Question

Question 2 You are the auditor of Green Machine Ltd, a manufacturer. You have obtained a summary of the property, plant and equipment for the year ended 30 June 2018, which identifies cost and accumulated depreciation brought forward, additions and disposals in the year and depreciation charges. A review of the management letter from the previous year’s audit shows that there were some problems in relation to making a distinction between capital and revenue expenditure; some items were capitalized when they should have been expensed and other capital items were included in repairs and maintenance in the income statement. Another risk identified from prior years relates to depreciation calculations: there is a range of depreciation rates within categories and there has been concern that the rates applied to some assets have been too low. The depreciation policy disclosed in the financial report shows: • Building: 2 – 4% straight line • Plant and machinery: 5 – 10% straight line • Fixtures fittings and equipment: 5 – 20% straight line REQUIRED (a) Identify and explain the two key assertions at risk in relation to property, plant and equipment (b) Identify and describe two substantive audit procedures that you could perform in response to each risk identified above (c) Explain the requirement of ASA 701 Communicating Key Audit Matters in the Auditor’s Report and the rationale for this auditing standard. Determine if the above matters are key audit matters, providing full rationale for the determination. If it is determined that they are Key Audit Matters, provide the disclosures which are required in Key Audit Matters Section of the Auditor’s report as required under ASA 701. Requirement: Using reference materials available on the internet, research the topic and prepare a report, fully referenced and up to 2,500 words (assignment in excess of 2,500 words will be penalized). Minimum of 8 academic references is required.

Answer 1

Answer to a & b

The two key significant assertions for property, plant and equipment (PPE) are existence and valuation and allocation.

Existence is important because the assets the company has recorded in its fixed assets register (which flows into the general ledger and finally into the financial statements) need to actually exist. Auditors usually test for existence by physically looking at the assets listed in the fixed asset register in the first year that a client is audited. In subsequent years, the existence procedures tend to focus on additions to and disposals from the fixed asset register. It is important to physically look at the fixed assets on a periodic basis as this provides insights into not only whether the asset exists but also whether there appear to be any assets that may be damaged, obsolete, impaired or excess to the client's needs, providing important evidence for the valuation and allocation assertion.

Valuation and allocation is the other significant assertion tested by auditors in relation to PPE as it is important that assets are recorded at the appropriate carrying value, or fair value as it is described and defined by IFRSs, in particular IAS 16Property, Plant and Equipment. Valuation also becomes very important when a company changes processes or structures as the decisions made by management and those charged with governance will often impact the values that items of PPE should be carried at. Procedures to test depreciation include performing reasonableness testing of the depreciation charge compared to the cost base of the assets, assessing the useful lives of the assets and comparing these to the depreciation rate used and, in the case of property, having an external valuation performed.

Notes on completeness, rights and obligations, and classification assertions Completeness is usually not a major issue for most entities as the auditor is typically most concerned with the overstatement of assets, and completeness tests tend to focus on the potential understatement of fixed asset

c)

The auditor shall determine, from the matters communicated with those charged with governance, those matters that required significant auditor attention in performing the audit. In making this determination, the auditor shall take into account the following: (Ref: Para. A9–A18)

(a) Areas of higher assessed risk of material misstatement, or significant risks identified in accordance with ASA 315.5 (Ref: Para. A19–A22)

(b) Significant auditor judgements relating to areas in the financial report that involved significant management judgement, including accounting estimates that have been identified as having high estimation uncertainty. (Ref: Para. A23–A24)

(c) The effect on the audit of significant events or transactions that occurred during the period. (Ref: Para. A25–A26)

The auditor shall determine which of the matters determined in accordance with paragraph 9 of this Auditing Standard were of most significance in the audit of the financial report of the current period and therefore are the key audit matters. (Ref: Para. A9–A11, A27–A30)

Communicating Key Audit Matters

The auditor shall describe each key audit matter, using an appropriate subheading, in a separate section of the auditor’s report under the heading “Key Audit Matters,” unless the circumstances in paragraphs 14 or 15 of this Auditing Standard apply. The introductory language in this section of the auditor’s report shall state that:

(a) Key audit matters are those matters that, in the auditor’s professional judgement, were of most significance in the audit of the financial report [of the current period]; and

(b) These matters were addressed in the context of the audit of the financial report as a whole, and in forming the auditor’s opinion thereon, and the auditor does not provide a separate opinion on these matters. (Ref: Para. A31–A33)