Response to Question 1:
Audit Committees that are most efficient are very much informed with respect to their responsibilities, comprehends them, integrates them, and identify what is essential to effectively fulfill them. The audit committee’s work keeps developing in light to the business’ leading practices and environment changes. Efficient corporate governance relies on collaborative and active participation of it entire major stakeholders namely the management, internal auditors, independent external auditors, director’s board and the audit committee. Making sure that the aforementioned collaboration happens efficiently, effectively and economically is important to the success of the audit committee. The responsibilities of auditing communities vary in different organizations owing to their mandate as sanctioned by the director’s board. However, the auditing committee’s main responsibilities are basically similar. The main responsibilities of the audit committee are discussed below (KPMG 2009).
Overseeing the financial risk‘s process of a company
A significant role is played by the audit committee in maintaining the financial integrity of a company. Members of the audit committee have to fully understand and embrace critical awareness over their oversight duties. The way the responsibilities are conducted may differ, nevertheless the board, shareholders and the audit committee could have consequences for failing to handle them. Risk management incorporates risk identification that could hinder companies from realizing their goals. Risk management also involves risk analysis, avoidance of particular risks and controlling the remaining risks. The director’s board is eventually in charge of the systems for risk management and evaluation of its efficiency. The responsibility of monitoring, management, assessment and identification of risks, and monitoring, operating and developing internal control systems, and furnishing the board with assurance belongs to the management of the company (KPMG 2009).
The risk management and identification process of a company incorporates management and identification of a company’s financial risks that could negatively impact on the financial reporting of a company. The audit committee considers this matter to be of fundamental importance. Not only do audit committees oversee risks affecting the financial reporting of a company directly, but a at times the board also directs them to scrutinize the level of overall management of risks, suitability of the strategy of risk management, adopted processes to handle these duties and the effectiveness and adequacy the process’ support system integrated by a company’s management. Based on KPMG (2009), this is achieved by the audit committee via asking the management probing questions to assist in bringing clarity to the risk management process employed and responsibilities’ assignment to react and monitor a company’s risk profile changes.
Internal Control Oversight
It is the duty of the auditing committee to oversee the process of financial reporting including the process’ controls and risks. On the other hand. Internal control integrates financial reporting, operational and regulations compliance controls. Generally, the duty of a company’s controls and overall risks lies with the board thus the audit committee can be mandated by the board to take oversight responsibility in ensuring adequate operational controls and regulations and laws compliance. As noted in the UK’s Smith Report, broader aspects of risk management and internal control systems should only be reviewed by the audit committee unless expressly decreed by the risk committee consisting of independent directors or the board. In addition, if decreed by the board or the risk committee, the audit committee could examine or approve all statements incorporated in a company’s annual report with respect to internal control and risk management (KPMG 2009).
Implementation and the designing of an efficient internal control system is the responsibility of the management. It is the duty of the auditing committee to determine the policies implemented by the management are capable of identifying financial reporting risks and the availability, proper functioning and adequacy of controls. During assessment, it is important that the audit committee considers asking the company’s management for risks’ overview, controls, procedures and policies surrounding financial reporting integrity. Representations furnished to them by the management should be supplemented with assurance and further information from the external and internal auditors by the audit committee (KPMG 2009).
The senior management’s and the board’s attitude and integrity together with its committees’ (management’s ‘tone at the top’) is the utmost fundamental factor amounting to the internal controls integrity together with factors surrounding the process of financial reporting. The tone constitutes a company’s cultural core and every level’s appropriate conduct model. Therefore, it is the duty of the auditing committee to evaluate annually whether the proper tone is set, documented and communicated by the management. In conducting this review, the audit committee needs to consider asking the relevant employees and the management briefings and updates on how ethical policies compliance and particular relevant procedures of the company is being realized (KPMG 2009).
Financial reporting oversight
Monitoring formal announcements regarding the final performance of the company before they are released and financial statements’ integrity is the auditing committee’s duty. To facilitate this review, the committee needs to ascertain its member’s awareness of disclosure issues and accounting policy, and that they acquire this information in time to facilitate requisite action to be undertaken as required. In addition, the committee needs to find out from auditors and the management concerning recommended disclosure changes and auditing adjustments either made by the company’s management or not, unusual transactions, the company’s accounting principles, key accounting principles embraced by the company’s management and accounting estimates and provisions incorporated in the company’s financial statements. A comprehensive understanding of the aforesaid factors is essential to the ability of the audit committee to realize its oversight duties. Finally, it is prudent that that audit committees concentrate on present issues and those emerging and act accordingly.
Response to Question 2:
The responsibilities of the management for financial statements related matters and comprehensive consideration of particular matters is highlighted via signing a representation letter. However, in certain circumstances, a company’s management may consider that they are incapable of signing a representation letter on particular or every matter addressed. These circumstances could further outline areas where the auditor’s or the management’s extra effort could be necessary. According to ISA 580 written representations supersedes oral representation and can be in the form of management’s representation letter, auditor’s letter illustrating his comprehension of representations from management duly approved and acknowledged by management, relevant minutes of board or directors meetings, or an executed copy of a company’s financial statement. From the above argument, it is apparent that there isn’t conclusive evidence allowing options requiring a written representation letter from the management.
According to ISA 580, when a company’s management declines to furnish relevant representations, the auditor is required to disclaim or qualify his opinion. The management’s refusal to furnish written representations infers the unwillingness of the management to accept accountability and responsibility for the company’s financial statements. Therefore, there is a great probability that an auditor would not arrive at conclusions without a management’s signed representation letter. However, an auditor could be able to form inferences as to the fairness and accuracy via referring to alternative sources especially in circumstances where controversial judgement were slim, but could not be established. Refusal by a company’s management to sign a representation letter might imply the existence of tension between the management’s and auditor’s working relationship or r challenges in a company that the management is attempting to hide. An auditor can thus proceed in the following manner.
To start with, an auditor has a right to access the vouchers, accounts and books of a company at all times and the right to request a company’s officer for explanations or information of such nature considered to be essential in performance of his responsibilities as an auditor. The auditor can proceed by identifying relevant individuals responsible for governance that he can communicate to with respect to audit matters. As such, the auditor can acquire the flexibility required to determine individuals required to furnish particular representations and inform them that they are accountable and responsible for making particular financial statements. Further, the auditor can employ ISA 580 section 16-20 in his actions which dictates that if in any way the auditor has doubts with respect to the enforcement, commitment, diligence, ethic values, integrity and competence of the management he shall establish the impact that these doubts may have on the audit evidence or on written and oral representations generally. Particularly, if the management’s written representations are not in accordance with some of the audit evidence, the auditor is required to undertake audit procedures in order to find resolutions to the matter. If the auditor fails to find resolutions on the matter, he needs to reconsider his assessment of the management’s diligence, ethical values, integrity, competence or of the management’s commitment or implementation of the aforementioned factors and establish the impact of these factors on the audit evidence or presentations reliability generally. If an inference is arrived at by the auditor that the management’s written representations are unreliable, the auditors is required to undertake requisite action including establishing the probable impact on the opinion in his report in line with ISA 705 whilst considering ISA 580’s paragraph 20 requirements. Finally, the auditor can disclaim an opinion if not furnished with any written representations by the management or he comes to a conclusion that the management’s integrity is in doubt.
Response to Question 3a:
The following information sources will be relevant in acquiring a comprehensive understanding of Dust & Rolls Stores Co. These include
The Audit file for the previous year
Information with respect to issues that emerged during the previous year company audit and how the problems that emerged were resolved can be obtained from this file. I can also determine the policies implemented by the management and their capability of identifying financial reporting risks and the availability, proper functioning and adequacy of controls. In addition, I cannot also assess whether the management of Dust & Rolls have adequate operational controls and have complied with regulations and laws. Information on significant Dust &Rolls agreements can also be acquired.
Discussions with management
By engaging in discussion with the management, I would be able to acquire information relating to any critical issues that have emerged or company changes that have occurred in the course of the year and representations of Dust and Roll’s management for risks’ overview, controls, procedures and policies surrounding financial reporting integrity.
Dust & Roll’s website, different companies’ websites and google
Information on Dust & Rolls with respect to changes that have occurred to the business in the sources of the year and background information of the company could assist me in identifying extra audit risks. In addition, I can also use google and different websites to acquire information with respect to external information that may affect Dust & Rolls Stores.co. Information relating to Dust & Roll’s competitors such as financial statements can also be acquired. This will facilitate the assessment of Dust & Roll’s performance during the year and whilst conducting a review on the going concern.
Current financial statements and budget
From this source, I can acquire relevant Dust & Rolls’ financial information for the present year. In addition, from this information source I shall be able to identify whether there is material changes in Dust & Rolls’ compared to the previous year. Finally, this information can be fundamental for preliminary risk identification and analytical review.
Financial statements and management reports of the previous year
Information relating to Dust & Rolls’ size, disclosure notes, accounting policies and accounting systems can be found in a company’s previous financial statements and management’s report. In addition, information of the past year’s deficiencies in the internal control systems can also be obtained from management report. This is of great importance since similar deficiencies could emerge during the present’s year audit.
Response to Question 3b
Audit risk 1
Dust & Rolls has spent $2·4 m on refurbishing 32 food supermarkets it owns. There is need to review this expenditure to evaluate whether it falls under Capital and ought to be listed as repair expenses or integrated in the non-current assets.
The auditor ought to review the breakdown costs and agree to Dust & Rolls’ invoice to evaluate the expenditures nature, and whether the capital agree to asset register’s inclusion, and whether the income statement and repairs agree. The auditor will also need to assess whether there was proper removal of the asset from the property equipment and plant to ascertain that there is no overstatement of the non-current register and profit obtained after disposals incorporated in the income statement. Furthermore, there is need to assess the register of non-current assets to confirm removal of the asset and recalculate the disposal profit and confirm the proceeds from disposals. Finally, the auditor would consider if the disposal profit is substantial enough to merit a separate disclosure in the company’s income statement.
Audit Risk 2
Dust &Rolls has borrowed the bank $1·6m through a loan repayable in five years. Therefore, there is need to properly categorize the loan between non-current and current liabilities. Moreover, the bank may have obtained a charge on one of Dust & Rolls assets as security till full payment of the loan. Accordingly, there exists a risk of lack of completeness in disclosure of security provided by Dust & Rolls.
In the course of the audit, the auditor would want confirmation that the $1.6m loan finance from the bank was received by the company. Moreover, the division between non-current and current liabilities for the loan needs also be comprehensively reviewed to confirm whether the company gave out any assets as security. Finally, the auditor needs to ensure that the financing bank is circularized to ascertain that the bank indeed issued the loan of such amount to Dust & Rolls
Audit Risk 3
Dust &Rolls will be conducting several inventory counts simultaneous on 31 December which shall comprise the 32 supermarkets and the warehouse. It is impractical that the auditor would be able to attend the simultaneous counts. Therefore, it could be impossible to acquire adequate proper audit evidence with respect to the inventory counts.
The auditor and his team thus needs to select a particular sample among Dust & Rolls supermarket to visit. It is highly probable that most goods are contained in the warehouse and thus it should be prioritized in the selection. With respect to Dust & Rolls’ 32 supermarkets, the audit team should pay visits to supermarkets having a history of issues regarding inventory counts and supermarkets having material balances in their inventory.
Audit Risk 4
Dust & Rolls’ policy of inventory valuation is selling price less an average profit margin. FRS 2 dictates that inventory needs to be valued at Net Realizable Value (NRV) and at Lower of Cost (LCM). If this accounting rules is not followed, a company’s inventory could either be overvalued or undervalued.
FRS 2 inventories permit this as a method of inventory valuation provided that it is the closest estimation to cost. If this is deviated from, the inventory may possibly be over or undervalued. Testing needs to be carried out to ascertain inventory NRV and cost and that the goods are correctly valued line-by-line. Besides, valuation testing needs to be emphasized on comparing the selling price less margin and the inventory cost to ascertain if this method amounts to a close estimation to inventory cost.
Audit Risk 5
Since there has been a transfer of each of Dust & Roll’s 32 supermarkets opening balances into the accounting records of the head office, at the year’s beginning, there exist a risk that the above transfer was not undertaken completely and accurately, thus it is likely that the opening balances could be incorrect. In addition the finance department has experience increase workload owing to the financial controller’s departure and his replacement is scheduled to report for duty late in December. Thus, the inherent risk of the company is increased signs errors might have occurred as a result of work overload by members of the finance team.
The auditor needs to discuss with the management regarding the testing conducted and the data transfer process to ascertain the accuracy and completeness of the transfer. Computer-assisted techniques of auditing could be employed by the auditor in sample testing the data transfer from every supermarket to Dust & Roll’s head office so as to recognize existing errors. The audit team also needs to stay vigilant through the process of auditing for extra errors arising from the department of finance. In addition, it is important that the finance director is informed on the need to furnish the auditor with any help of particular audit issues until the arrival of the novel finance controller.
Response to Question 3c:
Before creating the department of internal audit (IA) in Dust & Rolls the finance director need to take the matters below under consideration:
- There would be considerable establishment costs of a novel IA department, thus before committing to the management time and establishment costs, thus, it is vital that a cost-benefit analysis be conducted.
- Dust & Rolls complexity and size needs to be taken under consideration. This is because there is increased necessity for establishment of IA department I a more diverse and complex company. Therefore, a company like Dust &Rolls with 32 supermarket will benefit greatly from an internal audit department.
- The IA department’s role needs to be given considerable consideration. The director of finance should envisage whether he requires the IA department to conduct reviews of internal controls or conducting the stores’ inventory counts.
- The role of the IA department having been determined, it is important that the finance director considers whether the exiting personnel in Dust & Rolls could perform these tasks.
- The present control environment of Dust & Rolls needs to be assessed by the finance director and determination should be made whether there are stores or departments with a past of control problems. If the answer is affirmative, there is increased need for IA department establishment.
- Finally, the directors of finance should assess Dust & Rolls susceptibility to fraud. Dust & Rolls operates 32 supermarkets, thus there is a considerable fraud risk of cash and inventory.
KPMG 2009, The Role of the Audit Committee. Available from: http://www.kpmg.com/RU/en/topics/Audit-Committee Institute/Publications/Documents/toolkit/1_The%20role%20of%20the%20audit%20committee_eng.pdf [1 November 2016]