Auditing Group

In defined of ASA 135, the risk assessment procedures have been conducted to identify and assess the risk of material misstatement following the requirements Risk Assessment Procedures and Related Activities. The procedures involve enquiries of management, of the previous auditor who have ‘information that is likely to assist in identifying risks of material misstatement due to fraud or error’ and analytical procedures in accordance with Paragraph 6 ASA 135, on the basis of understanding the entity and its environment following Paragraph 11 ASA 135.

Understanding the entity and its environment

According to IBIS report, the Beer Manufacturing industry in Australia has undergone a sharply decline in the past few years since the drinkers have given up traditional brands (ISBS World). This situation might result in a sensitive market to bad news, increase in the pressure to meet targets on management, which cause the higher possibility of risk of earnings management. Furthermore, the company might consider changes in accounts receivable, inventories and assets value which increase the inherent risk of misstatements.

Regarding the nature of the entity, the fairness of assertions relating to receivables and inventories is important to identify the inherent risk as Beer Brewing Ltd. is a manufacturing company. In the case of BBL, the transactions with the related parties should be noticed since the main supplier is Stephen’s – board of directors chairman – cousin. There are potentially high inherent risks because ‘they may not have the economic substance of an arm’s-length transaction between two independent parties’ (Leung et al, 2011).

Analytical Procedures

The analytical procedures are essential to identify unexpected fluctuations and unusual relationships which indicate areas of greater risk of misstatements.

• Current ratio: the current ratio slightly changes over three years and is always higher than the industry averages shows
• Quick ratio: the quick ratio experiences significant decrease over the years, reveals the lower protection by cash or near-cash assets to short-term creditors. This means the cash, accounts receivable and current assets accounts should be noticed and require further investigation by the auditor.
• Debt to equity ratio: even remaining under the industry averages, the ratio increases slightly from 2012 to 2013 as a signal of the company using more debt to finance capacity. It might have a potential going concern and the auditor should look for any potential debt covenants.
• Times interest earned: the figures show a significant decline in three years and fall under the industry average in 2012 and 2013. The company experiences a decrease of ability to cover its interest charges with earnings, which is consistent with debt to equity ratio, means the appearance of more debts.
• Average collection period: there is longer period over time and in compared with the industry. This could possibly mean the company is facing greater credit risk or struggling with cash flow. The level of doubtful debt provision should be taken into account of the audit planning.
• Accounts payable: the figure increases from 2012 to 2013 though remains lower than industry averages. This indicates the company possibly dealing with difficulties in paying off its average accounts payable balance.
• Gross profit margin: Even though the company gross profit margin is always higher than the industry averages, there is a gradually decrease in three years, showing the possibility that the business is unable to control production and inventory costs or the price are set too low.
• Net profit margin: A sharply decrease in the net profit margin might indicate that the company was not keeping the operating expenses under control, the cost blowouts requires efficiency improvements. This might relate to the company action of taking on debt to pay its expenses.

Consideration of fraud risk

The risk factors associated with fraudulent financial reporting should be taken into account when there are incentives and pressures factors relating to low barriers to entry and high degree of competition with decline margin in the industry according to ISBS report and the BBL financial ratios. There is also the possibility that the company being close to debt covenants as the analytical procedures conducted above has figured out. Besides, as mentioned in the case the BBL management has refused to follow M&A auditors recommendation about allowance of doubtful debt and inventories, which are critical for a manufacturing company. This could be considered as attitudes/rationalization risk factors since the management paces a low priory on correcting known weaknesses in internal controls on a timely basis and control risk as the material misstatement could occur in an assertion but not be corrected on timely basis by the entity’s internal control structure.