Inherent Risk Factors That Are Likely to Affect the Audit - Article Example

Student’s Name: University: Course: Tutor: Date: ASX Code: BSI Abstract To perform an audit of BSI properly, an auditor should appreciate the accounting procedures and internal control system used by the company. This is necessary so that the auditor can successfully plan and develop an audit procedure. One of the key aspects for this understanding is to recognize the audit risks involved. Audit risks can weaken the professional judgment of the auditor and the situation of the company if discovered by the regulating authority. It is the risk of harming the name of the auditor, which may lead to financial loss as well as profession. Given that the auditor will analyze internal controls and financial statements independently and to provide a balanced view of the financial performance of the client, it is very important that the auditor guarantee that his/her judgments do not injure any party's interests (Chambers & Rand, p254). Inherent risks: "This refers to the vulnerability of an account balance or class of transactions to misstatement that could be material, singly or when combined with misstatements in other balances or transactions, with an assuming that there were no related internal controls (Douglas, p145). This paper highlights the inherent risk factors that are likely to affect the audit of Beyond Sportswear International Ltd (BSI), a listed company in ASX. BSI deals with manufacturing and distribution of sports wear to schools and clubs in Australia. For each of the risks factors, an analysis has performed so that possible discrepancies can be spotted out in the financial statements. In addition, associated supporting evidence is also provided within. Income Statement For the year ended 30 June 2009 Consolidated Company 2009 2008 2009 2008 Note $'000 $'000 $'000 $'000 Revenue 3 30,710 26,398 0 0 Changes in inventories of finished goods and work in progress 526 625 0 0 Raw materials and consumables used (19,968) (15,150) 0 0 Royalty expenses (527) (1,244) 0 0 Employee benefits expense 4 (4,771) (3,710) 0 0 Occupancy expenses (556) (528) 0 0 Event expenses (1,062) (1,297) 0 0 Advertising expenses (393) (372) 0 0 Freight expenses (705) (494) 0 0 Travel expenses (357) (315) 0 0 Depreciation and amortisation expenses 4 (741) (538) (3) 0 Professional fees 1,546) (1,183) (758) (680) Finance costs 4 (1,020) (1,724) (59) 347 Write down of related party loan 4 (20) (81) (742) 4,746 Discount on acquisition 0 1,662 0 0 Other expenses (1,747) (1,299) 0 (4) Profit/ (Loss) before tax (2,177) 750 (1,562) 4,409 Income tax benefit 5 1,600 2,400 1,600 2,400 Profit /(Loss) for the year attributable to members of the parent entity (577) 3,150 38 6,809 Earnings per share Basic (cents per share) 28 (0.23) 1.96 Diluted (cents per share) 28 (0.22) 1.84 Balance Sheet As at 30 June 2009 Consolidated Company 2009 2008 2009 2008 Notes $'000 $'000 $'000 $'000 Assets Current assets Cash and cash equivalents 7 388 744 0 0 Trade and other receivables 8 5,016 3,111 12 91 Inventories 9 3,327 3,854 0 0 Other current assets 10 233 90 0 0 Total current assets 8,964 7,799 12 91 Non-current assets Deferred tax assets 5 4,000 2,400 4,000 2,400 Financial assets 11 75 75 12,411 11,971 Property plant and equipment 12 3,191 3,514 26 0 Goodwill 13 4,184 3,743 0 0 Intangible assets 14 8,178 8,178 0 0 Total non-current assets 19,628 17,910 16,437 14,371 Total assets 28,592 25,709 16,449 14,462 Current liabilities Trade and other payables 15 8,973 9,396 295 1,375 Borrowings 16 6,700 4,847 0 0 Provisions 17 528 787 0 0 Current tax liabilities 0 44 0 0 Total current liabilities 16,201 15,074 295 1,375 Non-current liabilities Borrowings 16 2,110 2,648 0 0 Provisions 17 107 6 0 0 Total non-current liabilities 2,217 2,654 0 0 Total liabilities 18,418 17,728 295 1,375 Net assets 10,174 7,981 16,154 13,087 Equity Issued capital 18 38,312 35,283 38,312 35,283 Reserves 19 (199) 60 161 161 Accumulated losses 20 (27,939) (27,362) (22,319) (22,357) Total equity 10,174 7,981 16,154 13,087 Retrieved from Beyond Sportswear International Limited ACN 108 042 593 Annual Report 30 June 2009 Part 1 1. Cash Handling As indicated, free cash flows increased by 101.84% therefore there is a high risk in handling such a large amount of hard cash. In addition, it shows that company has not made investments and surplus cash is possible. Because cash is the most susceptible item in the account balances, its auditing process involve the tracing out of all cash associated transactions and activities. A variation in the reported cash in the balance sheet would lead to decreased or increased assets level (Mitchell & Scott para8). 2. Stock Management: BSI manufactures and distributes its product to a large number of people and therefore, it should always hold heavy stock in its warehouses at a given period. This means that effective stock management is necessary. The company must maintain stock level follow up. Continuous examination of stock should be guaranteed. As the company’s operations are highly stock- based the company’s management should develop internal systems where accountability is high (Mitchell & Scott para8) a) Minimum stock: this is the stock level that BSI Ltd has to maintain at all time, such levels of stocks must always be in stores. Inventory systems should be modeled in a way to address this problem effectively. b) Maximum stock: to avoid over-stocking, maximum stock level should be clearly defined. It will ensure that stock is within the control of management. Here as well, the point is the same where the inventory system should be well designed. c) Lead stock: this is stock level, which company should maintain during lead-time i.e. amount of time taken by supplier from the date of order to the date of supply. Lead-time or cycle time for any company is identified as the basic yield indicator. The objective is to be productive and profitable so that the business accomplish its purpose (William, p 458) d. Reordering levels: this is the most significant level of stock. It is the level that when reached order for the supply of goods should be placed with supplier. Correspondingly, the auditor can safely presume that no form of inventory system would be efficient without pre-determined reorder levels. Hence, in order to reduce inherent risk involved in stock, company must establish “Stock Management System”. In the case of BSI stock level has increased by 34.18% and the auditor should carry out tests to confirm in case of misappropriation. 3. Reliance on Supplier for Quality Supplies: BSI Ltd depends on suppliers for the supply of raw materials. Some of these raw materials are perishable and it is not possible to store them in bulk and therefore can cause problems in case of urgency in the manufacturing plants. Additionally reliance on one specific supplier for valuable supplies may be risky to the business and may affect the financial statements. This reliance on one supplier always leads to a higher risk for the company in difficult times. To make sure that the risk level is minimized, the company should strengthen its supply chain system maintain effective and efficient suppliers' relationship (Alvin, p58,). 4. Seasonal variances because of demand: Generally, demand has large effect on company’s sales. Seasonal oscillations may increase or decrease total turn over. Predictions and planning becomes a key variable of where the turnover can be centralised. There is a possibility of BSI sales be congested within certain months of the year. The auditor should analyse the effect of variations in demand all year round (Glezen, p254-255,). 5. Warehousing and Related Control: Finished stock in a manufacturing business like that of BSI is a material item hence checks and balances have to be set in advance so that there is no confusion. Compliance and documentation is central to all audit procedures, as the screening has to be transparent and accessible. 6. Cash in Transit: BSI operates a number of distribution shops all over the country. In addition, most of sales are on cash basis. At account balance level, ‘cash’ is most prone item and involves big deal of risk. Decisions relating to the nature of cash should be put up before hand to make its auditing easier. For example, if BSI Ltd decides to regard cash in transit as cash, this would add to its account balance but it does not ensure that it has enough liquid cash to cover its daily expenditure and utilization (American Institute of Certified Public Accountants, p 25). 7. Reliance on Timely Transportation of Goods to its outlets & stores): Inventory is the most important aspect of BSI Ltd operations. Logistics and distribution of finished goods is critical. For this reason, to handle the inventory in an appropriate manner so that supplies to customers of the goods may not be delayed is important, as this would negatively affect the financial performance of the company. Part 2 1. Market Price Wars: BSI Ltd is a medium sized company and it has a small share of the sportswear market. Large multinational companies involve great risk. As a result, entry of new competitor in this market may have considerably affect on company’s turnover. The auditor should analyse the impact of competition on the financial statements (Alvin, p 154) 2. Public preferences: BSI deals in products that are on high supply, this provides the consumer a wide range to choose from. It largely depends on likes and dislikes of people, which is rather risky. In the case of BSI business, there is high risk that the company’s products may loose popularity with the consumers. Nevertheless, careful assessment of just-in-time procedures together with inventory management can really benefit the company, as it would minimize the risk of over stocking of out-of-fashion clothes (Basu, p 124). 3. Government legislation and restrictions on sales: Legislative changes and government policies have considerable impact on company’s operations e.g. the Australian government has adopted the Trade Practices Act of 2002 and the Competition Policy to with intension of revitalizing the industry and this can seriously affect the company's position among other industrial players. This creates a risk in competition and the company controls over its finance to limit industry’s environment turbulence (Delaney & Whittington, p189). 4. Regulatory Body’s Regulations: Regulations imposed by regulatory bodies administering the activities of companies may affect on the operations of BSI Ltd. Regulatory bodies influence the mechanisms and the policies of the companies. The board of management is one such body within the company. which is responsible for new regulations and projects. The auditor should formulate procedure which would help him identify the impact of regulations in the financial statements (Michael, p 68) 5. Technology Advanced technology is a competitive tool on competitors. Radical changes in technological platform have momentous effect on the company’s operations and production. Investment in Information technology such as communication systems as well as supply chain systems at all distribution centers can tie capital for a period so that could be utilized elsewhere. There is risk in failing to report the investment in such none-returnable items on the balance sheet and the profit and loss statements (Basu, p88, 2007): 6. Global financial crisis In 2008, most businesses were negatively affected by global financial crisis. This crisis posed risk to many companies in Australia and BSI would not be exceptional. For the year ended June 30, 2010 it reported loss of $577,000 in it profit and loss account. The auditor should be keen to deduce whether the aspect of the loss attributed to the global crisis is fairly calculated (Delaney & Whittington, para10). Part 3: Internal Memo From: To: The Audit Partner Date: May 4, 2009 The assessment of BSI business arrangement and available information i.e. the company’s financial analysis in part one of this paper suggests that the inherent risks acknowledged, cause a big threat to the on the whole audit procedure. A major input to the development of audit procedure is the internal control system of the company, which would either support the audit procedure or create great danger to it. There are areas in the financial statements that need a careful planning so as to detect any misstatements. To begin with is the cash account. The cash has increased by more than 100% and this change might not have been expected. The audit plan should include mechanisms to ensure that all cash collected was banked as spelt out in the BSI cash handling policies. Stock management should thoroughly be inspected to make sure that all types of stock i.e. raw materials, work in progress and finished goods have been included in the financial statements. Supply of quality materials is a vital component in successfully meeting the consumers expectations. The audit should be arranged in a way that it will ensure that all the materials supplied are of required standard and the company does not rely on only one supplier for its materials. Low returns might be due to change in demand in certain months of the year. The audit should be programmed in a manner that it is going to assess the impact of low sales in certain months of the year. The audit should consider that BSI has a number of distribution channels for its products. This means they are transported to different regions of Australia. The audit procedure should help to identify any weakness in the logistics and distribution. Another area that needs much attention is the issue of cash in transit. The audit should assess the impact of including the cash in transit in the cash account. BSI operates in a competitive market where its operations and productivity depends on the actions of its audit. The audit procedure should be able to identify whether the impact of price wars has affected the financial statements. BSI operates in a regulated market where the government and other regulatory authorities determine the operations and policies of companies. The audit procedure should be able to determine the justification of the inclusion of regulative impact in financial terms. BSI operates an extensive IT platform to incorporate all the distribution centres. The auditor should be able to confirm the inclusion of IT factors in the financial statements. They should be fair and truly be reported. Finally, the global financial meltdown affected the business of BSI for the year ended June 2009. The inclusion of the effects of this crisis in the financial statements should be fair and true. Works cited Alvin, et el, (1984): Prentice-Hall series in accounting. Prentice-Hall. American Institute of Certified Public Accountants, (2008): AICPA Audit and Accounting Manual: Virginia: American Institute of Certified Public Accountants. Anthony, J.,(1999): Analytical procedures: (Auditing and Quality Review). Retrieved 3rd May, 2010 from: http://www.nysscpa.org/cpajournal/old/12268860.htm92 Basu (2007): Fundamentals of Auditing. New Delhi. Pearson Education. Chambers & Rand, (2010): Operational Auditing Handbook: Auditing Business and It Processes. John Wiley and Sons. Delaney & Whittington, (2009): Auditing and Attestation. John Wiley and Sons. Douglas, J.,(2006): The security risk assessment handbook: a complete guide for performing security risk assessments. CRC Press. Dusenbury, R., (2000): Audit Risk Model. Retrieved 3rd May, 2010 from: http//www.allbusiness.com/professional-scientific/accounting-tax/629074-1.html Glezen, G., (1997): Analytical auditing procedures. Retrieved 3rd May, 2010 from: http://www.allbusiness.com/accounting-reporting/auditing/605934-1.html Isaca, (2009): 2010 CISA Review Manual. Isaca. Mitchell & Scott (2005):Audit Risk. Retrieved 6th May, 2010 from: http/findarticles.com/p/articles/mi_qa5352/is_200501/ai_n21365446/ Michael, C., (2008): Contemporary Auditing: Real Issues and Case. Cengage Learning. Thomas, et el, (2002): Making enterprise risk management pay off. FT Press. William, W., (2006): Manufacturing, Distribution and Retail Guide. CCH. Read More

 

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