Part 1- Materiality
The Australian Auditing Standard (ASA) 320 in Para 9 provides that auditor should consider materiality at the time of determine the nature, timing and extent of audit procedure. The materiality needs be considered at the time of evaluating the effect of the misstatement (Knechel & Salterio, 2016). The Para 12 of the ASA 320 provides that an auditor is required to make a preliminary assessment of the materiality. The Para 13 provides that determination of materiality is a matter of professional judgment by the auditor and if affected by the qualitative and quantitative factors.
In this case, the calculation of materiality is given below:
|
Statement showing Planning Materiality |
|||
|
Particulars |
Amount (31-12-2011) |
Percentage (%) |
Planning Materiality |
|
Profit Before Tax |
$ (3,315,804.00) |
5% |
$ (165,790.20) |
|
Turnover |
$ 37,554,250.67 |
5% |
$ 1,877,712.53 |
|
Total Assets |
$ 24,100,296.00 |
0.50% |
$ 120,501.48 |
|
Equity |
$ 3,314,193.00 |
1% |
$ 33,141.93 |
Table 1: Planning Materiality
(Source: Created by Author)
The table above shows the different materiality level that the auditor can selected. However, it should be noted that as the company has incurred losses therefore materiality level cannot be determined based on the profit before tax. The auditor is required to determine the materiality and the process is difficult because both the qualitative and quantitative factors need to be evaluated (Simnett et al., 2016). There is no guidance for determining materiality and it is entirely dependent on the judgment of the auditor. In this case, the materiality level should be based on the turnover or revenue. There are various reason for selecting revenue as the basis for determining the materiality level. The revenue or turnover generally reflects the size of the organization. It means that the company that have high revenue usually are of large size and huge expenditure (Junior et al., 2014). Therefore, determining materiality based on the revenue will ensure that the size of the organization and scale of its operations are reflected in the materiality level selected. In this case, the materiality level selected is 5% of the turnover that comes to $1877712.53. This means that if the misstatement is below the materiality level then the auditor can form the opinion that the financial statement of the organization represents true and fair view. On the other hand, if the misstatement is higher than the materiality level determined then in such case, the auditor should perform further audit procedures to ascertain the truth and fairness of the financial statement (Carson et al., 2016).
The analytical procedure is a process of evaluating the financial information of an organization based on the financial and non-financial data. In this case, the financial position of the company and the risk associated with the business is evaluated based on the computation of ratios. The calculation of the ratios are given below:
Part 2- Analytical Procedures
|
Statement showing significant financial Ratios |
|||
|
Particulars |
Formula |
30-09-11 |
31-12-10 |
|
liquidity Ratio |
|||
|
Current Ratio |
Current Assets /Current Liability |
2.02 |
1.38 |
|
Quick ratio |
(Current Assets- Inventory- prepaid Expenses) /Current Liability |
1.38 |
0.97 |
|
Solvency Ratio |
|||
|
Debt to Equity Ratio |
Debt/Equity |
2.72 |
1.68 |
|
Times Interest earned |
Income before interest & expenses/interest earned |
-1.77 |
2.91 |
|
Profitability Ratio |
|||
|
Net Profit Ratio |
Net Profit/RevenueX100 |
-9% |
3% |
|
Return on equity |
Net Profit/ Shareholders Equity |
-0.75 |
0.18 |
Table 2: Significant financial Ratios
(Source: Created by Author)
The table above shows the calculation of ratios based on the analysis of the financial statement of the company. There are three types of ratios that have been calculated they are liquidity ratio, solvency ratio and profitability ratio. The liquidity ratio measures the ability of the company to pay of the current liability using the assets that can be easily converted to cash (Redmayne, 2013). In this case, the liquidity of the company is measured using the current ratio and the quick ratio. The current ratio and liquid ratio measures the ability of the company to pay the short-term liability using the current assets. The table above shows that the current ratio and the liquid ratio of the company has increase. This means the ability of the company to repay the short-term liability has increased (Hay et al., 2016).
The table above shows the computation of the solvency ratio. The solvency ratios measures the ability of the company to sustain operation by comparing the level of debt with the equity. In this, case the two ratios the debt equity ratios and the times interest earned both are calculated for determining the solvency situation of the company. The debt equity ratio compares the total debt and equity of the company. The calculation shows that the debt equity ratio of the company has increased (Soh & Martinov-Bennie, 2015). This means company is using more debt in its capital structure. It should be remembered that reasonable debt in the capital structure increases the profitability of the company by reducing the cost of capital. However, it should also be remembered that use of very high debt in the capitals structure increases the risk. The times to interest, earned ratio measures the ability of the company to pay of the liability of interest payment. The table above shows that in 2010 company has the ability of making the payment of interest. However, on 2011 the company has incurred loss so it can be said that it does not sufficient profit in 2011 to adjust the payment of interest.
The profitability ratios determines the ability of the company to generate profit from the operations. The net profit ratio measures the profit that the company has earned per dollar of sales (Ge et al., 2016). The calculation above shows that in 2010 the company has positive net profit ratio on the other hand in 2011 the company has incurred loss. The return on equity measures the ability of the business to earn profit from the amount invested by shareholders. The calculation shows that the return on equity of the company has decreased from 2010 to 2011.
a) Calculation of Financial Ratios
|
Common Size Balance sheet |
||||
|
Particulars |
2010 |
Percentage |
2011 |
Percentage |
|
Current Assets |
||||
|
Cash |
$ 1,753,765.00 |
7% |
$ 245,965.00 |
1% |
|
Trade Receivables |
$ 10,701,064.00 |
44% |
$ 10,552,109.00 |
44% |
|
Inventory |
$ 6,263,242.00 |
25% |
$ 5,924,156.00 |
25% |
|
Financial Assets |
$ 4,075,205.00 |
17% |
$ 4,469,759.00 |
19% |
|
Prepayment and other assets |
$ 666,054.00 |
3% |
$ 1,112,028.00 |
5% |
|
Total Current Assets |
$ 23,459,330.00 |
95% |
$ 22,304,017.00 |
93% |
|
Non-Current Assets |
0% |
|||
|
Property Plant and Equipment |
$ 852,965.00 |
3% |
$ 1,449,330.00 |
6% |
|
deferred Tax Assets |
$ 277,559.00 |
1% |
$ 346,949.00 |
1% |
|
Total Noncurrent Assets |
$ 1,130,524.00 |
5% |
$ 1,796,279.00 |
7% |
|
Total Assets |
$ 24,589,854.00 |
100% |
$ 24,100,296.00 |
100% |
|
Current Liabilities |
||||
|
Payables |
$ 8,413,818.00 |
45% |
$ 10,323,185.00 |
50% |
|
Interest Bearing liability |
$ 8,240,091.00 |
44% |
$ 149,354.00 |
1% |
|
Current tax liability |
$ 207,893.00 |
1% |
$ 159,866.00 |
1% |
|
Provisions |
$ 189,015.00 |
1% |
$ 401,658.00 |
2% |
|
Total Current Liability |
$ 17,050,818.00 |
91% |
$ 11,034,063.00 |
53% |
|
Non-Current Liability |
0% |
0% |
||
|
deferred tax Liabilities |
$ 170,284.00 |
1% |
$ 198,647.00 |
1% |
|
Interest bearing liabilities |
$ 1,500,000.00 |
8% |
$ 8,872,482.00 |
43% |
|
Provisions |
$ 79,556.00 |
0% |
$ 680,911.00 |
3% |
|
Total Non-Current liability |
$ 1,749,850.00 |
9% |
$ 9,752,040.00 |
47% |
|
Total Liabilities |
$ 18,800,668.00 |
100% |
$ 20,786,103.00 |
100% |
|
Net Assets |
$ 5,789,186.00 |
$ 3,314,193.00 |
||
|
Equity |
$ 5,448,026.00 |
94% |
$ 5,448,026.00 |
164% |
|
Reserves |
$ (259,498.00) |
-4% |
$ (247,638.00) |
-7% |
|
Accumulated Profit/ loss |
$ 600,658.00 |
10% |
$ (1,886,195.00) |
-57% |
|
Total Equity |
$ 5,789,186.00 |
100% |
$ 3,314,193.00 |
100% |
Table 3: Common Size Statement
(Source: Created by Author)
The table above shows the common size balance sheet of the company. The common size statement measures every items in terms of percentage and is an important tool for comparing the balance sheet of the balance sheet. The common size balance sheet above shows that the total noncurrent assets of the company has decreased by 2% from 2010 to 2011. The analysis of the common size balance sheet of the company shows that the noncurrent asset of the company has increased from 2010 to 2011. It can be seen that the total current liability of the company has decreased from 2010 to 2011. On the other hand, the proportion of the noncurrent liability of the company has decreased in 2010 and it has increased in 2011. Based on the above analysis it can be said that the auditor should focus on areas that have been highlighted in the above table.
To
Suzie Pickering,
Audit Senior,
Subjected: Potential problems areas and other concern
Sir,
In this memorandum, the material misstatement that exist on the financial statement and other concerns are highlighted after evaluating the financial statement of the company. On analyzing the financial statement, it can be seen that the revenue of the company has increased. It can be seen as a positive development for the company. However, it can be seen that though revenue has increased but still the overall profit of company has declined. On analysis, it can be seen that the main reason for such decline in profit is significant increase in borrowing cost and other expenses related to ordinary activity by 42% and 23% respectively. Therefore, it can be seen that the audit procedure should give special emphasis in this area of expenses. The auditor should apply appropriate analytical procedure to determine the reason for such significant increase in the advertisement, insurance, sales and promotion expenses.
The preliminary materiality level determined by the auditor is appropriate and should be consistently followed so that misstatement that are above materiality level is clearly identified. On overall evaluation of the income statement that is given below, it can be said that special attention should be given to analyze the reason of increasing expenditure.
Thanking You
Regards
|
Statement showing Profit or Loss Account |
||||
|
Particulars |
Amount |
Amount |
Amount |
Change % |
|
31-12-10 |
30-09-11 |
31-12-11 |
||
|
Revenue |
$ 34,300,042.00 |
$ 28,165,688.00 |
$ 37,554,250.67 |
9% |
|
Borrowing costs |
$ 748,106.00 |
$ 798,611.00 |
$ 1,064,814.67 |
42% |
|
Other Expenses from ordinary activity |
$ 32,122,122.00 |
$ 29,575,856.00 |
$ 39,434,474.67 |
23% |
|
Profit Before Income Taxes |
$ 1,429,814.00 |
$ (2,208,779.00) |
$ (2,945,038.67) |
-306% |
|
Income Tax Expenses |
$ 378,074.00 |
$ 278,074.00 |
$ 370,765.33 |
-2% |
|
Profit available to the members of the company |
$ 1,051,740.00 |
$ (2,486,853.00) |
$ (3,315,804.00) |
-415% |
Table 4: Income Statement
(Source: Created by Author)
Reference
Carson, E., Fargher, N., & Zhang, Y. (2016). Trends in Auditor Reporting in Australia: A Synthesis and Opportunities for Research. Australian Accounting Review, 26(3), 226-242.
Ge, Q., Simnett, R., & Zhou, S. (2016). Ethical and Quality Control Requirements When Undertaking Assurance Engagements.
Hay, D., Stewart, J., & Botica Redmayne, N. (2016). The Role of Auditing in Corporate Governance in Australia and New Zealand: A Research Synthesis.
Junior, R. M., Best, P. J., & Cotter, J. (2014). Sustainability reporting and assurance: a historical analysis on a world-wide phenomenon. Journal of Business Ethics, 120(1), 1-11.
Knechel, W. R., & Salterio, S. E. (2016). Auditing: assurance and risk. Routledge.
Redmayne, N. B. (2013). Auditing and Assurance Services and Ethics in Australia: An Integrated Approach. Journal of Accounting & Organizational Change.
Simnett, R., Carson, E., & Vanstraelen, A. (2016). International Archival Auditing and Assurance Research: Trends, Methodological Issues, and Opportunities. Auditing: A Journal of Practice & Theory, 35(3), 1-32.
Soh, D. S., & Martinov-Bennie, N. (2015). Internal auditors’ perceptions of their role in environmental, social and governance assurance and consulting. Managerial Auditing Journal, 30(1), 80-111.
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