Materiality and preliminary judgment
Materiality is the relative factor that asks for a base to support the fact that whether the misstatement involved due to fraud or errors is material or immaterial. On the other hand, preliminary judgement indicated the maximum possible amount that can be accepted by the auditor for misstatement and that will not have any significant impact on the decision making procedure of the users of the financial statement (Choudhary, Merkley and Schipper 2018). Whereas some of the misstatements are based on the amount involved, some are based on the nature of the items even though the amount involved is small. Level of materiality is calculated through taking the sales revenue as base. Generally, the materiality is established at 2% to 5% of sales revenue. Therefore, in case of Cadmium Enterprise materiality level will be from ($ 189,000 *2%) = $ 3,780 to ($ 189,000 * 5%) = $ 9,450. Further, the tolerable misstatement is established at 50% to 75% of the materiality. Therefore, in case of Cadmium Enterprise materiality can be established at around $ 6,000 (Eilifsen and Messier 2014). However, in case of the company the audit partner recommended that the preliminary assessment with regard to materiality shall be set at $ 15,000. Therefore, the amount of materiality shall be re-established at $ 6,000. Audit budget includes the number of items to be audited under the audit procedure of financial statement. Based on the materiality level the auditor prepares the budget regarding how many items are to be checked. However, if the tolerable misstatement level is reduced the auditor will have to check more items under audit. Therefore, changes on preliminary assessment will have great impact on audit budget (Lessambo 2018).
Analytical review under audit is carried out through taking into consideration various analyses like ratio analyses and trend analyses of the company as compared to the previous year or as compared to peer entity. This procedure analyse the trends and ratios and thereafter recognises the exception amount due to the nature or significant changes. Analytical procedure assists the auditor to establish the level of reliance that can be made depending on the inherent risk and control risk of the company. It further helps the auditor in planning the nature, timing and extent of audit (Mock and Fukukawa 2015).
Sales plays important role in business operation of the company as all the operating expenses are paid out of the sales revenue. Though it has been found that the sales revenue of Cadmium Enterprise has been increased by only $ 1,550 that is by only 0.83%, owing to its nature this item will be considered as material. Further, the employee’s bonus and manager’s remuneration are based on the sales revenue of the company that makes the item susceptible to misstatement (Legoria, Melendrez and Reynolds 2013).
While auditing the sales revenue the auditor is mainly concerned about the misstatement and accuracy. Likelihood is there that the management has recorded sales to fictitious purchasers or for fictitious items for increasing the sales amount which in turn will make them eligible for higher remuneration. Further, the amount may be misstated through raising the invoice without actually delivering the products or invoice not raised for the items already delivered (Kogan et al. 2014). Therefore, the assertion related to sales revenue is accuracy that is the amount of sales revenue has been misstated or there involved any mathematical inaccuracy.
Analytical review
It has been found that the amount received through consultancy fees is a major source of income for the after sales revenue. Though it has been found that the consultancy fees receipt by Cadmium Enterprise has been increased by only $ 2,251 that is by only 3.95%, owing to its nature this item will be considered as material.
While auditing the receipt from consultancy fees the auditor is mainly concerned about the misstatement regarding accuracy. Likelihood is there that the management has raised invoice at higher or lower amount than the actual. Further, as the fees has been increased as compared to the last year likelihood is there that the company started providing additional services to the existing clients or the charges has been increased or number of client has been increased (Ruhnke and Schmidt 2014). Therefore, the assertion related to consultancy fees is accuracy that is the amount of receipt has been misstated or has not been reported correctly.
It is found in case of Cadmium Enterprise that the amount of repairs and maintenance has been significantly reduced by $ 3,610 that is by 71.49%. Therefore, the item is material by amount.
While auditing for repairs and maintenance the auditor shall be concerned about the misstatement owing to mathematical accuracy and appropriateness of recording the amount. Likelihood is there that the invoice for consultancy has been raised at lower amount or the amount has been recorded at lower or higher amount. Therefore, in case of consultancy fees the assertion is with regard to accuracy that the amount has not been recorded appropriately and cut-off that is the amount has been recorded under appropriate accounting period.
For auditing the sales revenue the auditor shall check the sales register and match the accounting records with the names, amount receipt from sales and sales basis that is the cash basis or credit basis. Further, the sales report shall be verified with the invoices and customer order number shall be matched with that (Christensen, Glover and Wood 2013). The auditor shall further check the recognition method of sales revenue and whether the recognition method is used by the entity on consistent basis.
For auditing the fees received from consultancy fees the auditor shall verify the bill raised to the clients with details of their names, services provided and charges for the services. If additional services is provided fees charged for that additional service shall be verified. Further, the auditor shall match the bill number with the amount recorded in the accounts.
While auditing the repairs and maintenance at 1st the auditor shall verify that whether the capital expenses incurred for repairing the fixed assets have been capitalized or have been charged under income statement (Antonio 2014). Further, the auditor shall check that where the amount involved is big the expenses has been authorised by the proper authorization. Amount paid for repairs and maintenance shall be verified with the cash books or bank books.
The term fraud in auditing aspect is stated as the concealment of material fact or false representation intentionally for persuading any other person to act on that. Professionally the auditors are responsible for detecting the fraud while auditing the financial statement. It helps the auditor to sharpen their knowledge and skill which in turn teach them new technique to detect financial misstatement. Frauds are committed by the management or the employees as they want to rationalize their activities that include wilful misstatement or weakness in internal control. Therefore, fraud is very common activities that are used by most of the organizations (Boyle, DeZoort and Hermanson 2015). Hence, even if the audit partner feels that fraud risk is not there in case of Cadmium Enterprise as the employees are trustworthy, the auditor shall not ignore the likelihood of fraud.
Reference
Antonio, G.R., 2014. Continuous auditing: Developing automated audit systems for fraud and error detections. Journal of Economics, Business & Accountancy Ventura, 17(1), pp.127-144.
Boyle, D.M., DeZoort, F.T. and Hermanson, D.R., 2015. The effect of alternative fraud model use on auditors’ fraud risk judgments. Journal of Accounting and Public Policy, 34(6), pp.578-596.
Choudhary, P., Merkley, K.J. and Schipper, K., 2018. Auditors’ Quantitative Materiality Judgments: Properties and Implications for Financial Reporting Reliability.
Christensen, B.E., Glover, S.M. and Wood, D.A., 2013. Extreme estimation uncertainty and audit assurance. Current Issues in Auditing, 7(1), pp.P36-P42.
Eilifsen, A. and Messier Jr, W.F., 2014. Materiality guidance of the major public accounting firms. Auditing: A Journal of Practice & Theory, 34(2), pp.3-26.
Kogan, A., Alles, M.G., Vasarhelyi, M.A. and Wu, J., 2014. Design and evaluation of a continuous data level auditing system. Auditing: A Journal of Practice & Theory, 33(4), pp.221-245.
Legoria, J., Melendrez, K.D. and Reynolds, J.K., 2013. Qualitative audit materiality and earnings management. Review of Accounting Studies, 18(2), pp.414-442.
Lessambo, F.I., 2018. Audit Risks: Identification and Procedures. In Auditing, Assurance Services, and Forensics(pp. 183-202). Palgrave Macmillan, Cham.
Mock, T.J. and Fukukawa, H., 2015. Auditors’ risk assessments: The effects of elicitation approach and assertion framing. Behavioral Research in Accounting, 28(2), pp.75-84.
Ruhnke, K. and Schmidt, M., 2014. Misstatements in financial statements: The relationship between inherent and control risk factors and audit adjustments. Auditing: A Journal of Practice & Theory, 33(4), pp.247-269.
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