Background
The main purpose of this assessment is to analyze the business conditions of Miller Yates Howarth (MYH) which is an accounting firm engaged in business in Australia. MYH is planning to conduct an audit for Trunkey Creek Wines Limited which is engaged in the production and distribution of wine. The assessment will be identifying the audit risks of the business by analyzing the key financial ratios of the business. The auditor will be relying on the financial statements of 2017 and 2018 for comparing and identifying the risks which are associated with the audit of the business (Eilifsen et al., 2013). The assessment will be identifying key accounts which are prone to audit risks and analyze how the same can impact the financial reporting framework of the business. Moreover, the internal controls of the business is also to be analyzed in order to establish the effectiveness of the internal control system of Trunkey Creek Wines Limited.
The case study which is provided in the above assessment shows that the business of Trunkey Creek Wines Limited is engaged in production and distribution of wine and has been a long-term client of Miller Yates Howarth. The management of Trunkey Creek Wines Limited has computed the key financial ratios of the business for the year 2018 in order to assist the audit procedures which is conducted by Miller Yates Howarth. The initial audit investigation which is done to formulate a proper audit program for the business reveals that four account balances which are shown in the financial statements are considered to be in a risky situation (Louwers et al., 2015). In order to check the account balances which are considered to be risky, the auditor wants to apply analytical procedures for the purpose of identifying the risks which are associated with the business. The below statement shows the audit risks and analysis which are associated with the four accounts identified in preliminary investigation of the financial statement.
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Account |
Analysis |
Audit Risks |
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Account Receivable |
The account receivable balance which is shown in the annual reports of the business for the year 2018 represent credit sales which is undertaken by the management of the company during the year (Knechel & Salterio, 2016). The days in account receivable which is shown to 50.2 days in 2018 is much lesser than the estimate which is shown in previous year’s analysis. This suggest that there has been improvement in the efficiency of the business considering the lowering of the collection period which was previously required by the business. The aspect of account receivable is very important as it is a significant where manipulation can be made. The auditor needs to apply substantive audit procedures in order to estimate whether the estimates are showing true and fair view. |
The major risks which can be identified in the balance of account receivable is that the balance might be manipulated as the credit sales of the business might be overstated. The risk is that there might be material misstatement present in the balance which is shown in the annual reports of the business (Reding et al., 2013). As account receivable is closely related with credit sales material misstatement present in the estimate can affect the annual reports of the company. |
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Investment |
Investment balance which is shown in the annual reports of the business shows the funds and savings generation of the business. The return on beef production which is done by subsidiary is also shown in the consolidated annual reports of the business. The auditor needs to check the investment which is made by the management of the company in the business of Wagyu Selling Group in order to ensure that the same are fairly represented in the financial statements. |
Investments which are made by the business shows the financial stability of the business and also application of unused funds of the business (Wong & Millington, 2014). The risks which are involved in such an estimate is related to material misstatements which can affect the financial statements as a whole. In the case, the business of Trunkey Creek Wines Limited has invested in shares of Wagyu selling group in order to earn revenue from secondary sources. There is a risk that the valuation for such shares prices might not be done appropriately and thereby might be manipulated. |
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Property Assets |
The property assets of the business are used by the management in generation of revenues for the business. The assets of the business are important components which are shown in the balance sheet of the business and a positive estimate of the assets of the business can affect the decision of the investors (Turley, 2015). Therefore, the auditor needs to analyze the assets of the business in order to ensure that the valuation for the same are done appropriately and all other requirement as to depreciation and impairments are met. The auditor also needs to ensure that appropriate accounting standards which are related to fixed assets are followed by the business or not. |
The major risk which is associated with the property assets of the business is that the assurance that the assets are fictitious in nature or cooked up in the books of accounts by the management. The auditor needs to ensure that the property plants and equipment of the business are actually present and the management has valid papers to prove the same. In addition to this, there is always the risk of inappropriate valuation of the assets of the business during the period. |
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Marketing Expenses |
The marketing expenses of the business refers to the promotional activities which are undertaken by the management of Trunkey Creek Wines Limited is to promote the products of the business. In most cases, the management increases the marketing expenses of the business in order to claim tax benefits from the same or even the reverse is possible which will increase the profitability of the business and thereby make the financial statements look good (Hay, Knechel & Willekens, 2014). |
The risks which are associated with the marketing expenses which are incurred is that the same can be manipulated quite easily for the purpose of showing favorable results in the annual reports of the business. The marketing expenses are recorded in the profit and loss account, therefore the same affects the net profit of the business by reducing the same. The risks which are associated with the expenses of the business are therefore higher in the annual reports of the business. |
`The key financial ratios of the business are considered to important estimates which can easily determine the financial performance of a business during a year. In the case study which is provided, key financial ratios of Trunkey Creek Wines Limited is to be analyzed for establishing the performance of the business and also identify the risks which the business is associated with. In addition to this, key financial ratios of a business are also utilized in analytical procedures which considers key financial ratios of a business (Jans, Alles & Vasarhelyi, 2014). Such types of ratios normally include profitability ratios, liquidity ratios, efficiency ratios and capital structure ratios which overs important areas of the financial statements which is prepared by the business.
Audit Risk Analysis for Trunkey Creek Wines Limited
As per the significant ratios which are computed the auditor for the purpose of conducting analytical procedures includes profitability, solvency, capital structure and investment ratios which represents significant decision-making areas of a business (Titera, 2013). The return on equity of Trunkey Creek Wines Limited is shown to be 10.80 in 2018 which clearly shows that there has been a decrease in the estimate in comparison to previous year. This signifies that the management of the company is not living up to the expectations of the shareholders of the company and not providing appropriate returns to them as per the expectation of the shareholders. The auditor needs to assess the income statement of the company for such respect and analyze whether the revenue and expenses of the business are represented fairly or not. Return on equity of a business is considered to be an important estimate and also consider to be one of the financial indicators for the overall success of the business. The return on beef production assets represent the returns which the management of Trunkey Creek Wines Limited is getting from Wagyu selling group which is engaged in selling of meat. The estimate shows significant improvements which suggest that the management of the company is applying focus in this sector so that appropriate secondary revenues can be generated from this source. The return om grape and wine assets which constitutes as primary business activity of the company has decreased significantly during the year. The estimate was shown to be 14.5% in 2016 and the same has reduced significantly in 2017 which is shown to be 12.2% The decrease in the assets suggest that the management is diversifying the business and this is the main reason as to the fall in the returns of wine and grapes assets of the business.
The gross margin and net margin of the business which are main ratios reflecting the profitability aspect of the business has decreased significantly as shown in the ratio results. The main reasons which can be given for the fall in the gross profit margin and net profit margin of the business is due to the increase in the costs of the business or decrease in overall sales of the business during the year. The auditor of the company in such circumstances needs to check the value of sales of the business which can be cash sales as well as credit sales. In addition to this, the expenses which are incurred by the business are also to be checked whether the same are relevant or not. There always exist the risks that the information which is presented in the financial statement can be manipulated in a way. The figures of sales are especially at risk as the same can be overstated or understated for the purpose of showing favorable financial records.
Business Risk Analysis for Trunkey Creek Wines Limited
The marketing expenses of the business can be analyzed with the help of the estimate of Marketing expense % of total S & A expenses which shows the relation between the expenses which is incurred by the management in relation to the total expenses which is received by the business. The ratio shows that there has been an increase in the costs of the business in comparison to previous year estimates which also hints that the profits of the business might mainly be affected by the increase in the costs of the business. The times interest earned ratio which is shown in the question reflects the ability of the company to appropriately service the borrowings which are undertaken by the management of the company (Glover, Prawitt & Drake, 2014). The times earned ratio of the business is shown to be 6.67 which has decreased significantly which shows that the management in present case scenario is not able to meet the expenses of the business appropriately. The risk which the business faces is risks which are generally associated with the debt capital of the business.
The days in inventory of the business represent the overall efficiency of the business in handling the inventories of the business. The number of days in this respect has fallen which suggest that the management of the company has improved the inventory management practice of the business which is a positive factor for the business. This means that overall efficiency of the business has improved. The days in account receivables in respect for wines has also decreased which shows efficient debtor management policy is applied in the business. However, the days of account receivables in meat production has increased which needs to be the main focus of the organization. This also shows that there is further scope for improvement in the debtor management policy of the business. The auditor needs to apply audit procedures for the purpose of ensuring the annual reports of the business are showing correct view
The current ratio of the business is used to assess the liquidity of the business and whether the management of the company is able to meet the current obligations of the business. The current ratio which is computed is shown to be 2.80 which has improved significantly in comparison to previous year analysis. In addition to this, liquidity ratios of the business are important as they reveal the financial stability of the business and the same is shown to be favorable in nature. The management can cover up its liquidity risks in order to attract more investors (Kuenkaikaew & Vasarhelyi, 2013). The quick ratio of the business reveals similar information as current ratio that determines liquidity position of the business and the same is shown by the business to have improved during the year. The debt to equity ratio of the business is related to capital structure decisions of a business. The estimate which is computed by the auditor shows that the debt equity ratio of the business has reduced in comparison to previous year’s estimates. This suggest that there has been a considerable reduction in the debt capital which is used by the management of the company. The auditor needs to apply relevant auditing practices in order to verify the balances of debt which is used by the management.
Analysis of Internal Controls in Trunkey Creek Wines Limited
Internal control of a business plays a vital role in managing and controlling the activities of the management. In case a business has a well established internal control system which is effective in nature, significant amount of risks can be avoided by the management. As per the case of Trunkey Creek Wines Limited, the business has established an internal control system and the effectiveness of the same can be identified in the table below:
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Effective Control |
Risk alleviated |
|
The management of the company has effectively set targets which are to be achieved by different class of employees working in different departments. The targets which are set by the management of the company measures aspects like targeted monthly sales volumes, variance of actual to budget departmental overheads and profit before interest and tax (De Simone, Ege & Stomberg, 2014). On the basis of achievement of targets by an employee, his performance is ascertained. In case of any discrepancies or variances a proper show cause is to be given for the same by the employees of the business. |
If the management of the company effectively follows the target policy for measuring the performance of the employees, then the risks which is related to fraudulent activities which are undertaken by the employees will be reduced significantly. Moreover, the efficiency of the employees of the business will also be improved following the program. |
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The management of the company has developed an IT software for the purpose of effectively recording the financial information of a business. |
The implementation of a software in recording of financial information will make the system of the organization more secure in nature. In addition to this, introduction of online software system will make the record keeping system much easier for accessing and also analyzing. Moreover, the software will be having a password so that the information which are stored in the system are not easily accessible. This provides security to the business against fraudulent activities of bring about manipulations in the financial entries of the business. In addition to this, this will also reduce the risk of material misstatement in financial statement which is due to omission or wrong entry. |
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Effective and systematic work process arrangement in the management of the business. |
The management of the company has an effective set of control for different departments of the business which are supplier check, marketing, accounting and production. This effective control in the business will prevent the risks of any unethical practice and promote sustainable development of the business. |
The weaknesses in internal control of the business which can be identified by the management of the company are listed below in table format:
|
Weakness |
Justification |
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Purchases of the business depends on the online ordering system |
The purchases which are made by the three different department are all based on computer software if the purchase is less than 10000 units. In addition to this, suppliers are linked with the computer system. In case of a breakdown of the system, all the purchase process of the business will be rendered useless (Vovchenko et al., 2017). In addition to this, vital information about the suppliers might also get lost in such a situation. |
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The payments which are made by the management are only approved by the account before the same is entered in the computer system. |
The management needs to consider the payments which are made to the suppliers of the business to be review by the CEO of the business as there is always a high chance that manipulations in the same can be incorporate which can affect the entire financial statements of the business. In addition to this, in the absence of an accountant the information which is entered in the system might be wrong or misstated which can affect the whole of reporting process of the business. |
Conclusion
The above discussion analyzes the financial statements and key financial ratios of the business in order to assess the risks which are associated with the business. The financial ratios are analyzed as a part of the analytical procedure which is adopted by the auditor for collecting vital audit evidences for the business. The discussion also shows the internal control system of Trunkey Creek Wines Limited and also discusses the strengths and weaknesses of the internal control system of the business. The analysis shows that the management can bring about further improvements in the internal control system of the business.
References
De Simone, L., Ege, M. S., & Stomberg, B. (2014). Internal control quality: The role of auditor-provided tax services. The Accounting Review, 90(4), 1469-1496.
Eilifsen, A., Messier, W. F., Glover, S. M., & Prawitt, D. F. (2013). Auditing and assurance services. McGraw-Hill.
Glover, S. M., Prawitt, D. F., & Drake, M. S. (2014). Between a rock and a hard place: A path forward for using substantive analytical procedures in auditing large P&L accounts: Commentary and analysis. Auditing: A Journal of Practice & Theory, 34(3), 161-179.
Hay, D., Knechel, W. R., & Willekens, M. (Eds.). (2014). The Routledge companion to auditing. Routledge.
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.
Knechel, W. R., & Salterio, S. E. (2016). Auditing: Assurance and risk. Routledge.
Kuenkaikaew, S., & Vasarhelyi, M. A. (2013). The predictive audit framework.
Louwers, T. J., Ramsay, R. J., Sinason, D. H., Strawser, J. R., & Thibodeau, J. C. (2015). Auditing & assurance services. McGraw-Hill Education.
Reding, K. F., Sobel, P. J., Anderson, U. L., Head, M. J., Ramamoorti, S., Salamasick, M., & Riddle, C. (2013). Internal Auditing: Assurance & Advisory Services. Institute of Internal Auditors, The IIA Research Foundation.
Titera, W. R. (2013). Updating audit standard—Enabling audit data analysis. Journal of Information Systems, 27(1), 325-331.
Turley, S. (2015). Developments in the framework of auditing regulation in the United Kingdom. In Auditing, Trust and Governance (pp. 223-240). Routledge.
Vovchenko, G. N., Holina, G. M., Orobinskiy, S. A., & Sichev, A. R. (2017). Ensuring financial stability of companies on the basis of international experience in construction of risks maps, internal control and audit. European Research Studies Journal, 20(1), 350-368.
Wong, R., & Millington, A. (2014). Corporate social disclosures: a user perspective on assurance. Accounting, Auditing & Accountability Journal, 27(5), 863-887.
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