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Contents
Q NO-1......................................................................................................................... 2
The Need for Audit independence...................................................................................... 2
Audit approach in Business risk........................................................................................ 3
Impact on Auditors Independence.................................................................................... 5
QNO-2......................................................................................................................... 7
Implications in Audit....................................................................................................... 9
QNO-3....................................................................................................................... 11
Identification of the absence of the internal controls............................................................11
Transaction related audit objectives.................................................................................12
Effective control suggestions........................................................................................... 14
Bibliography............................................................................................................. 15

Q NO-1
(a)
The Need for Audit independence
Definition
Audit independence can be defined as the absence of Auditors interest that create a risk which is
unacceptable for the users of financial statement. Due to the existence of that risk the audit report
may not be providing a true and fair view about the financial statements of the company.
Purpose / Objective
The primary purpose of the audit is to provide an independent opinion to the shareholders about
the financial statements of the company. So an auditor was hired by the shareholders to verify the
financial statements. This person must be independent of both managers, directors and
shareholders. Assurance provider gives his opinion whether the financial statements given true
and fair view in all material respects. If the auditor is not independent then the director may
influence in the audit opinion of the auditor and ultimately audit report will have a little value.
Independence has two aspects

Actual Independence means a state of mind that permits the auditor for expression of
conclusions without any bias or influence.

Perceived Independence means that the auditor must be avoided such situations and
relationships that may cause observers to question an auditors independence.

Compliance Requirement for independence

Every auditor must obey the compliance requirement of the relevant country. Every company has
its own laws and regulations to ensure auditors independence. Like in United States SEC has
issued the requirements to ensure the independence of auditors. In United Kingdom many Act,
enforce the independence of auditor like Companies Act 1985
Ethical Requirement
A Chartered accountant should ensure to follow the five fundamental Principles of Ethics which
are: Confidentiality, Objectivity, Professional Behavior, Professional competence & due care and
Integrity. And try to ensure to reduce the threats to fundamental principles like Self-interest
threat, Self-Review threat, Familiarity threat, Intimidation threat and Advocacy threat.
Reliance on the Audit
Managers and directors who managed the company were different from the shareholders of the
company in many situations. Thats why managers and Directors had played a role of
stewardship. So to judge the performance of management and directors the shareholders asked
the auditor to provide an audit opinion about the financial performance of the company. Hence
independence is very necessary for the auditor to provide reasonable assurance about the
financial statements of the company.
(b)
Audit approach in Business risk
Under risk-based approach to auditing, auditor performs risk assessment procedures and
identifies risk of material misstatement at the financial statement level and at assertion level.
Thereafter, the auditor performs audit procedures at the financial statement level and at the
assertion level to address these risks.
Business Risk

Business risk is a risk which occurs due to major actions or inactions, events, conditions and
Circumstances that might be badly affected the entitys capability to reach its objectives and
implement its strategies. This may also be arise from setting the wrong objectives and strategies.
Examples of Business risk are: Loss of customers, economic instability, Reduction in product
demand, Fraud risk factors, Market competition will be increased due to increase in competitors
and pending of some significant claims and litigations. The auditor should obtain an
understanding about business risk because most of the business risk results in inherent in
following years.
Audit Risk
Audit risk is the chance that the auditor reaches a wrong conclusion on the area under audit.
Audit risk may also affect the business risk. Moreover, audit risk can be defined by this
relationship:
Audit Risk (A.R.) = Risk of Material Misstatement (RMM) * Detection Risk (D.R.)
Business risk & Components of Audit risk:
Inherent Risk
In case of inherent risk items may be misstated as the consequence of their inherent
characteristics. Inherent risk may be arising from these situations:

The nature of the items themselves. For example, estimated items are inherently risky; or
The nature of the industry and the entity in which it works.

Control Risk:

Control risk is the risk that a misstatement in the items of financial statement would not be
prevented and detected by the entitys internal control systems. Weakness in internal control can
be detected by performing tests of control. For the purpose of audit planning, TOC provides the
sufficient & appropriate audit evidence to validate the auditor for a decline in the expected
control risk.
Detection Risk
Detection risk is the risk that the procedure of audit testing will be flop to identify a misstatement
in the account balance. Auditor can be controlled the detection risk by handling the overall audit
risk. Management and auditor cannot controlled the inherent risk. So management of the
company can be reduced the control risk by improving the quality of internal controls.
(c)
Impact on Auditors Independence
Business risk directly affect the auditors decision in practice of audit thats why these factors are
very important for auditor in risk assessment procedures.
Factors

If the existing litigation of the company is more significant than level of business risk is

higher.
The industry in which the company is operating is healthier than level of business risk is

lower.
If the control environment of company is more aggressive than level of business risk is

higher, if conservative then level of business risk is lower.


If auditor provides qualified opinion in previous audit than level of business risk is
higher.

If the location of the company exists in small communities than level of business risk is

lower.
If the rate of turnover for high level of management is higher than business risk level is

lower.
If regulatory problems, conflict of interest and auditors independence problem is more

significant than the level of business risk is high.


If the expectation gap is higher than the level of business risk will be higher.

To reduce the business risk auditor should obtain the understanding of entity its internal control
and the environment. So auditor shall understand the following matters:

Obtain understanding about the relevant industry and other external factors, including
relevant accounting requirements.

Obtain understanding about the nature of the entity ownership, its operations, and
management structures.

Whether Human resource policies emphasize on the strong control environment

Whether Audit committee and board directors have significant influence in the
organization and actively participate in the business.

Whether Management actions and attitudes show character, integrity, and ethics.

Whether Management is committed towards Competence.

Obtain understanding about the measurement & Review of the clients financial
performance.

Whether management tolerate over petty theft.

To apply professional judgment and professional skepticism auditor should understand these
factors before performing the audit procedures in audit.

QNO-2
(a)
Ratio Analysis
With the help of Key Ratio analysis Shareholders of the company can easily evaluate the
financial performance of the Wood Art Furniture Pty Ltd with relevant industry and prior year
performance of the company. Thats why Ratio analysis is the most authentic analytical
procedure for which users can evaluate the companys performance in prior years as well as in
current period
COGS/Sales, Operating expenses/sales. Selling & Admin expenses/Sales:
According to the interpretation of our assistant that the performance of Wood Art Furniture Pty
Ltd management was improved, because all these ratios have decreased in 2015. This
interpretation looks good and accurate.
Alternate interpretation
There is a risk that expenses may be understated and sales are overstated thats why COGS/Sales
or Operating expense/Sales would be decreased. As well as there is a risk of incorrect cut-off of
Goods in Transit and, consequently sales may be incorrect. Further there is a risk of using
inappropriate exchange rates in recording of foreign currency transactions.
Inventory Turnover Period
According to the interpretation of our assistant that the inventory turnover period of Wood Art
Furniture Pty Ltd management was fallen. This interpretation looks inaccurate because the

inventory turnover period was increased in 2015 from 1% to 1.9% as compare to company prior
year inventory turnover ratio. If the inventory turnover period was increased this will indicate
that the holding cost of inventory was increased. As well as an increase in inventory turnover
period indicate that the company is unable to sell its inventory
Alternate interpretation
An increase in inventory turnover period also indicate that the company is expecting that the
sales was increased in following month or years. Moreover, inventory turnover period may be
increased
Due to expansion in the business.
Gross Profit Ratio
The ratio of gross profit was decrease as compare to industry average. So if the gross profit
margin ratio was decreased, which indicate that the cost of raw materials has increased. Hence
decrease in Gross profit margin was not a bad thing if the overall revenue is increased.
Alternative Interpretation
However if the management do not provide reasonable justification for decline in GP %. Then
these factors was important for decline in gross profit %.
(a) Improper purchasing policies
(b) Improper pricing and discounting policies
Current Ratio
According to the interpretation of our assistant that the Current ratio of Wood Art Furniture Pty
Ltd management is increased in 2015. This interpretation of assistant looks correct, because if

current ratio will increase as compare to prior year than this will indicate that the level of
inventory, debtors or cash will also be increased.
Alternate interpretation
Alternatively the current ratio will be increased if the company experiencing trading difficulties
and the company is incapable to sell its inventory or to collect cash from debtors.
Debtors Turnover Period
According to the interpretation of our assistant that the debtors turnover ratio of Wood Art
Furniture Pty Ltd management has decreased in 2015. This interpretation looks valid because
this will indicate that the internal control of the company becomes strong as compare to prior
years and concern department effectively collect cash from debtors.
Alternative interpretation
Debtors may be overstated by management to show the improvement in financial performance to
the users of the financial statement at the period end of 2015.
(b)
Implications in Audit
The area in which auditor considers that there is a significant risk of material misstatement then
auditor less rely on internal control of the entity and perform substantive procedures to verify the
assertions. Like in case of Inventory and receivables which are indicating a high risky area in
financial statement, auditor perform these substantive procedures at period end:
Inventory
1. Auditor obtain the inventory lists from client and perform audit procedure to ensure that
mathematical accuracy and agree balances with the entitys financial statements.

2. Auditor select sample of items from inventory lists and physically inspect them to verify
Existence assertion.

During physical verification, also select assets from the floor and trace them into

inventory list to ensure verification of completeness assertion.


During physical verification, also check for conditions of inventory for indications of
impairment to verify assertion of valuation.

3. Auditor Review the reconciliation between physical balance and book balance at year end if
total of listing differs with book value to ensure assertion of completeness)
Valuation:
1. Cost of Raw Material and Goods held for resale will be verified by auditor as follows:
Check figure of cost by comparing with prices as per purchase invoice.
Recalculate the cost using approach adopted by management.
2. Cost of Work in Process and Manufactured Finished Good will be verified by auditor as
follows:

Obtain a breakup of cost of each item of Work in Process and Manufactured Finished

Good and agree the total to the general ledger.


Check that correct cost and quantity of Material has been used in valuation.
Check Labor cost to approved payroll records, time sheets, etc.
Check only production overheads are included in the valuation. Also check that
overheads are based on normal levels of output.

Debtors
In case of debtors auditor perform following substantive procedure to check the accuracy of
debtors amount presented and disclosed in the financial statements.

Adequacy for Provision of Bad debt


a) Inquire management regarding estimates used in calculation of provision for bad debts.
b) Obtain aged receivable ledger. Compare it with control account and test the aging. Discuss the
status with the credit controller to assess whether they are likely to pay.
c) Examine whether there are any cash recovery of doubtful debts or bankruptcy after balance
sheet date.
d) For large overdue balances, review financial statements of debtors and discuss with credit
manager likelihood of their collection.
e) Recalculate provision for bad-debts using sales, write-offs and current economic conditions of
customers.
f) Inquire management about any disputes with customers and review board minutes for disputed
receivables.
g) Review communication of client with customers, lawyers and collection agencies regarding
debts which are in dispute or unlikely to be paid.
QNO-3
(a)
Identification of the absence of the internal controls
1. There is a weakness in internal control system of Fresh Food Co-operative because there is no
proper documentations and record maintenance of sales transactions and also there is no
independent check on the sales transactions processes.
2. Vendors invoice was paid twice for the same shipment, the fresh food cooperative have no
adequate system of recording transactions and no system of independent check on the invoices.

3. Lack of adequate record keeping system as there is a need to physically check before and after
the beef is ordered and received. There is also lack of independent check on the employee
performance.
4. There is a need of internal control to check independently the physical inventory count results
and evaluate its correctness.
5. There is a need of proper authorization of transactions before they sold. There is also weak
communication system in the fresh food retail business so the salesman sold the lamb without
knowing its actual price.
6. There is a need of adequate documentation of the purchase transaction and independent checks
on year inventory count results.
7. There is need of proper segregation of duties as the person who authorize the invoice and the
person who record it must be different. (Ashton, 1974)
(b)
Transaction related audit objectives
The auditor has responsibility to ensure that the financial statements are free from material
misstatements in order to give an independent opinion, so for this purpose the auditor have to
ensure the adequacy and appropriateness of the internal control system. (Chan, Farrell, & Lee,
2008)
1. There is a doubt that the invoices are not recorded on the correct amount so valuation problem
arises here. If the amounts are materially misstated it effects the auditor opinion on the financial
statements.

2. There is an existence issue of the transaction that is recorded twicely. The auditor have to
ensure that the transactions that recorded must have physical existence as purchase invoice is
raised for this transaction.
3. Auditor has to ensure that the beef that is received must be exist in inventory. For this purpose
he has to examine the receiving report with the physical count data to ensure the existence of
inventory. The transactions should be recorded completely as incompleteness in recording of
invoices certainly increase the chances of misstatements.
4. The auditor have to ensure that the amount calculated in the physical count of the inventory
must be correct there should be no material error in terms of quantity and amount valuation.
5. The salesperson sold the entire carload of lamb at a price below cost. There is a chance that the
transactions are not recorded on the correct amount and there is material misstatement that effect
the auditors opinion. There is also a chance that the recording of sales invoices not properly
maintained so incomplete record indicate the chances of material errors. (Braun, 2001)
6. There is a cut off issue as the truckload of beef sold in the year end day, so the fresh food cooperative recorded it in the next year sale. Auditor have to ensure that whether this sale belongs
to current year or next year. The transaction should be recorded in the correct period. If it
recorded in the wrong year then there is chance of material misstatement that need to be correct.
7. Auditor have to ensure that all the transactions that are recorded exist actually. For this
purpose he has to compare the purchase invoices with the payment invoices to ensure the
occurrence of the transactions.

(C)
Effective control suggestions
1. There should be independent check on all the input transactions that are recorded and for all
transactions computer automatically require the verification, when prices changed (Doyle, Ge, &
McVay, 2007).
2. Before any payment the invoice should attach with the receiving report otherwise the payment
not be processed further.
3. Implement the independent physical count system after every receiving of inventory. The
employees personal equipment should be park elsewhere but on the working place. In this way
the inventory record will be properly maintained.
4. Hire the personal that have sufficient experience in physical inventory count. Check the
performance of this employee by senior personal.
5. Improve the communication system by sending the letter in which change description
explained and ensure that every sales man receive it.
6. Compare the last day inventory count results with the last day sales documents to ensure the
transaction occurrence and its recording. If the inventory sold then no need to count it but if the
sales record in next year so this sale must be record in inventory count.
7. for any changes in the approved master file should be allow to the purchasing personnel not
the clerk. Take independent check on the supplier data on timely basis to restrict the fraud.
Auditor has a duty to identify the internal control weaknesses to the extent in which his audit
work allow him to detect the material misstatement in order to give independent opinion.

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