Preliminary Analytical Procedures for DIPL Ltd’s Financial Report
1. Substantive processes play a vital role in the auditing process because it assists an auditor to identify material misstatements prevalent in the financials of a company so that relevant judgement can be provided. Besides, such processes can also assist in compliance with qualitative attributes like completeness and efficacy of the financial statements. Nevertheless, in relation to DIPL Ltd, before conducting such procedures to arrive at a judgement, several concerns must be taken into account (Gay & Simnet, 2015). However, it must be noted that an auditor must go through various authenticated documents in order to qualify as an effective substantive process that can, in turn, assist in identification of material misstatements.
There are many analytical procedures that can be conducted in order to analyze the background information of DIPL Ltd. The first analytical process that can be utilized in this case is trend analysis wherein the future results of the company can be easily anticipated with the help of past results. The second process is associated with the evaluation of the financial information of the company based on the financial and non-financial information. This can assist in the implementation of relevant and effective decisions upon the financials of DIPL Ltd. The last analytical process in this regard is the implementation of ratio analysis so that a perfect comparison can be made with that of the last financial outcomes of the company, thereby assisting in effective financial decisions (Matthew, 2015). Thus, these three analytical processes can be taken into account in relation to the company’s background information.
Ratio analysis has been conducted in this scenario in order to assess whether the financial outcomes depicted in the financials of DIPL are efficient or not.
Ratio |
Formula |
2013 |
2014 |
2015 |
Current Ratio |
Current Assets/ Current Liabilities |
1.42 |
1.47 |
1.50 |
Gross Profit Ratio |
Gross Profit/ Sales |
17.55 |
16.13 |
15.20 |
Net Profit Ratio |
Net Profit after tax/ Sales |
6.89 |
6.07 |
6.84 |
Debt Equity Ratio |
Debt / Equity |
_ |
_ |
0.61 |
In the liquidity segment of the company, current ratio has been calculated that can assist in ascertaining its liquidity position. From the figures, it can be observed that the current ratio of DIPL had consistently remained in an average phase. This can be proved by the fact that the ratio remained below two over the years that concludes effective liquidity status on the company’s part (Heeler, 2009). The second part is the debt equity ratio that assists in ascertaining whether the company has an adequate balance of debt and equity in its capital structure (Davies & Crawford, 2012). It can be seen that the debt equity ratio of DIPL is nil in both 2013 and 2014 that signifies zero liabilities in these years. However, the reason behind an increment of 0.61 in the year 2015 can be attributed to the fact that the company had procured liabilities in such year. Furthermore, in relation to profitability ratio, it can be seen that on one hand, the net profit ratio of DIPL have depicted an effective result as it has decreased but on a slight note. However, it further increased in the year 2015. Similarly, the gross profit ratio has depicted a declining trend over the years that are a negative indicator on the part of company’s performance. It shows that the profitability status of the company is at stake and the management as soon as possible must address it.
Identifying Inherent Risk Factors for DIPL Ltd
After assessing the above calculations, it can be said that it is the moral responsibility of an auditor to take into account other concerns before undertaking such analytical procedures to provide a judgement. This is because it can be witnessed from the financials of the company that its debts have shown an enormous increment over the years that is a negative indicator of its performance. Further, the balances of cash have also depicted a declining trend that signifies lack of adequate resources to finance major working capital requirements. In addition to this, owing to lack of resources, the payables of the company have also portrayed an increasing trend that shows the inability of the company in addressing its usual transactions (Guerard, 2013). Lastly, it can also be seen that the accounts receivables of the company have depicted an increasing trend that signifies inappropriate functioning of the recovery policy of the company. Therefore, the auditor must also evaluate all these concerns before implementing analytical processes, as it may assist him in making decisions that are more valuable. Besides, these concerns are clearly present in the financials of DIPL that gives rise to the fact that if these are not addressed properly, future problems or complications may tend to arise. Moreover, the key reason behind the assessment of these concerns before implementation of analytical procedures is that these concerns can assist the auditor in completing the auditing process effectively so that an enhanced observation regarding the true and fair view of the company’s performance can be attained. In simple words, if the auditor may be influenced by any such material misstatement prevalent in the financials of the company, then the audit opinion offered may not be true in every respect and hence, it will be better to consider such concerns before making a judgement (Roach, 2010).
2. Evaluation of inherent risk is very vital for the success of an enterprise. However, such risks cannot be fully mitigated or avoided because these are present in the financials of a company despite efficient measures like internal control mechanisms, etc. The major inherent risks that form part of the financial statements of DIPL are as follows:
The appointment of the CEO of DIPL is considered unethical in nature because such appointed person must not pursue any kind of interest with the company. However, the company has not taken this into account because the CEO appointed has a financial interest in the company that is the major cause of the creation of inherent risk. It can be observed that the CEO has been allowed to gain ten percent of the profits of the company if the company also witnesses growth by ten percent or more. The major inherent risk in this scenario is that the CEO is in a position wherein he may attempt to operate the company’s affairs in such a way that may grant him the agreed profit. Besides, this attempt may either be moral or immoral because if the company does not witness a growth of ten percent or more, the CEO may influence the records to depict the opposite.
Fraudulent Financial Reporting Risk for DIPL Ltd
The company has adopted a new information technology system into its operations so that automated entries can be made, thereby enhancing the pace of operations. However, there was no prior research conducted by the company so that proper adoption can be undertaken. Besides, the prior examination may assist in reflecting ineffectiveness or problems that may create future problems (Reding et. al, 2015). However, the company did not implement the same and as a result, several transactions that appeared at the year-end were not appropriately allocated. In simple words, the transactions that appeared at one period were depicted in another period, thereby creating major differences. This clearly gives rise to the fact that a material misstatement was prevalent in the financials of the company, thereby giving rise to inherent risks. Moreover, the management may use such opportunity for their own benefits and the auditor may even be incapable in detecting such problems (Church et. al, 2008). On a whole, such fraudulent strategy may result in a practice that is clearly immoral, thereby hampering the reputation of the company as a whole.
Therefore, these two inherent risks are prevalent in the financials of DIPL that may hamper its goodwill in future. Furthermore, the auditor may also prove incapable in detecting such risks if the management itself is involved in the situation. Thus, it must be noted that the auditor must exert his professionalism and expertise to assess the prevalence of such risks so that relevant decisions can be made.
3. The major fraud risk that exposes the operations of the company to fraud is the appointment of the new CEO and improper functioning of the information technology system. In relation to the appointment of the new CEO, it can be seen that the same has been done with a profit motive but the CEO possessing a financial interest may fraudulently use such opportunity for his own benefit. Besides, this may result in indifferences in the account balances of the company, as the CEO may have influenced the figures in a way that may grant him additional profits. This also gives rise to the fact that the internal control strategy of DIPL is not effective as the executives are given an opportunity wherein they can manipulate the accounts for their own advantages. The second fraud risk is the adoption of the new information technology system wherein adequate testing was failed to be conducted. The most relevant fraud risk that may tend to arrive in this scenario is that the entire information from the past system may not be entered into the new system (Carcello, 2012). Besides, such information may also be wrongly entered into the system for the purpose of gaining an undue advantage. This may be the reason why the accounts receivables and payables have depicted a weird trend over the years even though there were massive sales. Hence, this can directly result in accounting figures that are inappropriate. Moreover, the accountants of the company are also under an undue advantage to derive access into the system and manipulate the accounts based on their profit motives (Johnstone al, 2014). For instance, the outstanding balances of the debtors may be written off for the purpose.
The materials that are offered by the company are taken into account by an auditor to make relevant decisions. However, if the management conducts fraudulent affairs, the auditor’s decision may become inefficient. Hence, the management must possess a strong authority over the company’s financial statements so that code of ethics is not put at stake. Further, the auditor comes under a responsibility wherein he must track every minute detail especially when the management is also involved. Hence, proper judgement and skills of an auditor are very relevant in this scenario (Elder et. al, 2010). For effective judgement, the auditor can take authenticated documents like bank statements into account so that truthfulness of the accounting entries can be determined. Besides, since the CEO is under an advantage to manipulate the accounts for his own benefit, the auditor may need extra time to ascertain the truthfulness of the figures. Moreover, if such matters are not properly observed by the auditor, then an inefficient judgement may be offered on his part. The second consideration in this regard is related to the adoption of new IT system wherein the auditor must be properly accustomed with the operations of the system so that his decision cannot be questioned. Further, the biggest risk in this scenario is that proper allocations of the past entries were not made to their correct period and the auditor may not identify such issues, thereby failing to offer an efficient opinion (Gilbert et. al, 2005). Nevertheless, this concludes the fact that when prior testing was absent before adoption of the system, concerns like piracy, and breach of data may have occurred that can result in a wrong auditor’s opinion. Further, if the auditor relies on such automated and new information technology system, there may be a possibility that the entire decision offered based on the background information of DIPL, is wrong. On a whole, since the testing procedure was incomplete, the audit process is clearly at stake in the given scenario and therefore, the auditor must address such issues before arriving at a final judgement (Geoffrey et. al, 2016). This will assist in a proper audit process as a whole.
References
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