Auditing Audit Risk

Question: Discuss about the Auditingfor Audit Risk. Answer: Risk Factors Present in the Audit Engagement: An audit risk (AR) could be stated as unacceptable report, which an auditor develops for failing to detect the manipulation related to transactions or the frauds inherent in that account. The major risk factors involved in this particular audit engagement include inherent risk (IR), detection risk (DR) and control risk (CR) and it is computed as follows: AR = IR x CR x DR As pointed out by Carson, Redmayne and Liao (2014), the risks associated with the nature and types of the business or financial transactions are adjudged as inherent risks. In case of MGC Limited, the cash transactions have greater IR compared transactions settled through cheques. The CR is the risk, which takes place through manipulation of the financial transactions or conduction of an error in the books of accounts that the internal control systems of an organisations have failed to identify or correct the same. For MGC Limited, the appraisal related to internal control has been higher, as there is absence of job separations. The probability of obtaining the misstatements, manipulations and undetected frauds is regarded as detection risk (Kumar and Mohan 2016). The main reasons that these risks have aroused in MGC Limited are due to the sampling factors and human factors, while the control risks took place because of the inefficiency of the internal control systems. Analytical Review with Key Financial Ratios and Identification of the Key Areas Requiring Special Audit Attention: The aim of financial auditing is to evaluate the statement of financial transactions of an organisation along with providing an accurate overview of its business transactions (McGain et al. 2015). Therefore, the financial auditor has applied ethical and professional judgement at the time of carrying out the audit process of MGC. The approach of the auditor has been neutral for depicting an accurate overview of the financial transactions associated with the business. After evaluating the financial ratios of MGC, the same has been compared with the industrial average. The financial ratios of MGC Limited for the years 2014-2016 have been provided in the form of a table (Refer to Appendix). It has been found that the solvency position of the organisation has deteriorated in 2016 in contrast to the past two years. The current ratio of MGC has been 1.60 in 2016, while the industrial average has been 2.01 in the same year, although the ratio has improved compared to the previous two years ( Parker 2013). In addition, the industrial average of quick ratio has been 1.15 in 2016 and the same for MGC Limited has been 0.54 in 2016, which has improved in contrast to the previous year. The debt-to-equity ratio of MGC denotes that the firm has deployed greater debts in its capital structure, as highest debt amount has been realised in 2016 and the lowest debt amount has been realised in 2014. The times interest earned ratio denotes that the firm has the highest capability of repaying its debts in 2014 and lowest in 2015; however, the ratio has been below the industry average in 2015 and 2016. The average collection period for MGC Limited has increased in 2016 (39 days) compared to the past two years. This signifies the poor liquidity position, as the industrial average has been 32 days in 2016 (Scaife et al. 2016). From the average payment period, it has been found that the company has blocked its cash assets for the longest time in 2014 (104 days) compared to 2015 and 2016. The inventory turnover of MGC has been lowest in 2015 (187 days) and it has been highest in 2016 (233 days). The gross profit of MGC has been highest in 2014 and the lowest in 2015 and the same trend is observed in case of net margin as well; however, both the ratios have performed well below the industrial standards (Singh et al. 2014). The auditor has not found any misstatement in materiality and as a result, there is absence of audit risk. The organisation is needed to minimise the debt level in capital structure to settle off its debt obligations effectively. In addition, it is necessary to minimise the credit terms and increase the rate of inventory turnover. Finally, MGC needs to reduce its costs for enhancing revenue level in order to achieve higher gross and net incomes. Recommendation of the Overall Audit Strategy for the Engagement: The audit needs to focus on substantive procedures to address the issues of risk controls and material misstatement. Thus, the combined approach would be deemed fit for this engagement in relation to the below-mentioned values: According to the audit evidence, MGC Limited realises unnamed revenue. In this case, issuance of qualified opinion is required for rectifying the same. It is necessary to determine if there are cases related to early realisation of income. The allowances account and sales return need to be considered. It is crucial to assure the recording of discounts provided to the customers. In case, they are unrecorded, it might result in overstatement of sales account. References: Carson, E., Redmayne, N.B. and Liao, L., 2014. Audit Market Structure and Competition in Australia.Australian Accounting Review,24(4), pp.298-312. Kumar, E.P. and Mohan, B., 2016. Origin And Development of Auditing.PARIPEX-Indian Journal of Research,4(9). McGain, F., Jarosz, K.M., Nguyen, M.N.H.H., Bates, S. and OShea, C.J., 2015. Auditing operating room recycling: a management case report.AA Case Reports,5(3), pp.47-50. Parker, R.H., 2013.Accounting in Australia (RLE Accounting): Historical Essays(Vol. 58). Routledge. Scaife, W.A., McGregor-Lowndes, M., Barraket, J. and Burns, W., 2016. Giving Australia: Literature Review Summary Report. Singh, H., Woodliff, D., Sultana, N., and Newby, R., 2014. Additional evidence on the relationship between an internal audit function and external audit fees in Australia.International Journal of Auditing,18(1), pp.27-39.