Audit Report On Small Entity Financial Statements

Discussion and Analysis

A report has been prepared on one of the small entity for which the audit planning is to be done. The trial balance of the company has been given from which the materiality of the entity needs to be determined. Besides this, the preliminary analytical review of the company has been done and variance analysis and the common size income statement has been prepared based on the input for both the given year 2016 and 2017 (Dichev, 2017). The report highlights the critical accounts where major anomalies can be seen and the audit procedures to be employed for each of these accounts has been shown. At the end, the fraud risk analysis has also been done for the entity to check the possibility of fraud, material misstatements, errors and other omissions, if any, in the entity.

The trial balance of the given company has been shown below for the years 2016 and 2017 and since the debit and credit is not reconciling, the balance can be considered to be the suspense account and the same has not been considered in rest of the calculations as the nature of the same is not certain (whether income / expense / asset / liability).

Trial Balance
Particulars	Jul 1, 2016 – June 30, 2017 Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	Jul 1, 2015 – June 30, 2016
Debit	Credit	Debit	Credit
Cash at Bank	120,000		73,000
Accounts receivable	207,000		122,750
Inventory	317,143		174,000
Machinery	71,000		64,000
Accumulated Depreciation	–	49,419		24,000
Motor Vehicles	66,000		66,000
Accumulated Depreciation	–	43,571		21,000
Furniture	7,400		7,400
Accumulated Depreciation	–	4,526		2,220
Bank Loan	–	230,000		230,000
Sales	–	197,950		187,450
Cost of sales	61,050		63,595
Consultancy fees	–	59,250		57,000
Interest income	–	48		50
Bank charges	348		350
Depreciation	16,565		15,738
Interest expense	11,500		11,500
Printing	370		375
Miscellaneous	1,440		5,050
Wages	52,570		53,000
Superannuation	3,994		4,770
Total	936,380	584,764	661,528	521,720

1. In the first place, the materiality level is to be determined for the given entity as it will help in ascertaining  which is the extent to which the checking needs to be done and what can be ignored. Anything is said to be material if it has the ability to change the economic or financial decision of the end user or the relevant stakeholder. It gives the auditor an idea as to what is the value limit until which the audit is to be restrained. It is one of the essential tools in the audit planning(Belton, 2017). In the given case, the materiality level, which has been determined by the head auditor of the consulting firm, is $ 15000 but the same is too high considering the values in the trial balance. There has been various iterations and the limits, which have been suggested by the accounting boards over the globe like those including IASB and several other top consulting and auditing companies. Some of these limits are 0.5%-1% of the gross sales or the total assets, 1-2% of the gross profit or the fixed assets or the shareholder’s equity or 5-10% of the net profit. Based on these percentages, the materiality limit for the given company can be worked out to $ 1686.6 to $ 1979.5 (Jefferson, 2017). The benefit of choosing this limit is some accounts like Interest expenses, superannuation and depreciation and furniture account would also be covered by audit, which would have been ignored as per earlier limits.

(in $)
Quantitative estimate of materiality
Criterion	Base	Amount	Materiality level/range
0.5% to 1% of gross revenue	Gross Revenue	197,950	989.75 to 1979.5
1% to 2% of the total assets	Total Assets	691,027	6910.27 to 13820.54
1% to 2% of the gross profit	Gross Profit	84,330	843.3 to 1686.6
2% – 5% of the shareholders’ equity	Equity	NA	NA
5% to 10% of the net profit	Net profit	109,411	5470.60 to 10941.10

1. The preliminary analytical review has been done based on the above given trial balance and the common size income statement and the variance analysis has been prepared to get idea of the critical accounts to be audited(Werner, 2017).

Income Statement
Particulars	2017	% of sales	2016	% of sales
Sales	197,950	76.9%	187,450	76.7%
Consultancy fees	59,250	23.0%	57,000	23.3%
Interest income	48	0.0%	50	0.0%
Total Revenue	257,248	100.0%	244,500	100.0%
Less: Expenses
Cost of sales	61,050	23.7%	63,595	26.0%
Bank charges	348	0.1%	350	0.1%
Depreciation	16,565	6.4%	15,738	6.4%
Interest expense	11,500	4.5%	11,500	4.7%
Printing	370	0.1%	375	0.2%
Repairs and Maintenance	1,440	0.6%	5,050	2.1%
Wages	52,570	20.4%	53,000	21.7%
Superannuation	3,994	1.6%	4,770	2.0%
Total Expenses	147,837	57.5%	154,378	63.1%
Net Profit	109,411	42.5%	90,122	36.9%

Income Statement
Particulars	2017	2016	Variance
Sales	197,950	187,450	10,500
Consultancy fees	59,250	57,000	2,250
Interest income	48	50	–                 2
Total Revenue	257,248	244,500	12,748
Less: Expenses
Cost of sales	61,050	63,595	–         2,545
Bank charges	348	350	–                 2
Depreciation	16,565	15,738	827
Interest expense	11,500	11,500	–
Printing	370	375	–                 5
Repairs and Maintenance	1,440	5,050	–         3,610
Wages	52,570	53,000	–            430
Superannuation	3,994	4,770	–            776
Total Expenses	147,837	154,378	–         6,541
Net Profit	109,411	90,122	19,289
Net Profit %	42.53%	36.86%

1. Based on the above analysis and common size income statement, there are many accounts which need immediate audit attention and the key risks and assertions for the same has been listed below:

Sl. No.	Account Name	Audit Assertion and risk
1.	Sales	We can see that the sales has increased over the last year by 6% and as a percentage of the overall receipts, it has been more or less same (Goldmann, 2016). On the other hand, the profit has increased by 21% over last year and as a percentage of receipts, it has grown by over 6%. Thus, it needs to be seen if the prices of the goods have been increased or decreased, what is the change in the quantitative sales and how the accounting has been done in books (Choy, 2018).
2	Cost of sales	The cost of sales has decreased by 4% where the sales has increased by 6%. Since these two are on the opposite sides, it poses a question as to if the cost of raw materials has come down or the it is due to increase in efficiency of operations. It needs to the carefully analysed if the cost bookings of both the years have followed the relevant standards of accounting (Bizfluent, 2017).
3	Superannuation Expenses	The superannuation expenses have fallen big time as compared to the last year to the tune of 16%. It needs to be seen if the employees has resigned or there is a change in the headcount or if the relevant labour laws and other regulations have been adhered to and necessary accruals have been done in the books (Sithole, et al., 2017).
4.	Depreciation	In this the depreciation expenses have increased by 5% as compared to the last year but since it is a fixed expenses, it should not have been so. Therefore the rate and useful lives being used by the management needs to be checked.

1. The audit risk and the relevant audit assertions for the accounts that need audit attention has been stated above. Now in this section the steps to be employed by the auditor in checking of the books of accounts has been shown below:
2. Sales: For auditing the sales account, the vouching of the invoices and the bills needs to be done and the same needs to be compared with the invoices of the last year as to whether the prices have increased or the increased sales is due to the quantitative impact. It also needs to be checked and ascertained that if the company has followed the revenue recognition policy and the completeness in recording the transactions has been ensured(Saeidi, 2012).
3. Cost of Sales: Where the sales has increased for 2017, we can see that the cost of sales has been on the decreasing side and in case if it is calculated as a percentage of the sales, it has dropped by 2.3%. It needs to be critically analysed by the auditors that if the raw materials prices have fallen down or is it that the efficiency of operations has improved and the company is using less input. (Raiborn, et al., 2016).
4. Superannuation expenses: In the superannuation expenses, there has been the major decrease of 16% as compared to the last year and it needs to be checked from the employee register if the employees have left or the wages and salaries have been lowered. Besides checking the completeness in the recording of all the expenses, the auditor also needs to check the statutory requirements(Knechel & Salterio, 2016).
5. Depreciation: The auditor needs to check All the management estimates and judgements needs to be taken into account and it also needs to be checked if the company has recorded all the costs and not shifted them to the future years. The useful lives, the depreciation rates and the asset class used by the company also needs to be checked by the auditor.

Conclusion

1. In the given case, the audit partner has suggested that the fraud risk analysis need not be done for the client as it is trustworthy and it can be assumed that there would be no fraud. However, as per the principles laid down in APES 110 and the other statutes of professional scepticism this is not acceptable and the auditor needs to check every given client for fraud risk factors as mentioned in the auditing standards. The auditors are one who give reasonable assurance on the financial statements being produced by the entities and therefore it needs be verified(Linden & Freeman, 2017). Few of the accounts, which hint that there can be fraud, are those of cost of sales and superannuation for reasons stated above, and depreciation since the same has increased but the gross block of the assets has remained the same. Also, it should be checked why the entity is keeping such a high stock balance, the receivables balance and the cash balance as it is leading to blockage of funds (Defond & Lennox, 2017).

References

Belton, P., 2017. Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat International ltd.

Bizfluent, 2017. Advantages & Disadvantages of Internal Control. [Online]
Available at: https://bizfluent.com/info-8064250-advantages-disadvantages-internal-control.html
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Choy, Y. K., 2018. Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis. Ecological Economics, p. 145.

Defond, M. & Lennox, C., 2017. Do PCAOB Inspections Improve the Quality of Internal Control Audits?. Journal of Accounting Research, 55(3), pp. 591-627.

Dichev, I., 2017. On the conceptual foundations of financial reporting. Accounting and Business Research, 47(6), pp. 617-632.

Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business. Financial Environment and Business Development, 4(3), pp. 103-112.

Jefferson, M., 2017. Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland. Technological Forecasting and Social Change, pp. 353-354.

Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.

Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), pp. 353-379.

Raiborn, C., Butler, J. & Martin, K., 2016. The internal audit function: A prerequisite for Good Governance. Journal of Corporate Accounting and Finance, 28(2), pp. 10-21.

Saeidi, F., 2012. Audit expectations gap and corporate fraud: Empirical evidence from Iran. African Journal of Business Management, 6(23), pp. 7031-41.

Sithole, S., Chandler, P., Abeysekera, I. & Paas, F., 2017. Benefits of guided self-management of attention on learning accounting. Journal of Educational Psychology, 109(2), p. 220.

Werner, M., 2017. Financial process mining – Accounting data structure dependent control flow inference. International Journal of Accounting Information Systems, Volume 25, pp. 57-80.