Materiality and Scope of Audit
The main purpose of this assessment is to undertake audit procedures for the purpose of reviewing the materiality which is to be considered by the auditor for detecting material misstatements in the financial statements (Louwers et al., 2015). The concept of materiality is considered to be important in the scope of audit as the same determines which misstatements are to be considered minor misstatements and which are to be considered significant misstatements. Significant misstatements are judged on the level of materiality of the item and how it will affect the decisions taken by potential investors and also other estimates which are shown in the financial statements (Reid, 2015). The company which is selected for this assessment is Caltex Australia ltd which is engaged in operations in Australia (Caltex Australia., 2018).
The concept of materiality is fundamental in the scope of audit as the auditor needs to consider material items and if the same are reported accurately by the management or not. The auditor needs to apply his judgements for the purpose of setting the materiality of the business. The auditor considers materiality on the basis of qualitative characteristics and quantitative characteristics. In qualitative aspect of materiality, the auditor considers significant items of the business such as net profit, inventory of the business, changes in accounting method and significant legislations. In the quantitative aspect of judging materiality, the auditor considers estimated percentages which are charged on appropriate bases in order to determine the materiality level for different items which are shown in the annual report of the business. The percentage which is to be charged for determining materiality are up to the judgements of the auditor depending on the size of the business and nature of its operations. The auditor compute the planning materiality at the initial planning stage of the audit and on the basis of such planning materiality estimate performance materiality of different items are computed (Eilifsen & Messier, 2014). Therefore, it is clear that the concept of materiality is essential in the overall planning process of the audit process.
In quantitative materiality estimation different bases may be considered for the purpose of estimating the planning materiality and performance materiality of the business. The different bases which are considered are based on significant items which are shown in profit and loss statement and balance sheet of the company. As per profit and loss statement, the bases which are to be considered net profit before tax, total revenue, total sales generated. As per the balance sheet, the bases which are considered are the total assets of the business.
The annual report which is shown for Caltex ltd for the year 2017 is considered for estimating the materiality of the business for the year. The annual reports of the business shows that the sales revenue of the business have improved significantly from the last year estimates. It is usually the practice of most of the businesses to consider the item which highest value as bases for estimating materiality level of the business (Jacoby and Levy, 2016). The total asset can be considered to be the base for calculating the planning materiality of the business and the same is shown to be $ 6,355,220 for the year 2017. An estimate which is assumed to be the percentage for calculation the planning materiality is considered to be 5% of the bases. The computation of planning materiality is shown below:
Therefore, the planning materiality for the company considering the total asset as base and 5% as the percentage based on the judgement of the auditor (Coppage & Shastri, 2014). On the basis of planning materiality, performance materiality of different items is shown.
Review of Draft notes and Disclosures
The draft notes and disclosures which appear in the annual report of Caltex ltd also have a level of significance on the audit process as the notes section contains certain treatments and explanations of items which are shown in the financial statements of the business. The significant items which are shown in the notes to account section of the annual reports are listed below:
Analytical Review of the Financial statements
Analytical review is one of the techniques which is available to the auditor in which significant ratios are computed from the financial statements which informs about various aspects of the business. The ratios which are computed cover different areas such as efficiency, profitability, solvency and capital structure of the business (Jans, Alles & Vasarhelyi, 2014). A chart below shows significant ratios of the business for 4 years period that is from 2014 to 2017.
Profitability Ratios
The profitability ratio of business which is shown in the above table shows current ratio, quick ratio and net working capital of the business. The current ratio of the company has decreased over the years and the estimate is shown to be 1.16 for 2017 and the same was 1.43 in 2016 which suggest that the liquidity situation of the business has fallen. The auditor needs to apply verification procedures to verify the values of current assets of the business. Similarly, the quick ratio of the business has fallen which is also related to liquidity position of the business. The net working capital of the business has also fallen which is a serious matter and the business might be facing liquidity risks. The auditor can look in the assets and verify the values to ensure that everything is showing true and fair view.
Profitability Ratios
The profitability ratios are directly linked with the profit generating capability of the business. The gross profit margin and net profit margin of the company has slightly decreased from 2016 estimates. The overall sale has increased for the business but the management has not be able to control the expenses of the company and therefore the profits have fallen (Pike, Curtis & Chui, 2013). The return on assets of the business and return on equity are considered to financial indicators of business performance and the same have decreased from previous year’s estimates. This can be due to the high costs and low profits which are earned by the business.
The auditor needs to ensure that the profits are not understated or overstated in the financial reports for which the auditor needs to check the sales figure including both cash and credit sales of the business. The auditor then must apply vouching procedures to check the viability of the expenses incurred by the business as all the ratios under profitability is affected by sales and total expenses figures (Elder et al., 2013). The auditor can use external confirmation for determining the extent and amount of expenses which the business actually owed.
Asset Management Ratios
The asset management ratio comprises of stock turnover ratio, asset turnover ratio of the business. Th inventories are considered to be important items of the business and are most vulnerable to material misstatement. The assets of the business also need to be appropriate regarding misstatements.
The auditor of the business needs to verify the inventory accounts and records and if need be arise conduct physical stock take to appropriate value the stocks of the business. The auditor needs to apply verification process for assets of the business and in order to undertake effective valuation of the assets, the auditor can also take the help of experts for the same reasons.
Leverage Ratios
These are significant ratios of a business and the same inform whether the business is using more of a debt capital and equity capital. The ratios show debt ratio, debt to equity ratio. The debt ratio of the business has increased which suggest that the borrowing of the business has also increased as per the annual report of the business. The business has not made much changes in the equity capital of the business and therefore it is clear that the business is putting more reliance on the application of debt capital.
The auditor needs to assess the risks which are associated with debt capital of the business and ensure that the same are not affecting the business in any way (Appelbaum, Kogan & Vasarhelyi, 2017). Moreover, the auditor needs to check whether the debt capital are appropriately stated in the financial statement.
Valuation Ratios
The valuation ratio of the business comprises of price-earning ratio, price to book value ratio which are considered to be significant indicators for overall success of a business. The price-earning ratio and price to book value ratio are shown to have increased from previous year’s estimates which indicates that the business is developing.
The auditor needs to check the earning per shares of the business and the dividends which is offered by the business to the shareholders for the period. The auditor also needs to verify the share capital which is accumulated by the business.
Analysis of Cash Flow Statement
The cash flow statement of the business shows the cash inflows and outflows of the business during a particular year and the same is also a display of the liquidity position of the business. The cash flow statement for Caltex ltd for the year 2017 shows cash from operating activities, investing activities and financing activities.
The cash flow from operating activities of the business show the maximum cash inflows of the business due to the receipts from the customers which is shown to be $ 23,693,457 for the year. The cash from operating activities of the business is shown to be $ 735,032 which as slightly fallen from previous year. The cash flow from investing activities show the maximum cash outflow of the business (Bhandari & Iyer, 2013). This is because the business has acquired a new business plant, property equipment and also made investments during the year. The primary cash receipts which is shown in the operating section which is receipts from the customers which is from the sales and the primary cash payments which is shown in the cash from operating activities of the business is from cash payments made to the creditors of the business.
The main cash flow from investing and financing activities are mainly from purchase of business net of cash in case of investing activities and the main cash which is acquired by the business in case of financing activities is shown as borrowings of the business which is shown to be $ 5,001,095.
The going concern principle is the fundamental principle in accounting process and the auditor needs to report any factor which can affect the going concern principle of the business. The liquidity ratio of the business shows that liquidity position of the business has deteriorate from the previous year’s estimate which is not a favorable sign. The profits of the business has fallen from previous year estimates and the overall cost of operations has increased. In addition to this, the debt capital of the business has increased as well which increased the risks of debts. It can be said that the indicators suggest that the going concern principle of the business might be affected (Goh, Krishnan & Li, 2013). The auditor can advise the business to improve the liquidity position and putting more reliance on equity capital rather than debt capital of the business.
Review of the Auditor Report
The auditor of the company is one of the big four auditing firm KPMG who has prepared the audit report of the business. As per the opinion of the auditor the financial statements are prepared following relevant accounting standards and followed provisions of Corporation Act 2001 and therefore are also showing true and fair view. This means that the financial statements are free from any material misstatements.
The key audit matter section of the audit report emphasizes on taxation issue which is related to entities in Singapore for which certain uncertainties are there for the timing of the transactions as per the provisions of Australian Tax office (ATO). Another recognized key audit matter relates to site remediation matters for oil and exploration projects which are of complex nature and thus included in the key audit matters of the business.
Reference
Appelbaum, D., Kogan, A., & Vasarhelyi, M. A. (2017). Big Data and analytics in the modern audit engagement: Research needs. Auditing: A Journal of Practice & Theory, 36(4), 1-27.
Bhandari, S. B., & Iyer, R. (2013). Predicting business failure using cash flow statement based measures. Managerial Finance, 39(7), 667-676.
Caltex Australia. (2018) Annual Reports & Reviews. Caltex. Retrieved 15 August 2018, from https://www.caltex.com.au/our-company/investor-centre/annual-reports-and-reviews
Coppage, R., & Shastri, T. (2014). Effectively Applying Professional Skepticism to Improve Audit Quality. The CPA Journal, 84(8), 24.
Eilifsen, A., & Messier Jr, W. F. (2014). Materiality guidance of the major public accounting firms. Auditing: A Journal of Practice & Theory, 34(2), 3-26.
Elder, R. J., Akresh, A. D., Glover, S. M., Higgs, J. L., & Liljegren, J. (2013). Audit sampling research: A synthesis and implications for future research. Auditing: A Journal of Practice & Theory, 32(sp1), 99-129.
Goh, B. W., Krishnan, J., & Li, D. (2013). Auditor reporting under Section 404: The association between the internal control and going concern audit opinions. Contemporary Accounting Research, 30(3), 970-995.
Jacoby, J. and Levy, H.B., 2016. The materiality mystery. The CPA Journal, 86(7), p.14.
Jans, M., Alles, M. G., & Vasarhelyi, M. A. (2014). A field study on the use of process mining of event logs as an analytical procedure in auditing. The Accounting Review, 89(5), 1751-1773.
Louwers, T. J., Ramsay, R. J., Sinason, D. H., Strawser, J. R., & Thibodeau, J. C. (2015). Auditing & assurance services. McGraw-Hill Education.
Müller-Burmeister, C., & Velte, P. (2016). Increased materiality judgments in financial accounting and external audit: a critical comparison between German and international standard setting. International Journal of Critical Accounting, 8(3-4), 227-245.
Pike, B. J., Curtis, M. B., & Chui, L. (2013). How does an initial expectation bias influence auditors’ application and performance of analytical procedures?. The Accounting Review, 88(4), 1413-1431.
Reid, L. C. (2015). Are auditor and audit committee report changes useful to investors? Evidence from the United Kingdom.
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