This report contains the analysis of the case study given for DIPL where the services of an expert is used by the company to collect evidences for material misstatements which was founded in financial reports. It is important for a company to prevent material misstatements in the financial records and statements. For this purpose company conduct internal and external audit depending on the demand needed for the type of auditing required. The questions been asked in the case study in relation to the factors which influence the preliminary figure determined for materiality in the audit of DIPL. The factors which are being identified are explained well to showcase the relevancy in calculating the materiality in the audit planning process.
On the basis of the case study given for the company DIPL, it is necessary to conduct audit from an expert for the sole purpose that it provides assurance to the management that presents a true and fair picture of the financial performance and position. There is an auditing standard 620 which explains the guidance to use the work of an expert in audit as evidence (Auasb.gov.au, 2009). An expert here means a person or a firm who possess some special skills and expertise in their particular field (Accaglobal.com, 2011).
As per the case of DIPL, where few issues were arising in the accounting department and auditor fails to maintain the financial ratios under the provided benchmarks. The new CEO William Jackson pounded a recommendation to introduce a new internal control system in the department to resolve the issues arising in the financial statement and also decides to invest in IT system which will automate the whole process of finance and accounting and integrate the current accounting process within the organization. But the IT manager had issues in implementing the IT system installation and the way it was handled. It was found out that there was not enough staff available to do the required reconciliation and testing. The testing which was conducted before implementing IT system into the accounting process various errors are found out in the transactions and its value allocation. Though there were staff appointed at each stage in the department but it happens to be showing non reliable results. Due to such weak system of finance and accounting department the need for the use of expert in audit is highly required where the expert will collect audit evidences of the company as per the new internal control system introduced it will be helpful for expert. The auditor must have to rely on the audit evidences given by expert. To be ensured about the qualification and expertise that an expert must consist and align the whole procedure with the new IT system introduced in the company and a complete study should be conducted about the assurance of expert’s qualifications (Boritz, Robinson, Wong, and Kochetova-Kozloski, 2014).
In the given case study, auditor will determine the need first to use the work of an expert while considering:
There is a need to obtain the understanding of DIPL and perform the procedure further in assessment of risk, the auditor requires in combined with company and individually the audit evidences that consists of reports, valuations, opinions and statements of an expert. For example the evidences must include the following:
While planning to use the work of expert in audit of the DIPL, it is the responsibility of auditor to look out for the competence of the expert in profession. The auditor of the company must consider that an expert carries a professional certification, licensed or acquire a membership in a professional body. The experience and reputation an expert is having in the field where the auditor requires audit evidence. Also the objectivity of the expert is being evaluated that an expert must not be related to entity by way of employment or dependent financially, having an investment in the same company. After the evaluation done the auditor will discuss with management whatever is required and then it is decided to use the work of an expert.
The preliminary figure for overall materiality are the maximum amount from which financial statements could be misstated. There are factors which will affect the preliminary figure about the overall materiality of DIPL:
The factors that are affecting the preliminary figure of overall materiality in the audit of DIPL are given hereunder:
The key purpose of preliminary materiality judgment is to determine the nature, timing and extent of procedures of audit and guide the auditor. The judgment will include the materiality of management’s financial statement where amounts may be higher or lower according to the risk and needs of the audit process. The factors mentioned above for determining the preliminary judgment which influence overall materiality have relevancy in calculating the preliminary figures that are explained below:
Materiality is not an absolute concept but more of a relative concept. It basically means material for one company may not be material for another company. The amount of information that is omitted, undisclosed or misstated affects economic decisions taken by users of financial statements or the management who discharge their accountability (Edgley, Jones, and Atkins, 2015). While evaluating materiality of the company the base is needed and the primary base for the same would be net income before taxes and bases will come under quantitative factors. While determining overall materiality there are some questions that need to be answered for example the major users of financial report, the use of information to make economic decisions and discharge their responsibilities on it. The factor of materiality is relevant for calculating preliminary figure for overall materiality as the relationship between materiality and the level of audit risk contrary (Asare, Majoor, and Wright, 2017). If materiality decreases then audit risk will increase and vice versa, for example if there is a decrease found out in materiality amount from $100,000 to $10,000 and same audit evidence has been collected then audit risk will increase. Low level of misstatements are difficult to detect so it is hard enough to rely on evidences. An auditor must collect additional audit evidence if the level of audit risk and materiality levels are same. The materiality factors contains both the quantitative and qualitative aspects with it (Hux, 2017).
The material amount may get increase or decrease by using quantitative factors on the basis of auditor judgment about the effect of qualitative factors. The quantitative factors impact upon the users of financial statement or reports as they all relate to materiality. In the quantitative factor the calculations are done in order to determine the parameters of benchmark percentages and other weighing factors for overall materiality (Eilifsen, Hamilton, and Messier Jr, 2017).
This benchmark percentage is based on the expectation and need of users of financial report. The percentages are set for the tolerance of misstatements by keeping in mind the expectation of users. When the expected audit risk is high then tolerability in misstatement is at lower level (Barndt, Fuller, and Flynn, 2016).
There are weighing factors in preliminary judgment of overall materiality which are also based upon the expectation and need of users and depending upon the organization type whether it is a profit, non for profit organizations or council (Griffin, 2014).
The section include revenue, profit before tax and total assets in which weighing factors are set for each entity type. The above guideline of these factors have shown relevancy while calculating the preliminary judgment for overall materiality.
The qualitative factors which affect the calculation of preliminary figure includes the amount involve fraud. Frauds usually reflect the honesty and reliability of the organization and the personnel involved namely users of financial statements so the amount involving fraud are of much importance than any other error occurs that is unintentional (Emby, and Pecchiari, 2013).
Certain types of misstatements are of significance for the users than other parties even if the amount are same in dollars. The misstatements can be minor but may be harm financial statements in big numbers. The amounts which involve fraud are given due importance rather than other unintentional errors. For example, a misstatement in inventory will be considered as more important to users than a small error of same amount in the same inventory. The misstatement where a required minimum balance in account causes to exceed the minimum and if the correct balance is less than the minimum balance it becomes the important misstatement for users. When a misstatement appear due to the loss be shown or reported as profit then it becomes the point of concern (Eilifsen, and Messier Jr, 2014).
The five factors that are being identified in the case study of DIPL which would affect the preliminary figure of overall materiality in audit planning process of the company. The first factor which is change in accounting policies and estimates where the change in the valuation of inventory, provision for inventory obsolesces and the life of printing machine. It creates the situation where auditor needs to check in detail, the areas where changes has taken place and the materiality level will be set by auditor at low level so as to make the checking extended. Therefore, the depreciation on machinery, closing inventory and provision for obsolescence will cause the auditor to set their preliminary figure of overall materiality at low (Saha, and Roy, 2017).
The second factor is the new IT system implementation and it causes the audit risk to go high so that the amount of materiality will be set at low level. The auditor is required to check all the classes of accounting transactions in order to ensure that risk of material misstatement is reduced. Another factor where the change in top management happened and it made the auditor to materiality level at low stage. When auditor believes the management honesty then the assessment of risk is low therefore, materiality level is also set at low level and the extent of checking can be increased (Ruhnke, Pronobis, and Michel, 2014). The implementation of internal audit reduces the risk of material misstatement which further reduces audit risk. It cause the auditor to reduce the level of materiality because an auditor can rely upon internal audit and allowed to reduce the extent of checking on his/her side.
The fluctuations in the amount of account receivables, inventory and cash balance will be taken into account by auditor while determining materiality amount. These severe fluctuations depicts manipulations and the risk of material misstatement. It made auditor to check in more detail with a purpose to collect evidences therefore, materiality level would be set low.
References
Accaglobal.com. 2011. Using the work of an auditor’s expert. [Online] Available at: https://www.accaglobal.com/content/dam/acca/global/PDF-students/2012s/sa_may11_cat8_fau_expert.pdf [Accessed 11 December. 2017].
Asare, S.K., Majoor, B. and Wright, A., 2017. The occurrence and awareness of a misstatement effect in auditors’ internal control severity judgments. International Journal of Auditing.
Auasb.gov.au. 2009. Auditing Standard ASA 620 Using the Work of an Auditor’s Expert. [Online]. Available at: https://www.auasb.gov.au/admin/file/content102/c3/ASA_620_27-10-09.pdf [Accessed 11 December. 2017].
Barndt, R.J., Fuller, L.R. and Flynn, K.E., 2016. Teaching Inherent Risk and Tolerable Misstatement in Auditing: A Modified Delphi Method as a Teaching Tool. In Advances in Accounting Education: Teaching and Curriculum Innovations (pp. 125-140). Emerald Group Publishing Limited.
Boritz, J.E., Robinson, L.A., Wong, C. and Kochetova-Kozloski, N., 2014. Auditors’ and specialists’ views about the use of specialists during an audit.
Edgley, C., Jones, M.J. and Atkins, J., 2015. The adoption of the materiality concept in social and environmental reporting assurance: A field study approach. The British Accounting Review, 47(1), pp.1-18.
Eilifsen, A. and Messier Jr, W.F., 2014. Materiality guidance of the major public accounting firms. Auditing: A Journal of Practice & Theory, 34(2), pp.3-26.
Eilifsen, A., Hamilton, E.L. and Messier Jr, W.F., 2017. The Importance of Quantifying Uncertainty: Examining the Effect of Audit Materiality and Sensitivity Analysis Disclosures on Investors’ Judgments and Decisions.
Emby, C. and Pecchiari, N., 2013. An Empirical Investigation of the Influence of Qualitative Risk Factors on Canadian Auditors’ Determination of Performance Materiality. Accounting Perspectives, 12(4), pp.281-299.
Griffin, J.B., 2014. The effects of uncertainty and disclosure on auditors’ fair value materiality decisions. Journal of Accounting Research, 52(5), pp.1165-1193.
Hux, C.T., 2017. Use of specialists on audit engagements: A research synthesis and directions for future research. Journal of Accounting Literature, 39, pp.23-51.
Ifac.org. 2017. International Standard on Auditing 620 Using the Work of an Expert. [Online] Available at: https://www.ifac.org/system/files/downloads/2008_Auditing_Handbook_A190_ISA_620.pdf [Accessed 11 December. 2017].
Lakis, V. and Masiulevi?ius, A., 2017. ACCEPTABLE AUDIT MATERIALITY FOR USERS OF FINANCIAL STATEMENTS. Journal of Management, 2(31).
Messier, Jr, W.F. and Schmidt, M., 2017. Offsetting Misstatements: The Effect of Misstatement Distribution, Quantitative Materiality and Client Pressure on Auditors’ Judgments. The Accounting Review.
Ruhnke, K., Pronobis, P. and Michel, M., 2014. Audit materiality disclosures and credit lending decisions.
Saha, S.S. and Roy, M.N., 2017. Quality Control Procedure for Statutory Financial Audit: An Empirical Study.
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