Question

Question 7

You are currently part of the audit team that is conducting the audit of Big Trucks Ltd (Big Trucks) for the year ended 30 June 2020. Big Trucks is an importer of large pickup trucks such as Ford’s F250 and Dodge’s Ram 2500. Big Trucks converts these vehicles to comply with Australian road rules and standards. Your audit manager has asked you to oversee the audit of Big Trucks’ inventory account balance, which is highly material. Big Trucks maintains details of stock quantities on its computer system. These stock quantities are updated from goods received notes and sales invoices. Due to the nature of its end-product, Big Trucks holds a large number of highly specialised component parts, for which there is no secondary market. Big Trucks conducts a ‘wall-to-wall’ count of inventory, whereby all operations cease and they count all inventory in a single stocktake. This stocktake takes several days to complete and is conducted over the last week of the financial year.

Required

1. Identify the two key assertions at inherent risk of misstatement for Big Trucks’ inventory and explain the reasons why.

[5 marks]

2. Outline an audit program of substantive testing to be conducted on the inventory account of Big Trucks. Provide a brief reason for each audit procedure chosen. Group the selected procedures under the following categories:

i      Initial Procedures.

[3 marks]

ii     Analytical Procedures.

[3 marks]

iii    Tests of Details of Transactions.

[3 marks]

iv    Tests of Details of Balances.

[6 marks]

v     Presentation and Disclosure.

[1 mark]

[Total for Question 7 = 21 marks]

Answer 1

a.ISA 315, Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment identifies the following assertions: Assertions about classes of transactions and events for the period under audit – occurrence completeness, accuracy, cut off and classification.

Inherent risk is the risk posed by an error or omission in a financial statement due to a factor other than a failure of internal control. In a financial audit, inherent risk is most likely to occur when transactions are complex, or in situations that require a high degree of judgment in regard to financial estimates.

Non-routine accounts or transactions can present some inherent risk. For example, accounting for fire damage or acquiring another company is uncommon enough that auditors run the risk of focusing too much or too little on the unique event.

KEY TAKEAWAYS:

• Financial statement assertions, or management assertions, are a company's official statement that the figures the company is reporting are accurate.
• Investors and analysts rely on accurate statements to evaluate a company's stock; otherwise, metrics such as the price-to-book ratio and earnings per share would be misleading.
• The Financial Accounting Standards Board requires publicly traded companies to prepare financial statements following the Generally Accepted Accounting Principles (GAAP).
• Companies must attest to assertions of existence, completeness, rights and obligations, accuracy and valuation, and presentation and disclosure.

a.Outline an audit program of substantive testing to be conducted on the inventory account of Big Trucks. Provide a brief reason for each audit procedure chosen. Group the selected procedures under the following categories:

i      Initial Procedure- Initial audit engagement – An engagement in which either: (i) The financial statements for the prior period were not audited; or. (ii) The financial statements for the prior period were audited by a predecessor auditor.

ii     Analytical Procedures - Analytical procedures are one of many financial audit processes which help an auditor understand the client's business and changes in the business, and to identify potential risk areas to plan other audit procedures.

• Substantive analytical procedures play an important part in a risk-based audit approach.
• Properly designed and executed analytical procedures can allow the auditor to achieve audit objectives more efficiently by reducing or replacing other detailed audit testing.
• The effectiveness of analytical procedures depends on the auditor’s understanding of the entity and its environment and the use of professional judgment; therefore, analytical procedures should be performed or reviewed by senior members of the engagement team.
• It is vital that the analytical procedures be sufficiently documented to enable an experienced auditor, having no previous connection with the audit, to understand the work done (ISA 230).

iii    Tests of Details of Transactions - Tests of details are used by auditors to collect evidence that the balances, disclosures, and underlying transactions associated with a client's financial statements are correct.For example, an auditor could test the prepaid expenses asset account by examining each of the prepaid expenses that comprise the ending prepaid expenses balance.

Auditing procedure related to examining specified transactions and supporting documentation. It is part of the testing process used by the auditor to check internal-controls reliability. ... In transaction tests, a selected number of specific transactions are tested to see if controls are performing properly.

iv    Tests of Details of Balances - The objective of the test of controls is to obtain audit evidence that the internal controls are effective in preventing or detecting material misstatement. On the other hand, the test of details is to gather audit evidence to form a basis of opinion.

Following are the five types of testing methods used during audits.

• Inquiry.
• Observation.
• Examination or Inspection of Evidence.
• Re-performance.
• Computer Assisted Audit Technique (CAAT)

v     Presentation and Disclosure - The final financial statement assertion is presentation and disclosure. This is the assertion that all appropriate information and disclosures are included in a company's statements and all the information presented in the statements is fair and easy to understand.

Auditors are required to express an opinion on the financial statements as a whole. This includes the notes to the financial statements which are an integral part of the accounts, providing additional information on balances and transactions and other relevant information.