Question

The company the team chose is Alphabet formally Google, and competitor is Yahoo

You are a senior manager for the highly successful regional CPA firm of Fine, Dee, Evah, Dense, LLP (Fine). Since its inception nearly 30 years ago, Fine's audit practice has exclusively consisted of auditing private and not-for-profit organizations. Recently, the partners have been considering an opportunity to audit a publically-traded company for the company your team has selected.

The primary reason Fine has not heretofore ventured into auditing public-traded companies is because of the potential risk and legal liability associated with auditing public companies. However, Fine has been a bit stagnant, business-wise, for the past few years, and some of the older and more risk adverse partners are beginning to retire. Consequently, the lure of the often-lucrative and prestigious opportunity to audit a public company has become to hard to resist, so the partners have decided to pursue the chance to audit this company.

On a beautiful early-september morning you are called into the senior partner's office and told you and your team have been selected to lead the first-ever effort to audit a public-traded company for Fine. You are honored, but also know auditing a public company is a bit more tricky and complicated than auditing private and not-for-profit organizations. Fortunately, the senior partner had considerable experience early in his career with another firm in auditing public companies and told you he would be with you all the way. Relieved, you asked him what he wanted you to do. He tossed you the most recent Form 10-K of the company you selected and gave you the following assignments:

Review and discuss the Form 10-K for the company you have selected.
Create a report that will have 4 Sections.

Section 1. Initial Risk Assessment

Hint: The business and risk information is usually found in the first part of the risks, do not simply restate what is in the Form 10-K. Think like a senior manager at a CPA firm-what accounts (cash, A/R, Inventory,etc.) might be the most potentially risky and Why? For example an airline might not have the same inventory considerations found with a retail outlet like Wal-Mart.

Describe the following issues:
Ethics and legal Issues

1. The ETHICS and sophistication of top management and cultures where the company operates.

2. Have there been significant auditing or accounting issues raised in the recent past?

3. Did they have disputes with their previous audit firm?
4. IS this company or industry particularly susceptible to lawsuits or other legal proceedings?

Evaluate the regulatory and compliance and requirements of this company.
1. The compliance requirements of this company.

2. is it subject to a high-level of governmental regulation?

3. Are employees unionized? Are they generally compliant with Sarbanes-Oxley and other regulatory rules?

Section 2. Analytical Procedures

Based on Table 8-1 Examples of Planning Analytical Procedures and the sections on Analytical Procedures, select three ratios ( current, ratio, Inventory turnover, debt to equity, return on assets). calculate these ratios for the most recent year and compare the results.

Write a 350 to 525 word analysis of your findings

Section 3. Materiality and Risk

The senior partner wants to confirm your understanding of key concept.
Summarize each concept 90 to 175 words each.

materiality
misstatement
audit risk
audit risk model
inherent risk.
relationship of risk to audit evidence

Answer 1

Form 10K taken for the assignment belongs to a public company engaged in providing software services.

Section 1: Initial risk assessment

Directors and Corporate governance: As per the information disclosed in Form 10K, the company has well documented and adopted Code of Ethics applicable to all the Directors. There have been no instances reported regarding non compliance with the code adopted.

The audit firm reported no issues in accounting. The report on management’s internal control over financial reporting provided that the internal controls maintained and implemented by the company are complete and effective in all aspects. No issues of conflicts with the audit firms have been reported by the company.

The company is highly susceptible to litigations. The litigations mainly relate to Intellectual Property rights (IPRs) - copyrights and patents.

As the company is engaged in the industry related to technology, various issues have been reported with respect to health hazards due to excessive usage of technology. The government has passed regulations to ensure safety and good health of the people. As a result, the compliance requirements of the company include IPRs and health regulations.

The company has not reported any issues of conflicts with the employees.

The main risks that the company faces include:

Competition in the technology sector due to low barriers of entry which may result in low sales

Execution and competitive risks resulting in improper or poor execution of strategies developed

Significant investments in research and development of new products which may not be profitable in the market resulting in capital erosion

Acquisitions and joint ventures which may not be fruitful

Impairment of goodwill resulting in huge losses

Infringement of property rights resulting in litigations and huge outflow of resources

Security vulnerabilities resulting in high costs and reputation damage

Ineffective handling of data which may result in non compliance with protection of data policies

Retention of talented employees

Section 2: Analytical procedures:

• Obtain the details of control implemented by the company with respect to litigation settlements
• Compare the percentage of change in sales vis-a-vis market increase
• Steps taken by the company to overcome competition
• Findings and outcomes of the research of the company
• Expected earnings vs Realized earnings
• Cost benefit analysis of each project
• Advertising costs vs Increase in sales

Ratio analysis:

The company’s gross margin has increased substantively by 8% in comparison with that of previous year.

The net revenue has increased by 10% than the last year.

Total assets have increased by 25%.

However, the long term liabilities have also increased by approximately 25%.

Section 3: Materiality and Risk

Materiality:

Information is material if its misstatement (i.e., omission or erroneous statement) could influence the economic decisions of users taken on the basis of the financial information. Materiality depends on the size and nature of the item, judged in the particular circumstances of its misstatement. The objective of an audit of financial information prepared within a framework of recognised

accounting policies and practices and relevant statutory requirements, if any, is to enable the auditor to express an opinion on such financial information. The assessment of what is material is a matter of professional judgement. The concept of materiality recognises that some matters, either individually or in the aggregate, are relatively important for true and fair presentation of financial information in conformity with recognised accounting policies and practices. The auditor considers materiality at both the overall financial information level and in relation to individual account balances and classes of transactions. Materiality may also be influenced by other considerations, such as the legal and regulatory requirements, non-compliance with which may have a significant bearing on the financial information, and considerations relating to individual account balances and relationships. This process may result

in different levels of materiality depending on the matter being audited. Although the auditor ordinarily establishes an acceptable materiality level to detect quantitatively material misstatements, both the amount (quantity) and nature (quality) of misstatements need to be considered. Materiality should be considered by the auditor when –

(a) determining the nature, timing and extent of audit procedures;

(b) evaluating the effect of misstatements.

Misstatement: Misstatement is a difference between the amount, classification, presentation or disclosure of a reported financial statement item and the amount, classification, presentation or disclosure that is required for the item to be in accordance with the applicable financial reporting framework.

Misstatements can arise from fraud or error.' In other words, a misstatement arises where there is a difference between the reported figures, and what is expected to be reported in order for the financial statements to be fairly presented (or show a true and fair view). Misstatements can be factual, in the case of a clear breach of a requirement of a financial reporting standard, or could be judgmental, arising from unsuitable estimation techniques or the selection of inappropriate accounting policies.

Audit risk and Audit risk model:

The audit risk model determines the total amount of risk associated with an audit, and describes how this risk can be managed. The calculation is:

Audit risk = Control risk + Detection risk + Inherent risk

These elements of the audit risk model are:

   •   Control risk. This risk is caused by the failure of existing controls or the absence of controls, leading to incorrect financial statements.

   •   Detection risk. This risk is caused by the failure of the auditor to discover a material misstatement in the financial statements.

   •   Inherent risk. This risk is caused by an error or omission arising from factors other than control failures. This risk is most common when accounting transactions are quite complex, there is a high degree of judgment involved in accounting for transactions, or the training level of the accounting staff is low.

When planning an audit engagement, the auditor must review each of the subsidiary levels of risk to determine the total amount of audit risk. If the risk level is too high, the auditor conducts additional procedures to reduce the risk to an acceptable level. When the level of control risk and inherent risk is high, the auditor can increase the sample size for audit testing, thereby reducing detection risk. Conversely, when control risk and inherent risk are considered to be low, it is safe for the auditor to reduce the sample size for auditing testing, which increases detection risk.

Relationship of risk to audit evidence:

There is an inverse relationship between materiality and audit evidence, and an inverse relationship between audit risk and audit evidence.

If we maintain the audit risk constant and reduce the materiality level, audit evidence must increase to complete the circle.Similarly, if we hold the materiality level constant and reduce audit evidence, the audit risk must increase to complete the circle. Or, if we wish to reduce audit risk, we can do any of the following:

   1   Increase the materiality level while holding audit evidence constant,

   2   Increase audit evidence while holding the materiality level constant, or

   3   Make smaller increase in both the amount of audit evidence and the materiality level.