As per this case study, Overseas Explorer Limited (OEL) acquired Local Proprietary Limited (Local) on June 30, 2018. Local Pty Ltd. is a small scale proprietary company and its acquisition was priced at USD 5 million on a single condition that Overseas Explorer Ltd. will be satisfied with the financial statements of the former. The CEO of the acquiring company seeks professional assurance services for evaluating the information that the acquired company has offered to the former concerning the following the three items and the same is provided and discussed in details below:
i. In the first case, the management accounts of the acquired company for the year ending on June 30, 2017, can be regarded as Limited Assurance. This is because the acquired company is a small-scale proprietary company and as a result of this, it is not mandatory for the same to prepare its financial statements. The financial accounts of the acquired company were even not audited ever since it got incorporated in the year 2016. Therefore, an Assurance Professional can't scrutinize the unaudited financial statements of the acquired company as it is difficult to procure proper evidence now.
ii. The most suitable assurance concerning the afore-mentioned deal is Reasonable Assurance. This is certainly because OEL will need to provide every information right from the negotiations commenced to the date of settlement of the acquisition deal between the two companies. The assurance practitioner will need to conduct detailed testing along with relevant standards of accounting and other procedures on every document and information provided by the acquired company. This will allow him to determine the reliability of the acquired company’s financial accounts.
iii. The Assurance practitioner will need to offer “Limited Assurance” concerning the financial statement presented by Local on June 30, 2018. This is because the financial accounts of the acquired company remained unaudited for all the years falling after its date of incorporation. The acquired company did not even meet the requirements for statutory reporting. Therefore, performing relevant audit procedures would have become impossible for the assurance practitioner and he might feel the need to issue limited assurance instead of reasonable assurance. There are probabilities for the financials of the Local Pty Limited to highly misstated, and hence, the assurance practitioner would decide upon issuing limited assurance and will not feel the need to issue reasonable assurance at all.
The management of the company is entrusted with the task of looking after the financial statements and the governance of the company while the role of the auditor is to ascertain whether the financial statements conform to the standards (Anderson 2010). If there is any deficiency, the auditor will provide a qualified opinion and that will indicate the area of deficit. In the case, fo Data Ltd, the audit of the financial statements did not provide any material mismanagement or deficit. The company was functioning without any liquidity crunch and the liquidity was in favor of the company.
As per the audit standard, the audit was conducted and reveals that the business was functioning without any deficiency, however, the business procured the loan from the bank in August 2018 that is after the audit was conducted and hence it is not under the ambit of the auditor or the audit firm. The auditor cannot be held liable for the loss or mismanagement after the conduct of the audit. Hence, in this scenario, the audit is not liable to the bank for granting loans based on the present situation. The bank should have hired an external auditor and conducted an audit of the current period. The bank relied upon the previous year statement thereby the auditor is out of the ambit for the liquidity crisis. The audit was conducted as per the relevant standards and no loopholes were seen in the conduct of the audit.
i. Self Review threat: It is one of the key threats presently faced by Hall & Association. CGL designed its internal control system of accounting which means the company will itself review its work and therefore, there are higher chances for the integrity of its account to get highly impacted (APES 110 2020)
ii. Intimidation Threats: Hall & Associates is intimidated for not disclosing the downward trend in CGL’s current ratio or else, the latter will reconsider giving any further assignments to the former. The auditing firm should go ahead and disclose the actual results along with detailing out the exact reasons attributing to the same (Parker 2019).
iii. Self Interest Threat: Hall & Associates also faces a self-interest threat where CGL offers the former to pay the audit fees using offering shares in the same. The auditing firm must refrain from accepting such an offer to deal with self-interest threat and must ensure to keep the integrity of the auditing profession (APES 110 2020).
i. Hall & Associates should report all the material financial data to the users of the financial statements with the utmost truthfulness. The QR or quick ratio and CR or current ratio desired by the banking institution is 1:1 and 0.9:1 respectively. The auditing firm must report this as this financial data is highly significant for the bank. The failure to non-disclosure of material information would question the integrity of the auditors and the auditing profession at large (APES 110 2020).
ii. The integrity of the auditing firm should be kept at par and therefore, the firm must refrain from making any sort of investment in the form of shares in CGL. The auditing firm must try and convince CGL to pay its audit fees using standard methods as pre-decided upon in the mutual agreement signed by both the parties. According to APES 110, acceptance of audit fees in any other remuneration form can lead to self-interest threat and as a result of this, the independence of the auditing firm shall be lost (APES 110 2020).
iii. Independent directors and non-executive directors are very much different from each other. An independent director is only entitled to receive his or her monthly remuneration and apart from that he neither can have shares nor any sort of monetary benefits in the organization (ASIC 2020). On the other hand, a non-executive director is very much like any regular director that does not have an active control in the day to day business operations of an organization. Therefore, this calls for the need to properly constitute an audit committee in compliance with the statutory requirements.
i. The presence of material misstatements can be seen in the very first case. This signifies a high level of detection risk as the financial statements of the company seems to be highly misstated concerning foreign exchange transactions. The accounting of forex transactions is ideally performed by a financial controller. However, in the present case, the accounting of forex transactions for two months was performed by the treasurer hired by the agency. This makes it difficult for the auditing firm to detect material misstatements present in the financials of the audited company.
ii. The company must fulfill certain regulatory requirements before auditing its financial statements. The company must realize its assets disposed of and take care of other requirements before getting its financials audited (Baldwin 2010). There is a strong probability of a high-level detection risk in this particular case and this might impact the ability of the auditor to offer reliable opinions concerning the financial statements of the audited company.
iii. Control risk and detection risk can be observed as the total number of sales seems to be manipulated. The employees of the company have manipulated the total sales number for achieving their sales target and earning a higher bonus amount (Cernusca & Balaciu 2015). The financial transactions can be easily misstated by the employees who have control over the internal control system and as a result of this, the financial data presented by the company might reflect certain discrepancies.
iv. The probabilities of risks are higher in companies that have a complicated environment. The software pre-installed by the company can have various errors, and therefore, the opinions and judgments of the auditors might get impacted as it becomes difficult to identify material misstatement in financial transactions.
v. The accountant hired by the company in question was also in charge of delegating the tasks that were meant to be performed by a system auditor. Therefore, a huge level of control risk is observed in the company (Cernusca & Balaciu 2015). In such a scenario, the accountant will not be able to deliver his duties about accounting with utmost responsibility and ultimately the financials of the company might get impacted.
i. Using the current ratio, users can learn about the liquidity of an organization. CR highlights the ability of an organization to take care of its nearing financial obligations. From the chart, it can be learned that the CR of Nova Limited has marginally increased as compared to the last year. The CR of the company for the year ended June 30, 2008, is close to the industry average which means that its liquidity is desirable and therefore, there is no need to conduct an audit in this segment.
ii. The ability of an organization in meeting its financial obligations can be easily learned from its quick ration. The quick ratio of Nova Limited is lower as compared to the industry average but very much the same when compared to the standard figures. This signifies that the performance of the Nova’s quick assets is slow and therefore, the audit must be conducted in this scenario for learning the reasons behind the deficit in the company’s quick ratio (Gay & Simnett 2018).
iii. The inventory turnover ratio is an indicator used to learn about the total number of times the sales of inventory has taken place. The budgeted result is higher than the actual result and this strongly depicts that the inventory turnover ratio of the company is super weak. Therefore, this scenario must be carefully audited for learning the reasons behind the improper pattern of stock movement as this will enable the management in strengthening the inventory turnover ratio in the nearing years (Matthew 2015).
iv. The profit earning ability of Nova Limited can be learned by its gross margin and the net profit ratio. From the chart, it can be learned that both gross margin and net profit ratio of the company has done exceedingly well as compared to the standard results. This is ideally possible due to a higher number of sales and expert management of all the expenses incurred by Nova Limited. Therefore, there seems no need for an audit to be conducted in this particular segment.
Anderson, A.W (2010) A practical approach to understanding audit risk, Account-Ability Plus
APES 110 2020, APES code of ethics
Baldwin, S (2010) Doing a content audit or inventory. Pearson Press.
Cernusca, L & Balaciu, D.E (2015) ‘The Perception of the Accounting Students on the Image of the Accountant and the Accounting Profession’. Journal of Economics and Business Research, 21(1), 7-24.
Gay, G., & Simnett, R. (2018) Auditing and Assurance Service in Australia. McGraw-Hill Education (Australia)
Matthew, S. E (2015) ‘Does Internal Audit Function Quality Deter Management Misconduct?’. The Accounting Review, 90(2), 495-527
Parker, D (2019) Seeing audit quality in Australia in a new light. available from: <https://www.intheblack.com/articles/2019/10/01/seeing-audit-quality-in-australia-in-a-new-light> [14 May 2020]
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