1. Executive summery
2. Methodology
This report is prepared based on the information in Case 3-3 MXW Limited from
Case studies in Auditing and Assurance 5th Edition (Roebuck P, Martinov-Bennie
N). There are six separate situations that are considered. On each situation the
audit assistant commented whether they are fairly stated. We focused on what
the auditor can do to reduce the audit risk by considering possible
misstatements by the client companies in accordance with ASAs (Australian
Auditing Standards) and AASB (Australian Accounting Standards Board).
Assertions may be used to consider the different kind of possible misstatement.
Information is limited to what is found in Case 3-3 since there is no other way to
find more information regarding the six situations. This is prepared for the level
of students who started to study auditing like ourselves, reviewing the lecture
notes provided by Mr. Atul Chandra and using knowledge which we achieved so
far.
I changed Stephanie’s methodology as I think this is the method what we did.
We didn’t actually talked with the client nor get any documents.
3. Introduction
In this report, six separate companies will be dealt with under case 3-3 MXW
Limited. Each company is at the end of financial year and the audit service is
required. In each situation an audit assistant has already commented on
whether there is material misstatement or not. We are going to assess the
assistant’s conclusions and suggest a course of action that the auditor should
follow in order to limit the audit risk to an acceptable level. Our suggestions will
include advice about the sufficient and appropriate evidence that would be
required to justify any assertions that might be made.
4-1. Situation a
MXW Limited
4-1-1. Detailed findings
At the end of financial year accounts receivables confirmation carried out on 40
debtors of the client. SJO Pty Limited which was selected as one of the debtors
has responded that no debt is owed to MXW Limited. An audit assistant
concluded that only one discrepancy was found so it is not material.
4-1-2. Implication of the Findings
Even though it is just one discrepancy, how it is made is important.
It might be from:
 time difference like SJO did return the products that they had bought
 mere mistakes
 intentional overstatement to make receivable bigger
 fraud made by an employee like one employee misappropriates the money
received and the next day he or she uses payment from SJO to cover the
shortage. More work is definitely required by the senior auditor.
Auditor must plan and perform audit with professional scepticism, being a
questioning mind and a critical assessment of evidence - ASA200.15
Assertions used by the auditor may use assertions according to ASA315.A111 to
consider the different types of potential misstatements.
Insufficient samples
The auditor should think about how sufficient 40 sample debtors are. Suppose
that MXW has 2,000 debtors, then, 40 debtors do not seem to be enough to be
sufficient evidence to test existence. Moreover sequence check of all sales
invoices may be needed to examine completeness.
I deleted some as request was made by auditor. ’ respond to your request’
Inspection of restrictions or commitments
The auditor has to make sure that all the receivables stated on the balance sheet
fully belong to MXW (rights and obligations). Therefore any restrictions or
commitments should be inspected.
Aged analysis
The auditor must consider real value of the accounts receivables in order to
obtain appropriate evidence to test valuation and allocation. By doing aged
analysis the auditor can sort the receivables out into each category. Then,
collectability should be considered. After the assessing receivables, if the auditor
concludes the amounts are not appropriate but should suggest to MXW to
expense them as bad debt expense. In case MXW knows that this amount will
not be collected yet leave it on accounts receivable in order to meet, for example,
debt covenants, then the auditor should think about mentioning going concern
issues depends on how serious it is.-ASA570.6
4-2. Situation b
4-2-1. Detailed findings
Property, plant equipment is depreciated at the flat rate of 15% pa on cost. The
audit assistant tests the accuracy of the depreciation expense using substantive
analytical procedures. The working paper supporting this procedure shows:
The balance of depreciation expense per client records is 6,076,555. The Audit
assistant concluded that it is stated reasonably.
4-2-2. Implications of findings
The conclusion made by audit assistant is premature.
Material discrepancy
There is more than 20%* difference between analytical procedure and the actual
depreciation expense that occurred. It is too large to be considered immaterial.
However, in analytical procedure salvage value was not considered, so
recalculation is required. After the recalculation if there still is the significant
difference, the auditor should look into deeply how the client got the depreciation
figures (test of details required). However, about the property, plant and
equipment, depreciation expenses are not the only things that have to be
considered.
*($7,341,341 - $6,076,555) / $6,076,555×100 = 20.8%
Test of existence
The auditor should check whether the client has the legal ownership. Especially
when the client has the leased property that is capitalised, the auditor should
make sure they meet the accounting standard (AASB117 Leases).
Capitalise or expense
Every cost that is capitalisable has to be capitalised. The auditor should review
what is capitalised and what is expensed making sure the client did these in
accordance with accounting standard (AASB 137 Contingent liabilities and
assets) to ensure their completeness.
Inquiry to ensure valuation and allocation
The auditor must be satisfied with how the client valued the property, plant and
equipment. The client can choose either cost or revaluation for valuing assets
(AASB 116 property, plant and equipment) but the auditor must think about the
impairment of asset and salvage value and also, when the client chooses the
revaluation model, the auditor have to make sure what they did was right in
accordance with the accounting standard by asking opinion from independent
experts or physical observation or asking the board of director, audit committee
or checking the minutes.
4-3. Situation c
4-3-1. Detailed findings
SST Limited has a 30 June balance date. The company’s inventory consists of
approximately 20,000 music cassettes and compact disc, details of which are
maintained on a perpetual IT inventory system. Inventory is counted on a cyclical
basis throughout the year with all items being counted at least once during the
year.
The stocktakes are attended by an audit assistant where a sample of 20 items is
counted from the floor and checked to stocktake sheets and perpetual records,
and a further sample of 20 is selected from the perpetual records for checking to
the floor.
The most recent stocktake took place in March. The client’s inventory system
was not subsequently updated for several errors identified at the time of the
stocktake.
4-3-2. Implications of the findings
Unupdated errors
There are three possible causations which leaded to several errors not being
updated.
 The IT inventory system is defected
 People who use the system are not well trained
 The client did not update the errors intentionally
Test of control should be performed to identify the causation of this issue. This
includes interviewing the stocktake staffs. Also the auditor should advise the
client to collect the feedback of the executive staff in order to improve the
performance of the system and to establish a stock take monitoring program.
Review records and files
As the inventory system has not performed properly since March, the quantities
of inventory must be different from the record and actual amount. In order to test
completeness and accuracy the auditor should review transactions and records
related to inventory occurred after March. For example, purchase invoices and
good received notes and relevant ledger should be checked. Those documents
and records should be original one (ASA 500 emphasises the need to inspect
original documents rather than photocopies), in order to locate when the mistake
occurred.
Further stocktake
The errors which occur in March and have not been recorded would lead the
misstatement of the balance sheet and profit and loss statement. Further
stocktake should be performed to ensure its existence.
4-4. Situation d
4-4-1. Detailed Finding
As part of year-end substantive testing of trade payables account, the audit
assistant has carried out a search for unrecorded liabilities. He tested a random
sample of 15 payments made after 31 March 2010, the company’s year end, and
has found the following items for which no accrual was made at 31 March 2010:
 Cheque number 19902 for $6,024 for stationery received in March
 Cheque number 19794 for $11,239 for February advertising in the local
community newspaper
 Cheque number20064 for $9,432 for hire of office furniture in February and
March.
4-4-2. Implications of the finding
The possible causation of these discrepancies are;
 Genuine mistakes of recordings
 Intentional understatement made by the client
Further inspections are required to express the auditor’s opinion.
Review of the transactions and records relating to those ceques
Review the appropriate and original (ASA 500 emphasises the need to inspect
original documents rather than photocopies) transactions and records, to find out
whether there are any other mistake and confirm the mistake of the three
cheques. Also the auditor should ensure that the amounts and other data
relating to recorded transactions and events have been recorded appropriately
(accuracy).
Interview personnel
It is important to interview the staffs who deal with those transactions. The
auditor should try to ascertain the reason leads to these mistakes.
Confirmation from creditors
The auditor has to obtain confirmations from creditors and review of unpaid
invoices for the period ended 31st of March. By doing so, occurrence can be
examined to make sure that the transactions and events that have been
recorded have occurred and pertain to the entity.
4-5. Situation e
4-5-1. Detailed findings
The client, ABC Contractors Limited, has started forward foreign exchange
contracts during the year.
Although there is no formal accounting or reporting system for the contracts, the
chief accountant after initiating the contract with the bank immediately lists the
transaction on a manual spreadsheet. In order to determine the unrealised
exchange gain or loss on the contracts to be taken to the income statement, the
chief accountant values this listing using closing foreign exchange rates at the
year end. All details of a sample of contracts which was made from the year end
listing for verification purposes were agreed back to original supporting
documentation form the bank and the valuation of the contracts at year end was
checked. No discrepancies were found.
4-5-2. Implications of the findings
Lack of formal accounting or reporting system for hedging contract
According to AASB139, the entity which enters into hedging contracts must have
a formal accounting or reporting system.
AASB 139 Financial instruments (para 99):
1. At the inception of the hedge there is a formal designation and
documentation of the hedging relationship and the entity’s risk
management objective and strategy for undertaking the hedge
Therefore the auditor should advise the client to introduce this kind of system.
Test of the closing foreign exchange rate
According to AASB 121, the entity should use the spot rate on the last day of its
financial year to determine the unrealised exchange gain or loss.
AASB 121 (par.21):
A foreign currency transaction shall be recorded, on initial recognition in
the functional currency, by applying to the foreign currency amount the
spot exchange rate between the functional currency and the foreign
currency at the date of the transaction
Therefore the closing foreign rate should be confirmed in order to test accuracy.
Insufficient sample
The sample of contracts was made from the year end listing on which those
contracts have not been settled yet thus those contracts are relatively new
therefore it does not test occurrence. A sample should be taken randomly out of
the contracts throughout the year.
4-6. Situation f
4-6-1. Detailed findings
In the review of the cash section;
 Year end balances have been agreed back to copies of the monthly bank
statements;
 Copies of the statements have been put on file as audit evidence; and
 Confirmation requests have been returned to the auditor via the client.
4-6-2. Implications of the findings
Tests of controls of cash receipt and cash payment transaction systems
As both the cash receipts and cash payments directly affect the account balance
of cash, tests of controls of both these systems should be undertaken in order to
check whether these systems work efficiently and accurately then assess the
level of the internal risk. These tests involve observing the process from opening
mails and preparing deposits or cheques.
Tests of cash transactions
Substantive tests of detail of transactions should be undertakes to detect errors
in order to test occurrence and completeness. For example, the client might
have included any cash receipts made after year end in cash receipts of the
current year. Through the tests of transaction, those errors may be detected.
Tests of cash balances
To ensure existence and completeness, test of bank reconciliations needs to be
undertaken to substantiate that balance confirmed with the bank agrees with the
client’s cash accounting records. If there are large or unusual items, the auditor
should ask the client to explain the nature of the reconciling item. For example,
an immaterial amount of item “net miscellaneous” might be a result of two
material items offsetting each other.
Inappropriate confirmation
Confirmation requests should be returned to the auditor by the bank directly as a
confirmation via the client does not test completeness. The auditor commonly
confirms the year-end cash balance by direct correspondence with all banks with
the client has had accounts during the period. AGS 1002 provides audit
guidance on bank confirmation procedures.
AGS 1002 Bank Confirmation Requests
Appendix 1 Bank Confirmation – Audit Request (General)
Three (3) copies of the form should be received by the bank. All
completed copies of the Confirmation are to be signed with original
returned direct to the auditor in the enclosed stamped addressed
envelope. The duplicate is to be forwarded to the client and the triplicate
retained by the bank.
Also it is important that the auditor keep the original documents as audit
evidence.
Cash on hand
Most of entities do not have substantial cash on hand thus it is not counted.
However, in some industries such as banks or casinos have material cash on
hand therefore a cash count may be necessary.
5.
Conclusion
The main objective of the auditor is to reduce audit risk which consists of
inherent risk, control risk and detection risk. Although inherent risk and control
risk cannot be changed by the auditor, detection risk can be reduced by auditor’s
effort. In order to achieve the objective, firstly the auditor assesses risks with
each item using financial report assertions. Secondly sufficient and appropriate
evidences are collected by the auditor.
The main risk with asset items such as cash, accounts receivable and inventory
is overstatement. On the other hand, the main risk associated with liability items
such as trade payables and negative items in income statement such as
expenses and losses is understatement. The auditor should identify those
misstatements by committing tests of control and substantive tests. It is crucial
for the auditor to obtain sufficient and appropriate evidences to express the
auditor’s opinion. Such evidences should be external, original and written
documents.