Auditing & Assurance Service Assignment Help

Problem Statement

In order to investigate and report on the “true and fair” status of the financial statement of Altium Ltd.’s for the year ended 2020, special focus will be made on “Key Audit Matters” by the company’s Auditor. The auditor’s report will be analyzed using risk-based auditing approach and auditing concepts based on Auditing Standards like ASA 315, ASA 320, ASA 330, ASA 560, ASA 570. ASA 700, ASA 705, ASA 706 and APES 110. As mentioned in the financial report 2020, the auditor of Altium Ltd. is PricewaterhouseCoopers with its headquarters in Barangaroo NSW, Australia.

The analysis will be conducted based on detailed financial and non-financial information presented in the current annual report. The Key Audit Matters area will be scrutinized for understanding the key business operations and auditor’s concerns on the company’s financial statement’s truth and fairness. The aim is to ensure that the impact of business risk, corporate governance, ethics, control risks, whistle-blowing, internal control, reporting to agencies, auditor’s negligence, auditor’s independence, accounting policies and fraud are considered and analyzed in detail while forming an opinion by the auditors on the firm’s financial statement.

Methodology

This report will utilize the qualitative analysis based on secondary data obtained from annual reports, Australian Standards of Auditing (ASA) issued by Auditing and Assurance Standards Board (AUASB) and various internet sources. Thus, this research will utilize the risk based approach for analyzing the audit success. In order to do so, the documentation and data sourcing will be done with due diligence so that the financial statements be reviewed in light of truth and fairness.

Risk based auditing process utilizes the risk assessment as the basis of conducting an audit. It aids the reviewer in addressing the key risks faced by the company, critical systems that could impact the operations of the firm and assessment of assets in order to mitigate the risks (Koutoupis & Tsamis, 2009). The RBA allows the auditors to perform the risk assessment by inquiring the management using analytical procedures, observation and inspections for obtaining the understanding of the firm and its surrounding environment. This approach lets the reviewer to identify key risks and assess the risks of any material misstatement (Koutoupis & Tsamis, 2009). Through RBA, the auditors assess overall risk management framework in order to provide assurance regarding firm’s risk management process and the risk appetite of the company (Robson, Humphrey, Khalifa, & Jones, 2007). Auditors would likely look at the foundational issues (including system inventory, data inventory, best practices and oversight).

In the annual report of 2020, the Auditing Standards were undertaken and reviewed before issuing reasonable assurance based on AAS as expressed by PwC. The annual report provided the clear application of auditing assurances including ASA 320- Materiality in Planning & Performing an Audit, Corporations Act-2001, APES 110- Code of Ethics, ASA 315- Identifying & Assessing the Risks of Material Misstatement through Understanding the Entity & its Environment, AASB 112- Income Taxes, AASB 136 – Impairment of Assets and AASB-15 Revenue Recognition (Altium Ltd, 2020). Furthermore, the key audit matters will be reviewed for analyzing the carrying value of goodwill, calculation of deferred tax balance, revenue recognition and subjective judgments made by group regarding uncertain future events.

Findings

ASA 320- Materiality in Planning & Performing an Audit

The ASA 320 – Materiality in Planning & Performing an audit by AUASB deals with the sole responsibility of the auditors in applying the materiality concept while performing the audit of the financial report (AUASB, 2020). This standard along with ASA 450 deals with the calculation and evaluation of materiality concept for identifying the misstatements. According to AUASB (2020), misstatements (except for omissions) are termed as material if the aggregate effect can negatively impact the economic decisions of the company and can alter the outlook of financial report. The standard provides overview on how materiality can be set based on surrounding circumstances and financial information needs of the group. During the audit planning, the auditors are required to make judgments on materiality based on nature, timing and the extent of risk assessment procedures; identifying and risk assessment of material misstatements and; determining the nature and timing of audit procedures (AUASB, 2020).

During the overall audit planning and performance, the auditors needs to set the materiality for the financial report at whole level regarding size, nature and the circumstances of the omissions that could influence the decision of external and internal users of the financial reports. If, there are some classes of transactions/amounts/disclosures, for which the misstatements of lesser than materiality amount can reasonably be considered, then the auditor must consider it as well.

Moving onto the current audit report issued by PwC for Altium Ltd., the auditors set the materiality level at $3.2 mn at 5% of the Group’s profit before tax (Altium Ltd, 2020). The auditors calculated the materiality level after considering the several qualitative matters so that the overall scope, nature, timing and extent of audit procedures be determined and carried on with effectively. For auditing purposes, the auditors are required to determine the threshold level of materiality as a percentage between 5-10 of net income, assets, total debt/equity or earning/profits. Since Altium Ltd. doesn’t belong to a high-risk industry, hence choosing a threshold between 5-10% seems appropriate. In the auditors’ report, PwC chose a 5% (of the group’s profit before tax) threshold using the professional judgment based on most commonly acceptable threshold levels (Altium Ltd, 2020).

ASA 315- Identifying & Assessing the Risks of Material Misstatement through Understanding the Entity & its Environment

The main aim of ASA 315 is to enable the auditor to identify and assess the risks of any omissions (misstatement) that is material whether it incurred due to error or fraud (AUASB, 2020a). This is done after assessing the environment in which the entity operates including the internal and external factors. In order to carry on with the risk assessment procedures, the auditor is required to conduct enquiries of management within the internal audit functions, analytical procedures and observation and inspection  (AUASB, 2020a). After sourcing all the information, auditor must ensure that it is relevant for identifying risks of material misstatement. The information obtained must include relevant industry & regulatory standards; nature of entity, entity’s accounting policies, firm’s objectives and the strategies and the measurement and review of its financial performance. For assessing the risk, the auditor shall obtain the understanding whether the business has an ongoing process for identification of business risk, estimation of risks, assessment and likelihood of its occurrence and ways of catering the risks  (AUASB, 2020a).

In the given case, Altium Ltd.’s annual report outlined the key business risks including the COVID-19 pandemic, strategic risks, financial & regulatory risks and the security of sensitive issues. The annual report discussed the impact of these business risks on the business operations on an ongoing basis (Altium Ltd, 2020). Firstly, the COVID-19 pandemic resulted in remote working environment for enhancing employee safety and effectiveness due to which loss of productivity was expected. The firm discussed how COVID-19 can reduce customer demand, trigger economic slowdown, shrink customer credit and result in employee absence. Secondly, clear strategy formation was identified to be critical for the company’s success. Thirdly, as Altium Ltd. operates in many countries around the world, it could trigger issues with accounting, compliance, regulatory nd the reporting requirements  (Altium Ltd, 2020). Altium Ltd. has put in the compliance framework for monitoring and reviewing issues like GDPR, tax and reporting on regular basis. Lastly, the business risk associated with security of the sensitive information was also mentioned in the annual report. As the potential of cyber-attack is likely, Altium identified it be the relevant risk that could alter the continuous improvement process at the company  (Altium Ltd, 2020).

As the above business risks and the likely impact was discussed in the annual report, it is expected that PwC must’ve carried on with analytical procedures, enquiries with management and observations for ensuring that internal control systems were present at Altium Ltd. for identifying, assessing, quantifying and minimizing these business risks. It has been found that PwC carries on the audit in five phases i.e. audit planning, risk assessment, audit strategy and plan, gathering evidence and finalization. As a process of risk assessment, the auditors obtain audit assurance from tests of controls, test of details and substantive analytical procedures (see figure below for assurance hierarchy of PwC.

Source: (PwC, 2017)

Also, in the audit report section of the Altium Ltd., PwC reported to have carried on all the procedures that were important to identify and assess the risks of the material misstatement (PwC, 2017). PwC clearly mentioned in the report to conduct the audit in accordance with AAS by obtaining an understanding of the internal controls of Altium Ltd. relevant to the audit in order to help in designing the audit procedure (Altium Ltd, 2020). The auditors also evaluated the appropriateness of the several accounting policies used for conducting accounting estimates and reviewed the related disclosures made by Altium Ltd. The auditors also identified the key audit matters that formed the basis of audit opinion issued by PwC (Altium Ltd, 2020).

APES 110- Code of Ethics for Professional Accountants

APES 110 is a code of ethics issued by APESB based on five fundamental principles of the professional accountants. It requires the accountants and auditors to carry on integrity, objectivity, professional competence, confidentiality and professional behavior (CPA Australia, 2020). The requirements of APES 110 have legal enforceability as per Auditing Standard ASA 102 (Compliance with Ethical Requirements when performing Audits, Reviews and other Assurance Engagement). The APES 110 requires auditors to perform audit and other services based on independence of mind and independence in appearance. The standard requires the audit team members, firms and network firms to be independent of audit clients  (CPA Australia, 2020). A conceptual framework shall be applied by the members for identifying the threats to independence, significance of identified threats and application of safeguards for eliminating the identified threats (or to reduce these threats to acceptable level). Moreover, members are required to use professional judgment while applying the conceptual framework (APESB, 2020).

In the report of Altium Ltd., PwC carried on with a statement that all ethical requirements regarding the independence were fulfilled by the auditors  (Altium Ltd, 2020). Moreover, the documentations were provided for assuring communications about matters that may impact the auditor’s independence and actions were taken by PwC for eliminating the threats or safeguards applied (Altium Ltd, 2020). As Altium Ltd. engages PwC on tax consulting and other services, it ensures that the services are always balanced with the objective of ensuring objectivity and independence of PwC as the auditors. The statement of independence given by PwC in Altium Ltd.’s annual report is as follows;

“PwC is independent of the Group in accordance with the requirements of Corporations Act 2001”.

Similarly, PwC also reported its compliance with ethical standard board’s APES 110 Code of Ethics for Professional Accountants. It also considered the Independence Standards that were relevant for the auditing of financial reports in Australia. Furthermore, the directors also issued the opinions on independence of auditors under Corporations Act 2001  (Altium Ltd, 2020). The report stated that directors were of opinion that none of the service compromised external auditor’s independence as all non-audit services were reviewed and approved for ensuring objectivity and integrity of auditor  (Altium Ltd, 2020). Similarly, the directors ensured that the services didn’t undermine APES 110 Code of Ethics for Accountants. As per section 307C of the Corporation’s Act 2001, the copy of auditor’s independence declaration was also printed in the annual report right after directors’ report  (Altium Ltd, 2020).  

AASB 136 – Impairment of Assets

Due to the magnitude of the amount of USD 29.507 mn, PwC chose impairment of assets as a key audit matter  (Altium Ltd, 2020). It is an obligation of auditors to report the key audit matters under new auditing standard (ISA 701) that is fulfilled by PwC as the goodwill is identified as an area of higher risk. PwC also gave the reasons for considering it as a key audit matter in line with ISA 701 requirement.

AASB 136 includes IAS 36 (Impairment of Assets) issued by IASB. The purpose of this standard is to assist the entities in maintaining their assets at no more than their recoverable amount (AASB, 2020a). If any asset’s carrying amount exceeds its recoverable amount, the asset shall be recognized as impaired and the entities are required to recognize the impairment loss on it. The standard also requires the entities to test goodwill for impairment if the entity has the intangible asset with an indefinite useful life. For carrying on with the recoverable amount calculation, the entity is required to recognize the cash generating units to which the assets belong if the recoverable amount of individual asset is not possible to be calculated  (AASB, 2020a).

For Altium Ltd., the group reported goodwill of USD 29.5 mn as at June, 2020. Hence, under AASB 136, an annual impairment assessment is mandatory (Altium Ltd, 2020). This was identified as a key audit matter by PwC because of the magnitude of goodwill amount reported by the group. The company reported to recognize goodwill on Board & Systems – Americas, Board & Systems EMEA and Electronic Parts, Search & Discovery business segments. In the report, Altium Ltd. reported to use financial modeling for determining the carrying value of goodwill that was supported by forecasts of future cash flows discounted at the present value. The forecasting was done under several assumptions. Under AASB 136, the firms are required to estimate the future cash inflows and outflows using the appropriate discount rates. For the cash flow forecasts, Altium Ltd. used a WACC of 9.2% for Americas & 9.3% for EMEA and Electronic Parts segment  (Altium Ltd, 2020). Other assumptions included the revenue growth rate of 5% for all CGUs from 2021 till 2024 and terminal growth rate of 2%  (Altium Ltd, 2020). Also, it was reported by Altium Ltd. that any changes in the assumptions wouldn’t be causing the change in carrying values of any CGUs to exceed the recoverable amounts.

As part of the audit assurance procedure, PwC assessed the Group’s property, plant & equipment, goodwill and the intangible assets included in CGUs for assessing and testing the impairment reported. It was done to ensure that Group compliance with AASB 136 while calculating the impairment losses (if any) and recoverable amount calculation  (Altium Ltd, 2020). The auditors considered the impairment models that were used for estimating the recoverable amounts and the budget scenarios set by the company for 2021 while comparing it with future cash flow estimations. The Group’s ability to generate forecasts was also assessed by making comparisons over historical budgets in past three years. Furthermore, the key assumptions underlying revenue & terminal growth rates of 5% and 2% were also tested to be consistent with the historical rates and external information  (Altium Ltd, 2020). PwC valuation specialists also assessed the underlying discount rates given the risks faced by CGUs in each segment. Auditors also confirmed the impact of COVID-19 on the future cash flows and goodwill valuation for understanding whether the company considered this business risk while carrying out the sensitivity analysis. The mathematical accuracy of sample models was also carried on to identify and confirm with calculation basis as reported by Altium Ltd. in the annual report. Hence, PwC carried on with substantive tests for verifying whether the information presented by Altium Ltd. was correct or not  (Altium Ltd, 2020).

AASB 112- Income Taxes

AASB 112 aims at prescribing the accounting treatment of income taxes along with analyzing the consequences of current and future taxes on future recovery and other events. Under the standard, the entity must recognize the taxable temporary differences (AASB, 2020). The deferred tax liability is the difference incurring when the carrying amount of the underlying asset exceeds the tax base. This is payable by the entity in the future periods. On the contrary, the deferred tax assets arise when the income tax becomes recoverable in future on basis of deductible temporary differences, carryforward of unused tax credits and unused tax losses carryforward. The entity is required by standard to recognize deferred tax assets only to the extent that benefits are sufficiently probable to be generated in foreseeable future in order to reduce tax payable on future taxable profits (AASB, 2020).

Altium Ltd. recognized the deductible temporary differences that were available to be utilized by the firm with high probability (Altium Ltd, 2020). The firm calculated the future taxable amount based on assumptions and management judgments. The firm reported the portion of deferred tax to be recorded only when the utilization arising from potential benefit was probable. A deferred tax asset of USD 61.7 mn was identified that was transferred to USA and it was considered to be probable to be realized in future  (Altium Ltd, 2020). The company used FDII rules for measuring the deferred tax assets and liabilities for USA while basing the estimations on future tax rates. The rate is expected to be applied from 2021, hence the re-measurement effects were considered during the estimation.

In the given audit report, the calculation of deferred tax balance was chosen as a key audit matter as a temporary difference of USD 54.5mn related to amortization of intellectual property arising from relocation of Group’s core business in 2015 was realized  (Altium Ltd, 2020). Using FDII rule, the company re-measured all deferred tax assets and liabilities for USA. As the quantum of assets and the complexity of US tax legislation were high, PwC considered it to be key audit matter because professional judgment was required for assessing whether or not sufficient future taxable profits will arise for utilization of tax benefits associated with intellectual property amortization  (Altium Ltd, 2020).

PwC carried on substantive analytical procedures amongst test of controls and test of transactions for assessing Group’s calculation of deferred tax balances. It assessed the forecasted profits over the relevant amortization period and then evaluated the consistency of forecasts in line with strategic plan and position of Altium Ltd. The forecasts were compared with previous forecasts for analyzing any differences in actual results and predicted results in order to see the strength of Group’s profit forecasting model  (Altium Ltd, 2020). It also carried on the sensitivity analysis under different growth rates under COVID-19 pandemic and other business risks that could likely alter the future probability of earning profits. Also, the PwC tax specialists were taken on board for reconsidering the deductions claims for amortization under US tax laws, federal laws and state tax rates for finding any discrepancies  (Altium Ltd, 2020). Mathematical estimation models were also used by taking samples of the deferred tax calculation segments in order to test the accuracy of calculations done by Altium Ltd. while preparing financial statements. PwC also evaluated the accuracy and adequacy of the deferred tax calculation under AASB 112 before forming an audit opinion regarding truth & fairness of the financial statements  (Altium Ltd, 2020).