Scenario assignment
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Week 3: General Electric Report
Chad Uhler, Chaka Birdette, Sharitza Bailey, Amy Piper
ACC/491
June 26, 2017
Alisa Dumond
Week 3 Scenario Assignments
Table of Contents
Section 1
Introduction…………………………………………………page 3
Initial Risk assessment……………………………………...page 3-5
Section 2
Analytical Procedures………………………………………page 5-6
Analysis of Ratios…………………………………………..page 6-7
Section 3
Materiality………………………………………………….page 7-8
Misstatement……………………………………………….page 8
Audit Risks…………………………………………………page 8
Audit Risk Model…………………………………………..page 8
Inherent Risks………………………………………………page 9
Relationship of Risk to Audit Evidence……………………page 9
Section 4
Five Types of Tests…………………………………………page 9-10
Test of Controls……………………………………………..page 10
Substantive Tests……………………………………………page 10
Analytical Procedures……………………………………….page 10
Test of Details of Balances………………………………….page 10-11
Conclusion…………………………………………………. page 11
Reference Page……………………………………………...page 12
Section 1
Introduction
General Electric has very aggressive competition through changing technology where they continue to do researching and development. They are affected by world economies and the instability in commodity prices, price of oil, and foreign currency volatility. Some factors that may affect General Electric’s business is the quality and efficiency in the product development department, research and development expenditures, and the regulatory standards of their products (United States Securities and Exchange Commission, 2016). Do to the size and global market of General Electric, it could take them at least three months to do a proper audit. One month for planning, one month for fieldwork, and one month for the audit report.
Initial Risk Assessment
General Electric is a global company operating in over eight different segments including: power, renewable energy, oil & gas, aviation, healthcare, transportation, energy/connections & lighting, and capital. With this diverse business platform comes numerous risks, consisting of both firm-specific and macro-level risks. As GE CEO, Jeffrey Immelt, points out, the most notable risk factors lie within product quality, cybersecurity, liquidity, global compliance and business integrations (SEC, 2016).
Product quality is the risk of product failure, safety and environmental issues, and risks stemming from operations surrounding the product’s development. It is crucial when conducting an audit of a product-focused firm to recognize all products and service lines, as well as the inherent risks that lie within the value chain of the products and services. Third-party vendors generally present additional risk on the front and back end of a product. It is pivotal to understand the value chain in its entirety in order to know when and where to gather audit evidence. It is also essential to know when there is new product introduction and how that affects the various revenue and expense items generated from the new product lines.
Cybersecurity is always a top concern when conducting an audit of a large public entity. General Electric has a very complex information technology platform that possess large amounts of private consumer and vendor data across the globe. This data is constantly at risk of being compromised, which increases the audit risk of the company. We must understand how the data flows, how internal controls mitigate the risks, as well as how to test such controls. It is important to assess effectiveness of the internal controls that are implemented to protect private consumer information and maintain the company’s integrity across all business lines and affiliated entities.
Liquidity, discussed further in section 2 (analytical procedures), is the ability of the company to cover its debt at any given period. Companies like General Electric are able to take on varying amounts of debt to finance its business operations; however, they must maintain healthy levels of liquidity in the event of a liquidation. This affects the risk of credit ratings and cost of borrowed funds, access to capital markets, and competitive positioning in the marketplace. Liquidity can be affected by market conditions and well as exposure to counterparty and customer risk.
Global compliance is the regulatory risk associated with conducting business across the world. With General Electric operating on a global level in over eight different segments, there lies a vast amount of laws, regulation, and compliance requirements around the world. It is imperative to understand the historic compliance performance of the company, the current legal proceedings, as well as all future evolving legislative and regulatory requirements around the world. The level of audit risk within global compliance is highest as General Electric operates within heavily scrutinized industries and relies on compliance and audit to ensure full disclosure and adherence to the law.
General Electric possesses a high amount of integration risk with M & A activity being consistently high each fiscal year as GE must maintain a balanced portfolio of business operations. This helps hedge General electrics exposure to the general market cycles; however, this increases firm-specific integration risk, also bringing a high level of risk of material misstatement with the consolidation of the financial statements. Most recently, GE acquired Alstom Synergies, where there is integration risk across strategic management, information technology systems, human capital development, and overall restructuring (SEC, 2016). General Electric has impeccable performance in past M & A activity and possesses management with considerable experience in mitigating collaboration and integration challenges faced by the company.
Other risks include economic, operational, and legal/environmental risks. Within operations there are significant risks regarding raw material shortages, supplier capacity restraints, supplier production disruption, and quality and sourcing issues. These variables create significant volatility in operational costs could result in material misstatements. Also, conditions in the global economy, financial markets, or international governments can adversely affect the financial results of operations. Lastly, current legal proceedings (GE is currently involved in 11 lawsuits) can materially affect the financial statements. Each current legal proceeding must be followed in its entirety so that audit is aware of current and future risks of material changes to the financial statements.
Section 2
Analytical Procedures
Debt to Equity
General Electric: 3.67% 284,668/77,491
Emerson Electric: 1.85% 14,125/7,618
Return on Assets
General Electric: 0.022 9,815/(365,183+493,071)/2
Emerson Electric: 0.10 2,316/(22,088+21,743)/2
Return on Common Equity
General Electric: 0.11 9,815-0/ (75,828+98,274)/2
Emerson Electric: 0.29 2,316-0/(8,081+7,568)/2
Analysis of Ratios
The debt to equity ratio is important for companies to see where they stand in acquiring debt. In comparing General Electric’s debt to equity to Emerson Electric’s debt to equity, it seems that Emerson Electric has more wiggle capacity to be able to borrow and would be able to take on more debt than General Electric. General Electric really needs to be careful on their borrowing as the higher the debt to equity, the less ability they will be able to acquire more debt (Arens, Elder & Beasley, 2014).
For the return on assets ratio, it was imperative to see how General electric compared to a competitor in their industry. The return on assets ratio is a profitability ratio which helps a company measure their overall profitability. It seems that Emerson Electric is able to generate a little more profit per dollar than General Electric; however, both companies have a positive ratio, so it indicates that both companies have upward profit trends. On the other hand, General Electric does have a much higher average total assets than Emerson’s, so their return of assets of 0.022 may be more enticing than Emerson who have a much smaller average total assets. Investors are interested in a higher return on assets because it shows that companies are effective at managing their assets and they are able to produce more net income (My Accounting Course, 2017).
The return on common equity is another profitability ratio; however, it indicates how much profit a company is able to generate off of each dollar of stockholder’s equity. Emerson Electric seems to be able to generate more per dollar of the stockholder’s equity, so it indicates that they have a stronger financial position that General Electric; therefore, it has a higher to convert investors into common stockholders (Accounting, 2017). This being said, General Electric does have a lot more invested in their stockholder’s equity than Emerson Electric and still should have a favorable return, so investors may want to consider investing in them over Emerson Electric.
Even though the numbers on these ratios may seem to favor Emerson Electric, considerations need to be taken into account as to how many assets each company generates and how much stockholder’s equity is invested into each company. After reviewing both company’s numerators and denominator, it looks like General Electric would be more favorable in all three ratios over Emerson Electric.
Section 3
Materiality
During the audit process, auditors have the main goal of finding out whether the financial statements of a company that has been prepared are right and consistent with the reporting framework. However, the financial entry, their reasons for creating their financial statements is totally different from that (Burke, 2015). Therefore, materiality refers to that the amounts audited and quantified are not just figures that add up but rather have a significant and right effect under various contexts applicable to the financial institution. The auditor determines the level of materiality be achieved. This is regarding the types of testing as well as the financial statements prepared.
Misstatement
A misstatement of audits takes place when the results of the audit process show that the relevant financial reporting frameworks were not adhered to. When the auditor sets down to conduct an audit, there are inherent risks due to human errors or errors of omission. The misstatement also occurs when the auditor gives an opinion is deemed inappropriate or unfit in regards to the financial statements at hand (Chandler, 2016).
Audit Risk
Audit statements that are made during the auditing process by auditors usually have a clause declaring that the reports have been crosschecked and are free from any material misstatements. However, the audit risk appears where there are misstatements suspected or identified in the reports even after the reports have been declared free from any misstatements. The audit risk can be categorized into two (Chan & Kogan, 2016). The first category is a risk of material misstatement while the second is the detection risk.
Audit Risk Model
The audit risk model is used to establish the entire amount of risk that was incurred during the auditing process. Further, the model goes ahead to offer management solutions regarding the type of risk established and the magnitude and nature of the risk (Chandler, 2016). The total audit risk is arrived at as being the total product of control risk, detection risk and inherent risk which are the major components of the audit risk model. If the risk identified is too high, the auditors must put in measures to restore the risk to the most acceptable level.
Inherent Risk
Inherent risk is one of the three components of the audit risk model. The other two components of the audit risk model include the control risk and the detection risk. Inherent risk occurs when the auditing process is characterized by very complex accounting and financial transactions (Chan & Kogan, 2016). It results from errors of omission from factors that are difficult to control. To mitigate the risk, it is recommended that qualified and experienced auditors be involved in the process.
Relationship of Risk to Audit Evidence
Evidence during the auditing process is necessary to be gathered and collected to mitigate the risks inherent in the process. The evidence is used to support their statements in the audit reports and minimize the risk of misstatements. The auditors are required to gather their evidence from material financial statements in the organizations and have the evidence certified by the management (Chandler, 2016). The evidence is required to be part of the audit process documentation. Therefore, the relationship that exists between risk and audit evidence is that risk evidence minimizes and mitigates audit risk.
Section 4
Five Types of Tests
Auditors use five types of tests to determine whether financial statements are fairly stated. These tests include risk assessment procedures, tests of controls, substantive tests of transactions, analytical procedures, and tests of details of balances. Risk assessment procedures are required in all audits to assess the risk of material misstatement while the other four types of tests are performed in response to the risks identified to provide the basis for the auditor's opinion. Risk assessment procedures are performed to assess the risk of material misstatement in the financial statements (Arens, Elder, & Beasley, 2014). For General Electric, performing a risk assessment is a necessary part of the audit because it is an accounting standard.
Test of Controls
Tests of controls are audit procedures to test the effectiveness of controls in support of a reduced assessed control risk (Arens, Elder, & Beasley, 2014). Tests of controls give the auditor a deeper understanding of how the internal controls work and if they are effective. Performing tests of controls is also necessary for General Electric because it will help the auditor understand GE’s internal control and evaluate if their internal controls are effective.
Substantive Tests
Substantive tests of transactions are audit procedures testing for monetary misstatements to determine whether the six transaction–related audit objectives have been satisfied for each class of transactions (Arens, Elder, & Beasley, 2014). Substantive tests of transactions are another necessary test for GE because it will allow the auditor to see if the all transactions were correctly recorded in the journals and correctly posted, considering all six transaction–related audit objectives, then they can be confident that general ledger totals are correct.
Analytical Procedures
Analytical procedures are evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data (Arens, Elder, & Beasley, 2014). Analytical procedures help auditors by indicate possible misstatements in the financial statements and by provide substantive evidence. GE would benefit from also preforming analytical procedures.
Test of Details of Balances
Tests of details of balances are audit procedures testing for monetary misstatements to determine whether the eight balance–related audit objectives have been satisfied for each significant account balance (Arens, Elder, & Beasley, 2014). Auditors perform detailed tests of the ending balances for sales and accounts receivable, including procedures such as confirmation of account receivable balances and sales cutoff tests. GE would be wise to also complete tests of details of balances. Tests of ending balances are essential because the evidence is usually obtained from a source independent of the client, which is considered highly reliable.
Conclusion
Overall, the auditing of General Electric will require some time as it is a global company dealing with multiple economies. Analytical procedures can help limit these risks and help General Electric make better future decisions. Additionally, understanding the different terms and tests that come with auditing will enable them to identify different misstatements that may occur on their financial statements.
References
Accounting. (2017). Return on common stockholders’ equity ratio. Retrieved from http://www.accountingformanagement.org/return-on-common-stockholders-equity-ratio/
Arens, Elder & Beasley (2014). Auditing and Assurance Services, 15/E. Prentice Hall.
Burke, A. (2015). Introduction to Audit Planning Certified Public Accountant. Retrieved from http://www.cpaireland.ie/docs/default-source/Students/Study-Support/P1-Auditing/introduction-to-audit-planning.pdf?sfvrsn=0
Chan, D. Y., & Kogan, A. (2016). Introduction to using Analytics in Auditing. Journal of Emerging Technologies in Accounting, 13(1), 121-140. Retrieved from http://aaajournals.org/doi/abs/10.2308/jeta-51463?code=aaan-site
Chandler, R. (2016). Auditing and assurance: University of London. Retrieved from http://www.londoninternational.ac.uk/sites/default/files/programme_resources/lse/lse_pdf/subject_guides/ac3093_ch1-4.pdf
My Accounting Course. (2017). Return on assets ratio. Retrieved from http:////www.myaccountingcourse.com/financial-ratios/return-on-assets
UNITED STATES SECURITIES AND EXCHANGE COMMISSION-Emerson. (2016). Form 10-K. Retrieved from http://www.emerson.com/documents/corporate/180344.pdf
United States Securities and Exchange Commission. (2016). Form 10-K. Retrieved from http://www.ge.com/ar2016/assets/pdf/GE_2016_Form_10K_SummaryAndFull.pdf
