Audit risk and its consequences

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The risk that an auditor will not discover errors or intentional miscalculations while reviewing a company or individual financial statements is known as Audit Risk.

Audit Risk = Inherent risk + Control risk + Detection risk

Inherent Risk

Risk that exists each line of business without consideration level of management control in place.

Control Risk

According to Millichamp,A.(2009)This is the risk that internal controls will not detect and prevent material errors. If this risk is large the auditor may eschew compliance tests apply only substantive tests.

Detection Risk

According to Millichamp,A.(2009) This is the risk that the auditor's substantive Procedures and analytical review will not detect material errors

Gala restaurant is pvt Limited company which owns a large restaurant plus a cafe and takeaway. The owners of the company are Edward and Diana Evans who are husband and wife. They have 50% of share capital each and they are the directors of the company. Because of only two owners they can do whatever they want with the business. EX: They can take money for their personal use from the share capital because they own the company. Therefore there is no external management to manage the business of the Gala restaurant because all the activities are only run by these two members therefore it is very difficult to concentrate on all activities, because of this the risk level is very high at the Gala restaurant.

However they have recently taken two managers who are allowing Diana and Edward to spend less time in the restaurant and concentrate on main activities. This is a recovery for gala restaurant to minimize the inherent risk.

The Gala restaurant business is seasonal with a high turnover and profits in the summer months. During the summer months large numbers of casual workers are taken on. Some workers only last for few days and do not return. Many of them are at school or college and are taking a holiday job. This is another inherent risk for gala restaurant. Some of the workers who do not return might have done fraud in the business. Because many of the sales are cash sales and shop was open in the weekend as well.

However on the other hand during the rest of the year, there are around 15 people on pay roll. Most have been there for at least two years and this part of the work force is fairly stable for the Gala restaurant.

The Gala restaurant has a number of suppliers and most of the purchases are credit purchases. This relates another risk where more number of suppliers and purchases on credit cause an inherent risk. Suppliers might try to overload the product. On the other hand, the staff of the Gala restaurant may purchase low stock when compared to actual stock. Gala restaurant staff should follow the pay date and delivery date of all the suppliers to maintain high standards in their business and to maintain the good will of the restaurant to avoid supplier credit facility problems.

Task-1.2

1. The Gala restaurant employs a book keeper for a few hours a month to prepare monthly accounts and the payroll. Both are prepared using sage software. There is no password protector over the software. Also the computer is kept in the back of the rest room.

There is no proper security for the company accounting data. Because there is no password and the area is not safe there are chances to do fraud with the accounting information.

EX: Employers might change the working hours or may change other personal information.

Recommendation

The Gala restaurant can use alternatively improved software such as tally and maintain a password for the particular system, which allows only authorized people to access the information. Additionally, they can arrange a special office room to keep the computer or arrange a computerized automatic door with a password and allow only authorized person to enter to that room.

2. A large amount of sales are paid by cash. At the end of the day the till is totaled by a new manager. The comparison is made between the amount in the till and the amount shown on the till rolls. This is another risk concerning only the till balance and the till roll. There are chances for other kind of fraud. For example: For a particular product sale if the staff deliver the product without scanning to the customer, the money might go to the staff's pocket and sometimes there are chances to issue free goods without scanning to the known person of the particular staff. EX: Friends. On the other hand if the staff forgets to scan then again there is a difference between the till and till roll. This is a difficult task for the manager, to identify the problem whether it is a fraud or mistake by the staff.

Recommendation

To avoid this kind of risk the company can introduce a new system like stock management with the daily sales and purchases.

EX: Before displaying a product on the shelf, they can maintain a scanning system by coding an update on how many products were stocked in all categories in a day. According to the sales, they can identify how many products were delivered in all categories from the till roll through scanned sales. According to the stock maintain system they can analyze where the problem went wrong whether it was a staff fraud or mistake (forget to scan) if it was a case of forgetting to scan, by cross checking the till roll and stock system they can identify the unscanned products and again can cross check with the till excess money for the particular products with the price list. This should be equal.

Additionally, they can advice the staff to start work at the till with an empty pocket. Alternatively, they can arrange them an individual locker to place their personal things. They can put a notice in the rest room saying that spot check will be undergoing at any time in the shop including the lockers to avoid shrinks and fraud.

3. Also there is no proper discipline in maintaining the bills. This causes some more problems to the book keeper to do the accounts and also to Edward when he is checking the monthly statement and the bills where available. On the other hand the company may be under estimated or overestimated through accounts due to unregistered purchases. Sometimes fraud may happen through staff.

EX: Purchase of milk. If this purchase bill not registered it is difficult to tally the accountant through bills. This will underestimate the figures in the gala restaurant. It is very difficult to identify whether it is a fraud or a mistake by staff.

Recommendation

Can maintain a proper computerized data update system and good file management for every business activities and inform the staff about the important of maintaining the bills. Therefore, they can to avoid difficulties to prepare all statements for the book keeper and for Edward to finalize the monthly statements.

4. On the other hand, cash is kept in the office all the time. There is no proper cash management in the gala restaurant. Every transaction should have a record to understand and to monitor the business. But in the gala restaurant there is no proper bill management, consequently it is very difficult to monitor the cash flow and balances in their business. Also, there is no high security against strangers and internally between the staff. There might chances for fraud in cash handling.

Recommendation

Can advice to maintain a Proper cash management system to monitor all the transactions in the gala restaurant. One can advise them to open a company bank account to have high security in all transactions. Through the bank account, it is very easy to pay salaries and wages for all the staff by doing a direct debit. Therefore there is a record for all the transactions to avoid risk to the gala restaurant. Also, in cheque transaction by having a record, they can easily understand when the cheque is cleared and when the cheques are not cleared in a particular month by checking monthly statements.

Task - 2

Task-2.1

Audit Program

A set of policies and procedures that dictate how auditing is to be implemented. The nature, Timing and extended of planned audit procedures are required to implement the audit plan. The Process involved in auditing a program as follows:

1. Test Control

2. Transaction Test

3. Analytical Procedures

Test Control

According to Millichamp,A.(2009) Are the test to obtain audit evidence about the effective operation of the accounting and control systems. If control risk is high in an organization auditor should do a test of control to find out where the activities went wrong as a proof for the top management.

According to the case study Gala restaurant has a high control risk. There is no proper internal control in staff recruitment. They had difficulties on staff NI, P45, P46. Also there is no password protection over the accounts software and no good discipline on updating the receipts. Food department control only depended on one person, there is no internal control on food ordering, checking and in payment. These are the main pieces of evidence I found in the gala restaurant and based on this I decided there is no proper internal control in their business activities. Because of the high control risk I plan to do the test control in my audit program.

Transaction Test

Auditing procedure related to examining specified transaction and supporting documentation. This is a part of testing process used by the auditor to check internal control reliability. If the control risk and deduction risk is high then transaction risk will be high in the organization. There for transaction test to be done in audit program.

According to the Gala restaurant internal control has high failure, which is identified in the test of control. Also, the deduction risk is high in the gala restaurant. Food department is only controlled by one person, so there are chances for fraud. Cheques are paid to the bank on the following day, there is no proper control on time payment. Receipts on bills are not maintained with correct discipline, therefore there is no control on bills. These are the deduction risks that I found in the gala restaurant. Because of the high control risk and deduction risk I decided to do a Transaction test for the gala restaurant. Firstly I have to do a Substance test to find out the Transaction fraud.

Substance Test

This test used on audit when internal control are few and on items in financial statement which are high risk or particularly Important. This test includes analytical review as well. Substance test as follows:

1. Recalculate order invoice - whether it is accuracy

2. Approved price list used or not

3. Receipt report used or not and cross check with renumbered serial numbers in the bills to find out the completeness.

4. Dates on report and compare with invoice to identify the timing

5. Master files reconciled - Posting and Summarizing

6. Classification Revenue

7. Cheques signed by owner.

These are the main test to be analyzed when doing a Test of Transaction.

3. Analytical Procedures

Which helps an auditor to understand changes in business. If the detection risk is high in an organization a auditor should process analytical procedures in audit program. Analytical procedures contain balances of Assets- (Current assets and noncurrent assets), Capital.

Compared to 2009 the cost of the sale is 60% but in 2010 the sale volume is high but the profit margin is low (52%). Therefore, they have to check whether figures are overestimated to show ahigh price in share market or underestimated to escape from tax. These figures should be analyzed through all statements and invoices.

Test of Detail Balance

When detection risk is high in an organization Test of detail balance should be process in audit program. According to gala restaurant detection risk is high therefore Test of detail balance should be considered.

Ex: Plant Machinery £100

To verify the amount have to check the receipts and depreciation policy to identify the truth.

Task-2.3 (a)

According to Profit and loss account and balance sheet of gala restaurant I can select different kind of sample population.

Profit and loss account -The purchase amount or selling amount

Balance Sheet - Asset-Current asset or the Noncurrent assets

Liabilities - Short Term or long term Liabilities

Task-2.3 (b)

1. I selected non probability sampling because it consider the Background and the Nature of an Organization.

EX: According to Gala restaurant I can audit the purchasing department according to the purchasing authority.(Background)

Check the authorized purchase Check the UN authorized purchase

Purchase by Edward or other People

By analyzing the background of purchasing authority can identify the material misstatement of gala restaurant.

2. Select the nature of the sample:

Find out the nature of the purchasing amount in the gala restaurant. For example: every large purchase amount (Tuesday) and every small purchase amount (Friday). We can also find out the amount in-between then prepare a proper representative. According to that we can find out all the transaction type to avoid material misstatement.

3. According to the test of control once we identify or suspect a transaction then we can do a block sampling to avoid material misstatement.

EX: Cheque transaction in Gala restaurant. For example if I suspect the month of march then I consider all the cancelled cheques in that particular month or all the other transaction cheques and prepare a proper representative and check all the payments or issue by serial numbers with all transactions to avoid material misstatement.

Task-3

Part-3.1

1. Advise the junior auditor to identify the inherent risk in Gala restaurant. This risk is as mentioned in question I. Once they have identified the misstatements by nature, a junior can look forward for internal control failure in the gala restaurant.

2. As an auditor, in his planning program he can give advice to do a test of control in all services to find out internal control of the gala restaurant. Once, they have found the control risk (high risk in gala restaurant) it is very easy to deal with the book keeper.

3. Advise the junior to follow the audit Procedures. For example: Find out whether purchases and expenditures are spent in goods or services.

4. Advise the junior to find out the amount that still needs to be paid. For example: The amount owed to the supplier. Also, tell him to specify how you find the fraud. EX: Cash, Cheque or credit card.

Part-3.1-1

When you state the risk that is the auditor's responsibility in an organization.

1. Non Recordable transaction -This is the auditor's responsibility to find out all the non recorded transactions to prove the misstatement. According to the gala restaurant there is no discipline over maintaining the bill Ex: Cash, Cheque or credit card

2. Non Cancellable Purchase Agreement- For example: if a five year agreement suddenly stops at the middle stage due to money shortage, the auditor should motivate and try to maintain the payments according to the agreements.

3. Strictly monitor the capitalizing expenses-This may under or overstate the figures on the balance sheet or in the profit and loss account. Therefore it is the auditor's responsibility to find out the misstatement.

Part-2

As an auditor, they should follow the Acquisition and Expenditure Cycle to review the audit procedures. At the gala restaurant there is only one person who requests, receives and checks the order. There is no proper maintenance of bills. Therefore as an auditor, I review this information as follows:

1. Information processing control.

1. Cross check the Quantity against the receiving report and the purchase order.

2. Compare price against quoted price or catalog listing.

3. Verify with the vendors invoice.

2. Segregation of duties

According to the gala restaurant only one authorized person does the purchasing in the food department. You should cross check inventory items with him and find out whether the payments transaction was done by cash, cheque or company cards. These data should be crosschecked with the control accounts.

3. Physical Control

Cross check with supplier delivery note. The Gala restaurant storekeeper can check the purchase order with the delivery note, and check the accounts to see whether the right amount was paid or not.

4. Performance reviews

Find out the purchase items and compare with last month's whether it is more or less and again compare this with the sale figures.

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