performance,
such as revenue and accounts receivable, while understating other accounts,
such as expenses and liabilities. For these key accounts, the auditor should
perform substantial tests of details of classes of transactions and account
balances.
 References

[1] CPA Australia (2007), ASA 570 Going Concern retrieved May 10th 2009 from
the CPA Australia website: http://www.cpaaustralia.com.au/cps/rde/xchg/SID-
3F57FECA6E5964B1/cpa/hs.xsl/14131_22174_ENA_HTML.htm

[2] PLS Australia, Audit Evidence (2006) retrieved May 10th 2009 from the PLS
Australia website: http://www.plsaustralia.com.au/av/video/Chap%2020%20-
%20Audit%20Evidence.pdf

[3] Auditing and Assurance Standards Board, Audit Evidence (1995) retrieved May
10th 2009 from the Australian Government website:
http://www.auasb.gov.au/admin/file/content102/c3/AUS502_10-95.pdf

[4] Christine Jubb, Stephen Topple, Peter Schelluch, Larry Rittenberg, Bradley
Schwieger. Assurance and Auditing: Concepts for a Changing Environment (2nd
Edition). Thomson Learning, Melbourne.P391

[5] Christine Jubb, Stephen Topple, Peter Schelluch, Larry Rittenberg, Bradley
Schwieger. Assurance and Auditing: Concepts for a Changing Environment (2nd
Edition). Thomson Learning, Melbourne. P338
Appendix A: Charts

Unaudited Audited
10 months 12 months
31/10/2001 31/12/2000 Chang%
$’000 $’000
Notes to Accounts
Note 1 – Operating Revenue
Modem sales 28,702 41,313 44
Personal computer sales 16,448 26,369 60
Other (spare parts) 2,637 4,325 64
47,787 72,007 51

Note 3 – Receivables
Unaudited Audited
Trade debtors 10 5,687
months 9,133
12 months 61
31/10/2001 31/12/2000 Chang%
$’000
$’000

Unaudited Audited
10 months 12 months
31/10/2001 31/12/2000 Chang%
$’000
$’000
Note 9 - return provisions
Warranty and returns 769 785 2