There are various questions asked before starting an audit that must be fully answered by the end of the process. Effective planning is one of the key pillars of this process and focuses on essential areas of the audit such as ensuring that there is adequate allocation of resources to the auditing procedure. Among other roles, effective planning guarantees a well directed activity and minimizes occurrence of audit risk.
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Wal-Mart Stores Inc, a chain store public company has been selected for analysis of the question at hand. Wal-mart is an international retailer that has widespread operations in North America, South America, Europe as well as in Asia specifically China. This company has been chosen for the study because it provides a challenge to the auditor in analysis of its financial statements that involve different currencies covering different outlets at different countries
Steps of planning an audit and designing an effective audit program
Step 1: Application of audit test
This step includes several processes;
- Test of controls: this refers to the procedures conducted to test the effectiveness of control policies and processes towards reducing and controlling risks, for example, checking gate books to determine whether the delivery truck brought supplies to the store.
- Monetary misstatement testing: it can be either substantive test of transactions or test of details of balances. Substantive test entails testing for financial statements to approve whether they meet audit transaction objectives while the later refers to assessment of financial statements to determine whether they are in line with balance related audit objectives (Schmidt, 2017).
- Reduction of risk: it involves application of procedures to detect the source of risks, understand them and then apply relevant control techniques to reduce their occurrence to minimal or insignificant probabilities that require no future attention.
- Timing of audit test: this should be performed just before the end of the company’s financial year to update depreciation schedules, analyze loan transactions and also review requirements of board of directors.
Step 2: Selecting tests to perform
This step involves cost testing, identification of appropriate evidence for audit testing and identification of risks facing the audit process, from the least costly to the most costly transaction. Evidence identification on the other hand involves drawing a chart of tests and type of evidence and comparing the two variables to obtain relevant evidence. Risk testing entails the process of determining the level of misstatements. For example, if the level of misstatements is low and inherent risks are high then the statements tests must be high.
Step 3: Designing the audit program
According to Schmidt (2017), the audit program design consists of three parts; test of controls and substantive test of transactions, analytical procedures and balances detail testing. A test control involves a four step approach aimed at reducing accessed risks to insignificant levels that might be a source of threat to the audit process.
Analytical procedures can be performed at three different stages of the audit process: during the planning process to help in auditor in understanding the clients business, during the audit or near the end of the audit process.
Step 4: Summary of the audit process
The final stage involves assessment of the whole audit process and determining whether the auditing process was effective as intended. This might involve actions such as the review of subsequent events, accumulation of final evidence and evaluation of the audit results and issuance of the audit report (Schmidt, 2017).
Actions that should be taken in planning and designing the audit program
The company planning and designing the audit program has to ensure that there is full involvement of the company’s accounting staff, identification of the company’s objectives and management structure in order to understand the chain of command which helps in acquiring all the relevant source documents as well as selecting of an audit program that is compatible to the company’s structure. The company should allocate sufficient resources to the audit team as well.
Return on capital
This measures the profitability of a company in relation to the net assets that have been invested in the business. The net assets are acquired from the balance sheet and can be defined as the difference between the total assets and total liabilities, (Hendy, 2011). It can be calculated using the following formula below;
Return on capital = Net profit / Net assets × 100
Acid test ratio
According to Hendy (2011), acid test ratio measures liquidity in a more effective way than the current ratio, as it excludes the value of stock in calculating current assets. This is because the conversion of inventory to cash can be time consuming therefore a high level of current assets of a company may be as a result of large amounts of stock which literally gives a false impression to investors.
- Acid test ratio = Current Assets – Inventory / Current liabilities
The accounts selected for testing are the inventory account and the property, plants and equipment account.
- Preliminary analytical procedures: they involve analysis of small transactions which include accounts such as fittings and fixtures
- Substantive analytical procedures: it is effective for large volumes of transactions that are predictable over a certain period of time. This procedure will be used to analyze inventory trends.
- Final analytical procedures: the final procedure is carried out on terminal transactions such as sales.
Analysis of the balance sheet and income statement
Current assets in the balance sheet are made up of a large proportion of inventory while property, plants and equipment forms the largest portion in the total assets. This is good for the business in the short run because inventory can be easily turned into cash (Persinos, 2016). Walmart can thus meet its short term obligations without becoming insolvent. Total revenues have grown between the years 2015 and 2016. This has been due to increased sales. The net income however dropped showing that the shareholders earnings have decreased in the last two years.
Method of evidence collection
Review of financial statements of Wal-Mart Stores Inc. This is used to collect primary evidence which in this case is documentary evidence from the company’s books. The evidence is acquired from online sources. It includes looking at the balance sheet and income statement of the company. The information used is reliable as it was extracted from the company’s official website which publishes Wal-Mart’s semi-annual as well as annual financial reports.
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Audit risk model
Audit risk model determines the total amount of risk associated with the auditing process and its management (Accounting Tools, 2016).
- Audit risk = Inherent risk × Control risk × Detection Risk
Audit risk can thus be described as the product of various risks that are encountered during the auditing process.
It is a risk arising from material misstatement in the financial statements caused by error or omission arising from factors other than control failures (Accounting Tools, 2016). Inherent risk is common in cases of complex transactions that require a high level of judgment and estimation or where the accounting personnel have low level of training. For example, inherent risk is higher in a new company that is involved in complex transactions than in a well organized company.
According to Accounting Tools (2016), control risk is risk of material misstatement arising from absence or failure existing control operations of a company. Companies should therefore ensure adequate controls to prevent occurrence of such errors. Control risk is high where a company lacks adequate internal controls of detecting or preventing fraud and error in its financial statements.
Detection risk is a risk, which occurs when auditors fail to notice material misstatements in the financial statements. Auditors must employ and follow all procedures in order to detect errors in the financial statements (Accounting Tools, 2016). Ignorance to follow some procedures increases the possibility of unnoticing errors.
Purposive sampling which is non-sampling technique is used to establish primary materiality judgment as it allows for personal judgment when selecting and analyzing the data.
Responsibilities of an audit firm after issuing an unqualified report
The audit firm should state that the financial statements are in accordance with the Generally Accepted Accounting Principles (GAAPS) (Schmidt, 2017). The firm must also state that the financial statements represent the company’s financial accounts in fair manner.
Accounting Tools. (2016). Audit Risk Model. Web.
Hendy, P. (2011). Accounting Ratios – measuring a business. PAH Accounting. Web.
Persinos, J. (2016). Financial Statement Analysis. Investing Answers. Web.
Schmidt, M. (2017). Auditor’s Opinion, Statement and Report, Accountant’s Opinion Explained. Web.