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Audit and assurance is a major aspect for the investors and other stakeholders in order to enhance the credibility of the disclosed financial information of the firms. In an assurance engagement, the main aim of an auditor is to gain adequate evidence for expressing a conclusion in order to improve the intended users’ level of confidence on the disclosed financial information on different financial reports. ASA 200 indicates that the main objective of the auditors in the audit of financial reports is expressing an opinion on whether the client has prepared the financial statements in accordance with the required financial reporting framework and whether there is any material misstatement in the financial statements (auasb.gov.au 2020). It requires to be mentioned that the responsibility of the auditors is to take into account all the required aspects while planning and carrying out the audit of any client. In order to proceed with the audit of a client, an auditor must gain adequate understating of the client as this is required for the determination of inherent risk of audit. After that, the auditor needs to identify the key accounts that can be at the risk of material misstatements. The next step is to determine the level of planning materiality in order to ascertain whether there is material misstatement or not. Lastly, it is required for the auditor to undertake risk assessment for assessing what can go wrong with the selected accounts. The main aim of this report is to undertake all the above-mentioned steps for undertaking the audit of Reece Group Limited.
According to ASA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment, Para 3, an auditor’s objective is the recognition of material misstatements risks by understanding the audit client and its environment that consists of internal control (Fontaine, Letaifa & Herda 2013). This particular standard is also applicable for the audit of Reece Group Limited where the external auditor is required to gain understanding of different aspects of Reece Group Limited. According to ASA 315, there are five specific components of the internal control of Reece Group Limited that the external auditor needs to assess; they are control environment, risk assessment process of the entity, information system, control activities and monitoring the controls (auasb.gov.au 2020). The external auditor of Reece Group Limited is required to assess these five components for gaining understating on the company.
Control Environment – Control environment consists of the culture, structure and discipline of a company. Reece Group Limited has a clearly defined organizational structure where the responsibilities of the management are clearly defined. The company has effectively segregated the duties while delegating the limits of the authority. As mentioned in the Corporate Governance statement of Reece Group Limited, the board of the company has put key emphasis on the ethical aspects like honesty and integrity in all the business dealings. The company has its own Code of Conduct and Code of Business Ethics for over viewing the business activities (reecegroup.com.au 2020).
Risk Assessment Process –Reece Group Limited has an effective risk management mechanism where the company does not only aim to eliminate the risks, but identify, monitor and manage the material risk of business (reecegroup.com.au 2020). The Board of Directors of the firm has developed a Risk and Compliance Committee in order to determine and implement the risk management controls in the daily business conducts. This risk management process assesses, evaluates and mitigates risks such as strategic risk, reputation risk, product and service quality risk, ethical conduct in business risks, financial risks and others (Tepalagul and Lin 2015).
Information System – It is mentioned in the Corporate Governance Statement of Reece Group Limited that one of the major responsibilities of the Board of Directors of the firms is to provide the approval of the annual reports and disclosure in the market while overseeing the processes of the company to make disclosure in timely and balanced manner of all the material information on financial and non-financial aspects (reecegroup.com.au 2020). The Board is also responsible to appoint, undertaken and properly check the material information in the annual general meeting.
Control Activities –Reece Group Limited has its Audit Committee whose one crucial responsibility is reviewing the risk management framework of Reece Group Limited along with its internal control (reecegroup.com.au 2020). In addition, Reece Group Limited has employed stable and reliable management reporting system along with appropriate accounting control. In addition, the Board of Directors of Reece Group Limited is responsible to set and monitor strategic plans as well as objectives that include measuring and monitoring the performance of senior executives. Incompatible duties have been segregated properly with the aim to eliminate the scope of frauds (Dao and Pham 2014).
Monitoring of Controls – The key responsibilities of the Board of Directors of Reece Group Limited include monitoring the strategic plans as well as corporate objectives, monitoring the functional and operational activities of the company, monitoring the business’s capital expenditures, monitoring the compliance of the company with the regulatory and legal necessities along with overall governance’s efficiency, monitoring compliance of Reece Group Limited with its own business and ethical standards that includes codes of conduct and values of the company and monitoring the senior executives’ performance. The Audit Committee is responsible to monitor the development of accounting and financial reporting, monitoring the external audit’s progress and monitoring the matters associated with Code of Conducts and Whistleblower Policy (reecegroup.com.au 2020).
According to ASA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Australian Auditing Standards, audit risk can be considered as a risk of expressing an unsuitable audit opinion in the presence of materially misstated financial statements (auasb.gov.au 2020). It is needed for the auditor of Reece Group Limited to undertake the risk assessment procedure for the identification of the areas of risk of material misstatements. Appropriate analytical procedures need to be applied by the auditors in this stage and simple comparison will be used for assessing the risks of Reece Group Limited (Jans, Alles and Vasarhelyi 2014). Five accounts with the risk of material misstatements of Reece Group Limited are discussed below:
Revenue and Other Income – It can be seen from the 2018 Annual Report of Reece Group Limited that there is significant rise in the revenue and other income of the company in 2018 from 2017 that is from $2430958000 to $2691356000 (reecegroup.com.au 2020). Sales revenue is considered as significant account and this large increase in this account casts significant doubt on the fact that that can be material misstatement in this account. The important assertions associated with this account are occurrence, accuracy, cut-off and completeness. Therefore, this account is at the risks of material misstatement (Lobo and Zhao 2013).
Cash and Cash Equivalents – As per the 2018 Annual Report of Reece Group Limited, there has been a major increase in the cash and cash equivalent that is from $101,805,000 in 2018 to $539,891,000 in 2018 (reecegroup.com.au 2020). Increase in cash and cash equivalent improve the short-term liquidity position of the companies and this can be a major aim of the management of Reece Group Limited to overstate cash and cash equivalent for improving the liquidity position. Therefore, this particular account is largely at the risks of material misstatements because of overstatement (Kochetova-Kozloski, Kozloski and Messier Jr 2013).
Receivables – 2018 Annual Report of Reece Group Limited shows that there is a major increase in the debtors of Reece Group Limited from 2017 to 2018 that is from $360,912,000 in 2017 to $410,212,000 in 2018 (reecegroup.com.au 2020). There are three important transactions that create major impact on the receivable balances; they are sales, cash receipts and sales return and allowance. Since sales and cash and cash equivalents are of significant risk of material misstatements, their effects can be on the balance of receivable. For this reason, the account of receivable is required to be considered at the high risk of material misstatements (Czerney, Schmidt and Thompson 2014).
Inventory – It can be seen from the 2018 Annual Report of Reece Group Limited that inventories of the company has largely increased from $457,063,000 in 2017 to $540,564,000 in 2018 (reecegroup.com.au 2020). Increase in inventory improved the short-term liquidity position of the companies and the same is also applicable for Reece Group Limited which provides the management of the company the reason to overstate this account. Moreover, there are three crucial transactions that affect the balance of inventory which are purchase, cash payments and inventory possess. For these reasons, the account of inventory is also at the high risk of material misstatements (Bhattacharjee, Maletta and Moreno 2015).
Long-term Borrowing – It can be seen from the 2018 Annual Report of Reece Group Limited that the long-term borrowing of the company worth $100,000,000 in 2017 has been fully repaid by the company in 2018 (reecegroup.com.au 2020). Since the main risk associated with this account is understatement, this account is at the most risk of material misstatements. On the other hand, two significant types of processes create impact on the balance of this account that are cash payments and purchase. In the presence of these reason, this accounts needs to be considered at the risk of material misstatement (Czerney, Schmidt and Thompson 2014).
Materiality is considered as a crucial concept in auditing that includes the misstatements creating major influence on the decision making process of the users of the financial reports of the clients. As a foundation of the opinions of the auditors, it is required by the auditors to acquire rational guarantee on there is material misstatement in the financial reports of the clients or not. This makes increases the significance of the concept of materiality in auditing. Auditors apply this as audit planning stage along with performing audit and evaluating the impacts of material misstatements on the overall audit.
The use of materiality in auditing can be seen in order to test and asses the legitimacy of information in the financial statements and associated notes. The presence of all materiality related rules and regulations can be seen under ASA 320 Materiality in Planning and Performing an Audit (auasb.gov.au 2020). It is needed for the auditor of Reece Group Limited to utilize his/her professional judgment and understanding of the client at the time to set panning materiality level and the auditor also needs to be alert of the primary users of the financial statements. The auditor of Reece Group Limited has the option to select the appropriate base of materiality either from income statement items or from balance sheet item. The main items of income statement are revenue, gross profit or profit before tax; and the key items of balance sheet are total equity or total assets. Professional judgment of the auditor needs to be used while selecting the appropriate base (Eilifsen and Messier Jr 2014). It can be seen from the annual report of Reece Group Limited that the company has been bale in registering large amount of revenues over the years; and therefore, revenue is the appropriate base for the planning materiality level of Reece Group Limited. According to
ASA 320 Materiality in Planning and Performing an Audit, Para A8, professional judgements need to be applied by the auditor to determine the percentage; and it needs to be taken into consideration that there is a relationship between the chosen benchmark and percentage. Therefore, in case of Reece Group Limited, 0.025% is considered as the appropriate percentage that is to be charged on total revenue. The level of materiality of Reece Group Limited is calculated below:
Planning Materiality Level = Revenue × 0.025%
= $ 2,691,356,000 × 0.00025
= $672839
After obtaining the required understanding on the client and identifying the significant accounts, it is needed for the auditors to assess what can go wrong in these accounts or the presence of material misstatements in these accounts. This helps in providing the basis to design and perform additional audit procedures. One crucial part of this is the prioritisation of the identified risks as this helps in determining what audit procedures need to be undertaken. The following discussion shows discusses about what can go wrong with these five selected accounts:
Revenue and Other Income – It is discussed in the above that the sales revenue of Reece Group Limited has majorly increased in 2018 and this indicates towards the presence of fraud risk. It is mentioned in the annual report of Reece Group Limited that the company faces major competition and interruption from unlikely sources. It means Reece Group Limited operates in a highly competitive industry where the pressure is on its management to achieve high sales targets. This particular aspect creates the risk of overstating the sales figure in manipulative and fraudulent manner. This risk cannot be reduced with the company’s internal control which implies that the inherent risk in this aspect is high for Reece Group Limited (McKee 2014).
Cash and Cash Equivalents – Earlier discussion indicates that there is significant increase in the cash and cash equivalent of Reece Group Limited in 2018 and this is also an indicator that there may be overstatement of cash and cash equivalent by the management to enhance its short-term liquidity position. It can be the outcome of the competitive pressure on the company. In addition, Reece Group Limited might have running low of cash which can raise significant doubt on its ability to continue as a going concern since the core operation of it were not able to fetch adequate cash. It implies that Reece Group Limited has a high inherent risk (Boritz, Kochetova-Kozloski and Robinson 2014).
Receivables – It can also be seen that receivables of Reece Group Limited have also increased in 2018 and two fraudulent activities can be involved in this. First, the management of Reece Group Limited may have realized the dues from the debtors but did not report it in the period when it was collected and this will show increased receivables amount. Second, the management may have used incorrect provision associated with the collection of receivables. However, the intention behind both of these actions is to enhance the short-term liquidity position of the company. This risk could be mitigated through internal control and therefore, the control risk is risk in this case (Fortvingler 2016).
Inventory – Inventories of Reece Group Limited has significantly increased in the year of 2018 which indicates towards the overstatement of inventory by the management for enhancing the short-term liquidity position. It needs to be mentioned that cash received majorly connected with inventories where cash is generated from the sale of inventories. However, increase in cash as well as inventories in Reece Group Limited indicate towards the presence of fraud around inventories. This risk could be mitigated with effective internal control and therefore, control risk is high in this case (Fukukawa, Mock and Srivastava 2014).
Long-term Borrowing – It can be seen from the above that the long-term borrowings of Reece Group Limited has been fully repaid in 2018 and it indicates towards the presence of understatement of long-term borrowings in 2018 by its management. The main intention of the management of the company behind this understatement may be the plan to raise further debt or renegotiate a loan. Presence of huge debt would affect the company’s long-term liquidity and solvency position to take more loans. Therefore, the management of Reece Group Limited may have understated the long-term debts or may have classified the long-term debts incorrectly. In this context, it needs to be mentioned that this increases the inherent risks of audit of Reece Group Limited associated with long-term debts (Favere-Marchesi 2013).
The above analysis undertakes the analysis of different steps in the audit planning of Reece Group Limited. It can be seen from the above that Reece Group Limited operates in a highly competitive industry where in likely forces disrupt its business operations. The company has become able in establishing an effective internal control by taking into consideration all the necessary aspects such as the implementation of an effective risk management framework, effective distribution and segregation of the duties of senior executives, control on financial reporting and others. The report also shows that there are five accounts that are at the high risk of material misstatements; they are sales revenue account, cash and cash equivalent account, receivables account, inventories account and long-term borrowings account. The balances of these accounts have fluctuated in 2018 unexpectedly which raises the doubt of the presence of material misstatements in them. This report discusses about the necessary aspects associated with the determination of planning materiality of the audit of Reece Group Limited by discussing the consideration of necessary aspects in materiality determination such as appropriate base and selection of percentage. The planning materiality level of Reece Group Limited is obtained by charging 2.5% on total sales. The last parts show that presence of frauds in the mentioned five accounts with the aim to achieve certain objectives of the management of Reece Group Limited. The increase in sales revenue can be the outcome of competitive pressure on the management to post higher amount of sales. The increase in cash and cash equivalent, receivables and inventories can be the reason to enhance short-term liquidity position and to mitigate the going concern risk. The decrease in long-term borrowings can be the reason to improve long-term liquidity position for raising more loans
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