Portfolio reflection

Portfolio reflection

PORTFOLIO REFLECTION ACCT420 001 (Auditing- Instructor: Susanna Matson Patricia A. Harrington WHAT ARE INTERNAL CONTROLS? Internal controls have become a key business function for every U.S. company since the accounting scandals in the early 2000s. In their wake, the Sarbanes-Oxley Act of 2002 was enacted to protect investors from fraudulent accounting activities and improve the accuracy and reliability of corporate disclosures

This has had a profound effect on corporate governance, by making managers responsible for financial reporting and creating an audit trail. Managers found guilty of not properly establishing and managing internal controls face serious criminal penalties. WHAT IS MATERIALITY? In accounting, the concept of materiality allows you to violate another

accounting principle if the amount is so small that the reader of the financial statements will not be misled. A classic example of the materiality concept or the materiality principle is the immediate expensing of a $10 wastebasket that has a useful life of 10 years. The matching principle directs you to record the wastebasket as an asset and then depreciate its cost over its useful life of 10 years. The materiality principle allows you to expense the entire $10 in the year it is

acquired instead of recording depreciation expense of $1 per year for 10 years. The reason is that no investor, creditor, or other interested party would be misled by not depreciating the wastebasket over a 10-year period. Importance and relevance of Materiality in Accounting Financial information is a useful measure of a company's performance. Financial statements inform interested parties of a company's overall worth, the value of the company's assets and liabilities, and the significance of the company's day-to-day transactions. Users of financial information assume companies comply with

accounting principles when creating financial statements. The manner in which a company accounts for a transaction can have a material effect on the usefulness of financial statements to the documents readers. Information is material if its misstatement or omission might influence the judgment of anyone who relies on the data provided in financial statements. DEFINE AUDIT RISK Audit risk, also known as residual risk, is the chance that financial statements will be issued with materials errors even though they have been reviewed by an auditor and approved. This risk consists of three main components: Detection risk, Control risk, and risk of Material misstatement. Detection risk is the threat that the auditor will not detect a miscalculation or misstatement. Control

risk is the threat that auditing errors will bypass control. Finally, risk of material misstatement or inherent risk is the chance that the auditor will deliberately conclude that the financial statements are misstated. EXAMPLES OF AUDIT RISK MATT IS AN AUDITOR AT COMPANY XYZ, AND HE IS ASKED TO REVIEW THE FINANCIAL STATEMENTS OF A TECHNOLOGY COMPANY. HIS MANAGER HAS PREPARED A MEMO FOR THE CONSIDERATION OF THE CONCERNS WITH THE AUDITING PROCESS: THE TECHNOLOGY COMPANY IS A LEADER IN THE INDUSTRY WITH A LARGE NETWORK OF CUSTOMERS, SUBSIDIARIES, AND BRANCHES. THE TECHNOLOGY COMPANY HAS ITS OWN AUDITORS, BUT THE MANAGEMENT SUSPECTS CONTROL RISK. THE ACCEPTABLE LEVEL OF AUDIT RISK FOR THE TECHNOLOGY COMPANY EQUAL TO OR BELOW THAN 8%. HAVING A VIEW OF THE FIRMS FINANCIAL STATEMENTS, MATT IDENTIFIES BOTH CONTROL

RISK AND INHERENT RISK. THE FIRMS AUDIT DEPARTMENT HAS NOT SUBMITTED THE FINANCIAL STATEMENTS TO AN AUDIT COMMITTEE, AND IT IS HIGHLY LIKELY THAT SEVERAL AUDITING ERRORS HAVE BYPASSED CONTROL. FURTHERMORE, THE TECHNOLOGY SECTOR IS HIGHLY COMPETITIVE AND COMPLEX, THUS PUTTING A LOT OF PRESSURE ON THE COMPANIES TO PRESENT STRONG FINANCIAL RESULTS. What are some examples of audit risk that will help the board of directors to understand the significance of audit risk during an audit? In the Bilrite case, a major area of concern is the increase in sales volume for 20X9, accompanied by a decrease in unit costs, an increase in the gross profit rate, and a decline in inventory turnover. The fact that the sales increase was not budgeted causes even greater concern. These abnormalities should prompt the auditors to raise questions about the existence, occurrence, and valuation/allocation assertions. The assertion in this instance, relates to inventories and whether quantities may have

been inflated; relates to sales revenue and whether the transactions actually occurred; and valuation and allocation relates to the reduced inventory unit costs and whether inventory costs were debited to other asset accounts (e.g., self-constructed assets). More specifically, the auditors must determine whether were on hand at 12/31/X9, whether sales actually occurred in 20X9, and whether the ending inventory carrying values include all inventory costs and whether other asset accounts contain costs that should be charged to inventory or the decline in inventory turnover should prompt the auditors to increase their attention to the audit of inventory. Based on the analysis, the auditors may wish to inherent risk in most areas. Although lack of product diversification within the production cycle reduces audit complexity, the geographic dispersion of warehouses and sales offices increases the complexity of the inventory audit. Additionally, failure of the internal audit staff to adequately test either transaction processing or inventories should be cause of concern. The increase in sales revenue, and the fact that the increase was unplanned (i.e., not

included in the budget), the decrease in inventory unit costs, the expanded gross profit rate, and the decline in inventory turnover suggest assessing inherent risk at 100 percent for the revenue cycle as well. These assessments should lead to additional in the areas of accounts receivable confirmation, sales cutoff, and inventory auditing. The $4 million gain on disposal of plant assets should also be audited carefully for possible .Also, the Bank Two loan agreement needs to be carefully examined for proper disclosure of terms and conformity with restrictive covenants. REFERENCES HTTPS://WWW.ACCOUNTINGCOACH.COM/BLOG/WHAT-ISMATERIALITY HTTPS://YOURBUSINESS.AZCENTRAL.COM/IMPORTANCEMATERIALITY-ACCOUNTING-20853.HTML HTTPS://WWW.MYACCOUNTINGCOURSE.COM/ ACCOUNTING-DICTIONARY/AUDIT-RISK

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