Approach to Audit in Respect of Review of Internal Control
Letter to the Management Regarding Approach to Audit- Audit of Financial Statements to 31st December 20XY
This letter identifies the procedures that were used in the internal audit of the company for the financial statements to 31st Dec 20×1. The approaches on the audit of each issue are discussed in this paper.
Please see the section with the title “Approach to Audit” for details on how the audit was conducted. We will be able to give you further explanations on issues raised in this paper in case you have any question.
Approach to Audit
ISA 404 provides guidelines on the audit of internal controls in an organization. Broadly, internal controls are the procedures and policies that the management designs in order to ensure that the company achieves its objectives. Therefore, the internal controls assist in ensuring that the company’s financial statements are reliable, if there is efficiency in operations, and if the entity complies with the law. Our audit of the internal control system aimed at fulfilling the aforementioned requirements in TWT.
IAS 18 provides guidelines on how revenue should be recognized and accounted in the financial statements. This regulation was used in the assessment of the internal control as pertaining sales. Generally, revenue from a sale is measured at fair value and the amount of consideration that will be earned is determined when all the conditions of the contracts have been fulfilled. The IAS 18.14 provides the following requirements must be fulfilled for there to be a sale:
- Significant risks and benefits have been transferred from the buyer to the seller
- The seller does not have any effective control and management over the sold item
- The value of the sold item can be measured reliably
- The economic benefits from the sold item will flow to the seller
- The costs regarding the transaction can be measured reliably
In the analysis of recognized revenue, we checked if the amounts recorded had been from transactions that fulfilled the requirements of IAS 18. Therefore, we checked if the risks associated with the ownership and use of the purchased coal had been transferred to the buyers. If the new owners had control over the coal they had purchased. We also checked if the value of the sold coal could be measured. Finally, we evaluated if the economic benefit of the coal was transferred to the buyers.
IAS 37 provides information on how to account for provisions, contingent liabilities, and contingent assets. We used this guideline to assess if adequate provisions had been allocated for doubtful debts by the company. In general, provisions are given at best estimate and they include the risks and uncertainties associated with a specific obligation. In the provision for doubtful debts, IAS 37 requires an organization to present adequate provision if there is a constructive obligation, if payment is probable, and if the collectible amount can be estimated correctly.
When auditing TWT, we checked if the company had provided realistic provisions for bad debts with regards to the ability to collect these amounts.
IAS 2 provides a guideline on how to account for inventories. Generally, this regulation requires inventories to be recognized at the lower of cost and net realizable value (NRV). Inventories are simply assets that an entity holds for the purpose of sale. IAS 2 requires that inventories should consist of the cost of purchase, conversion, and transportation to their present location. The cost of the inventory should not include storage, administration overheads, selling, interest rate cost, and costs due to abnormal waste. When conducting an audit of the inventories, we evaluated if these items had been valued correctly by TWT, as provided for by IAS 2.
IAS 12 recognizes the impact of current tax and future tax on the carrying amount of an asset or a liability. Therefore, this rule recognizes that an entity must account for the effects of tax in a similar manner as it accounts for transactions of other events. Further, this rule also notes that tax should be recognized at the same time as the asset, in order to determine the future tax consequences. In light of this, we reviewed if the company had provided adequate rules and guidelines on how income tax was calculated TWT. Further, we also evaluated its treatment and recognition of deferred tax.
Presentation of Financial Statements
IAS 1 provides guidelines on how the financial statements should be presented, on the balance sheet, cash flow statements, statement of changes in equity, and income statement. In addition, it also provides information on the structure of these statements such as going concern and accrual basis of accounting. In addition, it requires organizations to have a consistent presentation of financial statements, materiality, as well as guidelines on offsetting, comparative information and presentation period. In light of this, we assessed how TWT had presented its financial statements with regards to rules and regulations provided by IAS 1. In particular, we were interested in whether the statements had a consistent presentation, if the company complied with rules on offsetting, materiality, and the going concern of the entity.
Audit and Assurance
Describe How You Would Conduct the Audit Process, Incorporating the Analytical Procedures You Would Use to Investigate Selected Business Transactions1. What Steps Will You Take to Review the Company’s Business Transactions?
Notably, auditing and assurance refer to the investigative procedures done by both the internal and external auditors to provide a testimony of the accuracy and truth in the business financial statements. In essence, this procedure requires the use of analytical and technical skills. In addition, the auditor must exercise professional skepticism when analyzing the financial records (Arens et al., 2016). In light of this, the audit review of Walmart Inc. will have the following steps:
- Test of controls
- Substantive procedures
Planning of the Audit
In a few words, auditing standards require that proper planning must be done prior to the start of the audit. Essentially, planning helps in determining the scope of the audit, the required competencies, and the risks of material misstatements (Gomez, 2012). In light of this, the auditing team will first plan for the auditing procedure one week before the auditing day. Basically, this will ensure that all the members are aware of the scope and expectations in the audit.
Test of Controls
Notably, the internal audit process normally focuses on ensuring adherence to the internal control procedures. In brief, it should ensure that the internal controls are strictly adhered to and they are relevant to the business operations. In this case, the test of internal controls will entail testing of the use of set down procedures at Walmart Inc. In essence, these are tests on matters such as the ordering processes, the sales procedures, disposal of damaged inventory, and the return of damaged goods (Gomez, 2012). Moreover, the internal auditing team will require the personnel to provide supporting documents such as receipts, invoices, and bank statements for all transactions.
In brief, these are analytical methods that the auditing team will use to ensure the accuracy and reliability of the financial records. Basically, the auditing team will use computerized systems such as the computer-aided auditing techniques (CAAT) (Hall & Singleton, 2010). Notably, this will ensure quick and accurate auditing of the financial statements.
Completing the Audit
Generally, this stage entails an evaluation of the gathered audit evidence to evaluate its sufficiency and appropriateness. Accordingly, having determined the audit evidence sufficiency and appropriateness, the auditing team will determine its materiality. In essence, if there are misstatements, the team will seek for clarification and explanations from the personnel in charge. In turn, the kind of responses that the audit team receives at this level will influence the type of audit report it writes (Hall & Singleton, 2010). Noteworthy, there may be errors that may be detected; nonetheless, reasonable explanations with regard to such matters may reduce the audit team tone on the report. In this case, such issues may be noted down for a check on their improvement in future. Moreover, issues of fraud will need clarification on whether the management has detected them and their materiality.
Notably, the audit report will be formed based on the matters found after the internal audit. Noteworthy, unlike the external auditor’s report which issues an unmodified or modified auditing report, this report will address matters on the internal control process (Gomez, 2012). In brief, these are issues on the weaknesses or strengths of the internal control process, errors and fraud cases detected.
- What Would Your Plan Be to Utilize These Procedures?
In brief, the use of analytical procedures would fasten the auditing process, increase accuracy, and lessen the workload on the auditing team. Noteworthy, analytical processes entail the comparison of the relationship among financial and nonfinancial data. In light of this, analytical procedures espouse that the predictability of misstatements depends on the nature of assertions, the predictability of relationship, availability of data, and the accuracy of expectation (Leung et al., 2011). In general, this entails ratio analysis, trend analysis, reasonable tests, and model-based procedures.
Basically, these tests involve analysis of the various business and industry performance levels to predict an expected outcome. For example, if the business made an increase in revenue by 12% and the overall costs of commodities has not changed, it is reasonable for the auditor to expect a similar increase in the overall business performance.
In essence, this method compares the business performance over the past few years to establish if there is a certain trend (Gomez, 2012). Generally, the auditor checks if there are significant changes in the financial statements from the established trend. For example, when checking Walmart Inc. financial statement, the auditing team will check for any significant trends in the balance sheet over the years.
Noteworthy, this procedure uses the business operating data to predict specific business outcomes. In essence, financial activities in one item have a huge significance in more than one financial record (Leung et al., 2011). For example, if there is a decrease in sales in Walmart Inc. products the auditing team will expect a decrease in ordering levels, revenue, and, accordingly, a reduction in profits.
Generally, this procedure uses client internal data and the industry and economy performance information. Basically, if the client’s industry is thriving, it is reasonable for the auditor to expect an increase in business profits (Leung et al., 2011). In this case, we will evaluate the performance of supermarkets in the country as we evaluate Walmart Inc. financial statements. Naturally, if these businesses are thriving, we will expect an increase in sales and profits for the business.
Explain the Appropriate Field Work Needed to Review High-Risk Business Transactions For Cash and Revenue.
- What Would You Need to Do in the Field to Investigate These?
Evidently, money is an important asset for the business; nonetheless, it is still one of the easiest to steal. Consequently, there is always a need for ensuring proper accountability of all transactions. In addition, there should be relevant supporting documents for the financial transactions. In light of this, I will conduct fieldwork with an aim of identifying the individuals authorized to hold and bank the company’s money, availability of supporting documents, existence of the money, the materiality of transactions, and the presentation and disclosure of such transactions in the financial statements.
Notably, all individuals who deal with Walmart Inc.’s money are authorized by the company management. In this case, the auditing team will analyze the amount of money that individuals such as tellers or the banking officers can hold within a given time. In addition, we will evaluate if there have been any violation of these regulations. Further still, for all the money held or banked, we will check for supporting documents. Basically, this will be bank deposit slips, bank statements, and cheque book counterfoil. Simply, the existence of the cash will be done by evaluating the current bank balances, and a random surprise check of teller drawers to find whether the cash in the till box reflects the balances shown on the supermarket accounting system.
Importantly, materiality will be evaluated on huge bank deposits and withdrawals. Moreover, we will evaluate on the authorization for such deposits or withdrawals. Further, lump sum payments to suppliers will be evaluated. Correspondingly, other matters such as existence will be evaluated. Noteworthy, all transactions should have a proper presentation and disclosures. Basically, the audit team will expect to see such transactions on the company financial statements or on the notes section.
- Could You Convey this Information through Charts or Other Supporting Documentation?
I would convey this message through charts and other supporting documents. In general, auditing uses various supporting documents to ensure professionalism, accuracy, and an overall investigation of the accounting records. In essence, all auditing matters should be properly recorded in the working papers. Noteworthy, the working papers act as supporting documents in case of an investigation of matters raised in the audit process. Moreover, the audit team may use charts for their work. Importantly, charts may act as a guide for the auditing process to the junior staff and, correspondingly, result in a more focused and accurate audit.
Illustration 1: Example of an Audit Chart for the Finance Department Audit
Create a Test to Assess Appropriate Assertions for Designated High-Risk Business Transactions
Notably, in the auditing process of an ongoing and well-performing business, the auditor forms various assertions with regards to the going concern of the enterprise. In brief, the audit team will analyze financial transactions involving the payment of Walmart Inc. suppliers. In essence, cash is a high-risk commodity that is prone to theft (Stuart, 2011). In light of this, various assertions are used in cash transactions as follows:
In a few words, this assertion espouses that the transactions that Walmart Inc. is paying its suppliers happened. In this regard, the audit team will ask for supporting documents such as invoices, delivery note, and a copy of the local purchase order (Stuart, 2011). Moreover, if the commodities supplied were fixed assets, the audit team will check for their existence.
Noteworthy, all financial transactions must be disclosed in all relevant financial documents. Basically, the purchase of an item from a supplier will lead to a reduction in cash, and an increase in assets (Stuart, 2011). Correspondingly, this will affect the business bank account and the assets account. In light of this, the audit team will check for the proper and consistent use of the double-entry accounting rule to ensure accuracy and completeness.
Notably, the use of the double entry rule will reflect all the business transactions (Stuart, 2011). In addition, the audit team will check whether the amount shown on the invoice matches with the amount paid to Walmart Inc. suppliers. In the case of any inconsistency, the audit team will seek for explanations from the officers in charge.
In essence, this is an important accounting aspect of indicating when the transaction occurred. Basically, this accounting procedure suggests that accounting should be done on a going concern basis. Moreover, incomes and expenses should be recognized in the period they were incurred, not when they paid (Stuart, 2011). In light of this, the audit team will expect all expenses and incomes be accounted in their proper financial year. Notably, the financial statements should have a title indicating the financial year for the transactions under consideration. In this regard, the audit team will ensure that all the payments to the suppliers are properly recorded in the year they were paid, and not when they were earned.
Importantly, all items in the financial statements should be properly recorded to ensure correct and easy interpretation of financial records. In this regard, the audit team will check whether the suppliers had been accurately recorded as Walmarts creditors. In addition, the audit team will also check if the commodities supplied were properly classified (Stuart, 2011). In essence, most supplies will be inventories or office and operations consumer products. Accordingly, the audit team will expect these commodities to be recorded in the respective accounts.
In summary, auditing is an important aspect of all businesses as it ensures accuracy and reliability of financial records. In addition, it enables the detection of errors, fraud, and weaknesses in the internal control systems. In light of this, all organizations should have a strong and independent audit department to ensure that the company’s assets are safeguarded from misappropriation.
Arens, A., Elder, R., & Beasley, M. (2016). Auditing and assurance services. New York, NY: Pearson Education Limited.
Hall, J., & Singleton, T. (2010). Information technology auditing and assurance (3rd Ed.). Mason, OH: Cengage Learning.
Gomez, C. (2012). Auditing and assurance: Theory and practice. New Delhi, India: PHI Learning Private Limited.
Leung, P., Coram, P., & Cooper, B. (2011). Modern auditing and assurance services (5th Ed). Milton Qld, Australia: John Wiley & Sons Australia Limited.
Stuart, I. (2011). Auditing and assurance services: An applied approach. New York, NY: McGraw-Hill Education.