Posh Limited Auditing

(1)Inherent risk:

The repeat engagement of the accounting firm for Posh Limited may make the auditors feel more confident in auditing the same client, which is likely to gradually lower the inherent risk in the third year of misstatement for both the occurrence of sales revenue and net realisable value of inventory account when compared to the first year, because auditors obtain more relevant knowledge and experience of this company.

The attraction of the special bonus which would be paid to all staff if the company’s profit growth reached 5% creates incentives for sales staff to overstate profit by overstating sales, which increase the inherent risk of misstatement due to fraud for the sale occurrence objective.

The severe flooding in the central warehouse of inventories is a non-routine transaction, which is likely to cause accounting staff to make mistakes relating to the net realizable value audit objective of the inventory account, because the accounting for water damage are uncommon that the auditors run risk of too much or too little on the unique event. On the other hand, due to the damage of inventory, managers create an incentive to cover cost of the lost inventory. Thus, the risk of overstatement of ending inventory is increased, which affect the net realizable value audit objective of inventory account.

The near location of the competitors’ new store and lower selling price of the outdated goods give a lot of pressure to the company, which makes the audit client face high risk of inventory obsolescence. Due to the rapid change of the market value for inventories, it is likely to cause auditors make errors because the inventory may not be appropriate valued. That means the inherent risk of both overstatement and understatement may be increase.

Analytical procedures:

In terms of the interest coverage ratio of the audit client, it decreased obviously in the first 9 months of 2016 to 9.6%, while it increased to 10.1% in the last three months. At the same time, the debt to assets ratio experienced an increase trend from 2013 to 2016, while in the last three months of 2016, it decreased below 60%. These changes of the ratio may indicates potential misstatement of financial report due to the requirement of debt contract. That means the audit client may have incentives to fraudulent overstate the net profit by overstating sales revenue and understating cost for meeting the debt contract of the local bank, which affect the occurrence audit objective of sales revenue.

The profit growth ratio experienced a decrease trend from 2013 to 2016, and in the first 9 months of 2016, the profits growth was under 5%, while it increased to 5.1% during the later 3 months, which may indicates a fraud on financial report by overstating sales to overstate profit in order to get special bonus from CEO of the company, that affects the occurrence audit objective of sales revenue.

When compared the inventory turnover to the prior year of audit client, it shows a trend to decrease after 2015, which means the efficiency of the company managing its inventories reduced. Due to a fierce competition with its major competitor, the change of the ratio seems to be reasonable. There is a 12% decrease compared 2015 to the first 9 months in 2016, while just 0.13% decrease in the later 3 months, which is likely on account of the need for audit client to increase the inventory turnover, giving a incentive for managers  to understate average inventory. Thus, it is necessary to investigate the unusual difference later.

(2)Control risk:

The accounting department is separate from other operating departments in Posh Limited, that means an adequate division of responsibilities among those who perform accounting procedures or control authorization. This kind of internal control of adequate separation of duties can decrease the control risk in both error and fraud, because the chief accountant is responsible for any change the accounting records.

In terms of the computer systems for sales and inventory management, the proper authorisation of  transactions and activities of audit client is likely reduce the risk of fraud and error, because access to different system is restricted to authorised staff via individual password in the company. That means an invalid password cannot be accessed to specific systems, if fraud or error exists, the staff who was authorised of the transaction must be responsible. Therefore, if competent trustworthy employees are hired, both errors and fraud in sales and inventory management are likely to be prevented.