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a) Using analytical review techniques, prepare a report which identifies the key areas of audit interest when reviewing the financial statements of Krypton plc.
The auditor of Krypton Plc will have to identify some key areas of review and apply acceptable analytical reviews that will assist him or her in forming an opinion. Among the critical areas to be looked at include: When looking at these specific areas, the auditor will come up with an acceptable level of risk that will guide him or her through when applying the analytical reviews.
It can be noted from the books of the accounts that fixed assets increased by a significant figure in the year 2005 as compared to the year 2004.This was necessary because of the expansion in the operations of Krypton Plc abroad. However, actual existence of these assets should be verified because it may be fictitious. Again, the ownership should also be verified since some dishonest staff can indicate leased assets as property of the company with an ill intention of committing fraud. The valuation should also be looked at to ensure the right value has been quoted in the books of accounts. When it comes to analysis of the books to purchase the additional assets, authority from the board of directors of the company should be ascertained to ensure that the right acquisition procedures were followed while buying the property. If no authorization occurred during acquisition, the value of the assets is not correct or if the asset recorded is owned by another entity, this will have some negative results on the audit hence the audit may not achieve its objective of establishing the truthfulness and fairness of the financial statements.
Current assets: The current assets of Krypton plc form an important area of audit interest. This is because; some elements of fixed assets are more susceptible to misappropriations. For example, stock can be misappropriated by the staff concerned. It should be ascertained whether the value quoted is the correct.Incase of reclassification of current assets, authorization should have been from a senior authorized official. It should also be ascertained whether or not the current assets under investigation is owned by Krypton Plc because in some instances, it can be owned by some other entities. Actual existence of the stock should also form a subject for consideration. If all these factors do not hold, the results of the audit may not show a free and a fair view of the state of affairs hence the audit will be qualified
The value of the intangible assets should be looked at. For example, it is goodwill; the auditor should ensure that the method adopted by Krypton plc when arriving at the value should be consistent with the applicable international standards. Failure to meet this standard will mean that the valuation is misleading and will lead to the audit report being qualified.
The dividends paid in the year 2005 by Krypton Plc have declined. This has occurred even after the company making good profits. The reduced payments should have been authorized by the board of the company. It should also be verified that the right amount was paid and to the persons who are supposed to receive them. The names of the dividend recipients should be those who are valid members of the company as indicated by the company register. If the payment of the dividends has been authorized by the board, an approval should also have been offered at a general meeting of the members to allow for the ratification of the intentions of the board of directors to pay the agreed amount of dividends in the manner proposed. If the dividends paid are not of the correct amount, not to the right people, and not authorized, it will adversely affect the results of the audit.
Expenditure incurred by the company forms an important area for review. Due to the expansion abroad, the administration expenses incurred by Krypton Plc went up. This spending should always be approved by the right company personnel. The amount presented in the books of accounts should also be the right one.So`; the value presented should not be misleading at all. It should again be ascertained if the mentioned expenditure applies to the company expenses only. It must not at all include any amount spend on personal businesses by the company executives. The distribution costs also rose by a bigger margin. At times, not all these costs are attributed to the company operations. Some can be those spend for other no business related activities. So, it should be ascertained if the distribution costs are owned by the company, if the right amount have been declared and that all spending on distribution activities, be it nationally or internationally must be authorized by the board of Krypton Plc.
If all the mentioned considerations cannot be proved, then the results of the audit will have some qualifications which will vary depending on the level that can be regarded as acceptable.
Actual existence of the creditors should be ascertained. Especially those creditors that are due more than one year, letters of circularization should be send to ascertain if the y actually exist, if the values recorded are correct and what the company has done to ensure that the company recovers the amount the creditors owe it. It may be very possible hat some of these figure are fictitious and so the right position should be looked at. Especially where there are weak internal control systems, the correct position should be ascertained, failure to, the results of the audit report will be impacted negatively.
To finance its expansion activities, Krypton plc borrowed from external sources. This can be shown by the rise in financing expenses in the year 2005 as compared to the year 2004.So, the auditor should ascertain if there was an approval to borrow, if the amount approved to be borrowed was received, the rate of interest, the repayment period and the remaining balance. Failure to ascertain the correct amount borrowed and the repayment schedule, the audit report will be impacted negatively because the auditor will either issue a disclaimer or even qualify the audit report.
In the year 2005, Krypton Plc increased the amount of profits retained as compared to the year 2004.This reduced the amount of dividends paid drastically. But before such retention is done, an authorization from the members of the board must be obtained.Thesame amount that have been approved by the board should be retained. If these figures do not agree, definitely, it will show that there are some things that the company is hiding or it may also be a fraud scheme. If these do not coincide, the audit report will not be very friendly.
Generally, the auditor, in addition to applying analytical review techniques should ensure that all the elements being audited have the right values shown and are owned by the company. The auditor should also ensure that the property have been fully disclosed in the books of accounts of Krypton limited and are owned by the company. The existence of the property, or cost should be ascertainable and should be recognized as such. When accounts presented by a company fail to meet all the above factors, the audit report will be qualified in one way or another. If in doubt, the auditor should try as much as possible to get all the necessary clarifications to avoid making errors while drafting his audit report.
b) Areas that will be influential in determining inherent risk
The assessment and determination of inherent risk for Krypton plc requires the auditor to evaluate and consider the likelihood that the company might be engaged in activities that do not conform to acceptable professional standards when is assumed that no system of functioning quality control is in place. The assessed level of inherent risk is dependent on both internal and external circumstances.
From the history of Krypton plc, it can be seen that some happenings indicate the presence of inherent risks. There was high forced turnover within the senior management ranks of the firm .This is due tom the publicised boardroom battle between the chairman of the company and the senior members of management. This is an indication of a major underlying problem which sought to have an urgent solution. For a big company like this, failure to have a sound management in place can be dangerous as well if there is massive change in the senior management taking place at the same time, the transition might not be smooth. The new managers will not be able to get some important information from their new colleagues who are supposed to be giving the new managers good orientation. This might lead to the company making losses if not rectified on time hence a major indicator of an inherent risk at Krypton plc.
When a major advisor of a firm has a dispute with the company concerned or when the same advisor declines to stand for re election, it signifies some frosty professional relations between the company and himself. The disagreement over audit fees that should be paid to the outgoing auditor is a major indicator of the existence of an inherent risk at Krypton placid is actually very dangerous for such disagreements to occur since an auditor is a very important person to a company. Especially during this time that the company is going through massive expansion, the services of an auditor is very crucial. This disagreement thus led to the delay in the appointment of the incoming auditor which cannot be done without the outgoing auditor being cleared because the outgoing auditor might decide not to hand over the necessary information that the incoming auditor needs to carry out his activities. For the period of the disagreement, some dishonest employees may engage in unprofessional activities which will lead to the company making losses in one way or another.
The treatment of the cost of equipping the laboratories of the university when the company entered into research partnership with a local university is not in agreement with acceptable accounting standards and principles in force. Treating it as an investment in the accounts will increase the value of the balance sheet for the Krypton plc.Again, this brings inconsistency issues to the books of accounts hence the presented financial statements might be misleading in one way or another. This could have been expensed in the books of the accounts and added back when computation for taxation purposes is done. By treating it as an investment, it will not only reflect misleading asset values but will also inflate the amount of profit that the company will have to present in its books of accounts. This presents an inherent risk that that Krypton plc needs to address.
The actions of the company to engage the services of a factor indicate a major failure to collect its accounts receivables. A sound company should have a working credit policy and also a collection policy for its accounts receivables. These amounts to some suspicion from the external quarters and other stakeholders might treat the company with caution since factoring signifies a weakness in the credit policies of the company. By factoring its accounts receivable, Krypton plc is affirming that there is a problem with its internal control systems, and so the company will not be earning the amount it would be earning as a result of the factor charges adding to its costs. So the rationale of the company in deciding to factor should be questioned and all the facts behind the factoring contract should be disclosed.
The speedy expansion of the company poses inherent risks. Due to the rapid expansion, some of the internal control policies could be weak to the extend that it cannot guarantee the security of the company assets. The wide coverage may make the auditor visits more complicated hence it will not be possible visiting all the branches for purposes of assurance whether or not the internal control system in place is being followed or not.
The change of the end of the financial year from September to December of every year will affect many things. Comparison between the two years cannot be possible without some adjustments to the accounts. The stakeholders and shareholders of Krypton plc will have a rough time comparing the results of the two years as they cannot match.Also, there is a possibility of hiding frauds in this manner hence this is one area that presents a lot of inherent risk. Some questions will arise as to what prompted the change. Again; questions relating to the relevance of the change from September to December for Krypton plc will be asked. Some will argue that December is the end month of the year and so it will be possible to present fair financial statements. While this might be true, some questions will still remain in the minds of many people hence presenting an inherent risk.
The reliability of the financial figure that represent creditors in the balance sheet presents an inherent risk since due to the recent expansion by the company and the management and audit problems that the company went through, it might be possible that the reliability of the internal control systems of the company is in doubt. For example, without an auditor being in office to verify the figure, how sure can we be to the accuracy in presentation of this figures? Who is to verify the integrity of the creditorâ€™s information systems? If it is open to manipulation by the staff concerned, how can we know? This is an area that is high risky.
Krypton Plc is a major supplier of bottled gas both nationally and internationally. The valuation of this class of commodities requires not only auditing and accounting knowledge but some specialized knowledge of valuation. The valour will need an additional skill to come up with the correct value of the amount of stock that the company holds at any one particular time. For a person to be able to do this valuation, a technical knowledge of all the products together with understanding of all the processes involved. Since this figure is mainly decided by the staff of the company together with the auditor, the question of the accuracy and fairness in presentation of the amounts in the balance sheet will remain a doubt and incise an error is made, and putting in mind the scale of operations of the company, an inherent risk will occur.
Krypton Plc is hiring a new auditor. The incoming auditor may not be having some experience auditing the type of a business that Krypton plc runs. At the same time, this auditor may fail to understand the way some transactions are treated and in the process might present wrong audit information that may not present the true facts of the situation at hand. This wrong impression will not be good for the company as a wrong picture will be portrayed to the general public which may be costly to the company. For example, portraying the company as a loss making entity while the truth has that the company is profit making is costly to the company.