1: The function of the preliminary analytical procedure is to help the auditor to gain a proper understanding of the trade. Accordingly, an auditor prepares a strategy with respect to time, nature and extent of audit techniques. Along with the analysis of financial information, preliminary audit procedures also considers the evaluation of non-financial matters. Its base stands on two kinds of pillars. First is to clearly analyze the transactions and business of the client. The second pillar is to scrutinize those sections of financial statements that supposedly can have any form of error (Hirst & Koonce, 1996). The business of Double Ink Printers Limited is into the printing of books, magazines and advertising materials for the purpose of distributing, educational and advertising industries on a demand for printing basis.
While applying analytical procedures on the component of cash, it has been found that DIPL is lowering down its cash in hand. From 2013 to 2014, there has been a fall in the cash in hand by 129462 (647250-517788). The unadjusted figure of 2015 with respect to cash shows a steep fall by 170668 (517788-347120) when compared to 2014. This can lead to an alarming position for DIPL as lower cash equivalents will affect its liquidity. This has been analyzed with the help of trend analysis. The trend is towards decline which can further lead to a shortage of cash. This would simply mean that the company is under-billing for work. Cash management policy shall be reviewed along with the discretion of DIPL’s management. Surprise cash check shall be conducted at the discretion of the auditor (Johnstone, et al., 2012).
It is a known fact that if the money is blocked in the accounts receivable or inventory, it will not produce any productive return. Since the company works on a print-on-demand basis, technically it should not have such a high level of inventory stored in 2015 (unadjusted). The rise from 2014 to 2015 has been of 1509138 (4180500-2671362) while from 2013 to 2014, the rise in its level was comparatively less, 415174 (2671362-2256188). For the year 2015, the audit plan will have a component of rigorous stock taking and to match it with the level of revenue (PCAOB, 2017). This will affect the liquidity ratio of DIPL which will turn worse in the long run. Valuation of raw materials as well as for the inventory shall be verified whether the guidelines related to it has been followed or not. Money blocked in accounts receivable is another area of concern. The same of treatment as for inventories shall apply for it. Matters related to receivable shall be inquired as in why the company is unable to receive its blocked funds out of debtors. For this, debtor management policy and concerns of management shall be reviewed (ACCA, 2016).
It is expected that a company’s gross profit margin shall increase with the time of business. Gross Margin measures the profit level with respect to its costs during a given set of time. In the case of DIPL, its 2013 gross margin is 17.55% (6004500/34212000). For 2014, it was 16.13% (6079500/37699500) and for 2015 (unadjusted) it is expected to be 15.20% (6604500/43459500). This clearly indicates a state of the alarming situation for DIPL. If the level of current liabilities is less than current assets, it must have its impact on gross margin ratio. But such is not the case. The current ratio is increasing at an increasing rate but it fails to replicate the same image when it comes to gross margin. For this, thorough scrutiny of expenses and the cost of debt will be facilitated to learn about the fall in the gross margin rate. By this, management will be warned and well informed regarding the required steps to be taken to control the situation (Accounting_Financial_Tax, 2009).
Since DIPL has introduced a new IT system to minimize their manual work, there are certain issues with it. The outcome of the issue has been upon some transactions which have not been correctly allocated to the required period. As an auditor, it is important on my part to thoroughly check the system along with its loopholes, its repercussion on the financial statements. Since this will lead to the missing of few transactions, it is important to have an audit trail for it. The management should be well informed about the issue and necessary action should be taken in order to incorporate those items in the financial statements. Otherwise, the report has the chances of getting qualified (Anderson & Koonce, 1998).
DIPL has taken a loan of 7.5 million from BDO Finance Ltd. The requirement to maintain the loan is that DIPL should maintain its current ratio minimum of 1.5 and less than debt-equity ratio. As an auditor it is important to review the purpose of taking the loan and whether it is being applied for the said purpose. It is also crucial to identify whether the loan amount is not being used for personal profit by the company. Any latest update in relation to the loan is required to be keenly verified by the auditor at regular intervals. Documents related to the loan are also required to be scrutinized in order to check for its authenticity.
DIPL has recently got its new chief executive officer who has recommended to establish for internal audit. As an auditor, the internal audit report will serve as an important document for the purpose of review and attain important information. Secondly, since the board has been set up as per the recommendation of the CEO, it is important to inquire and analyze regarding its authenticity of work. I will check whether the board is under any kind of influence or under pressure of the CEO while reporting or not.
This ratio plays a major role in analyzing the wealth DIPL given the shareholder equity of that particular period.
|
Year |
Net Income (a) |
Shareholder equity (b) |
Return on Equity a/b * 100 (in %) |
|
2013 |
2359190 |
9150000 |
25.78 |
|
2014 |
2291362 |
10783650 |
21.25 |
|
2015 |
2972183 |
12250491 |
24.26 |
The above calculation shows that return on equity has fallen from 25.78% to 21.25% and in 2015, it has managed to gain upward movement to 24.26% (Glover, et al., 2000). The rate of rising and fall in the return on equity is quite volatile in nature. Hence the audit planning will have special attention towards it in order to find out the reasons behind it along with the corrective actions (Accounting_Financial_Tax, 2009).
|
Year |
2013 |
2014 |
2015 |
|
Net income before interest and tax (a) |
3454650 |
3357037 |
3867337 |
|
Interest expense(b) |
84379 |
83663 |
808038 |
|
Time Interest Earned ratio |
40.94 |
40.13 |
4.786 |
From the above table, it can be said that the company had higher time interest earned ratio in 2013 and 2014. Due to the loan is taken from BDO Finance Ltd. In 2015, the ratio has fallen drastically. This shows that DIPL has higher credit risk which is a risky position. For this, the auditor is required to look for the purpose of loan whether they are utilized for it or not. And the steps were taken by the company to repay the loan in order to get back their last year ratio (Accounting_Financial_Tax, 2009).
Thus, by applying the above analytical procedures to the financial information of DIPL, it will enlighten the path of conducting an audit for the year ended 2015. Right from the financial information to the loopholes of non financial information, the outcome of such information shall help in the planning for auditing. Each information mentioned above along with the measures to be taken by the auditor will help in conducting the course of the audit of DIPL.
2: Audit risk is that risk from the end of an auditor which has the chances that the errors in the financial statements can get materially misstated. Inherent risk is one of its kind. These are such kind of risk which cannot be easily avoided while the course of conducting an audit. In spite of having effective auditor training or having enough controls in the process of auditing, inherent risk cannot be avoided. The business of DIPL is a large scale and is trying to adopt growth and expansion by the loan of BDO Finance Ltd. As an auditor, it is my duty to assess the risk of DIPL’s business to the core extent possible. It is the control risk and detection risk which stands under the control of an auditor. As far as the role of inherent risk lies even audit procedures, audit trails and other methods of auditor’s control are unable to eliminate it from the business (ACCA, 2017).
The company has recently acquired Nuclear Publishing Ltd. for specializing on a large scale in medical textbooks. The reason behind it was to earn a high level of a profit margin when used in the universities across the globe. But due to the ever changing needs or requirements of the business environment, these textbooks will turn out obsolete. This was because of the adoption of the newer technology or theory in the world. This will result in the loss of high return from such textbooks as well as risk to the substantial Part of DIPL’s business. This is one of the inherent risk factors which if turned into reality soon, will lead to major loss of DIPL. If the theory materializes in the near future, DIPL will suffer a sharp dip in its revenue from operations. Apart from the revenue, the company will fall in the margin of profit. This is because the major part of the profit share was supposedly from the acquired section of NPL. This is also threat to the going concern which is a major business venture of DIPL (My_Accounting_Course, 2017).
The second inherent risk in the business of DIPL to convert their manual work into a computerized accounting system. Though even the computers commit errors, they are relatively less when compared to the human errors. In spite of the fact that computerized system is high-end technology, it can have its own limitations like a programming error, software crash etc. In the given case of DIPL, the installation of the new IT system was incomplete due to which certain system testing errors prevailed (Payne & Ramsay, 2005).
This has led to some errors in the financial statements like some transactions have been allocated to the wrong accounting period. This is the inherent limitation of the system which can lead to major material misstatements. The financial statements will be found misleading as all the transactions have not been incorporated due to a system error. A software patch is required to fix the issue. Now, it is very difficult for an auditor to find those lost transactions. This is a system error which lies outside the purview of an auditor.
Thus, there was the two inherent risk which has the potential to material misstate the financial statements of DIPL.
3: The case of DIPL though seems to be very clear, but its course of actions can be suspected which further leads to a fraud. If the background information is required to be summarized, there exist certain fraud risk factors which can lead to material misstatements. This will further lead to fraudulent financial reporting.
One of the fraud risk factors of DIPL is the pressure on it by the way of loan taken from BDO Finance Ltd. The loan amount is 7.5 million dollars which the company is required to pay off duly. Another issue with it is that it needs to maintain certain parameters in its finance in order to save it from recalling. It is a very crucial point for DIPL because these funds will help in its further expansion. Under such an immense pressure, the company may manipulate its accounts to show that they are duly maintaining its parameters. This will not only materially misstate the financial statements but would lead to fraud in the eyes of law (Knapp & Knapp, 2001).
Another fraud risk factor is the installation of new IT system. Due to its limitations and loopholes, the staff of DIPL has a chance to use it for their own gain at the cost of the company. The transactions can be deleted from the system or the figures can be wrongly inserted in order to taint the revenue component of DIPL.
The above risk factors will affect the course of conducting an audit in its own manner. For the risk factor of pressure on the company of the loan, the auditor is required to pay keen attention to the debt component. The purpose, the application and the accounting of the loan are required be under scrutiny in a strict manner. Any doubt or suspicious action in these three factors can raise the doubt upon the working course of the management. If the fraud in relation to it gets skipped by the auditor, the funds provided by BDO Finance Ltd. will be funding the wrong purpose. This will be against the whole convention of accounting and standards of auditing.
For the second fraud risk factor, an auditor can take the support of Computer Aided Audit Techniques (CAATs) in order to maintain the audit trail. If the transactions of the concerned period are not found, the audit process will stand ineffective. Such risk will not only harm the material misstatements of DIPL, but also the process of auditing. So, it is quite important that the new IT system of DIPL works in an effective manner. It is the duty of its management to resolve the issue of its new IT system else it will affect its reputation in the market by providing incomplete or misleading financial statements (Knapp & Knapp, 2001).
Thus, the pressure on the DIPL by the loan of BDO Finance Ltd. and the problems of IT System are two broad fraud risk factors. It is my duty as an auditor to pay special attention to such issues so that the course of auditing stands correct.
ACCA, 2016. Analytical Procedures. [Online] Available at: https://www.accaglobal.com/in/en/student/exam-support-resources/professional-exams-study-resources/p7/technical-articles/analytical-procedures.html [Accessed 15 August 2017].
ACCA, 2017. Audit Risk. [Online] Available at: https://www.accaglobal.com/in/en/student/exam-support-resources/professional-exams-study-resources/p7/technical-articles/audit-risk.html [Accessed 15 August 2017].
Accounting_Financial_Tax, 2009. Analytical Procedures in Auditing. [Online] Available at: https://accounting-financial-tax.com/2009/10/analytical-procedures-in-auditing/ [Accessed 15 August 2017].
Anderson, U. & Koonce, L., 1998. Evaluating the sufficiency of causes in audit analytical procedures. Auditing- A Journal of Practise and Theory, 17(1), pp. 1-12.
Glover, S., Jiambalvo, J. & Kennedy, J., 2000. Analytical procedures and audit-planning decisions. Auditing: A Journal of Practice & Theory, 19(2), pp. 27-45.
Hirst, D. & Koonce, L., 1996. , 1996. Audit analytical procedures: A field investigation.. Contemporary Accounting Research, 13(2), pp. 457-486.
Johnstone, K., Gramling, A. & Rittenberg, L. E., 2012. Auditing: A Risk-Based Approach To Conducting a Quality Audit. 9 ed. New York: Cengage Learning.
Knapp, C. A. & Knapp, M. C., 2001. Knapp, CaroThe effects of experience and explicit fraud risk assessment in detecting fraud with analytical procedures. Accounting, Organizations and Society, 26(1), pp. 25-37.
Knapp, C. A. & Knapp, M. C., 2001. Knapp,The effects of experience and explicit fraud risk assessment in detecting fraud with analytical procedures. Accounting, Organizations and Society, 26(1), pp. 25-37.
My_Accounting_Course, 2017. What is Inherent Risk?. [Online] Available at: https://www.myaccountingcourse.com/accounting-dictionary/inherent-risk [Accessed 15 August 2017].
Payne, E. A. & Ramsay, R. J., 2005. Fraud risk assessments and auditors’ professional skepticism. Managerial Auditing Journal, 20(3), pp. 321-330.
PCAOB, 2017. Analytical Procedures. [Online] Available at: https://pcaobus.org/Standards/Archived/Pages/AU329A.aspx [Accessed 15 August 2017].
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