Preliminary Assessment for Materiality
Preliminary assessment regarding materiality is computed at the initial level of audit and it is used for planning the nature and extent of audit to be carried out. AASB 108 defined material misstatement as omission of any account that can have an impact on the decision of the users of financial statement. The materiality is set at higher level if the risk of the client that is the control risk as well as the inherent risk is at lower level. Conversely, it is set at lower level if the risk of the client is lower (Eilifsen and Messier 2014). However, materiality level of each company differs on the basis of the type of business and industry nature of the company. These factors shall be considered as per ISA 320 requirements. Various bases those can be taken for ascertaining the materiality levels are net profit, revenue, fixes asset and gross profit (Icaew.com 2018). If revenues are taken as the base for ascertaining materiality it is assumed that the materiality will be 1% to 5% of revenues. Therefore, materiality level will be ($ 194,525 * 1%) = $ 1,945 to ($ 194,525 * 5%) = $ 9,726 for Feldsper Enterprise. However, the auditor can set up the level of tolerable misstatement at lower than the materiality level as it is unlikely that all the accounts will be material at the same time (Moroney and Trotman 2016). Hence, it is assumed that the tolerable misstatement can be ascertained at 75% of materiality that is ($ 9,726 *75%) = $ 7,295.
Audit budget determines the item numbers from the financial statement of the company requires to be selected. When the materiality level is low the auditors will be required to analyse more items from the financial reports and in case of high amount of materiality the number of items will be less (Ruhnke, Pronobis and Michel 2014). Here, in the given case if the materiality level is to be revised from $ 15,000 to $ 7,295 the auditor will be required to analyse more number of items and therefore the audit budget will be increased.
Auditors use the analytical review for assessing the reasonableness of the account balance recorded in the financial reports of the company under the concerned period. It is regarded as an important part of the analysis for the purpose of auditing (Arens et al. 2016). Analytical review can be carried out through various analyses like ratio analysis and trend analysis. Analytical review is carried out by the auditor for the below mentioned purposes –
- For overall review of financial data in final stage audit review.
- Assisting in planning of audit timing, extent and nature for the procedures of audit
- As the substantive test for gaining the evidential matter regarding the specific assertion associated to transaction class or account balance (Bowlin, Hobson and Piercey 2015)
Trend analysis of the income statement of Feldsper Enterprise
3.1.1 First account selected – Sales
3.1.2 Rational for selection
Sales revenue is considered as one of the major item in the financial reports of the company as it states the ability of the entity to meet its daily operational expenses. Hence the item is considered as a material item owing to its nature. Hence, irrespective of the amount of changes in sales revenue as compared to last year it shall be considered for analysis as materially misstated item.
Analytical Review through Trend Analysis
3.1.3 Assertion and explanation
Though the changes in sales revenue has been increased by only 3.77% as compared to previous year, owing to its nature it can be associated with various assertions like –
- Occurrence – it determines the assertion that the sales transactions recorded by the entity have been occurred during the period under concern.
- Accuracy – amounts for sales transaction is recorded by the entity for proper amount
- Classification – sales transaction is recorded by the entity under appropriate accounting heads (Mao 2014).
Further, the presentation and disclosures can also be asserted in different ways like –
- Occurrence – all the disclosures associated with the sales transactions related to entity’s business and occurred in the concerned period actually
- Classification – sales transactions have been segregated as per appropriate accounting heads and recognised as per the recognition criteria followed by the entity.
3.2 Second account selected – Cost of goods sold
3.2.1 Rational for selection
As large amount of saes revenue is eaten up by COGS this item shall be considered as material owing to its nature. As COGS includes the expenses for various heads like labour expenses, cost of material purchases and overhead expenses, it leaves wide scope to the management to misstate it if it prefers to show that the company is left with sufficient amount for paying off its operational expenses.
3.2.2 Assertion and explanation
The changes in COGS have been noticed that it reduced by 7.15% as compared to previous year that states the entity was able to reduce the costs. However, at the same time it may point out that the management may has misstated the amount to show that the company sufficient amount for paying off its operational expenses. Different assertions linked with the item may be as follows –
- Accuracy – amounts for COGS is recorded by the entity for proper amount
- Occurrence – it determines the assertion that the COGS recorded by the entity have been occurred during the period under concern (Louwers et al. 2015).
- Classification – COGS is recorded by the entity under appropriate accounting heads.
3.3 Third account selected – Miscellaneous expenses
3.3.1 Rational for selection
From the provided trial balance of Feldsper Enterprise it can be identified that the miscellaneous expenses of the entity for the current year amounted to 1,440. However, there were no such expenses recorded for the previous accounting year. It is likely that the management has included some expenses under this head to suppress any misstatement with regard to expenses.
3.3.2 Assertion and explanation
Various assertions related to the miscellaneous expenses are as follows –
- Occurrence – it determines the assertion that the miscellaneous expenses recorded by the entity have been occurred during the concerned accounting period
- Accuracy – appropriate amounts is recorded by the entity under miscellaneous expenses (Coetzee and Lubbe 2014)
Further, the presentation and disclosures can also be asserted as follows –
- Occurrence – all the disclosures associated with the miscellaneous expenses related to entity’s business and occurred in the concerned period
3.4 Fourth account selected – Wages
3.4.1 Rational for selection
Wage payment is a major expense for Feldsper Enterprise as among the recorded expenses under income statement wage expenses consumed the largest amount of operating income. Hence, though the changes are only reduction of 0.81% as compared to previous year owing to the amount involved it will be considered as material item.
3.4.2 Assertion and explanation
Wage expenses is the accounting head where the management has the scope of misstating the amount as per their target as the head consist payment to number of employees with different pay scales. Assertions related to wage payments are as follows –
- Occurrence – payments made to the employees who are actually employed by the company
- Cut-off – payment of wages are recorded under appropriate accounting words. In other words, it does not include payment made in previous year (Leung et al. 2014).
4.1 Sales
The auditor shall verify the recognition criteria applied by the company for recognizing the sales revenue and the authored recognition method is applied on consistent basis while recording the revenues. Further, the sales register shall be verified for big amount of transaction with regard to number of unit sold, name of the customer to whom sales being made and unit price charged (Griffin 2014).
4.2 Cost of goods sold
It shall be verified with regard to each accounting head like labour expenses, purchase of material and overhead expenses. Each of the heads shall be matched with proper records like purchase register for material purchased, labour register with respective basis for payment and associated vouchers and bills associated to overhead expenses.
4.3 Miscellaneous expenses
Which are the expenses recorded as miscellaneous expenses shall be verified with proper bills and vouchers. Further, the reason why the expenses are recorded as miscellaneous instead of inclusion under respective heads must be identified (Moeller 2013).
4.4 Wages
Payment made to each category of employees with respective payment slip shall be verified. In case of new engagement or retirement it shall be verified that the wage payment account has been amended accordingly.
Fraud is considered as the intentional error committed by the management for fulfilling its own target. However, the primary job of the auditor is to detect fraud, if any, while auditing the financial reports of the company. Therefore, irrespective of the fact that the employees of the company are faithful, the auditor must carry out the audit with the objective of detecting fraud (Glover and Prawitt 2014). No fraud likelihood is found as per analytical reviews, however due to the nature and amount involved some accounts like saes, COGS, miscellaneous expenses and wages shall be verified for the purpose of material misstatement.
References
Arens, A.A., Elder, R.J., Beasley, M.S. and Hogan, C.E., 2016. Auditing and assurance services. Pearson.
Bowlin, K.O., Hobson, J.L. and Piercey, M.D., 2015. The effects of auditor rotation, professional skepticism, and interactions with managers on audit quality. The Accounting Review, 90(4), pp.1363-1393.
Coetzee, P. and Lubbe, D., 2014. Improving the efficiency and effectiveness of risk?based internal audit engagements. International Journal of Auditing, 18(2), pp.115-125.
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.
Glover, S.M. and Prawitt, D.F., 2014. Enhancing auditor professional skepticism: The professional skepticism continuum. Current Issues in Auditing, 8(2), pp.P1-P10.
Griffin, J.B., 2014. The effects of uncertainty and disclosure on auditors’ fair value materiality decisions. Journal of Accounting Research, 52(5), pp.1165-1193.
Icaew.com., 2018. [online] Available at: https://www.icaew.com/-/media/corporate/files/technical/iaa/materiality-in-the-audit-of-financial-statements.ashx [Accessed 10 Oct. 2018].
Leung, P., Coram, P., Cooper, B.J. and Richardson, P., 2014. Modern Auditing and Assurance Services 6e. Wiley.
Louwers, T.J., Ramsay, R.J., Sinason, D.H., Strawser, J.R. and Thibodeau, J.C., 2015. Auditing & assurance services. McGraw-Hill Education.
Mao, M., 2014, June. Experimental Methods of Materiality Judgment on Auditor’s Experience and Performance. In 3rd International Conference on Science and Social Research (ICSSR 2014). Atlantis Press.
Moeller, R.R., 2013. Role of Internal Audit in Enterprise Risk Management. COSO Enterprise Risk Management: Establishing Effective Governance, Risk, and Compliance Processes, Second Edition, pp.247-266.
Moroney, R. and Trotman, K.T., 2016. Differences in Auditors’ Materiality Assessments When Auditing Financial Statements and Sustainability Reports. Contemporary Accounting Research, 33(2), pp.551-575.
Ruhnke, K., Pronobis, P. and Michel, M., 2014. Audit materiality disclosures and credit lending decisions
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