ASA315 requires the auditor to gain sufficient and appropriate knowledge about the audit client and its operating environment as part of risk assessment. This risk assessment will enable the auditor to set the level of materiality and performance materiality. It also aids in deciding the detection risk since the auditor will understand the inherent risk in the industry. In complying with this standard, auditors are required to gain an understanding of the regulatory framework used by the entity, the legal framework in its jurisdiction of operation, the competitive state of the industry and customer relationships. There are several sources of such information. The major sources are listed below (Arens, Elder, & Beasley, 2009).
Inspecting the sales ledger can give insight to the power of customers by revealing the size of their purchases. If a customer is purchasing 10% or more of the entity’s products, then this may be a powerful customer. The entity may go out of its way to please these customers to the extent of breaching financial reporting standards (Dassen, Hayes, Schidler, & Wallage, 2004).
Supplier databases and the purchases ledger can give evidence of the relationship with suppliers. Major suppliers can be identified by the amount and frequency of the payments made to them. Suppliers whose product is of strategic importance to the entity’s operations could also be considered as quite powerful (Davenhill & Patrick, 1998).
The internet, newspaper articles and television programmes can aid the auditor in understanding the industry state and the competitive environment. This is because if the industry players have actively been engaging in price wars or any other type of competition, it will most likely be reported about. However, mature industries with little competitive activity will rarely attract the media’s attention (Gray & Manson, 2007).
The relevant government publications could be read to gain insight about the industry’s regulatory framework. All the laws that govern the entity’s operations can be found here. The auditor should pay close attention to those which may be difficult to comply with thus providing incentive for misstatements in the financial statements (Guy, Carmichael, & Whittington, 2001).
An auditor’s expert can be used to determine the technological state of the industry. The auditor’s expert could be a specialist in IT. The general economic and political environment can be determined by checking consumer indices and inflation rates (Hayes, Dassen, Schilder, & Wallage, 2004).
To: The Audit Partner
From: The Audit Senior
Subject: The state of the media industry and associated risk factors
The media industry is quite unique. This industry’s products are virtual and thus quite difficult to regulate. The regulatory framework governing the media industry is lenient compared to other industries. E.g. in the manufacturing industry, there are often product specifications to be met, yet in the media industry, there are no specifications for products like movies and broadcasts. The only major legal requirement is to rate movies and programmes according to the appropriate viewership. Thus in terms of audit risk, the regulatory framework does not significantly increase detection risk (Messier, Glover, & Prawitt, 2009).
Customers of the media industry are many and spread all over the world. Having virtuosity, the products can be sold to customers all over the world via the internet. This reduces the power of consumers. If a movie fails in one country, it may succeed in another state. However, consumer tastes change quite fast and successful media firms have to keep up. This means they spend massive amounts on research and development. Firms may try to understate the spending on research as an expense in order to overstate profits. This increases inherent audit risk (Pickett, 2006).
Suppliers in the media industry include actors, news anchors and producers. Media companies are often fighting over the best with plenty of poaching of employees taking place. This is bound to cost a lot of money. Such expenses are likely not to be properly accounted for or disclosed. This increases the risk of material misstatement in the financial statements, and if the expenses are completely concealed and material, then the auditor also runs a high risk of expressing the wrong opinion (Ratliff & Reding, 2002).
The general economic environment usually affects the purchases of most products. However, most media products are not affected by changes in economic conditions since they account for a very small percentage of the consumer’s income. However, a few expensive media products are affected by the economic state. In times of recession, such may not be purchased as much. In determining the effect of the economic environment, the auditor should consider the entity’s product portfolio. If the entity in question deals in products whose price is highly elastic, and the economy is in recession, then the auditor should consider the probability of fraud to conceal poor performance. This results in an increase of audit risk and thus the extent of audit work to be performed.
The competition in the media industry is quite fierce. This is evident in the rapid speed of release of new innovative products. Movies are being rolled out every few weeks with some having quite similar themes. The competition may force some firms to engage in unethical financial reporting in order to appear better than their competitors. This also increases the level of audit risk (Hooks, 2010).
Arens, A. A., Elder, R. J., & Beasley, M. S. (2009). Auditing and Assurance Services: An Integrated Approach. New York: Prentice Hall.
Dassen, R., Hayes, R., Schidler, A., & Wallage, P. (2004). Principles of Auditing: An Introduction to International Standards on Auditing. New York: Prentice Hall.
Davenhill, R., & Patrick, M. (1998). Rethinking Clinical Audit. London: Routledge.
Gray, I., & Manson, S. (2007). The Audit Process: Principles, Practice and Cases. London: Cengage Lrng Business Press.
Guy, D. M., Carmichael, D. R., & Whittington, R. O. (2001). Audit Sampling: An Introduction. Chicago: Wiley.
Hayes, R., Dassen, R., Schilder, A., & Wallage, P. (2004). Principles of Auditing: An Introduction to International Standards on Auditing. New York: Prentice Hall.
Hooks, K. L. (2010). Auditing and Assurance Services: Understanding the Integrated Audit. Chicago: Wiley.
Messier, W., Glover, S., & Prawitt, D. (2009). Auditing and Assurance Services with ACL Software CD. London: Mc Graw Hill.
Pickett, S. K. (2006). Audit Planning: A Risk-Based Approach. Chicago: Wiley.
Ratliff, R. L., & Reding, K. F. (2002). Introduction to Auditing: Logic, Principles, and Techniques. New York: The Institute of Internal Auditors.