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An audit is an independent investigation that is conducted on the financial statements of an organization (Sekhri, 2010). The principal aim is to ascertain whether the latter reflect a true state of things within the organization. The report by the external auditors serves to boost the public reliability of the monetary operations. In this essay, the approach adopted by KPMG in auditing Tesco PLC Company is discussed. A rigorous examination of the issue is intended to give an insight into the necessary steps of the auditing process.
Planning and Determining an Effective Audit Program
Audit planning is a preparatory stage of making an assessment on the necessary requirements before conducting an actual audit process. It is prudent for an auditor to plan properly for the audit before actual commencements. First, he needs to initially get familiarized with the organization to determine the necessary audit approach to use. After that, information on the basic nature of the organization’s activity should be obtained. At this step, the auditor should seek to understand the major product that the company deals with and its prime suppliers. The position of the enterprise in the market is also important, as well as the volume of its transactions.
The understanding of the company’s trade behavior is required for a deep insight on the most suitable audit procedure. It is also crucial for the auditor to be able to determine whether to rely on the data provided by the company. Indeed, in audit planning, it is his responsibility to take a look on the internal control system of the organization and ascertain whether it is trustworthy. Therefore, determination of the audit engagement with Tesco audit committee constitutes the first step of analysis. Then, the level of Tesco compliance with the requirements in the industry is to be studied. Initial materiality tests on the balances, which aim to decide whether to continue relying on them in conducting the audit, are also important for the overall procedure.
To begin with, the suggested audit would conduct analytical tests on the data to determine whether it is free of error and misstatements (Sekhri, 2010). Financial ratios in the financial statements would be then used to test the reported figures. In particular, profitability and liquidity ratios are advisable to test the information on the financial statements. Recalculation of the ratios based on the same data would help see whether the similar results can be obtained. The audit would focus on the cash account, the credit control account, and the provision for bad debts account. During analysis of the cash account, the audit would include a test of the actual cash reported in the statement compared with the actual cash at hand in the organization. The cash issue is very crucial to consider, as Tesco company deals with huge transactions of cash. The analytical procedures would also involve the test of details for the credit control to determine the correctness of the creditors account. Substantive tests on the provision for bad debts would be applied to ascertain whether the correct allowance levels have been established (Sekhri, 2010).
Analysis of the Balance Sheet and the Income Statement
The balance sheet and the income statement analysis would be conducted in details in order to give a fair view as to the balances reported. The internal control system that is used to prepare the financial statements would be examined. When studied, the internal controls would give an indication of the reliability of the financial statements. An appropriate evidence of the internal control system validity would be collected by taking notes on the strengths of the system. Then, the adherence to the internal control system would be assessed. If the judgment on the internal controls was right, the actual balances in the account could be examined right away. Random sampling would be used to identify the items to be tested in the balance sheet and the income statement since by no means could all the items be tested. A comparison of the bank balance and the actual balance as per the balance sheet would be performed to test for any discrepancies. In the audit of the balance sheet items, the working notes would constitute the matter of interest to test for accuracy of the reported figures. An additional computation of the sampled balances would be made to check the accuracy of the items. Furthermore, an adherence to the accounting reporting standards would be verified, as these are a clear indicator of the reliability of the financial statements balances. Finally, when investigating the cash account, the controls put would have to be examined to conclude whether there are any risks of cash mishandling. The controls on the cash handling process would be a pointer on whether the reported cash balance is factual.
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Audit Risk Model
A risk model would be developed to assess the level of audit risk in Tesco PLC Company. This assessment would be crucial in terms of minimizing the audit risk. There are three risks that the audit process would have to address, namely the inherent risk, the control risk, and the detection risk (Gray & Manson, 2005). The inherent risk means the risk that Tesco financial statements are misstated due to errors or omissions in the preparation process. Control risk is the risk that the financial statements will be materially misstated due to weak internal control system. The detection risk, on the other hand, is the risk that material misstatements might be failed to detect when performing the audit. In this audit, a proper approach would be to seek to minimize both the inherent and the control risks by applying the necessary materiality tests. Materiality is the threshold that would guide the audit process on whether a certain omission amounts to significant misrepresentation of the financial statements. In determining the materiality threshold of items in the financial statements, the quantity of the transactions and their significance would be considered. For establishing the materiality level, a judgement on the significance of an item in the financial statements would be used.
After conducting the audit and checking whether Tesco Company elucidates the its financial situation honestly, an unqualified report would be issued. It would indicate that as per the test of balances and that of the internal controls, KPMG Company is satisfied with the Tesco Company following the right procedures. The report would emphasize that the methods KPMG applied for conducting the audit analysis of the company prove the documentation of Tesco to reflect a true and fair value. The audit company would also make it clear that their responsibility is basically to examine the financial statements of the company. It would be also clarified that the responsibility of issuing the financial statements principally belongs to the management (Gray & Manson, 2005).
An audit report is very important to both the company and the general public. The audit report serves as guiding principle in investment decision making. To the company, such report gives a boost to the quality of the financial statements. However, in the modern world, it is surprising to see that although the companies receive the audit reports, some of them end up crumbling. Anyway, the auditing standards have indeed provided some leeway for the audit companies by shifting the responsibility of preparing correct financial statements to the organization management.