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ACC621 Importance Of Auditing For Financial Audit Processes


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Questions:

Your task:
 
You must choose six (6) accounts from the trial balance for audit testing. In doing so, you should:
 
1. Complete an analytical review using horizontal analysis of the Income Statement and the Balance Sheet using the trial balance provided. Your analysis should include the gross profit margin, the net profit margin and one other ratio that you select. Explain why you have selected that ratio.
 
2. Make a preliminary judgement of materiality using the blended Method. Complete an overall (for the financial report as a whole) and performance materiality, justify your selected level and cite your sources.
 
3. Use the analytical review and materiality assessment to identify accounts that are at-risk of material misstatement.
 
4. Consider whether there are any accounts that should be selected regardless of their quantitative materiality, including one account that may be at-risk of fraud.
 
5. Provide a brief rationale for the selection of each of the 6 accounts.
 
6. For each account that you have selected, identify one assertion that is at risk (i.e. identify 6 assertions in total). Please include an explanation as to why the assertions are at risk

 

Answer:

Audit planning

Analytical review

An analytical procedure in accounting is one of the financial audit processes that help to understand the business and relevant changes that are required in the business. This includes the comparison of data in financial statement and financial information with the prior periods and forecasts. Horizontal analysis of the Income statement and Balance sheet of the given company, RAR Company is made to ascertain its financial growth in the year 2017 as compared to the previous year 2106.

The gross profit margin of the company is determined by calculating the sales percentage that exceeds the cost of goods sold. This helps in evaluating the efficiency of a company that uses its labor and material for producing and selling its products more profitably. The gross profit for the assessment year 2017 is 179,848 and the margin is ascertained by using the formulae, Gross Profit margin= (revenue- cost of goods sold) / revenue.  The margin is 0. 69 or 69%. This shows that RAR Company earns 69 cents on the dollar that is gross margin. The net profit margin of the company is the ratio of the company’s net profits to the given revenues. The margin is evaluated by the formula of Net Income/ Net Sales, which is 0.55 or 55%. The net profit has improved as the revenue has increased and expenses decreased for the year. The net margin of the company is 55%.  Current ratio of the company is further evaluated by dividing the company’s current assets with current liabilities, which is 0.24. This gives an idea about the organization ability to pay back its debt and determines the company’s financial health. 

 

Preliminary judgment of materiality

Audit risk and materiality puts a great impact on the application of generally accepted accounting standards. Both materiality and audit risk is to be considered together for determining the timing, nature and extent of the procedures related to auditing and further evaluates the results of the auditing procedures. Proper review of the accounting procedures helps in identifying and ascertaining the potential risks areas and planning the audit procedures more effectively. The auditor’s standard report should show true and fair view regarding all the material aspects of the organization. 

Sales Accounts

Rationale for selection

The Sales account is one of the most important accounts of the business.  The Sales account reflects the sales, which the company has made in a given year. Sales formulates as one of the core aspects of the business. If a company does not incur adequate sales, it will not be able to survive in the business organization . The given account consists of both cash as well as credit sales. Once these sales transactions are recorded in the sales account, the company then, pairs the account with the returns and various allowances in order to derive the net sales figures.

The sale of various years is tracked to estimate the growth of the business. Hence, this account was chosen for the calculation.

Assertion and explanation 

As seen from the horizontal analysis which has undertaken, it was observed that during the year 2016, the sales amount was 11500$, however, in the year 2017, this amount dropped to 10541.67. It can be observed that there has been a considerable decrease in the sales amount.  The difference in the amount has been 958$ and the percentage decrease has been 8.33%. This kind of decrease in percentage cannot be taken to be an acceptable amount. The sales of the company should always be increasing; however, this is not the case here for the RAR Company.

 

Recommended audit procedure

 Internal Auditing: The Company also checks out for any internal physical loopholes.

Transactional Testing: In the given auditing, the auditor shall check the validity of the statements by checking each transaction separately. He sends out confirmation message to the customers, to verify the existence of all transactions.

Interest Expenses Accounts

Rationale for selection

A bank needs capital for its operations. Hence, it often takes up certain loans and debentures in order to make up for its business. Due to this, it has to pay high amount of interest expenses to the company.  The company RAR company, has taken a bank loan of around 277220$ in 2016, and 392699$ in 2017.  Hence, one it takes up these loans, in order to fulfill its requirements, the company has to incur high amount of interest expenses. This account has been taken to see to it that how the expenses of the company have been doing.

Assertion and explanation

The interest expenses in 11500$ in 2016 and 10541 in 2017. Hence, the difference in the two different amounts is equal to 958$. The percentage difference between the two years is 8.33%. This is a decrease. Hence, it can be stated that a decrease in the interest expenses is good for the company.

Recommended audit procedure

Internal auditing: The auditing has to see to it that the company has entered the accounts in a proper manner and that all loans have been considered carefully before entering.

The auditor can also check with banks to make sure that their calculations match up to the company`s statements.

Accounts receivables

Rationale for selection

Accounts receivables is often the largest asset of the company, therefore it is important to identify the validity of the stated asset for future forecast. Accounts receivables are always reviewed in detail to obtain the fair position of the company.

Assertion and explanation

Accounts receivables have increased from $1, 74,000 to $185,000 in the financial year 2017. Therefore, increasing the current asset of RAR Company by 6.3%. The rate is good for the growth and productivity of the company.

Recommended audit procedure

Calculating receivables report total: the invoices in the account receivables report should be added. Furthermore, the receivables report should be traced to general ledger.

Investigating reconciliation items: the journal entry made for the account receivables should be fully documented. 

 

Cost of Sales Account

Rationale for selection

Cost of sales ascertains and measures the cost of good produced and sold within the time period for the company. It includes only the direct costs and does not show include any kind of overhead costs. It reflects the method for allocating the inventory costs of the organization.

Assertion and explanation

The cost of sales for the year 2107 of RAR Company has decreased by 12%. The direct cost related with the sales of the product has reduced as compared to the previous year. Though the cost of inventory has slightly risen by 1.6%. Effective control over inventories needs appropriate control over receiving, purchasing and issuing materials. A perpetual inventory system is effective for the organization.

Recommended audit procedure

Inventory cut off test: The inventory should be measured after the year end. The information for last shipped item should be received and shipped at the year end. All the inherent risks are to be considered.

Avoiding inherent risks: proper determination of cost of sales is to be valued according to the standards of GAAP. As audit of inventory is directly linked with cost of sales.

Substantive test for inventory account: there is immense possibility of the overstatement of the company’s year end balances. All the obsolete units while counting of inventory should be written down.

Fixed Asset account

Rationale for selection

Fixed assets of an organization are the vital asset account elements and the major target for asset audit. Auditing fixed assets facilitates in uncovering the valid asset transaction. The tangible assets are the major areas of management that requires adequate involvement for the efficiency and growth of the business in the long-run. 

 

Assertion and explanation

The total fixed assets of RAR Company have increased by $7000 in 2017 through the purchase of machinery as it increased from $64,000 to $ 71,000. While machinery and furniture values are still the same. The increment of 5% in assets is good sign for the company effectiveness.

Recommended audit procedure

Risks of material misstatement: the risk for material misstatements should be properly assessed for the growth of the business and the title deeds, ownership agreements and documents should be properly verified.

Avoiding fraud and errors: purchase of assets at higher prices should be properly verified and value of impairment should be determined.

The cut off costs for transaction should be properly verified affecting the fixed assets. Proper allocation or valuation of fixed assets should be established.

Depreciation Account

Rationale for selection

It provides the correct value of the fixed assets and present true and fair view of the organization. It facilitates in maintaining the replacement of assets and integrity of capital. It complies with the provision of companies act.

Assertion and explanation

The accumulated depreciation has increased by $15,186 in the year 2017. Fixed assets of the RAR Company repair and renewal cost has increased by 32% in the given year. Generally, residual value or scrap reduces the cost of fixed assets during its life period. Obsolescence is another factor to be considered.

Recommended audit procedure

Impairment of assets: the carrying amount should be reduced to the fixed assets recoverable amount. The depreciation method applied should be thoroughly reviewed to reflect it usage. The assets should be appropriately tested for impairment.

Internal auditing: The depreciation for the relevant assets should be done as per the rates prescribed in the companies act. It should be ensured that the depreciation is charged as per pro rata basis. During revaluation the depreciation should be charged basically on the revalued amount. 

 

List of References

Appelbaum, Deniz, Alexander Kogan, and Miklos A. Vasarhelyi. “Big Data and analytics in the modern audit engagement: Research needs.” Auditing: A Journal of Practice & Theory 36.4 (2017): 1-27.

Bowlin, Kendall O., Jessen L. Hobson, and M. David Piercey. “The effects of auditor rotation, professional skepticism, and interactions with managers on audit quality.” The Accounting Review 90.4 (2015): 1363-1393.

Brown-Liburd, H., Issa, H., & Lombardi, D. (2015). Behavioral implications of Big Data’s impact on audit judgment and decision making and future research directions. Accounting Horizons, 29(2), 451-468.

Cahan, Steven F., and Jerry Sun. “The effect of audit experience on audit fees and audit quality.” Journal of Accounting, auditing & finance 30.1 (2015): 78-100.

Datar, Srikant M., Madhav V. Rajan, and Charles T. Horngren. Managerial Accounting: Decision Making and Motivating Performance. Pearson Higher Ed, 2013.

Glover, Steven M., Mark H. Taylor, and Yi-Jing Wu. “Current practices and challenges in auditing fair value measurements and complex estimates: Implications for auditing standards and the academy.” Auditing: A Journal of Practice & Theory36.1 (2016): 63-84.

Griffith, Emily E., et al. “Auditor mindsets and audits of complex estimates.” Journal of Accounting Research 53.1 (2015): 49-77.

Horngren, C. B., W. T. Harrison, and M. S. Oliver. “Financial & Management Accounting.” (2015).

Horngren, Charles T., et al. Introduction to financial accounting. Pearson Higher Ed, 2013.

Krahel, John Peter, and William R. Titera. “Consequences of Big Data and formalization on accounting and auditing standards.” Accounting Horizons 29.2 (2015): 409-422.

Lenz, Rainer, and Ulrich Hahn. “A synthesis of empirical internal audit effectiveness literature pointing to new research opportunities.” Managerial Auditing Journal 30.1 (2015): 5-33.

Miller-Nobles, Tracie L., Brenda L. Mattison, and Ella Mae Matsumura. Horngren’s Accounting: The Managerial Chapters. Pearson, 2017.

Rhee, Amanda J., et al. “Team training in the perioperative arena: a methodology for implementation and auditing behavior.” American Journal of Medical Quality 32.4 (2017): 369-375.

Rikhardsson, Pall, and Richard Dull. “An exploratory study of the adoption, application and impacts of continuous auditing technologies in small businesses.” International Journal of Accounting Information Systems 20 (2016): 26-37.

Simon, Alexandra, et al. “An empirical analysis of the integration of internal and external management system audits.” Journal of cleaner production 66 (2014): 499-506.

Stewart, Danielle. “‘Auditing private companies’: a practitioner view.” Accounting and Business Research 47.5 (2017): 585-587.

Vinnari, Eija, and Peter Skærbæk. “The uncertainties of risk management: A field study on risk management internal audit practices in a Finnish municipality.” Accounting, Auditing & Accountability Journal 27.3 (2014): 489-526.

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