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Audit Essay

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Contents

Introduction: 2

Management Assertions: 2

Evaluations of the Assertions: 4

External Market Forces: 6

Overview: 6

Market Factors which affect the Financials of the Company: 6

Political, Legal and Government Forces: 6

Economic Forces: 7

Social Forces: 7

Technological Forces: 7

Demographic Forces: 8

Market Factors which Creates the Influence over the Audit Firms: 8

Supply and Demand: 8

Associated Fees: 9

Competition: 9

Quality: 10

Regulators actions to manage the External Audit Market: 11

Conclusion: 12

References 13

 

Introduction:

Many companies in the world are governed and owned by different parties such as shareholders own the company while management takes responsibility for day to day operation. As the company does not manage by the owners, therefore, the owners of the company need assurance over the credibleness of the reports (financial statements), present by the management at the end of the year. To obtain the assurance on the financial statement they mainly appoint an independent external audit which conducts an external audit over the financial statement of the company.  (Winter, 2015)    

External audit is defined as the sporadic audit which is conducted by a qualified auditor. The main aim of the audit is to certify that whether the financial statements of the company present the true and fair value or not and whether the financial statement of the company is prepared in accordance with the applicable financial reporting framework or not. (CareersinAudit.com, 2014)

To ascertain the truth and fairness of the financial statement, the auditor has to certify the management assertions according to which they prepare the financial statements. Along with this, they also have to understand the external forces which can affect the overall audit. This will help in determining the appropriateness of the reported assertions and the financial statements.

Management Assertions:

To prepare the financial statements of the company, management makes explicit and implicit claims or assertions with respect to the measurement, recognition, and presentation of the assets, liabilities, income, expense, equity, and disclosures which conclude that the financial statement is in accordance with the applicable financial reporting framework. The auditor is responsible to review these assertions and to provide an opinion about the objectivity of these assertions. (ACCA, 2016)

Management assertions are classified into following types:

Assertion Mnemonic Explanation
Accuracy A The assertion of accuracy is defined as the assertion which reflects that all recorded transactions in the financial statement have been recorded at their appropriate amount.
Completeness C The assertion of completeness is defined as the assertion which reflects that all transactions which should be recognized have been recorded in the financial statement.
Cut-Off C The assertion of cut-off is defined as the assertion which reflects that the transactions in the financial statement are recorded in the correct accounting period.
Allocation A The assertion of allocation is defined as the assertion which reflects that all recorded assets, liabilities and equity balances in the financial statement are recorded at appropriate amounts and any resulting allocation or valuation has been adjusted.
Classification and Understandability C The assertion of classification and understandability is defined as the assertion which reflects that all transactions are presented and classified appropriately or fairly in the financial statement.
Occurrence O The assertion of occurrence is defined as the assertion which reflects that all recorded transactions in the financial statement have occurred and related to the entity.
Valuation V The assertion of valuation is defined as the assertion which reflects that all recorded assets, liabilities and equity balances in the financial statement are valued appropriately.
Existence E The assertion of existence is defined as the assertion which reflects that the recorded assets, liabilities and equity in the financial statement exist at the period end.
Rights and Obligation R The assertion of rights and obligation is defined as the assertion which reflects that the entity has the right to use all recorded assets and has an obligation to fulfill all recorded liabilities of the financial statement.

 

Evaluations of the Assertions:

To evaluate the above assertions or to conduct an audit external auditor uses different procedures, some of them are: (Jr., 2012)

Inspection: It is an audit procedure which is used to examine internal and external records which are held in various forms such as paper, electronic and others. The inspection provides the evidence for the assertion of existence and policies of the company, however, it does not provide any evidence about the assertion of rights and obligation.

Observation: It is the audit procedure in which the auditor looks at a process. The evidence obtained from this procedure has limited use such as use for that particular time. Mostly auditor uses this procedure at the inventory count time.

External Confirmation: It is the audit procedure in which the auditor circulates the confirmation letter to the external parties. The evidence obtained from this procedure is considered as the most appropriate one because it is generated by the external source.

Recalculation: It is the audit procedure that is used to determine the mathematical accuracy of a transaction. In this procedure, auditor recalculates an amount to determine its mathematical accuracy, however, accuracy relating to the estimation cannot be determined through this procedure.

Re-performance: It is the audit procedure in which an auditor re-performs a process to verify the validity of certain assertions.

Analytical Procedures: It is the audit procedure which is used at every stage of the audit to verify the different assertion. In this procedure, auditor verifies the assertion by understanding the plausible relationships between non-financial and financial data and by comparing the current year’s results with the previous year. (CPD Article, 2015)

External Market Forces:

Overview:

External audit is defined as the statutory audit, in this audit, the external auditor is required to analyze the financial statements of a company and then provide his/her opinion about the fairness of the financial statement to the shareholders of the company.

Many external forces jeopardize the effectiveness of the audit therefore to determining an opinion, the auditor must analyze the internal working environment and policies of the business as this will help in evaluating the financial condition of the organization. However, as the companies operate in an environment, therefore, it is possible that this external environment may also affect the financials of the organization. Therefore, the auditor must take care of these external market forces as well. Along with this to conduct, effective audit firms have to understand the market factors which may influence their performance. Some of the external forces which may affect the financials of the company and which may create influence over the audit firms are as follows: (Johnston, 2017)

Market Factors which affect the Financials of the Company:

Political, Legal and Government Forces:

The decisions of the government impact either positively or negatively on the results of the company’s financials. For example, if a government imposes high regulations over the area which is considered as the biggest source of income for an organization, then it will affect negatively on the company’s results. On the other hand, if the government deregulates some of the regulations, then it will indicate an opportunity for the company to grow and hence it may increase the overall income of the company. In respect of this force, the auditor must take care that the management assertions or organization’s financials are in line with the political, legal and government environment. (Moore, 1989)

Economic Forces:

The auditor should also analyze the economic position of the country as this will help in determining the opinion over the financial results of the organization. For example, if the financial results of an organization deteriorate and at the same time the economy of the country is in a recession phase, then the auditor may understand the reason behind the worse results. However, if this is not the case and instead of recession the economy is in robust phase, then the auditor may conclude that the company is in a worse position which may affect his/her opinion. Hence we can conclude that the performance of the organization is directly related to the economic forces. Thus auditor has to ensure that the management assertions or organization’s financials are in line with the economic forces. (Husam Al-Khaddash, 2013)

Social Forces:

The social factors also affect the financials of the company. For example, if there is a significant shift in the tastes of the public then it will affect the sales of the company moreover, in the current era, the public has become educated in relation to the green technology hence this social change will affect drastically on the sales of the technological companies. Therefore, the auditor has to understand the social trend as this will help in ascertaining that whether the financials such as sales of the organization are in line with the social forces or not. (Low, 2004)

Technological Forces:

Technology is considered as the backbone of any organization. The enhancement in technology affects significantly on the results of the company. For example, the film industry is moving towards digitalization which is significantly increasing its sales and revenues. Moreover, due to technology a company may shift from traditional environment (paper) to computerized environment hence this will reduce the overall expenditures of the company. Hence we can conclude that boost in technology affects the organization’s results enormously therefore, the auditor has to understand that whether the industry in which the organization operates uses vast technology or not. This will help in determining that whether the projected figures are appropriate or not. (Titman, 1986)

Demographic Forces:

Demographic changes may affect the results of the company either positively or negatively. For example, if people shift from telephones to mobile phones then it will affect positively on the mobile industry while negatively in the telephone industry. Hence by understanding the demographic force auditor can determine the reasonableness of the financial results of the company. (MICHAIL, 2014)

Market Factors which Creates the Influence over the Audit Firms:

Supply and Demand:

Shareholders are the main party who needs assurance about the creditworthiness of the company’s financials. However, in addition to the shareholders, there are many other parties such as debt providers and potential acquirer who needs the audited financials to make the future decisions. These users need high assurance about the financials of the company, therefore, prefer those audit firms which provides a high quality of services. This indicates that the demand for effective audit is high in the market. Big four firms have high caliber staff along with as they have a high number of staff, therefore, they can implement effective safeguards to mitigate the potential threats such as self-review, familiarity, independence and other threats. Hence we can say that most of the users prefer audited financials of Big four firms hence this indicates that the supply of effective audit is low in the market and this creates the influence over the other audit firms. (David C. Hay, 2006)

Associated Fees:

Audit Firms mainly determine the audit fess using two streams the needs of works and required expertise as big four firms have high experts, therefore, the fees charged by them are high. Most of the management assumes that the audited financial statements have very little use, therefore, they become reluctant in paying higher audit fees and hence prefer that firms which charge lower amount. This emphasis many firms to reduce their fees and in doing this, they mainly compromise with the quality of the audit. Hence from this analysis, we can conclude that the fees are another factors which impose influence over the audit firms. (Francis, 1988)          

Competition:

Due to the above factors (Supply and demand and fees), the competition in the audit market has been increasing so significantly. Each firm tries to capture a high market share and doing this they mainly provide many other non-assurance services and by-products such as report over the internal controls of the company and others.

These non-assurances services and byproducts affects significantly over the quality of the audit because to make the competitive essence audit firms operates according to the clients such as they reduce its audit fees and increase other services fees this creates many threats such as self-review and advocacy threat an (i.e. service relating to the preparation of financial statement and secondment of the staff will create self-review threats and negotiations services will create advocacy threat). Hence we can conclude that the competition factor also affects adversely on the audit firms. (TIM PEARSON, 1994)

Quality:   

There are many factors which affect the assertions of the company some of the assertions which are affected by the above stated external factors are as follows:

Existence:

To understand the effect of external forces on the existence assertion assume that the government impose some regulation over the use of certain assets or deregulate some assets. If this is the case, then it may cause the occurrence of some assets or liabilities. Along with this, it is also possible that due to the demographic or social trends an asset may become obsolete but this assertion does not specify which assets should or should not be verified for the existence. To understand the effect of external forces over the assertion auditor should have high expertise in relation to understand the effect of external forces over the assertions and ultimately over the financial statement of the company.         

Completeness:

The assertion of completeness states that all the transactions should be recorded in the financial statement of the company. However, if we analyze the market forces, then we can conclude that there are many factors which may generate some hidden transactions such as the legal force (i.e. it is possible that the government changes the regulation which may create some obligations). If the obligation is not due to any internal event then it will be difficult for the auditor to identify and to obtain sufficient and appropriate audit evidence about this transaction under the completeness assertion. However, an experienced auditor can obtain sufficient and appropriate evidence in the above case.

Valuation:  

External forces also affect drastically on this assertion such as technology and economic. For example, if a new technology is introduced in the market then it will adversely affect on the values of the accounts of the company which uses old technology hence it will be difficult for the auditor to determine the actual amount of the account balances which has been affected by the external forces. Again an experienced auditor using its experience can tackle out this problem.

Concern:

From the above analysis, we can conclude that there are many external factors which can affect the financials of the company. Therefore to maintain the quality of the overall audit the audit firm has to hire experts in their firms. Hence this indicates that this is another factor which affects drastically in the audit market. (Linda Elizabeth, 1981)

Regulators actions to manage the External Audit Market:

To manage the audit market that no one can obtain advantages over the other the regulators create many barriers such as they define that to reduce the risk of familiarity auditor should be rotated after the predefined period. Along with this they also state that certain non-assurance services such as preparation of financial statement should not be provided by the audit firms to the audit client. Along with this the regulators also define that fees from non-assurance services should not exceed the predefined threshold. These all indicate that the regulators take effective steps to manage the audit market.  (Arruñada, 2000), (Stella Fearnley, 2005)      

Conclusion:

From the above analysis, we can conclude that external forces such as government intervention, change in economics, social, technological and demographic trends affect drastically over the financials of the client. Along with this external force such as supply and demand, audit fees, quality and competition also affect significantly to the audit market.

These both affects give advantages to some players such as big four firms in the market over the others. However to control these inequality regulators take effective steps. Hence, therefore, we can conclude that the market is highly regulated one, therefore, no one can take advantage over the other.  

References

ACCA. (2016). THE AUDIT OF FINANCIAL STATEMENT ASSERTIONS. www.accaglobal.com.

Arruñada, B. (2000). The Provision of Non-Audit Services by Auditors: Let the Market Evolve and Decide. International Review of Law and Economics .

CareersinAudit.com. (2014). The Basics of External Audit. www.careersinaudit.com.

CPD Article. (2015). Designing and performing audit procedures for obtaining audit evidence. www.accaglobal.com.

David C. Hay, W. R. (2006). Audit Fees: A Meta-analysis of the Effect of Supply and Demand Attributes*. Comtemporary Accounting Research .

Francis, D. T. (1988). The Effects of Auditor Change on Audit Fees: Tests of Price Cutting and Price Recovery. The Accounting Review .

Husam Al-Khaddash, R. A. (2013). Factors affecting the quality of Auditing. International Journal of Business and Social Science .

Johnston, K. (2017). What Are 5 External Forces That Should Be Examined As Part of an External Audit? bizfluent.com.

Jr., W. F. (2012). The Sequencing of Audit Evidence:. Accounting and Business Research .

Linda Elizabeth, D. (1981). Auditor size and audit quality. Journal of Accounting and Economics .

Low, K.-Y. (2004). The effects of industry specialization on audit risk assessments and audit-planning decisions. The Accounting Review .

MICHAIL, D. A. (2014). Marketing Audit Tools: External Environment. Business Strategy Marketing .

Moore, G. a. (1989). Auditors’ Legal Liability, Collusion with Management, and Investors’ Loss. Contemporary Accounting Research .

Stella Fearnley, P. V. (2005). Auditor Independence and Audit Risk: A Reconceptualization. Journal of International Accounting Research .

TIM PEARSON, G. T. (1994). Competition in the Market for Audit Services : The Effect of Supplier Concentration on Audit Fees . Contemporary Accounting Research .

Titman, S. a. (1986). Information Quality and the Valuation of New Issues. Journal of Accounting and Economics .

Winter, M. (2015). Four Reasons Your Company Needs an External Auditor. www.simonlever.com.

 

Posted on December 6, 2017 in Uncategorized

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