The Evidence Mix for the Planning of the Audit of BHP Billiton Limited - Term Paper Example

Auditing BHP Billiton Limited Name Institution Course Tutor Date Introduction In the audit practice, the auditors are likely to face risks. Materiality and risk are closely related. In audit, materiality refers to the practice of identifying the level of misstatement to the accounting information capable of influencing the decision makers relying on that information to change one’s mind. Risk refers to the level of uncertainty that is accepted by the auditor during the audit process. Different factors affect the evaluation of inherent risk during the audit procedure. This paper looks at the ‘key’ inherent risk factors that could have an impact on the audit of BHP Billiton Limited for the year ended 30th June 2016 and/or future audits. The paper describes the risk clearly and states how and why the issue is considered to be able to create the risk of potential material misstatement in the financial statements of BHP Billiton Limited for the year ended 30th June 2016 and beyond. The paper shows the application of the audit risk model in the discussion of how each identified inherent risk will impact on the evidence mix for the planning of the audit of BHP Billiton Limited in the relevant segment of the audit. The paper’s content refers to the financial statements and annual reports of the business. BHP Billiton Limited BHP Billiton Limited is an Australian Anglo multinational mining, metal, and petroleum company located in Melbourne. The analysis of the market values in 2015 indicates that BHP Billiton Limited is the largest mining company globally and fourth largest company in Australia according to the revenue. The company runs different operational units such as copper, potash, core, petroleum, and iron ore. Its mining activities are majorly influenced by the technological changes (Department of Resources Energy and Tourism, 2016, 5). The changes in the nature of natural resources also affect the company’s operations. Some of the resources handled by the company are dangerous to the environment, such as fossil fuels, petroleum, and gas, thus leading to environmental damages. BHP Billiton Limited produces and supplies resources that are vulnerable to accidents, such as fire to the gas and fuels. The changes in weather and unplanned events affect the company’s operations Question 1; The ‘key’ inherent risk factors The nature of the business- BHP Billiton Limited is a resource company conducting mining activities, metal and petroleum. The business inventory, property, equipment, plant, accounts, and loan receivable might lead to inherent risk (HKIAAT, 2016). In the case of a business in an industry affected by the changing technology, it is possible for the business to face the risk associated with inventory obsolescence. The business activities are not supposed to lead to major impact to its cash, mortgages and notes payable (BHP Billiton, 2016). BHP Billiton Limited deals with some frail products, such as gas and oil, thus making it likely to cause risk on audit. Products associated problems BHP Billiton Limited deals with gas and the gas market is vulnerable to changes. Gas market keeps on declining and the company fails to recoup its investments. The nature of the market environment and unexpected events leads to overestimation of the gas value. The company also sells petroleum and other minerals and are all vulnerable to uncertain environmental changes. The different assets of the company are likely to decline their grade and affect the expected profit (BHP Billiton, 2016, p.3) This is a risk because gas market declines significantly because of the poor economic plan in the gas business, thus influencing the fair value of the asset. The petroleum, fossil fuel and other products are vulnerable to fire accidents, thus leading to poor financial statement handling. The vague economic environment leads to biasness when trying to estimate the write down of the gas asset as per the market value. The company’s resources would be understated because of overestimation. It is necessary to evaluate the assumptions associated with the valuation process. It is possible for gas to go to the atmosphere uncontrollably and lead to wastage of huge amounts of gas. This might result to an adverse risk to the company’s revenue collection. It is possible for BHP to have understated expenses because of poor analysis of the value of the resources (BHP Billiton, 2016, p.26). Such incidences are capable to affect the company’s market position. The operating costs are normally high when the weather is unfriendly, thus affecting the business’s growth nature. The prices for the company’s products are challenging to set because of unexpected events. The market for the BHP’s products is also affected by the political, geographical, and economical issues, which affect entries in the financial statements. When doing audit, the professionals need to consider this risk associated with not only one of the company’s resources, but inclusive of all the other company’s products. Results of previous audits In the cases of misstatements being established in the earlier year’s audit, it is high likely for the same issue to be repeated in the current and future years during the audit practice (HKIAAT, 2016). It is clear that majority of the material misstatements are logical in nature and organisations do not bother making the relevant changes for their elimination. For instance, if there was some material misstatement in the pricing of the products being recognized in the previous years, the same is likely to recur. This required the auditor to apply a high inherent risk in the present year and make thorough testing to evaluate if there is proper following of the deficiency towards the client’s business system. Repetition of figures; BHP Billiton conducts auditing every financial year. The misstatements identified in the financial statements in the previous years are likely to be repeated in the current audit practice because it might look like a trend whereby some materials remain unchanged. For instance, the commodity price fluctuations are experienced every year. The oil price movements might be the same with those of gas, coal, copper, and ore, thus making the auditor to have that in mind and fail to test the deficiency in the financial statements (BHP Billiton, 2016, 30). This is an inherent risk because referring to the previous reports cannot help in realizing the misstatements. Some transactions might not be recorded in the current balance sheet if they were not recorded in the previous practices. This might make the auditor to check only the items recorded failing to test the left items. Initial vs repeat engagement Due to the issue of repeated engagement of one auditor to audit the client’s books, this makes the particular auditor to take advantage of the substantial experience and gained knowledge concerning the client’s financial statements (HKIAAT, 2016). The auditor might set a high inherent risk during the initial periods when conducting the audit practice and continue lowering the risk in the following years. Such repetitive engagement of one auditor is possible to cause some over-evidence and lack of care. The auditor starts developing some personal relationship with the client and this makes the auditor to be reluctant to involve an inherent risk in the audit procedure. BHP Billiton is likely to be influenced by the risk of lowering the risk level once it continues engaging the same auditor for the conduct of its audit practices (Department of Resources Energy and Tourism, 2016, 7). This occurs if no misstatements were identified in the previous audit practices. Relaxation of the auditors is identified after a certain client engages for them several times. Climate change impact on the business is a risk that is majorly realized during the audit practice because it influences the company’s financial statements. The auditor would reduce the level of inherent risk when conducting the audit practice in such cases. Nonroutine transactions Some transactions are unusual for the clients, thus possible to have incorrect recording. Such occurrences include fire, theft, and acquisition of major properties (HKIAAT, 2016). If a company incurs lose due to such incidences like the asset write-offs, it might not be possible for the client to understand how to record such transactions. This might lead to making of major mistakes resulting to lack of the appropriate experience. BHP Billiton change of the mine sites BHP Billiton acquired a gas asset in 2001 and required to conduct the asset write-off (BHP Billiton, 2016, 43). The company might be required to change its mine sites because of the availability of the resources. Such transactions are not regular and common for the running of the business, thus the need for the auditor to estimate the high inherent risk in relation to such a situation. Other cases are whereby the company might be required to compensate some victims of the accidents involving its operations, such as fire and destruction of the surrounding resulting from gas and oil among other products of the company. Judgement needed Estimates are necessary in different account balances. It is also important to manage the judgment towards the received but uncollected accounts warranty liabilities, and obsolete inventories (HKIAAT, 2016). The management of the business is supposed to conduct a great deal of judgment when recording and estimating the transactions. For instance, when investments are recorded at fair value, reserves of the bank loan losses, payable product warranty, writing-off of the obsolete products, and allowances for the uncollectible trade receivables. The higher the conduct of judgment necessary the higher the possibility of misstatements. This required the auditor to evaluate a higher inherent risk. This is a risk at BHP Billiton because the company’s management makes assumptions associated with the company’s operations. “Attributable profit decreased by 86 per cent to US$1.9 billion mainly driven by a significant decline in commodity prices” (FY 2015, P. 33). Once the company acquires another firm to run the business with, the asset write-off is conducted. “-----represents basic earnings per share excluding any exceptional items and Discontinued operation” (FY 2015, p. 31). It is necessary for the auditor to use a high inherent risk level when auditing such instances. Question 2; The audit risk model Audit risk model is the model used to balance the audit risks. The auditor uses this model to compute the overall audit risk. Audit risk = inherent risk * control risk * detection risk BHP Billiton’s audit risk results from various types of risks capable of being realized when the audit procedure is conducted. It is necessary to reduce the general audit risk through the evaluation of the risk level in relation to the three audit risk components. These components include; Detection risk, Inherent risk, and Control risk (SEMO, 2016). BHP Billiton’s audit risk is set at a low level of .01, .05, or .10. Given that it is the responsibility of the company or the client to control the inherent risk and control risk, BHP Billiton would be required to allow some degree of complexity and liquidity towards its business. The company also needs to have a strong control system for the prevention, detection, and correction of errors. BHP Billiton’s inherent risk of audit is quite more because of the nature of the business whereby the company operates a resources business and these resources are vulnerable to climate change, accidents like fire, and technological changes. It might be hard for the company’s accountant to record some transactions to the financial statements, thus leading to risks associated with the company’s materiality. The economic fluctuations are also likely to demand the consideration of high level of inherent risk when the auditor is carrying out the audit procedure. Due to other transactions such as management judgments, this would require BHP’s auditor to consider a higher inherent risk (SEMO, 2016). The company’s control risk of audit is high since the business has errors related to the internal controls. The company relies on the external auditor rather than having an internal auditor who might help in the control and prevention of the likely errors. Ultimately, the control risk needs to be recognized as high. Assumptions are necessary when trying to reduce the control risk. From the fact that BHP Billiton has a high inherent risk, it is important for the resource company to be audited with a lot of precaution for the determination of the extra level of necessary verification. According to the SAS 47, the evaluation of results using the audit risk model requires making of some assumptions especially when the audit risk tends to go beyond the set percentage. If BHP Billiton wants to control the errors associated with its financial statements, there would be the need for the company to focus much on the inherent risk. BHP should manage its operations properly. The company should engage in effectual internal control. All the transactions have to be recorded accordingly to prevent material misstatement. BHP Billiton’s auditor has the responsibility of verifying all the transactions during the audit procedure. Conclusion In auditing, the consideration of material misstatement risk is essential. Inherent and control risks are the major risks of audit. Inherent risk refers to the vulnerability of an assertion regarding a transaction, admission to a misstatement, or account balance, either individually or being combines with other misstatement that might be material with the assumption that no linked internal controls. Before reflecting on the value and impact on the customer business’ internal control, the auditor needs to evaluate the probability of any material misstatement or erroneous and deceptive entries in the accounting statement. BHP Billiton’s inherent risk of audit is influenced by factors like non-routine transactions, the nature of the business, and repeated engagement among others. Audit risk model is used to balance the components of audit risk. References BHP Billiton, 2016. BHP Billiton Annual Report 2015. Retrieved from; http://www.bhpbilliton.com/~/media/bhp/documents/investors/annual-reports/2015/bhpbillitonannualreport2015.pdf?la=en BHP Billiton, 2016. BHP Billiton Annual Report 2016. Retrieved from; http://www.bhpbilliton.com/~/media/bhp/documents/investors/annual-reports/2016/bhpbillitonannualreport2016.pdf?utm_source=Website&utm_medium=Organic&utm_term=ARDownload&utm_campaign=AR2016 BHP Billiton, 2016. BHP Billiton results for the year ended 30 June 2016. Retrieved from; http://www.bhpbilliton.com/~/media/bhp/documents/investors/news/2016/160816_bhpbillitonresultsyearended30june2016.pdf?la=en Department of Resources Energy and Tourism, 2016. Risk Assessment and Management. Retrieved from; http://www.industry.gov.au/resource/Documents/LPSDP/LPSDP-RiskHandbook.pdf HKIAAT, 2016. Risk in Auditing- Inherent Risk. Retrieved from; http://www.hkiaat.org/images/uploads/articles/PBEPIII_inherent_risk.pdf SEMO, 2016. Audit Risk Model; http://www4.semo.edu/gjohnson/notes/audit_risk_model.htm Read More