Auditing

STATE AUDITING IN THE PHILIPPINES Reported by: MYRLA P. SEDENIO RUTH C. TACUJAN A. OBJECTIVES I. To Discuss the State Audit System 2. To Identify Issues and Limitations of Government Auditing 3. To Discuss the Measurement of Government Performance B. INTRODUCTION The Philippine Constitution emphasizes the importance of accountability in the government. Article XI simply and bluntly begins: “Public office is a public trust,” before it adds that officials and employees should serve the people with “responsibility, integrity, loyalty and efficiency.   In the government budget cycle, accountability is laid down by the need for government agencies and departments submit to submit quarterly and monthly income statements; statements of allotment, obligations and balances along with other financial reports and documents for audit – a formal process whereby the authenticity, accuracy and reliability of financial accounts or transactions are checked and approved.

There are several kinds of audit: One is Financial Auditing wherein financial transactions and accounts are checked to ensure the submitting government agency has complied with the rules and regulations, specifically the pre-agreed and government accounting system. Another type is Performance Auditing whereby one is looking at the systems of the agency to assess it has delivered on its institutional purpose and mandate by linking the budgets with results or results-based budgets. An internal audit, as the name suggests, an internal check on agency systems and processes.

External Auditing involves an outside audit body being brought in to look at the agency. Pre-auditing refers to auditing by agencies before approval of transactions while post-auditing is auditing by an independent body after. The Philippine government has agencies mandated to ensure accountability and transparency on its overall operations. These agencies are: The Office of the Ombudsman, Sandiganbayan, Presidential Anti-Graft Commission, the Civil Service Commission and primarily, for the purpose of this paper, the Commission on Audit. C. STATE AUDIT SYSTEM

Auditing is the examination of information by a third party other than the preparer or user with the intention of establishing its realibility, and the reporting of the results of this examination with the expectation of increasing the usefulness of the information to the user. Commission on Audit The Commission on Audit (COA) is the constitutional commission mandated to be the supreme audit institution of the government. It has jurisdiction over national government agencies, local government units, government-owned and controlled corporations and non-government organizations receiving benefits and subsidies from the government.

The Constitution identified the following functions for the Commission:  1. Examine, audit and settle all accounts pertaining to the revenue and receipts of, and expenditures or uses of funds and property owned or held in trust by, or pertaining to, the government; 2. Promulgate accounting and auditing rules and regulations including those for the prevention and disallowance of irregular, unnecessary, excessive, extravagant or unconscionable expenditures, or uses of government funds and properties; 3.

Submit annual reports to the President and the Congress on the financial condition and operation of the government; 4. Recommend measures to improve the efficiency and effectiveness of government operations; 5. Keep the general accounts of government and preserve the vouchers and supporting papers pertaining thereto; 6. Decide any case brought before it within 60 days; 7. Perform such other duties and functions as may be provided by law. COA, as the other constitutional commissions are mandated, is headed by a Chairman and two Commissioners appointed by the President and the Commission on Appointments of Congress.

It also enjoys fiscal autonomy which means its appropriations must be released regularly and automatically. The Commission also deploys resident auditors in all national government agencies, local government units and government-owned and controlled corporations pursuant to its mandate to review each agency’s financial operations in a risk-based audit approach. The Commission on Audit (COA) has developed and introduced a risk-based audit approach (RBAA) that emphasizes the need for the auditors to focus on high-risk areas that are potential breeding grounds for graft and corruption.

Auditing plays an important role in public finance, the Auditing Code of the Philippines was promulgated in 1979 (P. D. 1445). As it proceeds mainly from the basic law, the Code amplifies, elaborates, specifies, and implements Under the declaration of policy in the Auditing Code, it is stated that all resources of the government shall be managed, spent and utilized in accordance with law and regulations and safeguard against loss or wastage through illegal or improper disposition, with a view to ensuring efficiency, economy and effectiveness in the operations of government.

COA reports In order to perform its audit functions, COA produces different kinds of reports. A study by the Philippine National Budget Monitoring Project identified and explained each of these: 1. Regular Annual Audit Report of each NGA, LGU and GOCC 2. Consolidated Annual Financial Report for NGAs, LGUs and GOCCs 3. Special Audit Reports 4. Circulars and other Issuances The Annual Audit Reports contain the results of the audit conducted on the financial statements submitted by agencies, local government units and government-owned and controlled corporations to COA auditors.

The results are shown in the form of audit opinions indicating how the agencies faired with their financial statements at the end of each fiscal year. The types of audit opinions are: Unqualified (U), Qualified (Q), Adverse (A) and Disclaimer (D). An Unqualified Opinion refers to the “clean opinion” or the agency reflected the results of the financial statements fairly, which means its operations and the financial condition in a period of time based on existing government accounting standards, and in compliance with government laws, rules and regulations.

A Qualified Opinion means that an agency reflected fairly except for some specific transactions and/or accounts that have been found to be problematic, either improper, questionable or needs further explanations. Adverse opinion means that the financial statements did not fairly present its results of operations and financial condition of the agency, and are not in compliance with prescribed laws and applicable guidelines. Lastly, the Disclaimer opinion means that “there is no sufficient basis to form any opinion” for an agency does not keep or submit its records of financial accounts and transactions.

An audit report has the following parts: Audit Certificate, which shows the audit opinion, the Financial Statements, Major Findings and Observations which explains if there are defects in the compliance of accounting and auditing rules and policies, and Recommendations to the entities. In turn, COA checks if these measures were conformed by the entity on the next year’s annual audit report. The Consolidated Annual Financial Reports on the other hand show the financial performance of the public sector in general.

Each level has a volume of the consolidated financial report, one each for NGAs, LGUs and GOCCs. These are based on the audit reports of each entity. These reports contain the financial condition and highlights of agencies, local government units and government corporations. These reports also reflect the financial resources of the government, even the off-budget accounts or funds that are not subject to annual appropriations. Interestingly, these reports are the only source where one can be informed about funds that are not sourced out from appropriations.

Special Audit Reports are purposely for investigation, in response to a request by interested parties or by a directive from Congress. The Commission has already undergone special audit reports on the country’s outstanding debt and special purpose funds such as the Agriculture and Fisheries Modernization Act and procurement of the Department of Public Works and Highways. GAFMIS The Government Accountancy and Financial Management Information System (GAFMIS) is a financial database which keeps the general accounts of the government.

It is spearheaded by the COA so as to implement its mandated function. Thru this, the appropriations are verified and allotment releases to agencies are ensured not to exceed the appropriations. From the Department of Budget Management (DBM), copies of Agency Budget Matrices (ABM) and Special Allotment release Orders (SARO) are submitted to GAFMIS and these make up the Registry of Appropriations and Allotments. The GAFMIS is also essential because it assists government agencies with the Electronic New Government Accounting System (e-NGAS).

It is a computerized program of the New Government Accounting System wherein budget transactions, allotments and obligations are recorded and monitored electronically. It also helps in streamlining the New Government Accounting System which provides the new accounting policies in the government. Some of the basic features of the new system are the Accrual accounting and One-fund concept. Accrual accounting recognizes the income when earned and expenses when incurred as oppose to recognizing income when cash is earned and expenses when paid.

Internal control and the internal control system Internal control is defined as a process effected by an organization’s structure, work and authority flows, people and management information systems which are designed to help it accomplish its goals. It is a means by which an organization’s resources are directed, monitored, and measured. It plays an important role in preventing and detecting fraud and protecting the organization’s resources. Internal audit is an integral part of internal control. It maintains efficiency and effectiveness in operations.

It looks at the reliability of financial transactions in reports by making sure that they are in accordance with rules and regulations. Several provisions in the Philippines have signified the internal control in the government such as Section 123 of the amended Presidential Decree 1445, the Administrative Code 1987 and Government Accounting and Auditing Manual guided by worldwide standards thru the International Organization for Standardization (ISO) and International Organization for Supreme Audit Institutions (INTOSAI). The INTOSAI also formulated standards for the internal control systems in the public sector.

It has emphasized that internal control systems shall be in line with the characteristics, values and context of the public organizations. In line with these provisions, the Government has formulated the National Government Internal Control System (NGICS) through the efforts of the DBM and resource and reference panels from various government agencies. It serves as a guide to government agencies in putting up internal control systems. It aims to strengthen accountability, safeguard assets, promote efficiency, economy and effectiveness in the operations and adhere with the policies of the organization. D.

Issues and Problems of Government Auditing In her public budgeting and accounting class, the late professor Emilia Boncodin stressed some issues on COAs mandate and the accounting and auditing system of the government as follows: 1. The audit system looks only on the agencies compliance with the accounting standards and laws in the financial reports instead of finding if the agencies have properly allocated their appropriate budgets. 2. Reporting of the GOCC’s entire budget What is reported in the government budget documents regarding the GOCCs are the budgetary support to government corporations or subsidies only.

Yet, COA audits the corporate operating expenses on the entire budget of government corporations. 3. Lax in penalizing because COA is limited to recommendatory functions only Adverse/disclaimer audit opinions and recommendations by COA to government agencies do not have the corresponding penalties or sanctions if they are not acted upon and followed. An example is DPWH’s audit report where it has been given an adverse opinion for the past 18 years. 4. Pre-Audit vs. Post audit Each type of audit has its own problems.

Post–audit is disadvantageous because it involves final evaluation of financial transaction – that is after the funds have already been disbursed. Pre-audit however, ironically defeats the overall essential purpose of auditing because financial transactions are assessed beforehand. In the past, COA had been operating on post audit basis since 1995-2009 when COA circular 2009-002 reinstituted the selective pre-auditing due to rising incidents and anomalous disbursements. However, Circular 2009-003 in June 16 2009 suspended some of the provisions in the earlier circular to ensure uniformity and consistency in its implementation.

On COA reports The Philippine National Budget Monitoring Project has identified the following limitations that affect the importance of COA reports in ensuring accountability: 1. Timeliness COA’s deadline on the submission of reports is not parallel to the schedule of budget preparation. Audit and financial reports must be submitted by end of September while budget preparation time ends in July when the Congress’ session opens. The timings would thus work best if reversed since the reports should serve as aids in reviewing the agencies’ budgets in time for budget legislation.

Given the reality, the value of COA’s reports being used as tools to determine the status of government entities in terms of financial performance and compliance with rules are nullified. 2. Completeness Audit reports of agencies are not completed on time due to inability of personnel and time constraints. In effect, this puts problems in reviewing the budget and in making the annual financial reports. 3. Availability Although COA’s website is useful in terms of the reports posted, many reports from agencies including those from LGUs and GOCCs are currently missing. 4. Contestability of findings

There are issues on COA’s findings on its reports. First is that the some of the past findings have not been resolved yet or the so-called “hereditary balance sheets. ” An example is the disallowances that must be deducted by agencies to employees. However, these have not been resolved even if some personnel have already left the service or died. Secondly, there is the inconsistency of audit rules by resident auditors. In some agencies, the rules of past auditors and new auditors differ like deductions that were not present in the past have already been installed at the time the new auditor comes to office.

The third issue is the unreasonable application of rules and regulations in auditing. Some expenses are disallowed even if it yields good results. The last issue is the inability of auditors to understand the situation of agencies’ operations. The operations have complexities that emergencies become inevitable and it is hard for them to look at the reasons for the issues in operations. 5. Feasibility of recommendations The COA’s recommendations on reports are not always being followed by agencies and these are already beyond the control of the institution. 6. Conflict of interest

COA auditors are still considered as “mere mortals” that may experience biases, influences and errors in judgment. There are often claims that some auditors are complicit in bribery and graft. On internal control and the internal control system The NGICS has identified the following limitations of internal control: Human error, i. e. , errors in judgment such as internal auditor’s biases/conflict of interest, negligence, misunderstanding, fatigue, distraction, collusion, abuse, etc. 1. Shifts in government policies or programs 2. Resource constraints 3. Organizational changes; and 4. Management attitude

E. Measurement of Government Performance Under COA Resolution No. 2002-005 dated May 17, 2002, the Special Audit Office was renamed Management Services to expand its services to include: a. Conduct of Value-For-Money audits and related operations review activities. b. Provide management consultancy services to other government agencies in such areas as: * Organization * Strategy Formulation * Financial Feasibility * Strategic Planning * Other related areas c. Coordinate with all offices of the Commission for the purpose of establishing feedback mechanisms on implemented innovations. d.

Formulate recommendations to the Chairman on the adoption of the most appropriate systems for the enhancement of operations. e. Perform such other functions as may be assigned. Recently, the Office is assigned to conduct Rate and Levy audits. The functions: Conduct of Value-For-Money (VFM) Audit This audit is concerned with the review of management efficiency with the end in view of eliminating waste and promoting efficient use of public funds and resources and the ascertainment of the agency’s effectiveness by determining whether desired results have been achieved and programs have accomplished their purposes and objectives.

Approaches in the conduct of VFM audits Agency-based approach An audit of a particular program, project or activity of a selected agency. Government-wide and Sectoral Performance Audits Government-wide and Sectoral Performance Audits are new approaches adopted by the Commission under COA Resolution No. 98-005 dated March 3, 1998. While these types of audits were introduced in 1998, it was only in 2002 that these approaches were operationalized under the COA-UNDP AusAID Project entitled “Enhancing the Public Accountability Programme of the Philippine Commission on Audit”.

Government-wide audit is the simultaneous examination of a management function or activity in a number of government agencies which is expected to provide: * basic data for comparing practices and operations between and among government agencies in the same sector or with the whole government; * collated data of practices in various government agencies that could show the magnitude or insignificance of deficiencies in the system; * audit criteria which are supported by best practices; * awareness on the part of auditors and the auditees of how their agency compares with other government agencies in terms of objectives, functions, operations, internal and administrative controls, and output; and * opportunities to the audited agency for benchmarking with other government agencies.

On the other hand, the Sectoral Audit refers to an audit of programs or activities that are delivered by more than one government agency and is expected to provide: * an overall picture of how various segments of a program are implemented and possibly lead to the identification of areas where improvements can be introduced; * audit criteria or benchmark for future audits of government programs by various government agencies; * basis for auditors to realize that program difficulties may not lie with a single agency but possibly with the way the agencies involved in the program work together; * an arena for airing program difficulties by audited agencies; and * opportunity for making changes in the program, if necessary.

Audit standards are set codes of conduct for auditors when auditing financial statements or other financial issues of a company. There is also a relation to performance audit and certain attestation engagements.

The American Institute of Certified Public Accountants (AICPA) established all Generally Accepted Auditing Standards (GAAS). GAAS, in turn, formed the basis for other standards like the Generally Accepted Government Auditing Standards (GAGAS) and the Public Company Accounting Oversight Board (PCAOB). This paper seeks to define those three standards, while clarifying the similarities and differences between them.

All the three standards have some underlying similarities. They all address the basic audit issues like transparency, accuracy, reliability etc of financial statements.

They all also spell out standards for audit field work and performances, simultaneously spelling out, on a dynamic base, the education and qualifications required of the audit and audit assistants. All the three standards ultimately target the protection of the firm and its assets or finances. They minimize operational risks. And though driven by different objects, GAGAS and PCAOB are based on the AICPA’s GAAS.

The different objectives of the three auditing standards results in a difference in their content, approach, criteria and specifications. Nowadays, the GAAS primarily deals with audits of non-issuer public companies. PCAOB, on the other hand, addresses the concerns of auditors auditing issuer and certified public companies.

Its hold in matters of issuer companies, as controlled by the American Securities and Exchange Commission (SEC) is paramount. GAGAS, as set by the Government Accountability Office, applies to government organizations or organizations availing government assistance, setting auditing standards for their functions, activities, programs and so on.[1]

Introduction

The external audits of governmental and non-governmental entities may be broadly classified into Financial Audits, Performance Audits and Attestation Engagements. Auditing Standards have some General Standards, as well as Field Work Standards and Reporting (GAO, July 2007).

The Generally Accepted Audit Standards (GAAS) are issued as Statements on Audit Standards (SAS)[2]. This is done by the Audit Standards Board or ASB which has been set up by the AICPA. These standards relate principally to the audit processes and procedures which are to be adopted by the public companies not issuing shares. [3]

The General Accepted Auditing Standards are sets of systematic guidelines used when conducting audits on company finances, to ensure accuracy, consistency and verifiability of auditor’s action and reports.

However, for auditing government bodies, the US Government Accounting Office sets separate rules and standards, outlined by the GAGAS. These include auditing of their activities and programs, as well as all their functions.

The objective is to ensure proper use of funded assistance availed from government bodies or agencies. (GAO, Jul 2008). Companies that issue shares and that are registered with the Securities and Exchange Commission were placed under the standards of the PCAOB[4].

As per the provisions of GAGAS, their reference incorporates GAAS, unless the Government Accounting Office specifically excludes them through a formal announcement. Sometimes, depending on the audit requirements and the organization being audited, GAGAS may be used together with PCAOB.

Basic Objectives and Premises behind all Audit Standards:

The similarities amongst all the auditing standards may be drawn from their basic premises and government policies driving them. For example, all auditing standards serve as a regulatory tool, prescribing the process to be followed by auditors, and determining what is to be scrutinized in the financial statements, internal control processes and management performances.

Audits done on an organization’s financial statements express an opinion on the fairness with which the statements represent the status and changes in the financial position, operational results and cash flows.

Universally, audits need to be performed by a person or persons who has/have adequate technical training and proficiency as an auditor. The auditors need to maintain their independence so that their assessment and opinions reflect an impartial and objective view of the issues involved. They are also expected to exercise due professional care in planning and conducting the audit report [5].

The auditor must have sufficient knowledge of internal control processes so as to enable him to plan properly and arrive at the nature, extent and timing of tests to be performed for ensuring a proper audit. While in the field, the work needs to be adequately planned and properly supervised.

The competency and sufficiency of evidence reviewed needs to be assured so that the auditor and others can form a proper opinion on the financial matters in the organization, which is subjected to the audit.

All performance audits have similar standards. The auditors must prepare written audit reports communicating the audit results[6].  The audit reports should be prepared and made available so as to ensure timely use by management legislative and other interested parties.

The auditors must report the scope, objectives and methodology of audits. They must report any significant findings of audits and in the applicable cases, also the auditor’s conclusions.

They should report recommendations for action. This is to correct problem areas and ensure operational improvement. They must state what auditing standard was used in the reporting. All cases of significant non compliance or abuse must be reported, found during or related to the audit. In some cases, this reporting has to be done to outside parties.

Appropriate inspection and observation must be conducted to gather competent and factual evidence so that a reasonable opinion on the financial state of affairs of the organization under audit may be formed.

Audit work must be properly planned & materiality considered for arriving at considered opinions based on competent evidence by selecting appropriate nature, timing & extent of tests. Audits must be designed so that material frauds may be detected reasonably well.[7] It is notable that frauds are intentional misstatements.

Material misstatements may result from direct & material illegal acts and this is to be considered in audit design so as to ensure the reasonable detection of such misstatements through the audit process.[8]  The auditor must detect any indirect illegal acts that may indirectly affect correctness of financial statements by applying audit procedures[9] (GAO, Jul 2007).

Every audit strives to maintain accountability and transparency within any organizational policy, whether for governmental or non-governmental organizations. To this end, public resources within an organization must be efficiently, ethically, effectively, equitably and economically utilized.

Where this is not the case, audits prescribe the remedial steps to be taken in a time-bound manner by the organization’s management and other concerned parties. All assessments by the auditors must be objective, concise, independent and factual, as related to an organization’s financial or management performance. The auditor therefore needs to be independent and impartial. All this adds up to a case for complete professionalism and quality of audit processes.

FASB (Financial Accounting Standards Board) plays the role of determining Generally Accepted Accounting Principles to ensure proper accounting standards are followed. According to FASB, revenue is recognized once it is earned.

Commission in Crazy Computer’s case is recognized immediately since Crazy Computers collects the cash on behalf of Third Party insurance and then pays it. Commission however should not be added to sales because when balancing the equation, Sales is equal to opening stock plus purchases less closing stock.

This means that by adding commission to sales the equation may not balance and it will be exaggerated. The commission revenue consists of income and it is therefore used in the final statements of accounts to calculate the profit of the business.

Commission received from TPI can therefore be used when coming up with profits for the year. In case Third Party Insurance agrees to re insure, revenue to be obtained from Third Party Insurance (TPI) will only be recognized after Third Party Insurance pays up the amount to Captive Insurance Company (CIC).

Commission revenue can only be recognized immediately if Crazy Computers will automatically be deducted from the $110 that the company gives to Third Party Insurance so that it does not have to wait for TPI to pay. This would mean that Crazy Computers would have $165 at the end of the sale then give $25 to TPI.

However, it may not show whether the computers on their own were able to sustain themselves without the boost from the commissions earned. When Crazy Computers introduce CIC, they will still get the commission but it will be offset when the amount received from TPI is added.

Even as Crazy Computers recognizes revenue from sale of third party insurance on behalf of TPI, it should be careful when it comes to receiving the money back for re-insurance through CIC. The best method to account for the funds to be collected from the Captive Insurance is to do them separately from Crazy Computers.

This is because Crazy Computers and CIC are two different kinds of businesses. FASB advices that in order to check the progress of a business it is good to gauge its profitability which is done by subtracting the expenses from sales made by the business.

This will ensure that when it comes to paying claims, revenue received from Crazy Computers should not be used for CIC obligations. It will also ensure that the money collected from CIC is not to be used in the computer business unless Crazy Computers borrows from CIC.

If Crazy Computers was to account for CIC revenue together with the computer revenue, calculating profits would get complicated since the revenue received is not made from sales only. In other words, treating the two businesses as separate entities will ensure the profitability of the two can be determined.

Crazy Computer’s idea to create a wholly owned subsidiary would be a good idea if the Third Party Insurer agrees to re-insure with them. Based on the transaction illustrated in the case study, currently Crazy computers pay $110 for insurance such that TPI takes responsibility for any obligations from customers.

Because CC gets commission for every sale made then from the $200 received it is left with $80 after paying the sales persons $10. With the introduction of CIC and if TPI agrees to re insure with CIC, CC will get $ 85 back out of the $110 paid to TPI.

This means that cash received goes up from $80 to $165. CIC would therefore be profitable. However, in case of any third party obligations CIC will be solely responsible. This is why it is extremely important for Crazy Computers to ensure that CIC’s income does not mix with computer income so as to ensure each department can sustain its own expenses.

Word count (635).

Reference

FASB. (2008). Financial Accounting Standards and Revenue Recognition.

            from http/www.fasb.org.

Q1.

Overlooking of the internal control system and the accounting function is a business risk and that is why it led to a 40% drop in the company profits. The managers of Nice On Pty Ltd has focused more on marketing and business development activities which has made them to overlook the control of the company’s internal operation and accounting function.  As a result the company’s internal control system is weak and the possibility of material misstatements in the financial accounts is very high (Luis Puncel, 2007). When the internal control system is weak inherent risks and control risks are very high since the internal policies are unable to detect or prevent the occurrence of a material misstatement (Bahram S.2007). Therefore, the occurrence of material misstatement in the financial accounts of Nice On Pty Ltd leads to inherent and control risks which will make me as the auditor to give an unqualified report. This business risk in Nice On Pty Ltd has therefore increased the chances of an audit risk.

The employment of few and unqualified personnel by the directors of Nice On Pty Ltd is a business risk since this leads to high chances of failure to comply with the accounting standards in the reporting of the companies accounts. For example the company Fiona Li to look after payroll, accounts payable and accost payable yet he does not have enough or adequate accounting skills. It has also employed Jason who has little knowledge in accounting knowledge.  Due to his inadequacy, Jason has commanded that no password be used in the accounting information system which makes him to have an access to the management accounts and profit statements. It is a business risk for Nice On Pty Ltd to let its accounting information system to be accessed by unauthorized people since they may change the account details.  Unauthorized access to companies accounting system together with having unqualified personnel in the company trigger financial misstatements which increase the chances of audit risks (Luis Puncel, 2007).

Employment of fewer employees by the company directors with the aim of obtaining high profits is also a business risk. This is because it will be strenuous for the available employees and they will tend to work under pressure. People working under pressure are likely to make errors which are material misstatements in the company accounts hence increasing the chances of audit risks (Bahram S.2007).It is as a result of the few employees that there are supplier invoices which have not been entered into the system. This increases the chances of an audit risk since some invoices may be unsorted by the end of that current year and hence material misstatement in the financial accounts.

The company valued its inventory at cost rather than at the net realizable value. All intangible assets should be valued at their net realizable value failure to which there will be high chances of inherent risks which make the auditor to give an unqualified opinion.  Also the fact that Mr. Sherk had not done an impairment test regarding the intangible asset recognized on the balance sheet face is a business risk since the company will find itself declaring untrue profits. This also increases the inherent risks for the company and any audit evidence obtained will show that the company’s reports are not true hence an unqualified opinion (Larry E. et.al 2009). The accounts payable control system of Nice On Pty Ltd is a bad since it is left under the control of one person who is also not experienced. The weakness of this control system is that it lacks supervision.  For example Fiona is fully in charge of the accounts payable system and he attaches remittance advice to cheques and sends them off to the suppliers. In this case, a supervisor should have been employed to verify the cheques and attachments before they are send to the suppliers to ensure that they are true as per the accounts payable details as this will reduce any chances of material misstatements in the financial accounts.

The fact that supplier invoices were sitting on Fionas desk since they had not been entered into the MYOB is an indication that the account payable may not be reflected in the books of account at that particular accounting or financial year. This therefore shows the inefficiency of the accounts payable system. This system also lacks a clear definition of duties which is experienced due to lack of enough personnel. Use of IT controls by Nice On Pty Ltd will be able to reduce material misstatements since the cheques will be send to the suppliers electronically and this will avoid any occurrence of errors and frauds (Larry E. et.al 2009). Through IT controls, the supplier details will be keyed into the system immediately a transaction is and this will save the company of unsorted invoices.

Even though the audit risks for Nice On Pty Ltd is high, there are high chances that the auditor will not detect some material misstatement in the financial accounts of the company.  For example there is a high detection risk in Nice On Pty Ltd concerning the fleet of 12 trucks used by the company.  From Mr. Sherks statement, it is clear that no financial records have been done on the amortization of the leased trucks and as a result no material misstatement will be detected. In my audit, I would use a substantive testing approach to obtain audit evidence concerning these trucks (Richard C. and Sandy 2007).Since the company has a weak internal control system, I would use a Substantive Test of Detail in which the lease agreement document will be checked against the financial report so as to give the auditor hard evidence.  Form this document, the auditor will be able to obtain information regarding the lease agreement. He will also obtain information concerning the amortization of the lease throughout its useful life from the company’s accounts from which he will give an opinion.

Q2.
Independence of auditors makes them to be objective in their professional judgment. That is, auditors should only have regard to relevant considerations to the client (Larry E. et.al 2009). Being a shareholder in the clients company compromises the independence of an auditor.  Therefore, allowing the accountant who owned shares in Nice On to be part of UCP’s auditing teams could lead to self-interest as a potential threat to the auditors. This type of threat arises when an auditor acts in accordance to his or her emotions for financial and other personal gains from the client. The ethical principles which govern the professional responsibilities of all auditors call for independence of thought and action (Ronald F. &Brenda S.2003). That is the auditor should not provide any other service to the client apart from auditing. If UCP’s could have allowed the auditor to join them, then they would have compromised their independence which is a fundamental ethical principle to all auditors: all auditors should be free of any self interest which may seem to be incompatible with objectivity and integrity.

The exclusive rights from Intellectual property gives the owner the mandate to enjoy the benefits derived from them. If an auditor owns part of the intellectual property of his or her client, then this becomes a threat to his or her independence (Larry E. et.al 2009). If the auditor owns the company’s intellectual property, then it means that he is also helping in the running and management of the company. The auditor’s independence says that an auditor should not offer any other service to the client outside auditing (Larry E. et.al 2009). This poses a self-interest threat since the auditor acts in accordance with his emotions with the am of gaining form the client.

As a result independence of the auditor as a fundamental ethical principle will be compromised or will be at risk. When an auditor compromises his or her independence, then the credibility of his or her financial reporting is questionable.

To eliminate this potential threat, UCP should not let the auditor to join the auditing team. That is it should only ensure that only the auditors who are kept their professional ethical principles join the team (Ronald F. &Brenda S.2003).

A potential safeguard that UCP could implement to reduce the occurrence of a similar risk in future is to prohibit nay of its team’s members from owning any shares or properties o f the audit client. It should also ensure that all the audit reports done by the auditor who is not independent are reviewed by another auditor.  The team should also do a thorough evaluation of the existing clients to assess any potential threat towards their independence or integrity. If any of the clients is found to exhibit a threat to their independence, then the team should either know how to mitigate the threats or stop auditing for the firm depending on the magnitude of the threats (Stefan Bode 2008)

References
Stefan Bode, (2008). Independence and Regulation. GRIN Verlag.
Richard Cascarino, Sandy van Esch, (2007). Internal Auditing. Juta and Company Ltd.
Ronald F. Duska, Brenda Shay Duska, (2003). Accounting ethics. Foundations of business ethics. Wiley-Blackwell.
Luis Puncel, (2007). Audit Procedures 2008.CH.
George G. Brenkert, (2004). Corporate integrity & accountability. SAGE.

Bahram Soltani, (2007). Auditing: an international approach. Financial Times Prentice Hall.

Alvin A. Arens, James K. Loebbecke, (1997). Auditing, an integrated approach
accounting. Prentice Hall.

Larry E. Rittenberg, Karla Johnstone, Audrey A. Gramling, (2009). Auditing: A Business Risk Approach. Cengage Learning.

Stefan Bode, (2008). Auditor Independence and Regulation. RIN Verlag.

Dimitris N. Chorafas, (2001). Implementing and auditing the internal control system. Palgrave Macmillan.

Certain accounts like Cash, Lines of Credit, and Intangibles have to be audited 100 percent because these generally involve perceptible and provable transactions which do not normally expend time in the entire audit process. These are also significant figures to a confectionary industry like Sweet Truths.

The accounts that are audited 100 percent needs to have materiality apportioned to such accounts; this is the reason why materiality is distributed only to those accounts that are sampled. In accounts like inventory, property, plant and equipment, and accounts payable, a number of transactions and verification have to be undergone and auditing them meticulously would take so much time.

Detection risk is the only component of audit risk that is within the control of the auditor. This risk may fall under the control of an auditor by means of knowing the range of the audit procedures performed by him or her as an auditor.  From the balance sheet accounts in the simulation provided, I presumed the audit risk is at high while having inherent risk and control risk at low for a certain detection risk at high.

            The reason the three risks that compose audit risk are inter-related is that they support the assessor like an auditor to ascertain the extent of auditing systems and procedures in a certain balance of account or in a group of transactions. The three risks namely, inherent risk, control risk and detection risk are deemed to be the products of an audit risk model. Both inherent risk and control risk cover the account balance or class of transaction, its associated claims and assertions that possibly contain erroneous reports that could be substantial to the financial statements upon combination with statement flaws in some other balances or classes. Detection risk, as defined, is an audit procedure that leads the auditor to conclude that erroneous statements which could be material do not exist when in the actual setting such incorrect statements do exist. The higher would be the identified audit risk, the lesser is the evidence of risk that has to be accumulated by the auditor, vice versa.

4

References

Austin Community College District (2007, May 16) Detection Risk. Retrieved July 15, 2008, from http://www.austincc.edu/audit/glossary/d.php

FratFiles (n.d.) The World of Risk. Retrieved July 15, 2008, from http://www.fratfiles.com/essays/74742.html

Reyhl, Duane (2006, May 28) Materiality. Retrieved July 15, 2008, from http://www.reyhl.com/peer_review/materiality.html

Australian Educational Research Pty Ltd. (n.d.) Audit Risk. Retrieved July 15, 2008, from http://www.abrema.net/abrema/risk_concepts_g.html

University of Birmingham (n.d.) Audit Risk, Retrieved July 15, 2008, from http://www.internalaudit.bham.ac.uk/audit/glossary.shtml

Introduction

Amazon.com is a 15-year old company established in 1995 by Jeffrey Bezos. Initially established as an online bookstore, it soon found itself in the trading business dealing with electronic commerce with a variety of product lines such as books, electronic items as well as an increasing number of varied consumer products. Based in Seattle, Washington and registered in Delaware in the United States, Amazon.com was launched in 1995 and has since made a number of forward as well as vertical integration strategic entries in its pursuit of accomplishing its mission stated as follows:

…”We seek to be Earth’s most customer-centric company for three primary customer sets: consumer customers, seller customers and developer customers.”

(Amazon,com Home Page)

As of 2009, Amazon.com has established online ecommerce sites in Japan, China, United Kingdom and other key areas of the world further diversifying its product lines, employing about 24,500 employees and generating an impressive 28 per cent year-over-year average revenue growth hitting $24.51 billion ending in 2009 from a mere $1.64 billion in 1999. (Amazon.com Annual Report 2009)

As the firm continuously moves towards global business implosion, it is perennially confronted by a number of phenomena that may significantly impact the business continuity of the firm. These set of global risk pressures equally confront a great number of companies aiming to respond to the drastic changes in the global market place aiming to play key roles in the scramble for next decade.

In the case of Amazon.com, these pressures are provided with audit strategies designed to obviate the risks and threats as well as harness its resource capability potentials to benefit from the opportunities of the ecommerce industry which it has spearheaded since 1995. Here, an audit strategy program has been designed as risk management guide to thwart the threats and risks of big business Amazon.com is in.

The Strategic Foundation of Management & Governance at Amazon.com  

In general, the board leadership of Amazon.com represents the core of control and direction for the company representing the firm’s shareholders. Its purpose is primarily

to build long-term shareholder value for the innovative enterprise. With the Chair selected by the board, he concurrently functions as the Chief Executive Officer (CEO) of the Company. Presently occupied by its founder, Jeff Bezos, the board firmly believes that this leadership structure appropriately fits Amazon.com considering his role in establishing the company and his controlling stake of the firm. Further, the Board believes that such organizational structure enhances its capability to concentrate on major corporate issues over the long term.

Amazon.com makes use of its lead independent board directors mandated to preside over executive meetings in the absence of the Chair. In this way, independent directors create a strong sense of fairness and balance for as long as these do not impair

their independence to create any form of conflict of interest. In assessing such directors’ independence, the Board ensures a form of ethical conduct in the form of a disclosure of interests. Thus, any form of risk oversight is periodically taken up as a component of risk management for the Company.

Thus, the Board assumes an overall responsibility for risk oversight, with certain delegated authorities to an Audit Committee and the Leadership Development and Compensation Committee with the former monitoring and overseeing risk management related to the Amazon.com’s financial reporting processes.

True to many audit committee functions, Amazon.com’s audit committee ensures the track record performance, qualifications and independence of the Company’s independent auditors, the performance of the Company’s internal audit processes, compliance system with legal and regulatory requirements as well compliance with International Financial Reporting Standards (IFRS) risks related to executive compensation including other share-based compensation plans. Here, a full Board periodically reviews management reports on various aspects of the company’s business and governance issues as defined in the company’s strategic plan. (www.amazon.com/ir,)

Amazon.com: The Strategic Drivers

This section summarizes the strategic issues for Amazon.com which can be monitored and evaluated by its internal audit system. Such issues represent the risk management targets of Amazon.com and are the subject of a strategic audit program as part of the risk oversight system.

Amazon.com competitive profile is an interesting play of industry strategy. Barnes and Noble, launched as an online retail store in 1997 I considered a threat considering the company to be the largest US book retailer with a larger volume of inventory while another competitor, Borders.com, is equally into books, compact discs,  videos and other novelty items.

Similarly, this is considered a threat along the area of music retail where Amazon.com lately expanded into. This implies that as Amazon.com further expands and diversifies into other product lines, the band of competition widens. Ingram Micro, which began but hardly succeeded in experimenting with online retailing.

For Amazon.com, the retail difficulties encountered by Ingram served to become an opportunity for Amazon.com considering the former’s wholesale orientation resulting to maintaining huge inventories and consequently to significant overhead costs.

A significant part of the audit program for Amazon.com would include an audit objective of industry analysis outlining the market share of the competition in the sector, the accompanying trends and variance analyses to pinpoint the causes of deviations to provide appropriate management control of deviant activities.  Such operating deviations from forecasts may serve to require managers some form of strategy shifts whenever necessary.

1. Expansion involving new products, services technologies and geographic regions subjects this company to additional business, legal, financial and competitive risks.

An audit program for this issue would entail the audit objective of ensuring the inclusion of appropriate relevant project or product feasibility studies (PFS) to anticipate business, legal, financial and competitive risks appurtenant to the expansion and long-term viability projections.

 The cost of research and development, initial production, distribution and product life cycle would be part of the audit documentation and control areas to ensure that the inherent and control risks are anticipated and appropriately provided with appropriate management control system. The kind of business Amazon.com is into would determine the extent of logistics planning and management required in the company value chain.

1. They may not be successful in their efforts to expand into international market segments;

This issue will involve the audit objective of evaluating the documents comprising the market research studies, country risk analysis including the political, economic, social, technological as well as environmental risk profiling of the country where production and distribution are proposed to be undertaken. The audit procedures will include inspection and authentication of objective studies, validation of market data, the supply chain factors, the cost advantage, product differentiation and adaptation anticipated for the products and services to be introduced in the international market.

1. If they do not successfully optimize and operate their Fulfillment Centers, their business could be harmed.

 The audit program for this risk factor would include the audit objective of determining the competent staffing, resources level, strategic location of the Fulfillment Centers as determined by market studies and researches.  The operating policy structures of the FCs and the performance management system that will prevail in the units. The optimization of  these FCs must ensure the roles the FCs play either as cost, profit or investments centers to delineate their roles in the overall operations of Amazon.com.  The logistics of maintaining the distribution system here will be dependent on the communication infrastructure of the host country.

1. The seasonality of this business places increased strain on their operations.

The audit program in this regard would include accurate forecasts of seasonal market volatility to anticipate operating highs and lows against inventory levels as means to avoid high operating costs due to inventory handling and ordering costs. Amazon.com needs some form of accurate market forecasts to ensure that its supply and value chain corresponds to the seasonal needs of certain markets. Amazon.com’s flexibility in shifting markets would prove important in its objective of optimizing areas of operations.

1. Amazon’s business could suffer if they are unsuccessful in making, integrating, and maintaining Commercial Agreements, Strategic Alliances, and Other Business Relationships.

 An audit program for this issue would require a comprehensive value and supply chain in certain areas where institutions such as distributors and food chains can become important parts of the supply chain. This would require detailed evaluation and monitoring of contracts with the parties in the value chain. An independent confirmation of contracts, agreements, and alliances would check the management capability of managers handling this component.  Likewise, Amazon.com must open new forms of alliances to enable it to tap the emerging changes in the way its mail order business is conducted to avoid obsolescence.

Our Business Could Suffer if We Are Unsuccessful in Making, Integrating, and Maintaining Acquisitions and Investments;

The audit program in this regard will require the adoption of management control over mergers and acquisitions as well as other investments where the returns are eagerly anticipated through market monitoring and evaluation of opportunities available in the area. The manager’s capability will require some form of inventory management to ensure that his capacity will sustain and any form of failure to tap available opportunities will constitute a deviation and variance subject to clarification and explanation by the managers of Amazon.com. The company would need resources to enable it to expand operations as well as confront competition over the long term.

 We Have Foreign Exchange Risk.

The audit program for this issue would include a systematic evaluation and monitoring of currencies where Amazon.com maintains offices or deliveries. Foreign currency risks are avoidable if adequate information is obtained by Amazon.com financial and audit analysts. This would require training and implementation of strategies in handling foreign exchange transactions as this would require global shifts in investments and implementation of the supply as well as value chain.

Hedging may assist in managing a better foreign currency risk management system for Amazon.com. Although there are risks appurtenant to handling (purchasing and selling) various currencies where Amazon.com operates, an audit procedure of monitoring foreign currency investments would require periodic audit examinations, visits, analysis, counts and recording.

The Loss of Key Senior Management Personnel Could Negatively Affect Our Business; System Interruption and the Lack of Integration and Redundancy in Our Systems May Affect Our Sales.

 This refers to the adoption of an integrated management and production processes for Amazon.com where the human capital must be motivated enough to sustain belongingness to Amazon.com by adoption of a reward and seniority system to retain good executives and decision makers for business continuity purposes. Audit procedures would require proactive review of employment contracts with key officers to avoid transfers and resignations due to policy issues.      

We Have Outstanding Debt and May Incur Additional Debt in the Future;

The audit program in this regard would be to ensure that matching of debt with funds applications whether short, medium or long-term in nature. The cost of capital is a key factor in determining the profit margin of amazon.com considering the volatility of interest rates as well as the appurtenant foreign currency risks if the debt is foreign currency denominated. Trading on the equity and a monitored leverage system will ensure that entering into debt agreements may indeed be more strategic than using one own funds.

We Face Significant Inventory Risk

In the case of amazon.com, facing inventory risks may have to be encountered if it enters into the wholesale market like Ingram Micro. Amazon.com’s products are perishable in nature where obsolescence and technology shifts may play a critical role in valuing inventories. Entering into a global system of operations would require an audit program where inventory levels are monitored through the economic order quantity as well as inventory analysis of each area where Amazon.com operates. Likewise, a system of promotions, advertising as well wholesale incentives to buyers are to be monitored to ensure that inventory risks are reduced to the minimum.

Conclusion

The risks and threats brought about by the global expansion of Amazon.com remain as potent as ever. Competition will continue to pervade its market and put pressure into changing strategies to ensure that management control remains strong and effective for the global firm.

Here, Amazon.com, by the nature of its business may have to sustain a highly diversified line of products and services to remain innovative and relevant in a constantly changing market involving electronic commerce. Thus, new forms of risks and threats will litter the horizon wherever Amazon.com establishes its presence. Thus, a system of strategic audit and management control is necessary to bring the business to its next higher level. (Anthony & Govindarajan, 2004)

 Works cited

Amazon.com, Amazon investor relations, Web. 18 May 2010.

http://phx.corporate-ir.net/phoenix.zhtml?p=irol-irhome&c=97664

Anthony, Robert and Govindarajan, Vijay. Management Control Systems . International Edition, New

Jersey. McGraw-Hill/Irwin Publications, 2004.

Chao, Janice C., Hsieh, Chia-Nan, Hsieh, Chih-yuan, Rice, Brandi S. & Yang, Cheng Chung. (1999).

Amazon.com: Successful etailer. Platform of ecommerce: So why are they still in debt? An

Investigative Study. Department of Electrical Engineering, University of Maryland, College Park,

Dec.8, 1999,  at website: http://www.rhsmith.umd.edu/faculty/jbailey/ents630/amazon.pdf

http://www.duncanwil.co.uk/pdfs/amazoncase.pdf