Auditing is a crucial aspect of the business in seeking to ensure that business standards and procedures are followed for the purpose of enhancing business continuity and performance management. In that view, auditing could take different approaches and entails considering several factors that play a crucial role in determining a business going concern capacity. In that respect, this analysis seeks to demonstrate an external audit’s operation by analyzing Carpetright financial reports for the year 2012-2013. To begin with, the analysis provides an explanation of the risk based external audit approach in addition to identifying the factors that may lead the auditor to identify going concern problems within the company. Further, the analysis provides an overview of the factors that the auditor could identify to conclude on the organization’s ability to continue operations in the near future. Finally, the analysis provides an analysis of the factors that could influence the external auditor’s opinion on Carpetright organization’s going concern over the periods under consideration for the analysis.
- Evaluation of the risk based approach to external audit
Understanding risks and controls
A risk based audit approach involves a preliminary understanding of relevant controls and risks. In addition, there should be a confirmation of the Carpetright’s management objectives and their relation to the organizations higher level objectives. This involves a review of previous audit work as well as discussions with management, relevant documents reviews and through conducting risk workshops. (Giacosa, Giovando & Mazzoleni, 2013)
Through the approach, the external auditor should review the adequacy of the process that Carpetright’s management uses as a way of identifying and assessing risks. This should be done along with a review of management’s risk acceptance level as compared with the documented risk appetite for the organization’s. However, if there is no defined risk appetite, the auditor should use their judgment to review whether the management’s actions and approach are reasonable. This judgment should be based on the auditor’s understanding of the business and discussion with the management. (Kemp, 2013)
In addition, the approach entails understanding of the processes underlying controls and risks through auditor’s discussion with management as well as through a review of documentation as well as walkthrough testing. The process and risks identified should then be documented that is easier for a reviewer to understand with an example of a process map use. Further, controls should be identified through walkthrough tests and discussion with management. The auditor should then ensure that documentation clearly shows the relationship between risks and controls as well as their relation to the audit’s objectives and scope. For effective records, matrices should be used as a way of documenting risks, controls, work done and findings relationship. Therefore, the risk based audit approach achieves more through discussions with management as well as through interviews. (Chandler, Edwards & Anderson, 1992)
Assessing controls design
The approach also focuses on assessing the controls design with a need to consider whether the control designs used are capable of producing residual risks portfolio that is reasonable in view of the defined or assessed risk appetite for the organization. (Lee, 1998) In that respect, the approach should seek to identify cases of over control such as overly restrictive authority delegation in addition to identifying the possible improvements that can be applied to suit the organization’s risk resource. Thus, there should also be an identification of deficiencies in control designs that should be communicated to the management through audit reporting. Finally, the auditor should obtain evidence and conduct tests to confirm their understanding of the operation and design of the controls in place. (Chandler et al, 1992)
For the purpose of risk assessment on Carpetright, the external auditor could apply the following methods for collecting risk assessment evidence.
- Inspection of the company records and documents including the financial statements and supporting records. However, the most important inspection would be an assets physical inspection since it would provide more reliable evidence.
- Observation of the company’s procedures which would provide evidence of the policies adherence or otherwise.
- Communication with third parties through written requests to confirm company policies and procedures.
In addition the auditor could apply analytical procedures that could involve risk assessment and substantive testing. Risk assessment would involve a focus on the higher risk areas in determining the nature, extent and timing of audit procedures. On the other hand, substantive testing would involve obtaining of accuracy evidence for identification of errors/misstatements. (Eilifsen, Messier, Glover & Prawit, 2005)
- Carpetright going concern problems
The appropriateness of an organization’s going concern can be affected and put at risk by a number of factors that have the possibility to collectively or individually create operating, financial or other business risks. (Eilifsen, Messier, Glover & Prawit, 2014) The lists of those factors that define the going concern problems and the specific ones facing Carpetright include the following:
- Negative cash-flows which indicates poor cash-flow management or poor sales performance.
- Borrowings that reflect lack of renewal or repayment close to maturity.
- Inability of the company to comply with borrowing agreements hence a change in borrowing agreements.
- Creditors variation of credit rating or withdrawal of such rating
- Lenders withdrawal of financial support.
- Reliance on short term borrowing to finance long-term ventures.
- Loss of a major customer, supplier and major market.
- Company’s inability to address and handle competition in a shrinking market. (Eilifsen et al, 2005)
- Loss of management and lack of replacement that negatively affects operations in some major operations.
- Other companies failure and poor in the floor products and services industry
- Reducing stock as well as reducing cost in some major markets.
- Reducing dividends payment.
- Investments reduction in some markets and product lines.
Those specific to Carpetright as indicated on the appendix extracts for performance figures from financial statements include:
- A 2.9% decline in revenue for the year 2013 from the financial year 2012’s revenue.
- Nil dividends payment per share for the two years 2012 and 2013.
- A year on year decline on the floor covering market as indicated by the chairman’s statement. (Carpetright, 2013)
- A declining operating margin for the year 2013 as compared to year 2012.
- Reduction on net assets from £70 million in 2012 to £65 million in 2013.
- A decrease in cash and cash equivalents from £1.5 million in 2012 to -£4.1 million in 2013.
- Continuation of uncertain economic environment in major markets. (Carpetright, 2013)
- Qualitative factors indication of Carpetright’s business continuity in near future
Business continuity is crucial to an auditor and entails an analysis of factors that provides an indication of the continuity possibility or otherwise. In that respect, external audit on Carpet right provides some indication on the business capacity to continue operations in the future as defined by the following factors. (Locke, 2010)
- The business has extended its product-offering with an example of offering beds in about half of their stores.
- Growth in group’s profit which is an indication of the capacity to deliver services and compete with the rivals in the industry. (Hooks, 2011)
- Reduction in debt which indicates the management’s ability to effectively address finance issues in the present and possibly in the future.
- Business ability to generate cash despite difficult market conditions is an indication that the business has a competitive edge and can continue operations in the competitive industry that faces difficult conditions. (Eilifsen et al, 2005)
- The company’s three year plan that indicates development conscious actions’ including refurbishing the UK store estate with an updated store design which is an indication that the business has some future plans on its markets and performance. It also includes an adjustment to its store portfolio in major markets which indicates that the business seeks to enhance its performance and operations in the industry in face of increasing competition and difficult economic conditions. Further, the company’s effort to enhance the range of floor services and coverings is a way of enhancing competitiveness in the industry. Finally, the company seeks to optimize the digital system as a means of enhancing its multi-channel offering. (Carpetright, 2013)
- Factors that could influence external auditor’s opinion in view of UK’s ISA 700/705/706. And the form that the opinion would take.
With an analysis of Carperight financial statements and auditor’s report, a number of factors would that influence the auditor’s opinion on Carpetright’s going concern including those that have an indication of financial problems and issues are as outlined.
- Financial losses from major operations may be an indication that the business could be facing challenges in maintaining its operations in the industry. This can be demonstrated by poor performance on some of the organization’s markets as well as the floor products and services segment. (FRC, 2012c)
- Poor cash-flows are an indication that the business could face challenges in meeting its payment obligation as well as in the ability to invest in the industry for the purpose of enhancing performance and sustainability. (Carpetright, 2013)
- The declining industry performance and demand for floor products and services as the market is faced with increasing innovation that is decreasing demand for tradition products and services. (FRC, 2012b)
- Indication of some divestitures and possible takeovers in some of the organization’s markets is a factor that could influence an auditor in providing a going concern opinion. (FRC, 2012a)
In that respect, the auditor’s opinion in respect to the organization’s going concern would be a caution on the possible effects of the noted factors. This would include a caution note on the financial performance and market uncertainty’s possible effect on the business’s future. (FRC, 2012b) Thus, the matters paragraph that the auditor could draw attention to are the possible effects of the increasing market uncertainty on the organization’s floor products and services portfolio. This would be drawn from the organizations disclosure on the financial statement. In addition, the auditor’s industry understanding would be applied hence a communication with the management on the possible effects of the declining industry performance. This would be necessary in drawing attention to the relevant stakeholders and the management as an emphasis on the factors consideration in further planning and decision making. (FRC, 2012a)
In view of the analysis, it is clear that the risk based audit approach focuses on addressing business risks and controls. This has been demonstrated as involving two main focuses on risks assessment as well as controls design’s assessment with a view of identifying the reasonability of the management risks taking as well as the controls in place. On the other hand, the going concern problems analysis have demonstrated that Carpetright could be facing a going concern’s uncertainty as indicated by a number of financial results ranging from poor performance to uncertain market conditions. However, some development information and performance details provide an indication of the business continuity in the near future with the key indicator including the business plans and efforts to enhance its operations. Finally, a number of factors have been identified as being crucial in influencing an external auditor’s opinion on the organization’s going concern with the crucial factors relating to financial performance measures. Such factors include financial loss and operations challenges in some major markets and products segments as well as industry environment that is negatively affecting other organizations.
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