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ACC321 Auditing And Professional Ethics
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ACC321 Auditing And Professional Ethics
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Course Code: ACC321
University: University Of The Sunshine Coast
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Country: Australia
Question:
Prepare a report for the audit senior, which addresses the 5 issues below. 1. The audit partner has suggested that the preliminary assessment of materiality for the financial report as a whole be set at $15,000. Comment on the appropriateness of this figure for your client. Provide evidence to support your view. Include a brief discussion of the effect that changing the preliminary assessment would have on the audit budget. 2. Prepare an analytical review (in the form of a trend analysis) using the income statement items from the trial balance. Note: Present your analysis in table format; comments on the results are not required for requirement 2. 3. Use the trend analysis to identify 3 income statement accounts that appear to be atrisk of material misstatement. Provide justification for why these accounts should be subjected to significant audit testing. In your explanations, identify an assertion that is likely to be at-risk for each account (i.e. identify 1 assertion per account; 3 in total). 4. For each account and assertion identified in requirement 3, design and describe an audit procedure that would provide relevant evidence for this (i.e. describe 1 procedure for each account; 3 procedures in total). Note: you need to explain the procedures in your own words with as much detail as possible (for example, if applicable, identify the sampling frame and specific documents required for your procedure). 5. The audit partner has suggested that fraud risk should not be considered for this client, as he feels that the client’s staff are all very trustworthy. Comment on the appropriateness of the audit partner’s suggestion. Identify whether there are any indications of fraud evident in the analytical review.
Answer:
Introduction:
Considering the balances provided in Chestnut Trial Balance a detailed discussion on the materiality level for the audit of the organization shall be made. Along with discussion on the materiality level for the audit an elaborate audit plan for certain account balances will also be made for the benefit of the readers in the document.
Part 1:
In Australia the auditing and assurance services are guided by the Auditing and Assurance Standards issued by the Australian Auditing Standards Board (AAUSB). In order to determine the materiality for class of transactions and account balances in financial statements an auditor must refer to ASA 320 (Simon et. al. 2018). ASA 320 provides following benchmarks for auditors to calculate materiality levels:
Class of transactions
Benchmarks
Sales for revenue
5% to 10% of sales.
Cost of sales for expenditures
5% to 10% of cost of sales
(Junior, Best and Cotter, 2014)
Considering that the sales balance is provided for 6 months period ending on December 31, 2016 the auditor should use 10% of sales to determine materiality level in respect of items of revenue. Thus, for a sales of $98,975 the materiality level would be (98975 x 10%) = $9,897.50. In respect of expenditures again 10% benchmark can be used to determine materiality level for the audit of items of expenditures. Hence, for amount of expenditures the materiality level would be (30525 x 10%) = $3,053.
Thus, the material amount determined initially for the audit is quite high at $15,000. Hence, the amount of $15,000 is not appropriate for determination of materiality level (Soh and Martinov-Bennie, 2015).
The change in preliminary assessment would substantially increase the efforts on the part of the auditor to verify transactions above the material amount. Since earlier it was quite high the auditor would have to increase their efforts during the course of auditing. Cost of auditing would obviously increase significantly subsequent to the change in material amount after preliminary assessment.
Part 2:
Analytical review: Conducting ratio analysis for evaluating any significant changes in profitability, liquidity and solvency position is one of the most effective means for an auditor to identify possible area of material misstatements in financial statements. Let’s have the ratio analysis on the profitability aspect of Chestnut before commenting on the possible areas misstatement in the trial balance (Simnett, Carson and Vanstraelen, 2016).
The amounts in the table below are in $ and the ratios are in percentages.
Period
July 01, 2016 – Dec 31, 2016
July 01, 2015 to June 30, 2016
Gross profit margin
Sales
98975
187450
Gross profit (Sale – Cost of sales)
68,450
123,855
Gross profit margin
69.16
66.07
Operating profit ratio
Sales
98975
187450
Operating profit (Sales – Operating expenses)
25,056
33,072
Operating profit ratio
25.32
17.64
(Bepari and Mollik, 2016)
Since, the period of information provided in trial balance in the current period is only for 6 months thus, it would be extremely difficult to come to a particular assertion from ratio analysis. However, an idea can still be formed about possible area of misstatement in financial information, if any from analytical review.
Part 3:
The operating profit ratio of Chestnut as increased by almost 8% in the six months period ending on December 31, 2016. Thus, the operating expenditures have to be checked carefully as there could some error material in the financial information. Another important factor that came to the notice is the amount of repairing and maintenance expenditures. In 2015-16 it was around $5050 for the entire year (Carson, Fargher and Zhang, 2016). However, in the 6 months period in 2016-17 it is merely $720. The drop is quite significant especially considering the organization has not huge turnover. Hence, there could be material error in financial information in this regard.
Percentage of repaid and maintenance cost to sales
Sales
98975
187450
Repair and maintenance
720
5,050
Percentage of repaid and maintenance cost to sales
0.73
2.69
(Simnett and Huggins, 2015)
The three account that shall be specifically verified are as following:
Accounts receivable:
Accounts receivable is quite huge for a small organization like Chestnut. Thus, for obvious reasons accounts receivable shall be verified to test whether transactions have been correctly recorded in accounts receivable ledger to reflect the correct amounts to be receivable for debtors. The accounts receivable balance is $120,750 as on December 31, 2016 (Ellis, 2018).
Repair and maintenance:
As already mentioned repair and maintenance expenditures is significantly low in the current 6 months compared to the last year. Is it due to anything that the organization has done or has there been any mistake on the part of the accountant to record the amount of repair and maintenance expenditures is to be determined by the auditor?
Expenditures: Cost of sales and other expenditures shall be verified to check whether there is any material error in reporting these amounts in the trail balance. This is due to importance of the account balances in determination of profit and loss of the organization (Fu, Carson and Simnett, 2015).
Part 4:
Account
Audit procedure
Accounts receivable
Obtaining external confirmation from customers of the organization to verify whether the amount showed as receivable are correctly stated.
Repair and maintenance
The transactions posted for repair and maintenance shall be verified with supporting documents and vouchers to ensure that all repaid and maintenance expenditures have been recorded correctly in the books of accounts of Chestnut.
Expenditures including cost of sales
The cost incurred to procure materials shall be verified with the entries posted in the books of accounts for cost of sales. Also the auditor must check whether all necessary trade discounts and rebates have been deducted at the time of payment and accordingly entries have been recorded or not.
(Simnett, Zhou and Hoang, 2016)
Part 5:
ASA 240 has been issued by AASUB for consideration of risk emanating from fraud committed by management or other employees of an organization. An auditor must follow the standard while considering fraud risk in an audit. Auditor’s personal point of view about the employees of an organization does not affect the status as far as ASA 240 is concerned (Arnold et. al. 2016). The personal judgement of an auditor about the trustworthiness of the employees of the client is of no significance in complying with the guidelines mentioned in the standard. Auditor will have to consider the fraud risk in accordance with ASA 240.
Hence, the advice of the senior partner of audit is not appropriate in this regard as the auditor will have to assess the risk of fraud in the audit even if the employees of Chestnut are trustworthy.
Conclusion:
From the above discussion the following points can be concluded about Chestnut and its audit:
Firstly, the auditor’s preliminary assessment of materiality for the financial report as a whole at $15,000 is very high compared to the amount of revenue and expenditures. Secondly, the analytical review reveals that the operating margin of the enterprises has improved significantly in the 6 months ending period in December, 2016. However, the repairing and maintenance expenditures seems have been misstated in the period. Finally, the suggestion given by the audit partner for not verifying the risk of fraud in the audit is not correct.
Recommendation:
The auditor must change the materiality level and lower the amount for financial statement as whole to ensure that more number of transactions are verified and tested with substantive audit procedures. The auditor must use substantive audit procedures on accounts receivable, repair and maintenance and cost of sales along with other account heads. The suggestion of audit partner for fraud risk purpose is not appropriate hence, must be ignored by the auditor. In fact the auditor must use ASA 240 to verify whether there has been any fraud (Yao, Percy and Hu, 2015).
References:
Arnold, B., Bateman, H., Ferguson, A. and Raftery, A., 2016. Partner-Scale Economies, Service Bundling, and Auditor Independence in the Australian Self-Managed Superannuation (Pension) Fund Industry. Auditing: A Journal of Practice & Theory, 36(2), pp.161-180.
Bepari, M.K. and Mollik, A.T., 2016. Stakeholders’ interest in sustainability assurance process: An examination of assurance statements reported by Australian companies. Managerial Auditing Journal, 31(6/7), pp.655-687.
Carson, E., Fargher, N. and Zhang, Y., 2016. Trends in auditor reporting in Australia: a synthesis and opportunities for research. Australian Accounting Review, 26(3), pp.226-242.
Ellis, R., 2018. Quality assurance for university teaching: Issues and approaches. In Handbook of Quality Assurance for University Teaching (pp. 21-36). Routledge.
Fu, Y., Carson, E. and Simnett, R., 2015. Transparency report disclosure by Australian audit firms and opportunities for research. Managerial Auditing Journal, 30(8/9), pp.870-910.
Junior, R.M., Best, P.J. and Cotter, J., 2014. Sustainability reporting and assurance: A historical analysis on a world-wide phenomenon. Journal of Business Ethics, 120(1), pp.1-11.
Simnett, R., Carson, E. and Vanstraelen, A., 2016. International archival auditing and assurance research: Trends, methodological issues, and opportunities. Auditing: A Journal of Practice & Theory, 35(3), pp.1-32.
Simnett, R. and Huggins, A.L., 2015. Integrated reporting and assurance: where can research add value?. Sustainability Accounting, Management and Policy Journal, 6(1), pp.29-53.
Simnett, R., Zhou, S. and Hoang, H., 2016. Assurance and other credibility enhancing mechanisms for integrated reporting. In Integrated Reporting (pp. 269-286). Palgrave Macmillan, London.
Simon, C.A., Smith, J.L. and Zimbelman, M.F., 2018. The Influence of Judgment Decomposition on Auditors’ Fraud Risk Assessments: Some Tradeoffs. The Accounting Review.
Soh, D.S. and Martinov-Bennie, N., 2015. Internal auditors’ perceptions of their role in environmental, social and governance assurance and consulting. Managerial Auditing Journal, 30(1), pp.80-111.
Yao, D.F.T., Percy, M. and Hu, F., 2015. Fair value accounting for non-current assets and audit fees: Evidence from Australian companies. Journal of Contemporary Accounting & Economics, 11(1), pp.31-45.
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