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Accept Client And Perform Initial Audit Planning Accounting Essay

1.0 EXECUTIVE SUMMARY:

Firstly we have been nominated to audit the financial statement of Center of Audit Education (CAE). It has been prepared by the auditors form VK in accordance to ASA 300. The Client which is Center of Adult Education (CAE) was founded in the year 1947 under the Victorian government Legislation to provide better education to the community. We would have to plan the audit in a professional manner. Basically planning the audit is comprised of the overall audit method in order for the better development of the audit plan. It is believed that the overall audit opinion would help CAE in mainly achieving its objectives as the industry leader and responding to the environmental change.

The educational industry is quite a steady industry but there is always possibility of new entry, changes in the laws and government funding should always be taken into consideration. Mostly the main reasons for an audit plan are mostly obtaining a better understanding of CAE in order to gain good evidence for the situation and carrying out the audit cost effectively. There is always an issue with Property, Revenue accounts and Receivables and Plant and equipment which have been assessed to have high risks. But due to good internal controls the risks can always be minimized. After conducting the pre phase of the audit, we concluded that the detection risk is moderate so for that reason the moderate quantity of proof would be the main purpose of this particular audit.

2.0 INTRODUCTION:

The twentieth century has mostly been the decade of enormous competition and prosperity, following the next coming decade, we at VK would want CAE to be at the centre of the business environment with cutting edge over competitors in the areas of efficiency and effectively. CAE is one of our important and newer clients and at VK we have the long history of successful client relationship which has helped all our clients in all the ways possible for streamlining their business. Over the years being quoted as of the most responsible, ethical and trustworthy firms, we at VK have tried to develop an audit plan for CAE which would be at par the industry standards and most importantly would help CAE to know the intricacies of their business. The main purpose of this audit plan is to find out the unknown issues and to clearly understand the known issues with the help of reasoning terminologies such as “What”, “Where”, “Why”, “When”, “who” and “How”.

A step wise structured approach has been implemented for performing the audit process for CAE and the aim of the audit process would be to analyze the current situation with significant evidence and to follow up with recommendations.

3.0 AUDIT PLAN:

3.1 Accept client and perform initial audit planning:

Accepting CAE as a client involves four elements to be considered. These four elements are considered in a flow as shown in the figure below.

STEP IV

STEP III

STEP II

STEP I

Select staff for the engagement/ evaluate need for outside specialists

Obtain mutual understanding with the client about the terms of the engagement

Identify the client’s reasons for an audit

Accept new client/ continue to service existing client

Figure: 1

Source: Arens et al., 2010, “Auditing, assurance services and ethics in Australia”, Pearson Australia, Australia

STEP I: Accept new client/continue to service existing client:

CAE entity is a new client for our auditing firm; hence client acceptance should be determined. Auditing standards for quality control for audits of historical financial information [ASA 220] should be considered for policies and procedures necessary for acceptance of CAE as a client (Arens et al. 2010). Our company has to determine the acceptable audit risk of CAE and check it with our threshold risk set. Our CPA firm has to evaluate CAE’s business risk, audit risk and the threshold risk. Our Company should perform assessments in a cost effective manner as this cost would be embedded in auditing fees for CAE is accepted else we have to bear the loss (Kerr et al. 2007).

Reviewing the CAE’s annual report we can conclude that the CAE has a good financial stability, fair standing in the business industry. However it is hard to identify the relation of CAE with previous auditors. This difficultly could be overcome by fulfilling the requirement by Code of Ethics for Professional Accountants of communicating predecessor auditor (Arens et al. 2010).

STEP II: Identify the client’s reasons for an audit:

There are numerous reasons for audit of CAE. The audit report has to be flashed by CAE to various parties for various different purposes.

The financial reports are reflecting a decline in the year’s (2008) profit as compared to previous years. Thus CAE has to self assessment and more over there was a decline in government funds sanctioned (CAE report 2008).

CAE focuses on new directions with new strategic plan. This plan reflects the adaption of changes in needs for Melbourne community, educational industry and rapid changing global business environment.

ACFE will use the audit report and information gathered for monitoring. Moreover it has to be reflected to Victorian parliament.

STEP III: Obtain mutual understanding with the client about the terms of engagement:

CAE’s concern persons have been dealt with for the engagement letter. The engagement letter has been made in accordance with the ASA210. Engagement letter includes the time and fees factors for audit documents and reports.

STEP IV: Select staff for the engagement/ evaluate need for outside specialists:

Our company has assigned four staff for the full audit of CAE. The Audit reports would be ready and submitted to CAE in one week. CAE being a educational institute, doesn’t fall under a risky industry. Moreover the CAE’s reflect clarity and less ambiguity, hence we would not need any outside specialist.

3.2 Understand the client’s business and industry:

According to auditing standards ASA 315 for judging the entity and to evaluate material misstatement risk, ASA 315.05 states that, “The auditor shall obtain an understanding of the entity and its environment, including its internal control, sufficient to identity and assess the risks of material misstatement of the financial report whether due to fraud or error, and sufficient to design and perform further audit procedures”.

Centre for Adult Education (CAE) is an adult educational institute. They serve for the Victorians with wide range of courses (CAE report 2008). They provide programs and services for adults helping them to complete there secondary education. The educational industry in Australia is one of the booming industries since decades. The educational institutes highly contribute to the Australian economy. CAE being the part of educational institute and also being operated smoothly over 60 years reflect a sound client’s business risk as well as acceptable audit risks (Arens et al. 2010).

However more factors like CAE’s business processes, strategies, management and the performance chart should be considered. These elements are depicted in the figure below.

Understanding client’s business and industry

Industry and external environment

Business operations and processes

Management and governance

Objectives and strategies

Measurement and performance

Figure: 2

Source: Arens et al., 2010, “Auditing, assurance services and ethics in Australia”, Pearson Australia, Australia

3.3 Assess client business risk:

CAE’s business risk has to be evaluated to proceed with formation of audit plan. All the information gathered in 3.2 above could be used for assessing the business risk of CAE. Further, risk of material misstatements is estimated using CAE’s business risk. The link for figure 2 is depicted below reflecting the connection of gathering information to assess the risks.

Understanding CAE’s business and industry

Assess CAE’s business risk

Assess risk of material misstatements for CAE

Figure: 3

Source: Arens et al., 2010, “Auditing, assurance services and ethics in Australia”, Pearson Australia, Australia

Specific elements are considered for our evaluation process.

Educational industry:

The industry in which CAE is operating is booming and the company has proved its stability from last 60 years (CAE report 2008). Thus the risk level for CAE with respect to industry is moderate.

External factors:

Many external factors may sway CAE in its performance. External factors like political, economical, social and technological elements. Thus PEST analysis would be used to understand the effects of external factors on CAE (http://www.highbeam.com/doc/1G1-141751353.html). The change in government laws and regulation may affect CAE in any direction. Laws may declare subsidies else may stop funding, hence the future for CAE is uncertain. Also new technologies embedded with competitors may enforce CAE to adapt with industry demands. Thus the risk for external factors is moderate to high.

Funding:

Funding risk depends on the dependent of CAE on the external donations and government funds. CAE is capable of coping up with such funds as it has focused on funds from commercial activities at different places in the world (CAE report 2008). Also report flashes a decline in government funds for this year (2008) compared to previous years. CAE is not significantly depending on these funds, the risk is low to moderate.

Business strategies and processes:

“Strategic framework 2009-2010” is set by CAE for coming four years. They aim to cope up with the changing needs of customers, business, educational institutes and overall global environment. Changeling to adapt to the fast changing world is progress CAE, but strategies and processes to achieve them has to be concentrated. CAE complies with Whistleblowers protecting act 2001, for the transparency of the processes (CAE report 2008). Transparency of CAE processes declines risk factor to a considerable amount, but cannot be precise. We can conclude from detailed understanding of strategies and processes from CAE’s report that risk is moderate to high.

Internal factors:

CAE management levels reflect a smooth operating team. However the decisions of higher level management reflect noteworthy effects on financial statements and estimated risk of material misstatements (CAE report 2008). CAE’s goodwill depends on the performance of the company and managements decisions. Past data flashes a good reputation, thus helps in declining the risk curve. CAE’s risk with respect to internal factors is moderate.

3.4 Perform preliminary analytical procedures:

Auditing standards ASA 520 refers for analytical procedures and ASA 520(7) states that, “Analytical procedures mean evaluations of financial information made by a study of plausible relationships among both financial and non-financial data. Analytical procedures also encompass the investigation of identified fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts” (Arens et al. 2010).

To evaluate CAE’s business and associated risk with less ambiguity we have to perform preliminary analytical procedures. We would use the procedure of comparing the financial ratios of CAE in different time spans. Due to cost-benefit constraint we are not able to compare CAE’s performance with other similar entities and also with industry. Thus we would focus on ability to pay short-tern debt and long-term obligations and check the profitability.

The table below depicts the financial ratios comparison for year 2008 and year 2007 used for preface analytical measures. These financial ratios have been calculated using the data available in CAE’s annual reports.

Ratios focused for preliminary analytical procedures

2008

2007

Short-term debt-paying ability

Cash Ratio

1.7

1.2

Quick Ratio

1.8

1.4

Current Ratio

1.9

1.5

Ability to meet long-term obligations

Debt to Equity

0.8

1.0

Profitability Ratio

Profit Margin

.06

.05

Return on Asset (ROA)

0.08

0.06

Return on Investment (ROI)

0.08

0.06

Table: 1

3.5 Set materiality and assess acceptable audit risk and inherent risk:

Auditor’s responsibilities include two vital elements of materiality and risk. These elements are used to establish an appropriate audit report. Thus setting materiality threshold and assessing acceptable audit risk and inherent risk for CAE is very important.

Accounting standards AASB 1031 and Auditing standards ASA 320 reflect the underlying concept of materiality. ASA 320(5) flashes materiality as, “‘Materiality’ means, in relation to information, that information which if omitted, misstated or not disclosed has the potential to adversely affect decisions about the allocation of scarce resources made by users of the financial report or the discharge of accountability by management or the governing body of the entity” (Arens et al. 2010).

Two phrases with five step method could be applied to estimate materiality. Preliminary judgments of materiality are made on different segments of audits in first phrase. In the second step, combined misstatement is estimated and results are evaluated based on audit tests. Five-step process in applying materiality is depicted below.

Preliminary assessment of materiality

Step I

Allocate preliminary assessment of materiality to segments

Preliminary extent of tests

Step II

Step III

Estimate total misstatement in segment

Evaluating results

Step IV

Estimate the combined misstatement

Step V

Compare combined assessment with preliminary or revised assessment of materiality

Figure: 4

Source: Arens et al., 2010, “Auditing, assurance services and ethics in Australia”, Pearson Australia, Australia

3.6 Understand internal control and assess control risk:

The internal control structure of CAE’s policies and procedures has to be undertaken for the study. The internal controls set by management which directly or indirectly impact the financial reports have to be concentrated.

For understanding CAE’s internal control and to evaluate CAE’s control risk, the process depicted below would be used.

Obtain understanding of internal control: design& operation

Assess control risk

Test control

Decide planned detection risk and substantive tests

Figure: 5

Source: Arens et al., 2010, “Auditing, assurance services and ethics in Australia”, Pearson Australia, Australia

CAE is focusing on innovation and looking forward for partnership which would attract Melbourne community. CAE is also focused on achieving the objectives of ACFE board. CAE is ready to cope up with the changes in needs of Melbourne community which willing to learn, changes in business and industry (CAE report 2008).

CAE’s Audit and Risk Management committee promotes the effective and efficient internal control, also monitoring of the internal policies and procedures has been focused. Moreover Mark Brogan is the chair for this committee; he is proficient in audits, information technology, risk management and flashing financial reports. Mark Brogan also guides Ernst & Young Melbourne being an executive director (CAE report 2008).

After understanding of CAE’s goals and objectives we would focus on identifying risks involved in achieving those goals and objectives. Once the risks are been identified we have to analyze those risks in order to evaluate internal control risk for CAE (Anonymous A 2009).

3.7 Gather information to assess fraud risk:

Auditing standards ASA240 flashes the consideration of fraud during auditing of financial report by the auditor. To perceive material misstatements caused by fraud we have to evaluate CAE’s fraud risk. We have to calculate CAE’s fraud risk factors and also determine probable fraud schemes. Once the fraud risks for CAE are indentified they should be prioritized and mitigating controls should be determined. To evaluate the CAE’s fraud risk we would use the four step process depicted below.

Prioritise identified fraud risks

Identify possible fraud schemes

Evaluate mitigating controls

Evaluate the organization’s fraud risk factors

Figure: 6

Source: Zikmund P., 2008, “4 steps to a successful fraud risk assessment”, < http://findarticles.com/p/articles/mi_m4153/is_1_65/ai_n24377929/pg_4/?tag=content;col1>

The high priority factors for CAE arousing for fraudulent financial reporting and misappropriations of assets must be identified and analyzed for evaluating fraud risk. The factors for CAE entity could be best identified and analyzed using fraud triangle. The fraud triangle is depicted below.

Incentives/pressures

Attitudes/rationalization

Opportunities

Figure: 7

Incentives/pressures:

CAE is an entity serving for welfare of the people, thus it reflects less incentive schemes as compared to other service, trading or marketing industries. However CAE deals with the incentive pattern for the leased assets. Incentives straight-line pattern helps CAE in reduction on rental assets (CAE report 2008). CAE member serve education to the Victorian community and have no intension of achieving targets such as sales target. Hence this factor reduces the pressures on the management and the employees. Moreover the work load for employees in educational industry is low. Thus overall risk for incentives/pressure factor could be considered as moderate.

Opportunities:

Internal control is the main element flashing opportunities for management and employees (Arens et al. 2010). The management of CAE has a strong internal control which declines the risk. Audit and Risk Management Committee (ARMC) has an active monitoring and control on the operations of CAE. The factors directly or indirectly affecting the financial reports are been scrutinized effectively and efficiently. Thus fraud risk with respect to opportunity is low.

Attitude/rationalization:

CAE is an entity operating for the welfare of the people, and CAE’s aims for educating people and doesn’t fall under general business entity. In general educational industry flashes ethical values and CAE being an educational institute would have an ethical attitude. Thus we can conclude that ethical culture exists in the CAE’s environment promoting ethical values in employees and management of CAE. Hence the fraud risk in this factor is low.

3.8 Develop overall audit plan and audit program:

Audit plan is of vital importance as the whole process of auditing would be based on plan designed. Many elements of auditing are to be considered and set before starting the auditing program. Elements such as audit procedures, sizes of samples, items to be undertaken for study are to be identified and set under the consideration of time constraints (Arens et al. 2010). Moreover the resources allocated and cost-benefit tradeoff is seriously considered. The cost effectiveness has been considered seriously because of competition in market among auditing companies and also we have to segment our staff with responsibilities within quality and time constraint.

Various tests are to be conducted to determine the fairness of the CAE’s financial statements. Various tests are performed to evaluate inherent risk and control risks for CAE. These risks will be used to evaluate risk of material misstatements in CAE’s financial reports (Arens et al. 2010).

CAE’s internal control is used to evaluate the control risk (CR) for the audit objectives related to transactions (Arens et al. 2010). Enquiries would be made with CAE’s concern persons, financial documents and reports of CAE would be scrutinized and overall controlling activities would be studied.

Planned detection risk (PDR) reflects the threshold for auditors; hence we should consider PDR with substantive tests for transactions, analytical procedures and tests of details of balances. Higher the PDR, more the tests have to be performed. Hence we would set PDR at a moderate level.

Analytical test are very cheaper and fast. Tests of control have higher costs but still cheaper than substantive tests. The cost differs for different tests, thus a cost-effective combination of tests has to be set for CAE. More over we would use latest software used for auditing which would promote us in copping up with time constraint.

We would set the audit program considering tests of details of balances of various segments of balance statement. We would consider inherent risk and conduct different audit procedures for different segments.

CONCLUSION:

To summarize and to conclude the CAE audit process would be as a suitable company which will continue to grow is coming years, there has been stable and substantial cash flow which resulted in profitable year. Equal dollar amount was distributed in all of the CAE accounts. The analysis depict that there were no issues, misleads or difficulties for CAE for generating profits. The financial condition for CAE is good and can be predicted to be same for the coming year.

From our analysis we hereby conclude that, the materiality limit is preventive, acceptable audit risk is high, inherent risk is medium, control risk is 60% and the fraud risk is low.

The plan is made in order to give a clear understanding of current position of CAE for implementing auditing process.

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