Havelock Europa Audit Risk Essay

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Auditing Risk

Areas of Heightened Audit Risk

Audit risk = Inherent risk x Control risk x Detection risk. Audit risk can be referred to as the probability that an audit team will give an outright and absolute judgment when the financial statements of an institution are in actual fact materially misstated. To start with, inherent risk is the possibility that material frauds and errors will get into the accounting system employed to cultivate and improve the financial statements. On the other hand, control risk is the possibility that the internal control system of a client or company is not able to prevent or detect material misstatements (Griffiths, 2005). Lastly, detection risk is the probability that an auditor's audit procedures will not able to detect material misstatements. Taking into consideration the financial statements and the management commentary in the annual report of Havelock Europa there are a number of areas of heightened audit risk concerning the audit of the company.

1. Revenue

One major area of risk in the financial statements of Havelock Europa is improper revenue recognition. In particular, one of the main audit risks concerning revenues is the fraud or material misstatements which arise from revenue recognition and also the timing of the revenues. It is imperative to note that for different organizations and companies, numerous schemes have been employed in a fraudulent manner to misstate the amount and level of revenues. One major aspect to consider in the financial statements of this particular company includes sham sales. This is in the sense that the representatives and agents of the company might falsify the records made for the inventories, shipping records, and also invoices and make bookkeeping records of the fictitious transactions as sales revenue. This is largely for the reason that the management notes in the company's annual report that in as much as the production facility is situated in Scotland, a substantial figure and fraction of the revenue of the company is generated in the rest of the United Kingdom and the European Union (Havelock Europa PLC, 2013). One aspect of risk is that in certain situations, the company might ship its goods to a different location. In other situations, the company representatives might also pretend to ship the inventory and conceal such information and numbers from the company auditors. Another probable risk is the company making recognition of its revenues prematurely prior to the completion of all the terms of the sales. The risk is that the representatives of the company can record the sales of the products or the goods that have been ordered even before they are shipped to the consumer or before all of the risks have been transferred to the consumer. Another area of risk regarding revenues is that the accounting records of the revenues might be held open past the date of the balance sheet in order for the sales which are actually occurring in the succeeding or forthcoming period to be recorded or recognized in the present or current period (Goldman and Kaufman, 2011).

1. Tax

Another area in the financial statements of the company that has high audit risk is tax. Material and false misstatements and also omissions with regards to tax on financial statements are done so with the main intent of avoiding taxes or paying less tax than required. This sort of fraud can actually take plenty of different forms ranging from improper groupings on expenditure in order to reduce the level of income that is taxable to the misstatements of income and also the improper categorization of executive reimbursement (Goldman and Kaufman, 2011). For Havelock Europa this is an area of great risk. This is so because the company has not paid any corporation tax on the profits or returns generated in the year due to the losses that were brought forward. This is an aspect of risk as the company can easily declare more losses or decrease the level of taxable income in order to pay fewer taxes. The company makes recognition that current tax is the taxation charge that is payable on the taxable-income for the reporting period by use of rates for taxation which are ratified or fundamentally ratified at the balance sheet date, and any change to the tax payable with regard to previous years. It is important to take note that the corporation tax in the United Kingdom changed in the reporting period as the rate declined from 24% to 23% in the year 2013 and went on to decline again to 21% in the year 2014 and then much further to 20% in the year 2015 (Havelock Europa PLC, 2013).

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One major point to note is that considering the fact that the rate reduction to 20% took place or was ratified prior to the balance sheet date, then the deferred tax assets as well as liabilities have to be recognized at this rate of 20%. This decline in the corporation tax rate implies that the losses which the company brings forward and carried on to the balance sheet as deferred tax assets have a lesser value. This in turn shows the audit risk as the company can choose to recognize the deferred tax assets and liabilities at the rate of 21% in order to have a greater value of the deferred tax asset on the balance sheet (Havelock Europa PLC, 2013).

For instance, in the balance sheet of the company as of 31 December 2013, the deferred tax assets of the company recognized for the group is 1,167 and 2,315 for the years 2012 and 2013 respectively. The risk is that the company could have recognized the corporation rate at 24% and not 23% so that the company would have reported higher deferred tax assets (Havelock Europa PLC, 2013).

1.24/1.23 x 1,167 = 1,176 and 1.24/1.23 x 2,315 = 2,334

This would be done so that the company would have a higher and better tax relief and would be fraud or material misstatement (Havelock Europa PLC, 2013).

1. Profit

This is an area of high risk as it can be materially misstated for two contrasting reasons. To begin with the company can opt to inflate or increase its profit level in order to appear more profitable and successful for investors and also for the stakeholders of the company. This can therefore cause the preparers of financial statements to materially misstate the amount of profit of the company. On the other hand, the company might also report profit levels which are lower than those generated in order to avoid paying taxes as required by the government. By reporting losses and not profits implies the company does not pay taxes as this is a loss to the company (Goldman and Kaufman, 2011).

PART B: Substantive Audit Procedures

Out of the three areas discussed above, the area of risk that is selected for further analysis is revenues. The following are five substantive procedures that would be carried out in an attempt to reduce audit risk to an acceptably low level.

1. Comparison of revenues that are recorded on a daily basis for period shortly prior to and subsequent to the end of the audit period.

This substantive procedure would be undertaken particularly in consideration of the unusual variations and fluctuations for instance an increase right before and a decrease right after the end of the period. Timing of the revenues is one of the aspects that increases audit risk and therefore have to be considered. It is imperative to ensure that the revenues recognized fall in line with the right period (Goldman and Kaufman, 2011).

1. Comparison of the details of the units of goods and products which are shipped with the revenues and also the records of manufacture or production and taking into consideration whether the revenues are realistic and sensible in comparison to the levels of goods produced and the average sales price (Goldman and Kaufman, 2011).

The reason why this substantive procedure is undertaken is to ensure that that the representatives and agents of the company are not able to do so; or there is the detection of any falsified records made in the inventories, shipping records, and also invoices and bookkeeping records of fictitious transactions as sales revenue.

1. Comparison of the amount of inventory with regards to the number of weeks in distribution channels with previous or preceding periods for unfamiliar increases that may point toward channel packaging.

The main reason for undertaking this particular substantive procedure is to ensure that representatives of the company are not able to record the sales of the products or the goods that have been ordered even before they are shipped to the consumer or before all of the risks have been transferred to the consumer. More so this would reduce audit risk as the auditor would be able to detect when representatives might also pretend to ship the inventory and conceal such information and numbers from the company auditors (Goldman and Kaufman, 2011).

1. Comparison of the revenue.....

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