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At the planning stage, an audit is planned and carried out as to provide a reasonable assurance that the financial statements are free from any material misstatement and also in order to provide a true and fair view presentation of the financial statements. Assessing materiality is an issue of professional judgments that consists the consideration of both the quantity and quality of misstatements.
Materiality is considered in the connection of the financial statements as a whole and in relevance to the individual account balances, classes of transactions and disclosures. At the planning stage, it emphasizes on the assertion level such as the individual account balances and classes of transactions. The assessment of materiality at the planning stage helps in building an efficient and effective audit approach. Therefore, the preliminary materiality together with the risk assessment can help to determine the nature, timing and extent of the audit process. Furthermore, a materiality threshold in monetary terms is often set up according to percentage criteria. For instance, if an outline profit before tax is RM100, 000, if it is less than 5% which is RM5, 000, it can be considered as immaterial. If it is more than RM10, 000, it is material.
Overall review stage
At the overall review stage, it emphasizes on the financial statements as a whole and disclosures. In assessing whether the financial statements have provided a true and fair view presentation, the materiality of the sum of the uncorrected misstatements is determined. This includes the specific misstatements which are including the uncorrected misstatements determined in the prior periods if they influence the current period, and also consists the best measurement of other misstatements.
If the sum of uncorrected misstatements is material, an unqualified opinion would not be adequate to be issued, unless the management has to adjust the financial statements to the extent that any unadjusted amount is not material. At this stage, qualitative factors also may render financial or quantifiable materiality which is irrelevant. For instance, some matters such as the related party transactions are requested to be disclosed in accordance with the financial reporting framework.
b) Discuss the suitability of Jade's draft. Your answer should identify and comment on the principal matters relevant to forming an appropriate opinion on the financial statements of Beige Interiors for the year ended 30 September 2004.
A disclaimer of opinion is drafted by Jade. A disclaimer of opinion is appropriate if the auditor is unable to satisfy himself or herself that the financial statements are fairly presented and the effect of limitation in the scope of audit is pervasive.
Jade's draft is suitable
The auditor shall assess the estimates and judgments made by management during the audit. The auditor is unable to form an unqualified opinion based on the evidence about transactions in the first four months of the financial year which is very insufficient. Therefore, auditor should assess the estimates and judgments regarding the reconstruction of financial information made by management of Beige Interiors. The auditor should consider the extent to which financial records have been reconstructed and the adequacy of about the effects of reconstruction on classes of transactions and account balances. This is because they will affect how much disclosure needs to be made in the auditors' report. If management's disclosure in the notes to the financial statements is absent, a cross-reference to the notes is needed as what is Jade's draft.
An unqualified opinion is issued when the financial statements are fairly presented and free from any material misstatement caused by fraud or error. However, the auditor would most likely issue qualified opinion even if there is extensive amount of reconstruction of financial information because the scope of audit is limited and the auditor is unable to accumulate sufficient and appropriate evidence. In addition, the actions of former chief executive may suggest fraudulent reporting exists but may not be able to quantifiable as the accounting records are missing. Since there can only be suspicion of fraud, it is appropriate for Jade did not referred to fraud or the former chief executive until the fraud is proven in law.
Jade's draft is unsuitable
To express the opinion on the true and fair view of financial statement, auditor is responsible to gather sufficient appropriate evidence. If the auditor is unable to gather sufficient appropriate audit evidence, conduct of the audit work will be affected. In Jade's draft, it has stated that the scope of the audit has been limited as some accounting records were unavailable. Nevertheless, users of the financial statements will not know which or why accounting records were missing, or which accounting period the missing records covered.
The potential misstatement arising from the reconstruction of financial information may not be pervasive even though it is material. This is because the carrying amounts of fixed assets, inventory, accounts receivable, cash at bank and other accounts balances as at 30 September 2004 is unlikely affected by the loss of accounting records. However, Jade has supposed that the matter is pervasive and therefore, disclaiming an opinion on the financial statements as a whole. In fact, disclaiming an opinion on the profit and loss account can be achieved with 'except for'.
The unqualified audit opinion issued for prior period (30 September 2003) may not appropriate because the accounting records which were taken by the former chief executive would have provided evidence about balances at 30 September 2003. Therefore, the extent to which the former chief executive contributed to sufficient appropriate evidence in forming the prior period audit opinion auditor should be reconsidered. The fact that the prior year opinion was unqualified does not preclude a disclaimer of opinion on the comparative information. However, Jade has not considered the reference to comparative information since it is not standard wording.
Other than that, Jade has not considered matters to be reported by exception when a qualified opinion is formed. In fact, the opinion paragraph should include a statement 'In respect of the limitation of scope on our work, we were unable to confirm whether proper accounting records have been kept.'
Explain the auditor's responsibilities of the going concern assumption as a basis for the preparation of financial statements.
The going concern assumption is a fundamental principle in the preparation of financial statements. With the going concern assumption, an entity is normally reflected as continuing in business for the anticipated future, halting trading or looking for protection from creditors according to laws or regulations. Therefore, management is required to carry out an assessment of an entity's capability to continue its business as a going concern.
The auditor's responsibility is to acquire sufficient appropriate audit evidence to consider the appropriateness of management's ability of the going concern assumption in the preparation and presentation of the financial statements. Furthermore, auditor also should hold out whether there are any material uncertainties that will influence the entity's capability to carry on as a going concern. If it is occurred, it has been required to be disclosed in the financial statements.
Nevertheless, the potential consequences of inherent limitations on the auditor's talent to discover the material misstatements that larger for future events or situations that may lead to an entity to stop to continue as a going concern. The auditor cannot forecast the future events or situations that may result an entity to stop to carry on as a going concern. Thereby, the lack of any reference to going concern uncertainty in an auditor's report cannot be referred as an assurance as to the entity's capacity to carry out as a going concern.
Hence, it is important to the auditor that to communicate with the management and if appropriate, they should try to charge with the governance early in the audit. The auditor should assess the management's procedures so as to acquire an understanding of how management plans to evaluate the entity's ability to proceed as a going concern. In addition, auditor also should have to obtain the written management representation as to assess whether there are any deficiencies in the internal control of an entity and thus influence the capacity of an entity to proceed as a going concern. Besides, auditor also should assess the any disclosure in the financial statements. Sometimes, management may have already held out an initial assessment that the auditor would review when carrying out the risk assessment procedures to find out whether any events or situations relating to the going concern assumption have been determined and whether the management has planned to make concern against them.
Comment on the suitability or otherwise of an unmodified auditor's report for Cinnabar for the year ended 31 December 2001. Your answer should discuss the appropriateness of alternative audit opinions.
For the case of Cinnabar, from the information in the disclosure notes, it show that the company not a going concern. Besides that, the information given is not clear on which type of the financial statement have been prepared. So, they may prepare on the going concern basis or on an alternative basis.
An unqualified audit report means that the account of the company may true and fair view and they may prepare in accordance with standard and statute. Besides that, there are no circumstances which will require the opinion with an addition of an explanatory paragraph or modification of the report. In this case, if the accounts prepare on a going concern basis of the unqualified opinion would not appropriate. This is because it does not reflect the true position of the company. This will result that the readers or users would be misleading by this report which did not show the true position of the company. The users will assume that the company is has the ability to continue which are clearly not about this case's situation. In the addition to the inappropriate basis of preparation, the disclosure of the notes of financial statement do not highlight the significant problem of the company which facing by the company. So, they are not properly prepared.
Besides that, if the report have been prepared with the "except for" or disclaimer of opinion also would not be appropriate of the basis of preparation when the issue is not one of uncertainty. This is because the issue had by Cinnabar was a certainty which had been sold a significant amount of its business and certain assets and commenced a systematic winding down its operation.
If the financial statements prepare on a going concern basis, an adverse opinion should be expressed. This opinion would be due to the disagreement on the basis of preparation. This opinion would be adverse as the disagreement is pervasive to the overall true and fair view, which means that the overall of the financial statement are materially misstated and do not present the financial position of the company with true and fair view.