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Continuous measurement and assessment of audit activity

It is important that audit activity is implemented on a risk based basis. Through continuous measurement and the assessment of the risks that audit team may be exposed to, areas of high risk shall be determined and accordingly the audit plan and program shall be prepared. The audit activity shall be implemented in accordance with this plan and program.

Audit’s main objective is to express an opinion whether the financial statement is fairly stated in accordance with AASB and other statutory regulations. Besides that, audit also provides assurance and help management in measuring, evaluating and improving the controls and systems to achieve Solace’s objectives. Such a way can be realized by good audit plan and program in addressing specific issue and risk.

However, the foundation and continuance of the internal controls are still the management’s responsibility.

2. Introduction

SOLACE Limited is a limited company primarily engages in the activity of providing private tutoring services.

As this entity is listed on the Australian Stock Exchange and has a separation of management from economic interest and therefore it is likely that this entity is a reporting entity in accordance with SAC 1.

SOLACE Ltd is a company and as such must abide by the corporations law.

This general purpose financial report which has been prepared on an accrual basis in accordance with Australian Accounting Standards (including AASB interpretations), the Financial Management Act 1994 AASB Interpretations and other authoritative pronouncements of the AASB, the guidelines of the Department of Education, Employment and Workplace Relations (DEEWR) and with the Public Finance and Audit Act 1983, the Public Finance and Audit Regulation 2005.

Compliance with International Financial Reporting Standards (IFRS)

The financial statements and notes of the Solace Limited comply with Australian Accounting Standards, some of which contain requirements specific to not-for-profit (NFP) entities that are inconsistent with IFRS requirements.

3. Audit plan with the following headings:

3.1 Accept client and perform initial audit planning

Signing Letter of Engagement (ASA 300) and Terms of Engagement, which consist of:

Auditors Contact Detail: including name, address, telephone (work) and mobile

Auditee Contact Detail: contact person, address, telephone (work) and mobile

Location to be audited

The scope of the audit

Includes the following matter:

Standards, codes & legislation

Size of business (number of sites and employees)

Industry

Type of products

Processing technologies

Hours of operations

List of Auditor Team

The scheduled time and proposed duration of the audit, including desk audit, site audit and delivery of final report

Date for receipt of desk audit documentation and time frame for review of documentation

The preliminary agenda for the site audit

Proposed date for completion of follow up actions

Statements of confidentiality, OHS compliance and other business criteria

Reasons for termination of audit

Actions or recourse in case of disagreement

3.2 Understand the client’s business and industry

PRIVATE SECTOR TUTORING

The private tutoring industry is a growing sector of the education and training industry and school teachers are regularly approached to work in private tutoring or coaching “colleges”. Other teachers establish themselves as tutors in private practice working through an agency or as “sole traders”.

3.2.1. Industry and external environment

Identify issues for specific industry

Read relevant audit alerts (from AASB, AUASB or CPA Australia Journal and Publications)

Obtain knowledge of particular facts

Identify major competitors in the industry (such as: GEOS Queensland College - www.qcegoldcoast.qld.edu.au, Cengange Education - www.cengage.edu.au, Box Hill Institute - www.bhtafe.edu.au, etc)

Read industry publications

Consider impact of common economic factors

Understand IT issues

Identify inherent risks - very nature of what is done, such as handling cash, handling government contributions and student fee vs total enrollments, etc

Know unique accounting principles/policies/practices (AASB)

Review permanent and last year’s current file

Read industry audit guides

Read regulatory guides and other documents.

3.2.2. Solace’s operations and processes

Major source of Revenue and financing : Government contributions, HELP-HECS, Student fees & charges and fee for service

Tour facilities and operations

Identify major customers and suppliers

Solace is positioned in the life-cycle of the business

Identify related parties: permanent file, affiliated companies, principal owner, or other party that influences.

Identify joint ventures and strategic alliances

Evaluate use and quality of information technology (Pollock, 2003)

3.2.3. Solace’s management and governance

Understand organizational structure, board of directors, audit committee

Understand management philosophy and operating style

Read code of ethics

Read corporate charter and bylaws

Read minutes of meetings of board of directors (Pollock, 2003)

3.2.4. Solace’s strategies and objectives

Understand commitment to design a system which attest the effective and efficient of operation and comply to laws and regulations

Understand methodology and commitment for presenting reliable financial reporting

3.2.5. Solace’s performance and measurement

Key indicators for evaluating progress to achieve its objectives

3.3 Assess client business risk

3.3.1 Assess client business risk (the risk that the client will fail to achieve its objectives)

Conditions and events that may indicate the existence of business risks:

New locations.

Significant changes in the entity (e.g., acquisitions and reorganizations) or industry

Significant changes in the IT environment.

Significant new products, services, or lines of business.

High degree of complex regulation

Operations in areas with unstable economies.

Out of the above conditions, we should still consider five basic risk categories (Financial Risks, Technical Risks, Managerial Risks, Behavioral Risks and Legal Risks)

3.3.2. Evaluate management controls affecting business risk

Review minutes of department head meeting and other control methods.

Potential Risk in Private tutoring industry such as conflict of interest and corruption risk can be minimize by effective supervision with honesty and transparency and corruption risk management with the impartiality, integrity and openness of management characteristics

3.3.3. Assess risk of material misstatements

Evaluate the material misstatement and differentiate between error and fraud. While Errors are unintentional misstatements (mistakes), Fraud usually come in the form of fraudulent financial reporting (Alteration, Manipulation, or falsification of accounting records, misrepresentation in, or intentional omission from, the financial statements transaction or intentional misapplication of accounting principles)

or misappropriation of assets (stealing assets, paying for goods and services not received, embezzling cash received, etc).

3.4 Perform preliminary analytical procedures

SOLACE LTD

PRELIMINARY ANALYTICAL PROCEDURE

COMMON SIZE AND PERCENTAGE CHANGE

FOR YEARS ENDED

DESCRIPTION

2007

2008

CHANGE

Risk Priority Level

Amount ($'000s)

Common Size

Amount ($'000s)

Common Size

Amount ($'000s)

Percent

Income from continuing operations

 

 

 

 

 

 

 

Operating activities

 

 

 

 

 

 

 

Government contributions - operating

9,307

41.19%

9,204

38.20%

(103)

-1.11%

1

Student fees and charges

716

3.17%

783

3.25%

67

9.36%

1

Fee for service

10,887

48.19%

12,438

51.62%

1,551

14.25%

1

Investment Income

404

1.79%

620

2.57%

216

53.47%

2

Other income

1,280

5.67%

1,050

4.36%

(230)

-17.97%

2

Total income from continuing operations

22,594

100.00%

24,095

100.00%

1,501

6.64%

 

 

 

 

 

 

 

 

 

Expenses from continuing operations

 

 

 

 

 

 

 

Employee benefits

12,623

59.89%

13,330

60.16%

707

5.60%

1

Repairs and maintenance

187

0.89%

258

1.16%

71

37.97%

2

Finance costs

248

1.18%

221

1.00%

(27)

-10.89%

3

Impairment of asset

92

0.44%

75

0.34%

(17)

-18.48%

3

Other expenses

7,928

37.61%

8,272

37.34%

344

4.34%

1

Total exp from continuing operations

21,078

100.00%

22,156

100.00%

1,078

5.11%

 

Net result before capital & specific items

1,516

6.71%

1,939

8.05%

423

27.90%

 

 

 

 

 

 

 

 

 

Government contributions - capital

70

0.31%

80

0.33%

10

14.29%

1

Gains (Losses) on disposal of assets

(7)

-0.03%

-

0.00%

7

-100.00%

2

Depreciation and amortisation

(513)

-2.27%

(503)

-2.09%

10

-1.95%

2

Exp using gov contributions-capital

-

0.00%

(31)

-0.13%

(31)

100.00%

1

Net result from continuing operations

1,066

4.72%

1,485

6.16%

419

39.31%

 

Net result for the period

1,066

4.72%

1,485

6.16%

419

39.31%

 

 

 

 

 

 

 

 

 

CURRENT ASSETS

 

 

 

 

 

 

 

Cash and cash equivalents

6,835

43.35%

8,655

51.75%

1,820

26.63%

1

Receivables

1,123

7.12%

855

5.11%

(268)

-23.86%

2

Other non financial assets

203

1.29%

260

1.55%

57

28.08%

3

Total Current Assets

8,161

51.76%

9,770

58.42%

1,609

19.72%

 

 

 

 

 

 

 

 

 

NON-CURRENT ASSETS

 

 

 

 

 

 

 

Property, plant and equipment

7,035

44.62%

6,955

41.58%

(80)

-1.14%

1

Receivables

570

3.62%

-

0.00%

(570)

-100.00%

2

Total non-current assets

7,605

48.24%

6,955

41.58%

(650)

-8.55%

 

Total Assets

15,766

100.00%

16,725

100.00%

959

6.08%

 

 

 

 

 

 

 

 

 

CURRENT LIABILITIES

 

 

 

 

 

 

 

Payables

3,951

25.06%

3,756

22.46%

(195)

-4.94%

2

Provisions

1,277

8.10%

1,198

7.16%

(79)

-6.19%

3

Other liabilities

96

0.61%

94

0.56%

(2)

-2.08%

3

Total current liabilities

5,324

33.77%

5,048

30.18%

(276)

-5.18%

 

 

 

 

 

 

 

 

 

NON-CURRENT LIABILITIES

 

 

 

 

 

 

 

Provisions

282

1.79%

183

1.09%

(99)

-35.11%

3

Other Liabilities

2,408

15.27%

2,257

13.49%

(151)

-6.27%

3

Total Non-Current Liabilities

2,690

17.06%

2,440

14.59%

(250)

-9.29%

 

Total Liabilities

8,014

50.83%

7,488

44.77%

(526)

-6.56%

 

 

 

 

 

 

 

 

 

EQUITY

 

 

 

 

 

 

 

Contributed Capital

7,618

48.32%

7,618

45.55%

-

0.00%

2

Reserves

3,195

20.27%

3,195

19.10%

-

0.00%

3

Accumulated surplus

(3,061)

-19.42%

(1,576)

-9.42%

1,485

-48.51%

3

Total Equity

7,752

49.17%

9,237

55.23%

1,485

19.16%

 

 

 

 

 

 

 

 

 

TOTAL Liabilities and Equity

15,766

100.00%

16,725

100.00%

959

6.08%

 

 

 

 

 

 

 

 

 

SOLACE LTD

PRELIMINARY ANALYTICAL PROCEDURES

SELECTED FINANCIAL RATIOS

Comparison with Prior Period Data and Industry Data

DESCRIPTION

2007

2008

Percent Change

INDUSTRY

COMMENTS

 

 

 

 

 

 

SHORT-TERM DEBT-PAYING ABILITY

 

 

 

 

 

Cash Ratio

1.2838

1.7145

33.55%

1.2317

 

Quick Ratio

1.4947

1.8839

26.04%

1.5330

 

Current Ratio

1.5329

1.9354

26.26%

1.6813

 

 

 

 

 

 

 

LIQUIDITY ACTIVITY RATIOS

 

 

 

 

 

Receivable Turnover

8.4619

18.1602

114.61%

13.5561

 

Days to collect Receivable

43.1345

20.0989

-53.40%

26.9251

 

 

 

 

 

 

 

ABILITY TO MEET LONG-TERM DEBT OBLIGATION

 

 

 

 

 

Debt to Equity

1.0338

0.8107

-21.58%

0.5583

 

Times Interest Earned

91.1048

109.0271

19.67%

100.0633

 

 

 

 

 

 

 

PROFITABILITY RATIO

 

 

 

 

 

Earning per Share

 

 

 

 

 

Gross Profit Percent

0.6341

0.6444

1.63%

0.6390

 

Profit Margin

0.0472

0.0616

30.63%

0.0578

 

Return on Assets

0.0676

0.0888

31.32%

0.0324

 

 

 

 

 

 

 

Source : SOLACE Financial Statements, www.unimelb.edu.au, www.monash.edu.au, www.bhtafe.edu.au

3.5 Set materiality and assess acceptable audit risk and inherent risk

3.5.1 Set Materiality

Set Preliminary Judgment about Materiality for Financial Statements

SOLACE LTD

MATERIALITY LEVEL TEST

 

TOTAL AMOUNT ($'000s)

RATE

MATERIAL ($'000s)

ASSET

16,725

1.00%

167.25

LIABILITIES

7,488

4.00%

299.52

REVENUE

24,175

2.00%

483.50

EXPENSES

22,690

4.00%

907.60

Source : SOLACE Financial Statements

From the above table, therefore, the planning materiality set for SOLACE Limited is $167,250

Set Tolerable Misstatement (TM) for Segments – 50% to 75% of planning materiality

TM = 59.79% X $167,250 = $100,000

Estimate Misstatement in Segment = [(Misstatement in sample/Total sampled) X Total recorded population value for segment] +/- Sampling error (Pollock, 2003)

Combine misstatements

Compare Difference to Preliminary Judgment

3.5.2 Acceptable Audit Risk (AAR)

Factors to consider in setting AAR (Leung et al, 2007):

The occurrence in the financial statement item of related party transactions

Management integrity

The existence of specific statutory requirements

External users’ reliance on financial statements (distribution, size, liabilities)

The amount of the financial statement items

Likelihood of financial difficulties (liquidity, profits, financing, nature of operations, management competence)

After considering the above factors, target AAR for Solace would be 5%

3.5.3 Inherent Risk (IR)

Factors to consider in setting IR (Gay and Simnett, 2005):

Nature of the education business

Results of previous audits

Non-routine transactions

Factors related to fraudulent financial reporting

Initial versus repeat engagement

Makeup of population

Related parties

Susceptibility of assets to misappropriation

Judgment required to correctly record account balance

3.6 Understand internal control and assess control risk

3.6.1 Understand Internal Controls

Purpose to Assist in Planning the Audit by (Pollock, 2003):

Identifying type of potential misstatements.

Recognizing likelihood of misstatements occurring.

Client enquiry and review documents, records, reports, and prior year working papers

Observe control related activities

Determining the nature, timing, and extent of tests to be performed.

Considering audibility of financial statements.

Perform walkthrough

3.6.2 Assessment of Control Risk (CR)

A. Identifying Internal Control Weaknesses

Identify Transaction Related Audit Objectives (TRAO) that applies to type of transaction.

What’s the potential misstatement?

What key controls are missing which assure the TRAOs being fulfilled?

Consider compensating controls.

Identify key controls that Solace has for TRAO under consideration.

Identify weaknesses.

B. Evaluating absence of internal controls (control deficiency and material weakness)

After that, then make a decision on an initial estimate of CR. The points should be considered are:

CR is never zero (inherently human, collusion always possible)

If 100% then go straight to substantive testing

Do not apply policies and procedures

Internal controls not effective at all

Evaluating internal controls inefficient

Publicly-traded company (like SOLACE Ltd) – assume low CR, with intent to support through tests of controls.

3.7 Gather information to assess fraud risk

3.7.1 Gather Information

Gather Information from outside sources and internally, such as brainstorming, interviews, analytical procedure, review of prior fraud, review of auditor’s management letter, etc)

Make inquiries of management and others within the entity to seek their views about the risks of fraud and how they are addressed.

Consider other information which may be helpful in identifying fraud and corruption risks

3.7.2 Assessment of Fraud Risk

3.7.2.1 Using the information gathered to identify fraud and corruption risks

Based on the information gathered, then we should identify the potential fraud occurred with regards to three conditions (fraud triangle):

Incentives / pressures (Is there any pressure to meet budgeted amount? is there incentive in order to receive a bonus?),

Opportunities;

Attitudes / rationalizations

Besides that, auditors should also consider (ASOSAI, 2003) :

Auditors’ professional judgment (experience and perceptions)

Nature of the organization (the size and complexity); For Solace Ltd, consider factors that generally constrain inappropriate conduct by management (audit committee’s effectiveness, committee’s risk management and internal audit).

Characteristics of fraud and corruption risks: (a) the risk type which may exist, (b) risks significance and likelihood, and (c) the extensiveness of the risks related to audited areas, whether the potential risk is extensive to the program and financial statement as a whole or only in particular accounts, assertion, or activities and class of transactions.

3.7.2.2 A Presumption that improper revenue recognition is a fraud risk

Pay attention on an overstatement of revenues (premature revenue recognition or recording fictitious revenues) or an understatement of revenues (improperly shifting revenues to a later period).

3.7.2.3 A Consideration of the Risk of Management Override of Controls

Does senior management have the ability to override control? If so, auditor should consider that risk apart from any conclusions regarding the existence of more specifically identifiable risks.

3.7.2.4 Assessing SOLACE’s programs and controls for identifying fraud and corruption

The examples of the programs and controls are:

Particular controls designed to reduce particular fraud and corruption risks, for example, controls to address the misappropriation of assets

Broader programs designed to prevent, deter and detect fraud, for example, programs to promote a culture of honesty and ethical behavior (ASOSAI, 2003).

Auditor should also consider the other programs to reduce the fraud and corruption risks.

Assess the likelihood and significance of each potential fraud risk (What controls or compensating controls are in place to address each fraud identified? If fraud did occur in certain area, how significant would it be?

3.7.2.5 Identifying High Risk Areas

Some of common high risk areas are (ASOSAI Guidelines, 2003):

Revenue receipt;

Program management;

Cash Management;

General expenditure (expense reimbursements may be a fraud risk area as it is difficult to determine if expenses submitted could be for personal benefit);

Contracts of service/ procurement;

Inventory management;

Sanctions/Clearance;

Other areas with public interface

After all the above steps, the next step would be:

Determine how and where internal control can be strengthened (Adequate documents and records, Proper authorization of transactions and activities, Independent checks on performance, Physical control over assets and records and Adequate separation of duties)

Follow up and monitor any changes in internal control systems

3.8 Develop overall audit plan and audit program

3.8.1 Pre-Audit Meeting Program

Prepare a detail of bank accounts, investments, and debt by financial institution

Review the nature and timing of preliminary and final audit works.

Focused on unusual activities during the financial year

Review internal and external factors affecting the business

Review and verify the accounting and computer operations for flow of transaction and controls, change in workforce and technology.

Review procedures relating to audit adjustments and the process and approval from these entries

Provide a list of solicitor retained or from whom services were received

Maintain a board minutes documents to provide to the auditors

Review the aspects of sampling from transactions (disbursements, payroll, sales, receipts) or year-end balances (accounts receivable and accounts payable).

Develop and plan audit program for key potential risk accounts (see below explanations)

Reconciliation

Student Fee, Fee for Service and Government Contributions – and related expense

Cash and Cash Equivalent

Fixed Assets (Property, Plant and Equipment)

Receivable

Payable, Provisions and Other Liabilities

Operational Expense (Employee Benefits, Repairs & Maintenance and Other Expenses)

Set out a time schedule (including activity budget) and indicating person in charge (assign for trainee/junior auditor, senior auditor, team leader/manager and audit partner) in each of audit program.

Audit Plan Summary

3.8.2 Audit Program for Reconciliation

Attest and examine internal controls

Execute the reconciliation for yearly gross income, tax accrual and tax collected

3.8.3 Audit Program for Key Potential Risk Accounts

Attest and examine internal controls. Review reporting methods and determine if taxes are paid on appropriate categories of accounts.

Detail all accounts transactions over $167,250. Develop a sampling procedure for transactions under $167,250 dollar amount.

Detail all related transactions and develop a sample to test detail flow procedure, for example:

Verify and cross check the amount of student fee and fee for service received compare with the amounts of student enrollments

Verify and cross check all the expenditure using government contributions

Identify all sources of revenue and expenses

Conduct Physical Examination (if applicable, for example for fixed assets audit program)

Provide copy of related documents (such as invoices, building or land legal documents, etc) for review by the auditor.

Prepare a schedule of detailed transactions where tax were not paid / received or supported by a valid resale/exemption certificate.

Identify extraordinary transactions and review the status of the audit on related accounts.

Develop a sample for all accounts transactions under $167,250 and discuss about planned sampling approach.

Review transactions for taxability.

Plan a schedule for adjustments (if applicable)

Have all supporting documentation and invoices available for the auditor to review and test the audit procedures used with regard to the regulations and tax decisions made.

3.8.4 Specific Audit Program

Besides the application of general audit program above in each account, there are several particular audit programs to be applied for specific accounts (usually apply before develop a sample):

A. Cash and Cash Equivalent

Separate between bank balance, cash and other non-bank balance

Perform a test for reconciliation of bank balance and cash to summary records and financial statements. The test for bank reconciliation including test for unpresented cheque and undeposited fund.

Send bank confirmation letters

B. Receivable

Separate between current and non current for receivable

Identify similar receivable populations and develop a procedure for each group and differentiate between tax and non-tax received items.

Send confirmation letter to customer about the receivable balance

C. Payable, Provisions and Other Liabilities

Separate between current and non current for payable, provisions and other liabilities

Identify similar payable populations and develop a procedure for each group and differentiate between tax and non-tax paid items.

Send confirmation letter to creditor about the payable balance

D. Operational Expense

Identify similar expenses populations and develop a procedure for each group and differentiate between tax and non-tax paid items.

Detail all employee benefits (payroll) and develop a sample to test detail flow procedure for payroll (cross check a sample for potential fraud)

NOTE : For all the audit program, never done test of control if it is proven that the internal control is unreliable (High Control Risk)

4. Conclusion

Summary of Audit Plan approach are:

Conduct the test of control (if applicable) and substantive test to identify risk areas;

Performance of a risk assessment to gauge the degree of risk or materiality level associated with a particular area;

Risk is categorized and rated in accordance with; corporate importance, corporate sensitivity, inherent risk and control risk;

Calculation of the audit risk index and classified as high, moderate or low in each audit areas;

Audit resources are focused on the areas of highest risk (with regard to fraud risk).

We used cumulative knowledge of the organisation from previous Audit work to identify areas that would benefit from Audit coverage

The Audit Needs Assessment also identified areas of coverage that do not appear as high priority risks, but where Audit can provide tangible input to assurance, such as:

Areas of concern flagged by management or the Audit Committee

Emerging issues; and

Need for ongoing assurance in relation to key aspects of internal control

Develop overall audit plan and audit program

After we have done the audit program and proven that the financial report presented fairly in all material respect in accordance with AASB, financial information complies with relevant statutory and other requirements and consistent with auditor’s understanding of the entity and its environment, hence Audit committee can issue an audit report with unqualified audit opinion.

5. Appendix

Financial Ratio

Definition (Formula)

Cash Ratio

(Cash + Marketable Securities)

Current Liabilities

Quick Ratio

(Cash + Marketable Securities + Net Accounts Receivable)

Current Liabilities

Current Ratio

Current Assets

Current Liabilities

Accounts Receivable Turnover

Net Sales

Average Gross Receivable

Days to collect receivable

365 days

Accounts Receivable Turnover

Debt to Equity

Total Liabilities

Total Equity

Times interest earned

Operating Income

Interest Expense

Gross Profit Percent

(Net Sales - Cost of Goods Sold)

Net Sales

Profit Margin

Operating Income

Net Sales

Return on Assets

Income before taxes

Average Total assets

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