Analyzing Analytical Procedures For DIPL Ltd: A Substantive Procedure Perspective

Different analytical procedures for DIPL Ltd

In the case of DIPL Ltd, analytical procedures are performed and in this scenario, there are different procedures and other ideas needed to be ascertained.  It is known by the name of the substantive procedure and a procedure of such type enables the business to evaluate the trend or forecast the future course of action. The substantive procedure can be defined as a procedure that helps in tracing the evidence that is gathered by the auditors so that the assertion is backed up completely and leads to elimination of material misstatement that is linked to the validity, accuracy of the financial record of the entity (Cappelleto, 2010).

It is expected that the auditor will bring into his experience and will use those procedure and other forms of judgment that will enable knowing the forms that will have a direct bearing upon the future course of action of the business.  It is of utmost importance that the analytical procedure should be known to the auditor.  The substantial procedure will, therefore, help the auditor to spot any differences in the transactions. The following analytical procedure can be used in the present scenario (Guan et. al, 2008).  Initially, an analysis of the trend can be done that depends on the prudence, as well as judgment that will provide a clear cut demarcation of the future prospect.  The analytical procedure must be used as per the normal functioning of the business. The trend analysis is an effective mechanism that helps to evaluate the differences in the accounts in a specific time period. The trend of the business can be known with ease and hence it helps in the decision making process.  Further, the mechanism of ratio analysis is an important tool that tends to shed light on the financial performance and helps in smooth comparison (Douglas et. al, 2015). Moreover, the decision-making process can be influenced through proper evaluation, testing, and control.

Ratio analysis has been done considering the three years that is the period from 2013 to 2015

The above ratio analysis clearly indicates that the company is a consistent performer. The ratio indicates that it has maintained a momentum and has done reasonably well. The current ratio of the company indicates that the company has sufficient assets to meet the obligations and there is no dearth of liquidity. A standard ratio of 2:1 is an ideal however, the ratio is more than 1:1 indicating the sufficiency of the current assets. Therefore, the current ratio is proper for the company.

Trend analysis and ratio analysis

Going by the debt equity ratio it can be said that the company raised debt in 2015 and the debt equity stands at 0.61 meaning that the company has more than 0.50 debt that might prove to be problematic. A perfect blend of debt equity ratio yields the best result as it indicates the presence of proper equity and debt. Higher debt results in higher interest payment.

Going by the profitability ratio that is the gross profit and the net profit ratio, the company is operating on a profitable basis and there is a drop in the profitability over the period ranging from 2013 to 2015. The gross profit has declined marginally while the net profit has increased. However, it has maintained a consistent performance. It can be more effective in nature if the company is having a strong control over the cost of sales.  Hence, it is imperative for the management to consider the cost of sales because the revenues are huge and if it has a proper control it will have a strong percentage.

There is some of the noteworthy facts that should be taken into consideration like the cash position of the firm has undergone a strong dip in the past three years and it does not project a good position.  Further, the funds are blocked in accounts receivable and this gives a clear cut indication that the recovery process is not effective in nature.  A block of funds disturbs the overall business. The stock position is showing vague information and that the piling up of inventories does not denote a strong situation. This can be cited due to wrong method selection or the process of valuation (Geoffrey et. al, 2016). It must be corrected at the earliest. The accounts payable denotes a significant surge in 2014 without any corresponding change in the purchase or any other expense.  The bad debts have increased that is a cause of worry for the management. 

The business of DIPL Ltd is exposed to certain inherent risk. An inherent risk can be defined as the risk that happens due to the error or omission in a financial statement. It happens due to a factor apart from a failure of control. Inherent risk happens when the transactions are complex in a scenario or a situation that needs a strong degree of judgment in tune to the financial estimates. It cannot be altogether eliminated rather it can be lessened by addressing it properly. The two inherent risk that happened in the case of DIPL Ltd are:

Inherent risk and fraud risk factors

The system of IT was implemented under immense control from the board.  It is to be noted that a new system needs proper evaluation and control from the staff. The staffs should be competent and well versed with all the techniques of the system so that the function can be performed in an effective manner. Lack of reconciliation and testing was the chief error. As per the IT manager, the project was not tested and hence the installation proved to be ineffective. The initial testing was done at the installation time before the year end and it came to the observance that the transactions were not allocated to the right period.  Hence, it fluctuated the computation of the profit figures (Gilbert et. al, 2005).  The fault in the accounting software was the chief issue and a major reason for the misstatement in the financial report. Moreover, the staffs and the officials were aware of the fault and this fault can be utilized by the top officials to take an advantage of the fault (Ghandar & Tsahuridu, 2013).  Hence, accounting software issue can lead to vast differences and unethical practice that will disturb the business operations.

The receipts from the debtors are recorded by the company on a day to day basis. However, the major issues that the company face is the recognition are done through email. The recognition is done when the mail is received from the debtors where the cheque is enclosed. However, the policy is drafted in a manner that it has nothing to do with the cheque encashment and when the accounts receivables are adjusted.  This process will tend to create major differences. On the contrary, the main reconciliation from the bank is undertaken by a different accountant in a month’s time (Goodstein, 2011). Hence, it clearly signifies that the company adopts or follows no particular method for the reconciliation of the figures that come from the debtors (Ghandar & Tsahuridu, 2013). Thereby, it can be a major problem while preparing the financial report and differences can seep in if such an inconsistent method is followed for the accounts receivable.  The main effect that can be observed through such a policy is that the auditors depend upon the financial statement provided by the company and if the financial statements contain gross error then such an error will get reflected in the auditor’s report (Fazal, 2013).

Going by the nature of the business, it can be stated that the above mentioned inherent risk will lead to material misstatement as such risks can influence the decision making and a small mistake can make a difference in the financial statements.  Therefore, it is of utmost necessity to have a proper accounting system and strong internal control mechanism to ward off any problem. 

Importance of a strong internal control mechanism

As per the nature and functioning of DIPL Ltd, there is two kinds of fraud risk that has been identified through the misstatements arising from improper financial reporting.

It has been observed that the company has used the new IT infrastructure for the recording of transactions. However, the system is not completely equipped because the testing was not sufficient.  Moreover, the wrong set of data was entered into the system leading to wrong customer receivables or payables. The key fraud risk that can happen is that of the striking of the balances (Harrington, 2013). The noteworthy point is that the accountants might indulge into unethical or fraudulent activities. The balances might be written off by the accountants and shown as uncovered while a shift is done to the new IT system but in reality, the same might have been encashed by the management. The newly developed IT system led to the problem because the data might not be correctly entered into the new system. This has a huge impact on the receivables and the payables of the company.The system of revenue recognition through e-mail can give rise to a huge number of complications. In this scenario, there is no verification from the bank that is the main loophole. It is of prime importance that the verification must be done with that of the bank because the bank statement contains some amount which requires authentication (Elder et. al, 2010). The company is having a faulty internal control mechanism that will lead to fraudulent practices. The accountants might divert the company’s funds by crediting the same to the wrong account. This will not only have an impact on the funds but also the financial position will tamper.  Therefore, it is of utmost necessity to have a proper reconciliation at the month end. Further, the management is required to carefully observe the accounts on a daily basis. Such a practice will lead to a strong link and establishment of balance that will provide transparency. 

If the management of the company is engaged in activities that are fraudulent then the auditor’s decision might not reveal the true position of the business. This is due to the fact that the accounts tamper in a manner that is difficult to note. Hence, it is of utmost necessity that the auditor should plan in a manner that will help to trace the deficiencies. The auditor should back up the decision through authenticated documents like ledgers, bank statements, tax challans etc. Moreover, the weak internal control mechanism might affect the auditor’s function (Messier, 2013). The cash position of the business might project a different situation if all the total cash is not deposited with the bank. Hence, a difference will exist and the auditor role might be impacted. This can, in turn, drive the auditor to provide a decision that is irrelevant and the quality gets affected (Hoffelder, 2012). The auditor depends on the statement provided by the management and hence, the management must ensure valid evidence otherwise the entire decision making will get affected.

The new adopted IT infrastructure and its working is new and hence, the auditor needs to know the complete functioning of such a system. Since the system was not properly tested and evaluated, therefore, it will have a negative appeal while conducting an audit.  As the transaction recording was faulty in nature and the same needs to be traced by the auditor else the entire decision making will be wrongly projected.  The insufficiency in the testing part will create obstacles for the company (Jubb, 2012). Since, the system is new and not properly tested there might be issues relating to software piracy, breach of data, etc.  Hence, it remains an onus for the auditor to know the complete system. Being a new system it will consume time and as it is fed by the management, the auditor might provide a decision based on it leading to the wrong decision. 

References

Cappelleto, G. 2010, Challenges Facing Accounting Education in Australia, AFAANZ,

Douglas M.B, Todd, D.F &  Hermanson, D.R 2015, ‘The Effects of Internal Audit Report Type and Reporting Relationship on Internal Auditors’ Risk’,  Judgments.Accounting Horizons, vol. 29, no. 3, pp. 695-718.

Elder, J. R, Beasley S. M.& Arens A. A 2010,  Auditing and Assurance Services, Person Education, New Jersey: USA

Fazal, H 2013, What is Intimidation threat in auditing?, viewed 16 August, https://pakaccountants.com/what-is-intimidation-threat-in-auditing/.

Geoffrey D. B, Joleen K, K. Kelli S & David A. W 2016,  ‘Attracting Applicants for In-House and Outsourced Internal Audit Positions: Views from External Auditors’,  Accounting Horizons, vol.  30, no. 1, pp. 143-156. 

Ghandar, A & Tsahuridu, E 2013, The Auditing Handbook 2013, Australia: Pearson.

Gilbert, W. Joseph J & Terry J. E 2005, The Use of Control Self-Assessment by Independent Auditors, The CPA Journal, vol.3, pp. 66-92

Goodstein, E 2011, Ethics and Economics, Economics and the Environment, Wiley

Guan, L,  Kaminski, K. A & Wetzel, T. S 2008, ‘Can Investors Detect Fraud Using Financial Statements: An Exploratory Study’,  Advances in Public Interest Accounting vol. 13, pp. 17-34.

Harrington N 2003,  Risk Management & Insurance, McGraw- Hill Education (I) Ltd.

Hoffelder, K 2012, New Audit Standard Encourages More Talking, Harvard Press.

Jubb, C 2012, Auditing: A Business Risk Approach, Australia: Cengage

Messier, F. W 2013, Auditing and Assurance Services – A systematic approach, 9th ed. Australia: McGraw Hill.

Parker, L, Guthrie, J & Linacre, S 2011, The relationship between academic accounting research and professional practice, Accounting, Auditing & Accountability Journal, vol. 24, no. 1, pp. 5-14.

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