Planning the Audit
Developing and implementing strategies help businesses to run most of their operations successfully. Organizations with qualified leaders and strategic plans learn to create value and control the market in a manner that increases profit margins. Similarly, planning for an audit is essential because it helps in identifying risks, fraud cases, as well as reducing errors in auditing. It also enhances audit quality (Meliyev, 2017).
This case focuses on the audit plan for Earthwear Clothiers, which was founded in 1973 and specialized in high-quality clothing for outdoor sports, such as skiing and hiking. The company also offers casual clothing, soft luggage, shoes, and accessories. Earthwear has a business objective of increasing the customer base by introducing a new extreme sports product line to attract younger consumers.
Business risks are essential because it enables businesses to determine the maximum acceptable risks when engaging in an activity. Earthwear intends to expand its operations through the addition of new clothing that focuses on a younger crowd. There are both internal and external business risks involved when introducing a new product. Internal risks include issues such as preparations, resources available, missing deadlines, inability to test, as well as research and design involved when creating the product.
These factors would influence the success of the extreme sports products the company wants to create. External risks would include issues such as competition, delays in supply of raw materials, changes in market prices, natural and political issues influencing extreme sports. These factors are in line with audit guideline No.12, as recorded in the public company accounting oversight board (PCAOB, 2010a). This guideline addresses the planned nature, timing, and extent of risk assessment procedures, as well as risks of material misstatement.
Financial statements and reporting done should be supported with sufficient evidence. In PCAOB (2010d), audit guideline No.15 places much emphasis on audit evidence. Auditors are required to obtain appropriate evidence that supports the claims made regarding financial statements and internal control in financial reporting. Therefore, the auditor selected to perform the audit at Earthwear should be competent and thorough in collecting data linked with a new product line to support assertions. The financial evidence would help in supporting the assertions regarding control and inherent risks related to the company and the market. The auditor obtains evidence by assessing the company’s cash, payable, and receivable accounts, among others.
Quality of audit risk relies on the approaches made by an auditor in lowering risk as low as possible. Auditing standard No.8 focuses on audit risk (PCAOB, 2010b). It enables the auditor to plan an audit and assess possible areas of risk. In turn, the auditor pays more attention to areas with high risks, which helps in lowering the audit risk level. The auditors follow substantive procedures that include the detection of risks and evaluation of evidence. At Earthwear, the auditor should monitor the sources of income such as cash, payable and receivable accounts, and earnings from shares, among others. Analytical tests should be carried out on these accounts to identify whether anything was overlooked and steps to be undertaken to eliminate risks.
Various policies and procedures are put in place that guides the management and auditors during the auditing process. Internal control helps the auditors determine whether an audit can be conducted and the scope of the audit. The internal controls also help the businesses to maintain data reliability and accuracy that they can use to stop nonperforming activities. The process is achieved by conducting substantive tests that give auditors an idea of how business activities are handled within the company.
For instance, the auditor can monitor the cash inflows at Earthwear to understand the control designs implemented by the company. The internal controls are addressed in auditing standards No. 5 and No.12 (PCAOB, 2010a; PCAOB, 2010c). The two show how walkthroughs can be performed to identify flaws. Earthwear should create new internal controls purposefully for the extreme cloth product line.
Effect on Audit Procedures
The addition of a new product to Earthwear’s catalog will increase the audit procedure. The auditors selected to audit a firm need to review all the products or activities in a business. Therefore, the auditor would be required to assess the effectiveness of the new product line on the company using analytical testing and other approaches. The new product line also means that the company would add more accounts that increase the testing time. Also, the designing of new internal controls for the extreme product line could further increase the auditing activities. An example is that the new extreme cloth would require the purchasing of equipment, which auditors need to account for in the fixed assets.
Preliminary Risk Assessment
Preliminary analytics are essential when calculating materiality as they reveal how a company is performing in different areas. Multiple bases can be used to find materiality. In this case, Earthwear is a for-profit company, which means that income raised before tax can be used to determine materiality. Therefore, omissions or combined misstatements greater than seven percent or roughly $2,502,990 are regarded as material. In case the revenue was used, then the combined misstatement greater than three percent or $28,514,520 should be counted as material.
The risk of material misstatement is assessed for various accounts, including cash, receivables, and revenues, as well as payroll, among others. Each carries different level material misstatement risks. Cash and payroll have the lowest because various financial officers regularly monitor these transactions, whereas receivables and revenue are high risks as they are regulated in the financial year.
Meliyev, I.I. (2017). Impact of audit planning on audit quality: A case study of local audit firms in Uzbekistan. International Journal of Economics, Commerce, and Management, 5(11). Web.
PCAOB. (2010a). Auditing Standard No. 12. Web.
PCAOB. (2010b). Auditing Standard No. 8. Web.
PCAOB. (2010c). Auditing Standard No. 5. Web.
PCAOB. (2010d). Auditing Standard No. 15. Web.