Question

Case Study (Part 2) – ACCT 3000 Semester 2, 2020
You are an Audit Senior on the AUDIO Health Limited (AUDIO) audit engagement for the financial year ending 30 June 2019. AUDIO specialises in the design and manufacture of implantable hearing aids and invests more than twice the industry average in research and development. While undertaking audit planning procedures you become aware of the following:
AUDIO has been developing its latest hearing implant, the X5, for a number of years. AUDIO has invested heavily in research and development of the X5 and has capitalised a significant amount in relation to the development phase of the product. Market studies and prototypes of the X5 have proved successful for bringing it to the market. In July 2018, AUDIO acquired two technologically advanced machines specifically designed for manufacturing the X5, at a cost of $15 million each. Production and sales of the X5 hearing implant commenced in October 2018, and demand for the product has been extremely high since its launch. AUDIO has sold large volumes of the product and further manufactured a large stockpile of the X5 in anticipation of on-going high demand, and a substantial number have already been implanted in patients.
There has recently been a sharp increase in incidences of the implant shutting down post-surgery, resulting in a number of patients commencing legal action against AUDIO for damages and prompting the company to initiate a recall. Initial investigations reveal that the defect is attributable to a design flaw. It is likely that the product in its current form cannot be sold. Management of AUDIO is confident that it will be possible to re-engineer the two machines acquired for the manufacturing of the X5 to enable production of its four other product lines and potentially for other products currently under development.
You have raised concerns with AUDIO’s audit committee on improving the competence and objectivity of the internal audit department. Currently, the internal audit department is made up of three recent graduates with no prior experience who periodically report the Audio’s Chief Executive Officer Dr. Dave Bautista.
Required:
Prepare a memorandum to the audit manager, outlining your risk assessment relating to AUDIO Limited. When making your risk assessment:
(a) Identify three (3) key account balances from the information provided that are subjected to an increase in audit risk. Briefly explain what factors increase the audit risk associated with the three (3) accounts identified. In your explanation, please mention the key assertion(s) at risk of material misstatement.
(b) Identify how the audit plan will be affected and recommend specific audit procedures to address the risks associated with each account identified.
(Please Note – Maximum Word Limit: 950 Words)

Answer 1

Memorandum to the audit manager, outlining your risk assessment relating to AUDIO Limited

The purposes of the audit plan are, first, to contribute to the effectiveness of the audit and, second, to contribute to the audit efficiency. This audit planning memorandum should be completed and approved as part of the initial audit planning process. In completing this document, there may be occasions when matters already documented in other work papers are relevant. There is no need to re-write such material if a specific reference can be made.

This audit planning memorandum is structured so that planning documentation common to all projects is presented. All items should be read and considered on every project.

At the conclusion of each audit, upon issuance of the draft report, management of the audited unit is responsible for developing and implementing an action plan that will remediate any risks associated with the observations noted during the audit. This written action plan is known as the management response. Written management responses to audit observations are a crucial step toward remediating potential risks and should address the complete action plan.

(AS 2110 - Identifying and Assessing Risks of Material Misstatement):

1 Paragraphs .05-.08 of AS 1101, Audit Risk.

2Terms defined in Appendix A, Definitions, are set in boldface type the first time they appear.

3AS 2401, Consideration of Fraud in a Financial Statement Audit, discusses fraud, its characteristics, and the types of misstatements due to fraud that are relevant to the audit,i.e., misstatements arising from fraudulent financial reporting and misstatements arising from asset misappropriation. Also, AS 2410, Related Parties, requires the auditor to perform procedures to obtain an understanding of the company's relationships and transactions with its related parties that might reasonably be expected to affect the risks of material misstatement of the financial statements.

4AS 1105, Audit Evidence, describes further audit procedures as consisting of tests of controls and substantive procedures.

5AS 1105.11 discusses financial statement assertions.

6The auditor should look to the requirements of the Securities and Exchange Commission for the company under audit with respect to the accounting principles applicable to that company.

7AS 2405, Illegal Acts by Clients, discusses the auditor's consideration of laws and regulations relevant to the audit. 7ASee AS 2401.66-.67A.

8Paragraphs .21-.22 of this standard discuss components of internal control over financial reporting.

9Paragraph .13 of AS 2201, An Audit of Internal Control Over Financial Reporting That is Integrated with An Audit of Financial Statements, states, "The size and complexity of the company, its business processes, and business units, may affect the way in which the company achieves many of its control objectives. The size and complexity of the company also might affect the risks of misstatement and the controls necessary to address those risks."

10AS 1105.10.

11Different internal control frameworks use different terms and approaches to describe the components of internal control over financial reporting. 12See Securities Exchange Act Release No. 34-47986 (June 5, 2003) for a description of the characteristics of a suitable, recognized framework. 13AS 2201.05.

14AS 2201.25.

15AS 2201.A3.

16Examples of such events and conditions include depreciation and amortization and conditions affecting the recoverability of assets. 17Paragraphs .12-.13 of this standard.

18Also see paragraph .B5 of Appendix B of this standard.

19In some companies, internal auditors or others performing an equivalent function contribute to the monitoring of controls. AS 2605, Consideration of the Internal Audit Function, establishes requirements regarding the auditor's consideration and use of the work of the internal audit function.

20See AS 2201.34-.38.

21Paragraphs .16-.35 of AS 2301, The Auditor's Responses to the Risks of Material Misstatement.

22AS 2201.B1.

23AS 2201.22. 24The entity-level controls included in AS 2201.

24 include controls related to the control environment; the company's risk assessment process; centralized processing and controls; controls over the period-end financial reporting process; and controls to monitor other controls.

25See PCAOB Rule 3501(a)(i), which defines "affiliate of the accounting firm."

26Paragraph .07 of AS 2101, Audit Planning.

27Analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data.

28Paragraphs .52-.53 of this standard. 29See also paragraph

.29 of AS 2810, Evaluating Audit Results.

30AS 2401.13. 31AS 2810.20-.23 establish further requirements for evaluating whether misstatements might be indicative of fraud and determining the necessary procedures to be performed in those situations.

31ASee AS 2401.66-.67A.

32AS 2301.16-.35.

33AS 2201.A10 states: An account or disclosure is a significant account or disclosure if there is a reasonable possibility that the account or disclosure could contain a misstatement that, individually or when aggregated with others, has a material effect on the financial statements, considering the risks of both overstatement and understatement. The determination of whether an account or disclosure is significant is based on inherent risk, without regard to the effect of controls.

34AS 2201.A9 states: A relevant assertion is a financial statement assertion that has a reasonable possibility of containing a misstatement or misstatements that would cause the financial statements to be materially misstated. The determination of whether an assertion is a relevant assertion is based on inherent risk, without regard to the effect of controls.

35The auditor might perform substantive auditing procedures because his or her assessment of the risk that undetected misstatement would cause the financial statements to be materially misstated is unacceptably high or as a means of introducing unpredictability in the procedures performed. See AS 2810.11, .14, and .25, for further discussion about undetected misstatement. See AS 2201.61 and AS 2301.5c, for further discussion about the unpredictability of auditing procedures.

36AS 2301 discusses the auditor's response to fraud risks and other significant risks.

37AS 2201.14 presents examples of controls that address fraud risks.

38See also AS 2301.

This sample procurement card internal audit planning memorandum documents the audit approach and scope. The purpose of the audit is to assess the adequacy of internal controls, the level of compliance with established policies and procedures, and the effectiveness and efficiency of business operation. This audit planning memorandum should be completed as part of the initial audit planning process and is meant to enhance audit efficiency. This document can be used as a general guide to understand and review the procurement card memorandum. Organizations should continuously update and monitor the processes included in this document to ensure that it reflects business operations.