Preliminary Assessment of Materiality for Financial Report as a Whole
The audit partner of the company has authorised audit senior to prepare the audit planning report and post completion it will be handed over to him.
- Limitations
The trial balance of the company has been given for 2 years, 2016 and 2017. For both the years, the debit and the credit totals is not matching and thus has been assumed to be suspense account or equity account. The same not being an income statement account, has not been considered in the trend and variance analysis (Boccia & Leonardi, 2016).
- Scope
The report has been prepared using the trial balance of the company and doing preliminary analytical review through the same. Significant accounts have been identified using variance and trend analysis and audit procedures to be employed by auditor has been stated. All this will help the auditor in gathering audit evidences and thereby giving an opinion on the financial statements.
- Question 1: Materiality
Preliminary assessment of materiality for the financial report on total asset
Materiality may be defined as something which can change the economic or financial decision of the user. It is one of the most important tools of audit planning as it helps the auditor in determining what all accounts and areas are critical and therefore needs to be checked in details and what all things can be ignored. Based on the input given in the question the trial balance of the entity has been shown in appendix. On this basis the materiality would be determined (Bailey, et al., 2017).
A discussion of appropriateness of this figure for client
The audit partner has suggested the materiality to be taken as $ 15000 for the given client but the same seems to be very high considering the trial balance of Cyan Enterprises. There are accounting boards and bodies over the world and consulting and auditing firms like those of Big 4’s which have suggested materiality based on percentage of sales, assets, profits or shareholder’s equity. Based on the same, the materiality for given entity should be in range of $ 1484 and $1993 (Werner, 2017).
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(Amt in $) |
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Cyan Enterprises |
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|
Quantitative estimate of materiality |
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Criterion |
Base |
Amount |
Materiality level/range |
|
0.5% to 1% of gross revenue |
Gross Revenue |
148,463 |
742.31 to 1484.63 |
|
1% to 2% of the total assets |
Total Assets |
460,505 |
4605.05 to 9210.1 |
|
1% to 2% of the gross profit |
Gross Profit |
99,679 |
996.79 to 1993.59 |
|
2% – 5% of the shareholders’ equity |
Equity |
NA |
NA |
|
5% to 10% of the net profit |
Net profit |
82,058 |
4102.91 to 8205.81 |
Possible impact of the changing the preliminary assessment on the audit budget
The most possible impact of choosing the above mentioned range as materiality would be that many accounts like those of superannuation, repair and maintenance, depreciation and interest expenses account which would have been ignored as per the previous materiality limit would now fall in the scope of audit (Visinescu, et al., 2017).
- Question 2: Preliminary Analytical review – Trend analysis
The preliminary analytical review has been done in the form of trend analysis through common size income statement and the variance analysis. Since the data for 2017 is only for 9 months, it has been annualised for the purpose of variance analysis.
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Cyan Enterprises |
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Income Statement |
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Particulars |
2017 |
% of sales |
2016 |
% of sales |
|
Sales |
148,463 |
76.9% |
187,450 |
76.7% |
|
Service fees |
44,438 |
23.0% |
57,000 |
23.3% |
|
Other Income + Interest |
36 |
0.0% |
50 |
0.0% |
|
Total Revenue |
192,936 |
100.0% |
244,500 |
100.0% |
|
Less: Expenses |
||||
|
Cost of sales |
45,788 |
23.7% |
63,595 |
26.0% |
|
Bank charges |
261 |
0.1% |
350 |
0.1% |
|
Depreciation |
12,424 |
6.4% |
15,738 |
6.4% |
|
Interest expense |
8,625 |
4.5% |
11,500 |
4.7% |
|
Printing |
278 |
0.1% |
375 |
0.2% |
|
Repairs and Maintenance |
1,080 |
0.6% |
5,050 |
2.1% |
|
Wages |
39,428 |
20.4% |
53,000 |
21.7% |
|
Superannuation |
2,996 |
1.6% |
4,770 |
2.0% |
|
Total Expenses |
110,878 |
57.5% |
154,378 |
63.1% |
|
Net Profit |
82,058 |
42.5% |
90,122 |
36.9% |
|
Cyan Enterprises |
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|
Income Statement |
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|
Particulars |
2017 |
2016 |
Variance |
Variance % |
|
Sales |
148,463 |
187,450 |
10,500 |
6% |
|
Consultancy fees |
44,438 |
57,000 |
2,250 |
4% |
|
Interest income |
36 |
50 |
– 2 |
-4% |
|
Total Revenue |
192,936 |
244,500 |
12,748 |
5% |
|
Less: Expenses |
||||
|
Cost of sales |
45,788 |
63,595 |
– 2,545 |
-4% |
|
Bank charges |
261 |
350 |
– 2 |
-1% |
|
Depreciation |
12,424 |
15,738 |
827 |
5% |
|
Interest expense |
8,625 |
11,500 |
– |
0% |
|
Printing |
278 |
375 |
– 5 |
-1% |
|
Repairs and Maintenance |
1,080 |
5,050 |
– 3,610 |
-71% |
|
Wages |
39,428 |
53,000 |
– 430 |
-1% |
|
Superannuation |
2,996 |
4,770 |
– 776 |
-16% |
|
Total Expenses |
110,878 |
154,378 |
– 6,541 |
-4% |
|
Net Profit |
82,058 |
90,122 |
19,289 |
21% |
|
Net Profit % |
42.53% |
36.86% |
Question 3: Income statement accounts having risk of material misstatement
Based on the analysis above, 3 key risks income statement accounts have been chosen and the risk and the associated assertions have been stated.
|
Sl. No. |
Account Name |
Audit Assertion and risk |
|
1. |
Sales |
The sales of the company Cyan Enterprises has increased by 6% as compared to the last year even though the proportion of the same as a percentage of total receipts has been same. The management assertion of completeness in recording of revenue and the right to recognise the revenue in the books needs to be checked here (Meroño-Cerdán, et al., 2017). |
|
2 |
Cost of Sales |
The cost of sales has decreased by 4% as compared to the last year when the sales has increased. In terms of the common size income statement, the same has declined by ~2.3%. It should therefore be checked if the management assertion of accuracy in recording of costs and the cut off entries at the period end has been correctly done (Bumgarner & Vasarhelyi, 2018). |
|
3 |
Repair and maintenance |
The repair and maintenance expenses have declined by 71% as compared to the last year and as a percentage of the total receipts the same has fallen by 1.5%. Therefore, it needs to be checked if all the expenses has been completely recorded by management and necessary disclosure in regard to change in any policy has been shown in financials. |
Question 4: Audit procedures to be employed
Based on the above critical accounts, the audit procedure to be employed are as follows:
- Sales: For this account, vouching of all the sales invoices should be done and it should be reconciled with the sales ledger. Furthermore it should be checked if the company is following the revenue recognition policy as per the accounting standards and recorded all the sales in line with the same(Kuhn & Morris, 2016).
- Cost of Sales: Here, the vouching of the purchase invoices should be employed and it needs to be checked if the prices of the raw material has come down or it is due to increase in efficiency. The cut off entries during month and year end also needs to be verified. The prices of the raw material can be compared with the market prices(Goldmann, 2016).
- Repair and Maintenance: Since this expense head has shown a drastic decline in the expenses, it needs to be checked if the company has recorded all the expenses in the books and what the estimates and judgements of the management in this regard and whether the same has been disclosed in the notes and disclosures in financial statements.
- Question 5: Fraud Risk Analysis
Fraud risk analysis may be defined as one of the audit procedures which is being employed to check the possibility of fraud in the given company. In the given case, the audit partner has suggested that the client Cyan Enterprises should not be subjected to fraud risk analysis as it is trustworthy but this is against the concept of professional scepticism and what has been mentioned in the standards as per APES 110 (Guragai, et al., 2017). Some of the accounts which hint towards the possibility of fraud are cost of sales account and the repair and maintenance account for reasons shown above. In addition, depreciation and superannuation account should also be checked as the balances of assets have neither increased nor decreased but the depreciation has increased (Marques, 2018).
-
Conclusion
As per above discussion and analysis, key risk accounts have been highlighted along with the assertions as well as the audit procedures to be undertaken. Also, it was discussed that irrespective of any factor, all the clients should be subject to fraud risk analysis.
Reference:
Bailey, C., Collins, D. & Abbott, L., 2017. The Impact of Enterprise Risk Management on the Audit Process: Evidence from Audit Fees and Audit Delay. Auditing: A Journal of Practice & Theory, 37(3), pp. 25-46.
Boccia, F. & Leonardi, R., 2016. The Challenge of the Digital Economy. Markets, Taxation and Appropriate Economic Models, pp. 1-16.
Bumgarner, N. & Vasarhelyi, M., 2018. Continuous auditing—a new view.. Continuous Auditing: Theory and Application, 20(1), pp. 7-51.
Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business. Financial Environment and Business Development, 4(3), pp. 103-112.
Guragai, B., Hunt, N., Neri, M. & Taylor, E., 2017. Accounting Information Systems and Ethics Research: Review, Synthesis, and the Future. Journal of Information Systems: Summer 2017, 31(2), pp. 65-81.
Kuhn, J. & Morris, B., 2016. IT internal control weaknesses and the market value of firms. Journal of Enterprise Information Management, 30(6).
Marques, R. P. F., 2018. Continuous Assurance and the Use of Technology for Business Compliance. Encyclopedia of Information Science and Technology, pp. 820-830.
Meroño-Cerdán, A., Lopez-Nicolas, C. & Molina-Castillo, F., 2017. Risk aversion, innovation and performance in family firms. Economics of Innovation and new technology, pp. 1-15.
Visinescu, L., Jones, M. & Sidorova, A., 2017. Improving Decision Quality: The Role of Business Intelligence. Journal of Computer Information Systems, 57(1), pp. 58-66.
Werner, M., 2017. Financial process mining – Accounting data structure dependent control flow inference. International Journal of Accounting Information Systems, 25(1), pp. 57-80.
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