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Solace Ltd. Company is specialising in private tutoring services and the company is Australian listed company so at the end of the year they have present financial report. Furthermore, Solace ltd. is a public company so the external users are heavily depends on financial statement. Moreover, Solace current focus is to infiltrate the Australian marketplace and achieve a market share of at least 30%. In addition, to strong its position in market she is planning to take over other smaller tutoring service company. The company ASX listed company so our firm is contracted to audit the Solace Ltd. statement of affairs. According to ASA 300, an audit plan is required so the engagement is executed in an effectual manner. Simultaneously, it helps auditor to identify risk and any unusual or unexpected error associated with financial statements. Moreover, it enables them create audit procedure for a particular material misstatements errors and issue a true and fair audit report. The next step is to develop an audit plan for auditing the statement of affairs of Solace Ltd.
Our Audit plan includes the followings:
Accept client and perform initial audit planning.
Understand the client's business and industry.
Assess client business risk.
Perform preliminary analytical procedures.
Set materiality and assess acceptable audit risk and inherent risk.
Understand internal control and assess control risk.
Gather information to assess fraud risk.
Develop overall audit plan and audit program.
The first approach for audit plan is to plan an engagement and accept the client. However, before accepting the client it is crucial to gather information regarding the financial stability of client, relationship of client with its previous auditors. The main reason to audit the Solace Ltd. is that the company is listed in ASX and under corporations act the firm financial statement should be audited and at the end they have to express an opinion in the form of audit report.
According to ASA 210, the auditor should document their understanding of an engagement in the working papers, including the engagement's objective, the responsibilities of auditor and management, and the engagement limitations. Finally, appropriate staff is assigned for the engagement.
Understanding the client Entity and its environment
A thorough understanding of the client entity, its business and its environment and knowledge about company's operations are essential for conducting an adequate audit as per ASA 315. It helps in understanding client's business risk and the risk of material misstatement in the financial statements.
As per our client Solace Ltd that runs private tutoring services that aims for high quality, low priced tutoring services. In addition to tutoring services Solace also indulges in real estate business that will even help them in leasing premises to set up classrooms to provide services to local students.
Business Operations and Processes
Business operations and processes include how much company is profitable and its financial condition. Solace ltd. mainly generates revenue from student fees & services and the equity is the main source of finance. Hence, the company have good financial condition.
Management and governance
The auditor needs to familiarize the company's Organizational Charts. A public company needs to establish a code of Ethics, and they have to be taken into consideration and it should be reviewed by the auditor for any changes.
Client's objectives and strategies
The following are the objectives and strategies of the client which auditor needs to understand:
Effectiveness and efficiency of operations
Reliability of Financial reporting
Compliance with laws and regulations(ASA 250)
Assessing Business Risk
"The client's business risk is that it will fail to achieve its objective which includes financial statements, compliance with laws and regulation and effectiveness of efficiency of operations" (Arens, 2007). There can be material misstatements in the financial statements of solace ltd. because of business risk. The Industry or the environment in which Solace Ltd operates is risky and there are chances of material misstatements in the following areas:
Fee for service
Student fees and charges
Preliminary analytical procedure
Analytical procedure refers to an accumulation of activities executed by auditor to gather sufficient evidence. The main objective of analytical procedure is to compare the financial information of entity such as comparison between current year and last year financial ratios (ASA520). These comparison helps auditor to identify any unusual or unexpected changes occurred in the financial statement. In ratio analysis mainly the following ratios are considered:
Solace ltd. cash ratio is more than 1 and it is increasing as compare to last year; hence, the entity can quickly liquidate assets to cover short term liabilities (Appendix 1).
Quick ratio is more considered than current ratio to view financial strength or weakness of a company because it exclude inventory from current assets. The Solace ltd. Quick ratio is more than 1 so the financial strength of the entity is strong (Appendix 1).
Solace ltd. current assets are almost twice of current liabilities so the entity can easily fulfill its short term debt obligations. The current ratio is more than previous year; hence, the company is in good financial condition (Appendix 1).
Debt/Equity Ratio and Debt/Assets Ratio
Debt equity ratio and debt assets ratio of Solace ltd. is smaller than 1 so the assets are mainly financed through equity and there is no future financing difficulties (Appendix 1).
Solace ltd. Profit margin is rising from last year i.e. 5% to 6%; hence, the company is effective at its cost control and they are converting revenue into actual profit (Appendix 1).
Return on Assets
As we compare the ROA of last year from current year of Solace ltd. it is rising from 7% to 9% which proves that the company is profitable and earning more income on actual investment (Appendix 1).
Return on Common Equity
Solace ltd ROCE is more than 10% and it is rising as compare to last year; hence, the company have enough funds to boost their business and to pay dividend to shareholders (Appendix 1).
Set Materiality & assess acceptable audit risk and Inherent risk
"The magnitude of an omission or misstatement of accounting information that, in light of the surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement" (ASA 320).
Materiality is important because if financial statements are materially misstated, users decisions may be affected, and thereby cause financial harms (Arens, 2007). To assess materiality level of Solace Ltd. the auditors are following AASB 1031 which provides that misstatements greater than 10% of the base value are considered material while misstatements less than 5% of the base value are considered immaterial (Appendix 2).
Acceptable audit risk is a measure of how willing the auditor is to accept that the financial statements are may be materially misstated after the audit is completed and an unqualified opinion has been issued (Arens, 2007). Acceptable audit risk can be calculated by following formula:
Acceptable Audit Risk = Inherent Risk x Control Risk x Planned Detection Risk
Planned Detection Risk (PDR) = Acceptable Audit Risk (AAR)
Inherent Risk (IR) x Control Risk (CR)
To assess AAR the auditors first measure engagement risk and use it to revise AAR. Engagement risk is the risk that auditor will suffer harm because of a client relationship, even though the audit report rendered for the client was correct (Arens, 2007). There are many factors which affect AAR such as external users rely on statement of affairs. Hence, Solace Ltd. is a public company so the external users are depend on financial statements and these can be determined by client size, distribution of ownership and amount of liabilities. Moreover, there is possibility that the client will suffer some financial difficulties at the time of issue of audit report. In addition, Solace ltd has low AAR so the experienced staff should be assigned to gain sufficient evidence.
Inherent risk is a measure of the auditor's assessment of the likelihood that there are material misstatements in a segment before considering the effectiveness of internal control (Arens, 2007). There are many factors which affect inherent risk of Solace ltd. such as nature of client business, previous audits results and non routine transactions.
Understand Internal Control and assess control Risk
Internal control structure consists of policies and procedures designed to provide management with reasonable assurance that the company achieves its objectives and goals in following categories:
Effectiveness and efficiency of operations,
reliability of financial reporting and
compliance with applicable laws and regulations
Management holds the responsibility for taking care of all the internal controls of their organisation in the same way they should prepare the financial statements of the organisation in accordance with the set accounting standards. The Auditing and Assurance Standards Board (AUASB) issues Auditing Standard ASA 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement.
This Auditing Standard:
(a) requires the auditor to perform risk assessment procedures to obtain an understanding of the entity and its environment, including its internal control;
(b) requires the engagement team to discuss the susceptibility of the entity's financial report to material misstatements, including those due to fraud;
(c) requires the auditor to understand specified aspects of the entity and its environment, including its internal control components;
(d) requires the auditor to assess the risks of material misstatements both at the financial report and assertion level;
(e) requires the auditor to identify significant risks and assertions where substantive procedures alone will not be sufficient (Arens, 2007).
The auditor shall obtain an understanding of internal control relevant to the audit they are also concerned about:
Controls over classes of transaction
The primary emphasis is on internal control over classes of transaction rather than account balance. This is because the accuracy of the output of the accounting system is heavily dependent on the accuracy of the input and processing, in the case of Solace Ltd we have to perform mainly these audit objectives:
Existence or occurrence
Posting and summarising
Controls related to reliability of financial reporting
Main concern is all about the financial statements that can be figured out through the internal performance reports of Solace Ltd have in its daily working that includes the working of the employees as well as the daily performance target achieved by Solace Ltd.
Effects on information technology on internal control
Solace can improve effectiveness and efficiency of internal control by consistently processing large volume of transaction and data through IT. This will help in enhancing timeliness and accuracy of information, even having so much to give it even has some issue involved with it such as staff adding wrong data in the system that can lead to loss.
Procedures that will help in avoiding such issues in Solace Ltd are:
Independent check on performance
Physical control over assets and records
Adequate documents and records
Proper authorisation of transactions and activities Adequate separation of duties
Procedures to obtain an understanding of the internal control of Solace Ltd is:
Keeping proper check on staff and their activities
Making note of the daily working of Solace Ltd, their corporate policies and the code of conduct used.
In brief viewing the records, files and data maintained by Solace Ltd.
Assess control risk
Assess whether the financial statements are auditable
Determine assessed control risk supported by the understanding obtained
Assess whether it is likely that a lower assessed control risk could be supported
Determine the appropriate control risk
Tests of Control:
This is performed after a good understanding of the internal control has been achieved and control risk is been known in a more evident manner.
Making enquires of Appropriate client personnel of the Solace Ltd
Examine documents ,reports and records
Reorganize client procedures
Observe control related activities
GATHER INFORMATION TO ASSESS FRAUD RISK
While auditing the Solace ltd. it is crucial to gather information to assess fraud risk. There are three conditions for fraud Incentives/Pressures, Opportunities and Attitudes/rationalisation.
Assessing the risk of fraud
As per ASA240, auditor must maintain a level of professional scepticism as they consider a broad set of information, including fraud risk factors, to identify and respond to fraud risk.
The following sources help to identify risk of material misstatements due to fraud:
Communication among the team
Inquiries of management
Documenting Fraud Assessment.
As per ASA 240, the auditor should document fraud risk factors identified during the assessment process and the auditor's response to such factors. Auditors mainly document the following matters related to the consideration of material misstatements due to fraud:
Discussion among engagement team.
Procedures performed to obtained information.
Results of the procedures performed to address the risk.
Nature of Communication.
Develop overall audit plan and audit program
In developing an overall audit plan and to gather enough suitable evidence the auditors have to perform following five types of tests:
Gather evidence about the design and placement in operation of specific controls.
Test the effectiveness of controls in support of a reduced assessed control risk.
Testing of monetary errors to determine whether the six transactions-related audit objectives have been satisfied for each class of transactions.
Comparing and assessing whether account balances or other data are fairly stated.
Testing of monetary errors to determine whether the nine balance-related audit objectives have been satisfied for each significant account balance (Arens, 2007).
The importance on the types of tests in any audit relies on the position of the client. The nature time and extent is determined by the assessed level of control and inherent risks.
This audit plan involves risk assessment of Solace ltd. which is the ASX listed company involved in private tutoring services. According to the corporation act the audit is necessary for Solace ltd. because it is a public company so audit report is required annually for external users. According to audit plan we have covered all the necessary steps involved in auditing of a firm. The audit plan starts from accepting audit engagement and continue with brief understanding of the client business and industry. Furthermore, assessing of business risk is required because solace ltd company is funded by government and there is a chance of materiality misstatements. To gather sufficient appropriate evidence and to set the materiality level preliminary analytical procedures are required. In order to get reasonable assurance as to management objectives internal control was taken into consideration wherein few control procedure were flowed to find the risk involved. Finally, before developing the audit plan we assessed the risk of fraud.