Strategic analysis for risk assessment

Accounting Ahead | Original study resource | accountingahead.com.au

Strategic analysis for risk assessment

MODULE 2 | 2.7.1 | STUDENT COMPANION

The auditor must perform three kinds of risk assessment procedure: enquiry, analytical procedures, and

observation and inspection. Strategic analysis organises what they reveal: SWOT sorts internal strengths

and weaknesses from external opportunities and threats; a PESTEL scan checks six outside forces

(political, economic, social and technological, plus legal and environmental); and value chain analysis

follows how the business creates value, showing where each risk enters the accounts.

The three risk assessment procedures

The auditor also draws on what was learned when accepting or continuing the engagement, on past audits and

on the team discussion. Enquiry alone is never enough: it tells you what people believe, or want you to believe.

Procedure What it involves Why it matters

Enquiry Management and others inside the entity: sales

staff, warehouse managers, in-house lawyers,

internal auditors, the people who run IT

Each sees a different part of the business,

and people further from the accounts

sometimes speak more freely

Analytical

procedures

Comparing figures and relationships to find

anything unexpected (the next lesson)

An unexpected change points to an

account that may be misstated

Observation and

inspection

Touring the factory, watching goods received and

dispatched; reading board minutes, plans,

budgets, contracts and reports to regulators

Tests what people say against what

actually happens and what is written

down

A SWOT analysis of Voltana

Helpful Harmful

Internal

External

Strengths

A well-known brand

Its own assembly plant

A large network of trained installers

Weaknesses

Dependence on imported cells from a few suppliers

A dominant founder

A new system still settling in

Opportunities

Rising electricity prices

Government rebates for home batteries

Payments to households that feed power back to the grid

Threats

Cheaper imported batteries

Changes to rebate rules

A stronger US dollar

A technology leap that makes current batteries look old

For the auditor, weaknesses and threats are the most useful corners: that is where pressure and misstatement tend to come from

Reading the SWOT. Strengths and weaknesses are internal; opportunities and threats come from outside.

Voltana's weaknesses (a few overseas cell suppliers, a dominant founder, a system still settling in) raise control

ADVANCED AUDIT AND ASSURANCE | M2 | 2.7.1 | STUDENT COMPANION

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and fraud risk; its threats (cheaper imports, rebate changes, a stronger US dollar, a technology leap) put

pressure on margins and on the value of its stock.

A PESTEL scan of Voltana

P | Political

Rebate programs can be expanded,

tightened or ended

In the accounts: A tighter rule could cut

sales and make amounts due under the

scheme harder to collect

E | Economic

Interest rates, inflation and the exchange

rate: customers' ability to buy, and Voltana's

costs

In the accounts: A stronger US dollar raises

the cost of imported cells and moves the

value of currency contracts

S | Social

Growing interest in energy independence;

concern about safety

In the accounts: A safety scare could cut

demand and leave stock harder to sell

T | Technological

Rapid improvement in battery chemistry and

software

In the accounts: A technology leap could

leave inventory overvalued

E | Environmental

Extreme heat and flooding; growing

expectations about recycling old batteries

In the accounts: Heat feeds the warranty

provision; flooding threatens stock

L | Legal

Electrical licensing laws, consumer

guarantees under Australian consumer law,

rebate scheme rules

In the accounts: Consumer law could make

warranty obligations wider than the written

warranty

Voltana's value chain

Support activities

Procurement

Purchases concentrated with a few

suppliers

Technology development

Software costs management may

want to treat as an asset

Human resources

Commissions and bonuses

Firm infrastructure

Governance, finance and IT,

including the new system

Primary activities, in order

Inbound logistics

Cells and inverters

arrive by sea

In the accounts:

Cut-off for stock in

transit; currency on

amounts owed overseas

Operations

Assembly in the factory

In the accounts: How

inventory is costed

Outbound and

installation

Batteries delivered and

installed

In the accounts: The

point revenue should be

recognised

Marketing and sales

A commissioned sales

force signs contracts

In the accounts:

Pressure to record sales

early

Service

Monitoring subscriptions

and warranty repairs

In the accounts:

Deferred revenue; the

warranty provision

A map: business activity, then account balance, then assertion

From activity to assertion. Each primary activity raises its own accounting questions, and the support activities

shape the controls and the pressures behind them: concentrated procurement, software costs that might be

capitalised, commissions and bonuses, and the new system.

Why an auditor cares about marketing

Suppose Voltana's marketing team runs a June promotion: free installation for anyone who signs before 30

June. That could pull a wave of signed contracts into June that won't be installed until July or August. If any are

recorded as June revenue, that is a cut-off misstatement, and with bonuses tied to annual growth there is an

incentive for it to happen. A marketing decision has become an audit risk.

ADVANCED AUDIT AND ASSURANCE | M2 | 2.7.1 | STUDENT COMPANION

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From strategic risk to audit risk

For each strategic risk, ask how likely it is to cause a material misstatement, and which accounts and assertions

it would affect. Not every business risk becomes an audit risk, but every audit risk on the plan should trace back

to something real about the business.

Strategic risk How it could cause a misstatement Accounts and assertions

A move to sell through one

national retailer

Credit risk concentrated in a single

customer

Valuation of receivables

A plan to collect and recycle old

batteries

Environmental obligations, which may arise

before any recycling starts

Provisions: is there a present

obligation yet? Completeness and

valuation; disclosure

A major distribution partner is lost Sales fall; amounts the partner owes

become harder to collect

Revenue; valuation of receivables

A June promotion pulls sales

forward

Contracts recorded as revenue before

installation

Revenue occurrence and cut-off;

receivables

ADVANCED AUDIT AND ASSURANCE | M2 | 2.7.1 | STUDENT COMPANION

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Practice questions

MODULE 2 | 2.7.1 | TRY THESE BEFORE THE WORKED ANSWERS

Moonah Marinas Pty Ltd (imagined) runs six marinas on the east coast with about 1,800 berths, most

with waiting lists. Berth holders pay annual licence fees in advance; visitors pay by the night. Each marina

also sells fuel and boating supplies and runs a boat lift, repair yard and dry storage. Two marinas sit on

seabed leased from the state government, and those leases require Moonah to remove its structures when

they end. Moonah bought two marinas last year with a variable-rate bank loan. In March a storm wrecked

pontoons at one marina; the insurance claim is still being assessed, and premiums have risen. A new

booking and billing system went live in January. Marina managers earn bonuses on berth occupancy, fuel

storage and sewage pump-out need environmental licences, and channels must be dredged regularly.

Question 1 - A SWOT analysis of Moonah

Prepare a SWOT analysis for Moonah, then name the two items most relevant to the audit.

Items for Moonah

Strengths

Weaknesses

Opportunities

Threats

ADVANCED AUDIT AND ASSURANCE | M2 | 2.7.1 | STUDENT COMPANION

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Question 2 - A PESTEL scan of Moonah

Complete a PESTEL scan for Moonah, linking each force to an account or assertion.

Force What it means for Moonah Account or assertion affected

Political

Economic

Social

Technological

Environmental

Legal

Question 3 - Map Moonah's value chain

Map each activity in Moonah's value chain to the financial statements.

Activity What happens at Moonah Where it lands in the accounts

Inbound logistics

Operations

Outbound logistics

Marketing and sales

Service

Procurement

Technology

development

Human resources

Firm infrastructure

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Worked answers

MODULE 2 | 2.7.1 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - SWOT (suggested)

Items for Moonah

Strengths Hard-to-copy waterfront sites; waiting lists; fees paid in advance; varied income

Weaknesses Debt-funded acquisitions; storm-exposed pontoons; a new system bedding in; reliance on

state leases

Opportunities Higher prices or more berths for the waiting lists; dry storage; electric boat charging

Threats Storms and rising seas; interest rates; insurance premiums; tougher environmental rules

Most relevant to the audit 1. The storm: impairment of damaged pontoons, repairs versus improvements, and no

insurance recovery until virtually certain. 2. Fees in advance through a new system, with

occupancy bonuses: deferred revenue, occurrence and cut-off, billing controls

Question 2 - PESTEL (suggested)

Force What it means for Moonah Account or assertion

Political State control of seabed leases, rents and renewals Lease balances; removal provisions;

marina values

Economic Interest rates; boat owners' spending; fuel prices Interest and loan conditions; revenue; fuel

stock

Social Growing interest in recreational boating Revenue; berth fees paid in advance

Technological New booking system; electric boats needing

chargers

Billing completeness; capital spending

Environmental Storms, rising seas, dredging, fuel spills Pontoon impairment; remediation

provisions

Legal Environmental licences; lease removal clauses;

safety

Non-compliance; provisions; contingent

liabilities

Question 3 - Value chain (suggested)

Activity What happens at Moonah Where it lands in the accounts

Inbound logistics Fuel and supplies for resale Inventory existence and value; fuel cut-off

Operations Berths, boat lift, repairs, dry storage Accuracy of fees; repairs in progress

Outbound logistics Fuel at the dock; boats returned Revenue cut-off; cash handling

Marketing and sales Annual licences sold in advance Deferred revenue; occurrence

Service Pump-out, security, disputes Refunds; claims and provisions

Procurement One fuel supplier; dredging contractors Commitments; capitalising repairs

Technology development New booking and billing system Capitalised software; billing controls

Human resources Occupancy bonuses; seasonal staff Bonus accruals; pressure on occupancy

Firm infrastructure Acquisitions, loan, state leases Asset values; loan conditions; removal provisions

ADVANCED AUDIT AND ASSURANCE | M2 | 2.7.1 | WORKED ANSWERS

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