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Audit Planning Practice Analysis

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This coursework will be divided into two sections. The first section will discuss the key issues relating to audit planning, business risk and audit procedures and the second section will discuss the aspects of GB Food Ltd that need to be understood by BBK & Co audit team, additionally we will describe the audit procures in respect of the amount capitalised and the amount recognised as an expense.

Section 1;

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An audit can be referred to a systematic process of objectivity obtaining and evaluating evidence regarding assertions about economic actions and events to determine the degree of correspondence between these assertions and established criteria, and communicating the results to interest of the users.

[1] “The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements this is achieved by the expression of an opinion by the auditors on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.

In the case of most general purpose frameworks, that opinion is on whether the financial statements are presented fairly, in all material respects, or give a true and fair value view in accordance with the frameworks[2]”. There are three main stages of an audit; the planning, performing and reporting stage.[3] However, this section will focus on the planning stage of an audit by examining the key issues relating to an audit plan, business risks and audit procedures in regards to the International Standards on Auditing, we will explain the main aspects required to understand client’s business and the procedures needed to gain such understanding will be explained further.

Auditors can only begin with the planning stage once the official expectance or continuation decision made by the client has been obtained[4]. Only then they can commence performing their statutory obligations. The planning stage permits the auditors to focus their attention on high risks areas which enables them to decrease the audit risks[5]. Through the understanding of the entity and its environment, auditors will identify and assess the risks of material misstatement by developing an audit strategy. ISA 315 provides guidance on the following relevant aspects of the entity and its environment that necessitate to be understood during the planning stage; these are explained in the following lines; [6]

1. The relevant industry, Regulatory and other external factors including the applicable financial reporting framework.” [7]

According to ISA315, auditors need to understand their client’s industry given that every industry has specific risks generated by the nature of the business, Industry regulation and accounting conventions. By understanding the common risks to all companies in a particular industry, auditors can recognise whether there are any inherent risks in their client’s company. Given the Industry level, they will gain an overall understanding on the client’s position. Auditors are concerned with the status of their client within the industry, the comparison between the client and their competitors and the pressure of the competition level at that industry. They will assess their client’s status against its competitors and will focus on the issues that affect the demand by taking into consideration the level of demand for products and service that delivered by the companies. At the regulatory level, Auditors will gain an understanding on the effect that the government regulations have on their client’s business. Consequently, they will need to understand the following issues in order to avoid material misstatement; Accounting principles of the company, taxation, environment requirements and the laws and government policies. Auditors are also concerned with the financial reporting framework consequently, they will assess whether the applicable financial framework of the entity has been properly applied on the financial statements with regard to the nature of the entity, its objective and what is required by law or regulation. From an External point of view, auditors need to understand the external drivers that influence the client’s industry such as politic or economic factors as auditors are concerned with ability of their clients to survive to economic and politic pressures.[8]

1. The nature of the entity and its accounting policies [9]

In accordance to ISA 315, the required understanding of the nature of the entity and its accounting policies cope with the core of the entity. Auditors need to understand what type of operation, how the company is financed and the appliance of accounting policies. The business operations include the source of revenue that the company generates through; services, dealers or banking for example. To get the information they will look at the main customers, significant supplies of goods and services (for example long term contract) or transactions with related parties since they contain a high- risk of material misstatement (ISA 550). The types of the major Investment made by the company need to be understood by auditors these include; acquisition, mergers or disposal of a business division. For a better understanding, auditors will also look at how their client’s company is financed, this may include; Group-structure, debt structure or related party for example. It is important to note that financing activities and capital structure will allow auditors to determine the capacity of the company to continue as a going concern, it is a major part of the audit process as it will determine the type of audit opinion. One of the main considerations that auditors have is the client’s choice and application of the Financial reporting Policies since, it is the criteria on which auditors give guarantee. They look at how management applies and communicate accounting policies.[10]

1. Objectives and strategies and related business risks;

ISA 315 describes the objectives of an entity as “the overall plans for the company as determined by those charged with governance and management”. Strategies are the operational methods by which management tend to accomplish its objectives. However, significant conditions, events, circumstances, actions or inactions can adversely affect an entity’s ability to achieve its objectives and execute its strategies. On the other hand setting off inappropriate objectives and strategies may cause business risks. [11]The idea behind this approach is to prevent material misstatement by understanding business risks faced by companies in their normal course of activities and avoid bad strategy decision which can result in losses ( for example GB Food Ltd expansionary policies;). Auditors look at multiple aspects such as strategy, operational, Governance, Finance to evaluate the risks.[12]

1. Measurement and review of the entity’s financial statement performance [13]

This aspect will help the auditors to understand the measurement and review of the entity’s financial performance by looking at internal and external measures, which includes; key ratios, operating statistics, key performance indicators, industry trends, employee performance, variance analysis, and analyst report. Using these measures will help auditors to identify whether nonconformity in performance measures has caused financial misstatement.[14]

1. Internal control [15]

By using this approach auditors will make a judgement on the efficiency and reliability of the internal control systems. They will focus on the high risks areas where the systems are most vulnerable by looking at the following aspects; the control of the environment, the risk assessment procedures, control activities, information systems and monitoring of controls. The control of the environment takes into accounts the attitudes, awareness and actions of the directors and senior managers of the company. The risk assessments process looks at how management identifies business risks relevant to financial reporting ,how they estimate the significance of the those risks, how they assess the likelihood of their occurrence and what kind of actions they have decided to take in respect of those risks. Auditors will also obtain a full understanding of the information systems and the related business process. By using this approach they can also understand whether the control of activities or the monitoring of control is effective by considering relevant areas which will ensure them that management directives are carried out. Consequently, auditors will decide whether the entity needs implementation of controls. [16]

As we stated earlier, auditors are required to use certain procedures to gain such understanding and these are; analytical procedures, inquiry, observation and inspection. The analytical procedures are the assessment of financial information through an analysis of plausible relationships among both financial and non-financial data. These procedures will help auditors to understand their client’s business and variation in the business. Auditors may also wish to use the inquiry procedures, it can help them to gather information on the business such as sales trends, contractual arrangements with customers or the financial statement preparation. This can be done by interviewing the management team or people those responsible for financial reporting. The observation and inspection procedures involve a physical visit of the premises of the business from auditors. Auditors will observe the activities and operation of the business and inspect recorded documents relevant to financial reporting.[17]

Section 2;

Since, GB Food Ltd is large chains of restaurants we can argue that it operates in a monopolistic competitive market. This environment allows many competitors to produce or sell more or less distinguish products. An understanding on the level of competition within this industry can be relevant to us, since competitive industry can effect on our client’s profits[18]. However, the limitation of information does not permit us to understand our client’s position within this industry. In term of customers, GB Food Ltd provides four different types of food-atmosphere in their restaurants in order to fill in different customers’ expectations. Casual food, Fast-Food, Organic food or Luxury food, as they target different customers this can create multiple business risks. In the following lines, we will first identify and explain each business risks that our client is facing by each branch of the company.

From external level;

New regulatory requirements;

1. Increase in minimum wage rate, therefore it will increase the cost related to running the business and create a decrease in profits since, one third of the company’s employees are currently earning the minimum wage.

Nature of employment;

1. Low wage can create unhappy staff,

2. Risk of industrial actions. We look at these aspects since the majority of the company’s employees earn a minimum wage.

Health regulations;

1. Exclusion of targeting kids in order to prevent obesity, this can dramatically affect the entire company as fifty per cent of the turnover for this business segment comes from the sale of meals which target children.

Security and safety regulation;

1. Injury and hygiene issues the company’s reputation can be affected.

From internal level;

Expansion of bleu café

1. Huge expansion, from 250 to 500 restaurants

2. Spread out transactions can lead our client to lose control on the situation therefore, fraud and errors may occur.

1. High qualified food needs high trained employees in order to deliver customer expectations.

GB Food Ltd needs to align its objectives with its future performances as this could have bad repercussion on cash.

Expansion of Star Gazers;

1. Unrealistic plan.

2. The demand market needs to be correctly studied, as an unstudied market could lead the company to failure.

1. Appropriated suppliers in order to meet objectives of organic food.

Liquidity issues;

1. GB Food Ltd has suffered from a dramatic 65 % decrease in cash at the bank. Cash is vital for a company has it permits to survive in a period of crunch for example, and can avoid liquidation. It is important to note that GB Food Ltd total assets have increased due to the fact that they are expanding the business this may explain the decrease in cash at the bank.

Company overall profit;

1. Decrease in profit of 14 % can make the company less attractive to potential investors, therefore puts constraints on the obtainability of capital.

Turnover;

1. Jamie the Cook branch has went through a decrease in turnover.

2. Falling in the objective of maximising share market.

Debt structure;

1. Loans could cost more than what the company estimated.

Disclosure of information

1. Limited Data

Jamie the Cook;

The decrease in sales in has brought down the revenue to 8.62% less than the previous year; this can be due to a high level of competition in this segment. On top of these, an enormous amount of money has been spent on advertising and marketing the brand which represent 40 % of the total sales. Moreover, it appears that the advertisement won’t help the brand to increase their sales as; the new regulation on advertising funk-food for targeting children will be applicable in 2011. Imperative actions need to be taken to not decrease share market since, 50% of the sales are coming from food assigned for children. In regards to the expense of 145M incurred for advertising and marketing. Expenses, can be describe as a cost that business incurs through its operations to earn revenue therefore, auditors need to assess and make sure that this expense was necessary. The variance analysis of the budgeted expenditures against the actual expenditures will help to see whether the marketing department has committed any errors. If substantial differences are found we will need to investigate to find the material discrepancies by looking at relevant documentations.[19]

Toucan;

This branch generates 53.5% of the company sales. The company has increase sales by 21.3% this year despite the fact that there were some injury and hygiene issues which could have affected the branch reputation.

Star Gazers ;

This branch represents only 2 % of the overall turnover of the company for the first year, the branch brings the smallest revenue compared to the others branch. The company has planned to expand the company from 25 to 50 in 2 years’ time. However, this sound unrealistic since cash at the bank has decreased by 65 % which leave the company with only 122M. The company will need to borrow money from the bank in addition to their first loan in order to complete the expansion. Consequently, this situation can affect the whole company as a going concern by putting it in financial distress. Apropos to the amount capitalised for the construction, ISA 16 states that costs that are directly attributable to bringing the asset into working condition for its intended use should be capitalised[20], these can include for example; Borrowing costs [21], Professional services (for example; engineers), Land improvements. However, capitalisation should stop once the asset is ready to generated future cash flow.

Any additional costs will be counted as an expanse. Nevertheless, additional costs that can improve the asset’s performance will be capitalised.[22] In relation to the procedures that can be taken by our team, all the costs capitalised will have to match with the costs found in the nominal ledgers (for example; borrowing costs, material costs). Our team must check whether the management team has not treated by mistake revenue items as costs of capitalisation. Variance analyses (such as amount capitalised/expenditure budget or initial contract/actual contract) can also be discussed with the management team. In relation to cost capitalisation or the recognition of an expenses, in the both case auditors will make sure that the amount disclosed in the financial statement will correspond to relevant documentations such as; Invoices, payrolls, bank loan contract, advertisement invoices.[23]

Café Bleu Bars and Grill;

This branch contributed to 19 % of the total company’s revenue in 2010; from 2009 to 2010 the sales have increased by 3.5 %. Within a year the company has planned to expand from 250 restaurants to 500 restaurants. From a financial aspect, the company will necessitate a huge amount of capital to achieve such a project considering the market target, which implies acquisition of central premises plus the refurbishment of the entire restaurants very three years. By considering the decrease in cash at the bank by 65% plus small period of time given, we can conclude that this project looks extremely implausible.

Conclusion;

As demonstrated earlier, the planning process required an understanding of multiples aspects of the company. During the planning process, we came across many business risks. One of the major risks found during the planning process was the unrealistic expansion plans steed for Star gazer and Café Blue. In facts, after assessment, we have concluded that the company have made a bad strategic decision which could lead it to a huge loss as the management did not take into account the company’s liquidity and the period of time. This situation may affect the whole company to continue as a going concern.

The strategy of the business need to be reviewed imperatively, more time is needed for the expansion of the two brands. The refurbishment of Café Blue is expected to be completed every three years; however it should be done only if it is necessary as it will permit to minimize costs. For Star gazers, we suggest that the expansion plan should be temporary stopped in order to make some market research. The assessments have also brought us to conclude that external events such as regulation on health or wage will affect the company profitability for next year. Jamie the Cook restaurants, one of the highest revenue makers are expected to lose in revenue due to the health regulation. To improve the profitability of the brand the company could redesign the menus by using low fat menus with the hope to regain the equity market in. In respects of Toucan brand, the company should invest money on training personnel in order to cope with the health and security regulation as this may affect the brand’s reputation.

References ;

1. Auditing, A. Millichamp & J. Taylor, tenth edition

2. Internal Auditing Manual second ed. (1989) Gorham & Lamont

3. Internal Auditing Manual second ed. (1989) Gorham & Lamont.

4. Financial accounting and Reporting, B. Elliott and J. Elliott , 13th ed.

5. ISA (200, 210, 300, 315,16, 23) www.ifa.org

6. The Audit Process, I. Gray and S. Manson, fifth ed.

7. Managerial Economics and business strategy, McGraw-Hill Higher Education; 7 edition (2010)

| Page

Audit planning, business risk and audit procedures.

[1] Principles of auditing, second edition, Rick Hayes and The Audit Process, I. Gray and S. Manson, fifth ed.

[2] ISA 200 www.ifa.org

[3] Internal Auditing Manual second ed. (1989) Gorham & Lamont.

[4] ISA 210 Para. A21 www.ifa.org

[5] ISA 300 Para. 2

[6] Internal Auditing Manual second ed. (1989) Gorham & Lamont and The Audit Process, I. Gray and S. Manson, fifth ed.

[7] ISA 315 Para. A17-A22

[8] Internal Auditing Manual second ed. (1989) Gorham & Lamont.

[9] ISA 315, Para. A30-A34

[10] Internal Auditing Manual second ed. (1989) Gorham & Lamont.

[11] ISA 315 Para. A36-A42 www.ifa.org

[12] Auditing, A. Millichamp & J. Taylor, tenth edition

[13] ISA 315 Para. A 49-A72 www.ifa.org

[14] Auditing, A. Millichamp & J. Taylor, tenth edition

[15] ISA 315 Para. A49-A72 www.ifa.org

[16] Auditing, A. Millichamp & J. Taylor, tenth edition and

[17] Internal Auditing Manual second ed. (1989) Gorham & Lamont

[18] Managerial Economics and business strategy, McGraw-Hill Higher Education; 7 edition (2010)

[19] Financial accounting and Reporting, B. Elliott and J. Elliott , 13th ed.

[20] IAS 16 www.ifa.org

[21] ISA 23 www.ifa.org

[22] Financial accounting and Reporting, B. Elliott and J. Elliott , 13th ed.

[23] Auditing, A. Millichamp & J. Taylor, tenth edition.

Cite this Audit Planning Practice Analysis

Audit Planning Practice Analysis. (2017, Dec 24). Retrieved from https://graduateway.com/audit-planning-2/

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