Case Study: Double Ink Printers Ltd (DIPL) – Audit Analysis And Risk Assessment

Background Information

Preliminary analytical procedures help an auditor in the development of a strategy for the purpose of auditing. These are framed with respect to the extent, nature and time techniques so as to gain the overall knowledge of the client’s business. This procedure is basically a two step format where the first step involves understanding the client’s business. The other step is of analyzing certain sections of financial statements which are suspicious of having any form of error. For the business of DIPL, the following items shall be evaluated (PCAOB, 2017).

This particular ratio helps in evaluating DIPL’s growth in earnings with respect to its level of investments.

From the above table, it can be ascertained that with time, the level of return on equity has eroded in 2014 and uplifted in 2015. The volatility in the return of equity proves the fact that DIPL is trying to expand its business with the help of borrowings and investments. As an auditor, it is my duty to keep a check on DIPL’s investments along with the borrowings and its overall effect on the return on equity (Anderson & Koonce, 1998).

From the financial statement of DIPL, it has been found that a loan of $7.5 million has been taken from BDO Finance Ltd. It is important for the organization to strictly follow the conditions of BDO Ltd. In relation to the debt-equity ratio and current ratio. As far as applying analytical procedures are concerned, it is very important that as an auditor, I should review the nature of the loan. It should be analyzed whether the loan is being used for the applied purpose or not. The chances of fraud are relatively high in this component because of the amount involved. So, the fraud risk factors would be strictly kept under observation by adopting the measures of surprise check (Accounting_Financial_Tax, 2009).

From the above table, it can be reflected that gross profit margin has fallen from 2013 to 2015 by 2.35 basis points (17.55-15.20). Generally, a rise in the gross profit margin is considered as a favorable position for any organization. Here, DIPL’s gross profit margin ratio is falling in spite of the fact that its current assets outweigh the current liabilities. This requires keen attention of the management and it is the duty of an auditor to inform them about the current position. For this, the level of cost of debt along with the organization’s expenses shall be analyzed to learn the reason behind fall in the margin. Accordingly, the management of DIPL can adopt a necessary course of action to safeguard from the downfall of the margin (Hirst & Koonce, 1996).

The above table highlights the fact that DIPL has tried to maintain time interest earned ratio in 2013 and 2014 but it has drastically fallen in 2015. The reason behind such steep fall is the loan component which DIPL has taken from BDO Finance Ltd. Hence from 2015, the position of DIPL seems to be very risky due to the debt component. As an auditor is required to check whether the interest is being paid regularly along with whether the purpose of the loan is being justified regularly or not. In order to get back to the earlier level of the ratio, the steps planned by the management will fall under the regular scrutiny of the auditor’s course of conducting an audit (Glover, et al., 2000).

Purchase and Inventory

The rate of fall in the level of cash is an alarming situation for DIPL. Its direct effect will be on the position of liquidity. The reason behind such level of cash can be due to various reasons. One of the reasons can be DIPL’s inventory and debtors. The company is blocking its cash in these two components. Another reason is that DIPL is supposedly billing its clients at a lower rate. For this, surprise check of cash will be adopted as and when required (PCAOB, 2017).

Thus these were some analytical procedures wihcih will be applied on DIPL’s financial statements. The above parameters are quite crucial which requires the above stated planning for conducting audit.

Inherent risk is those risk which lies beyond the control of an auditor’s audit procedures and methods of control (My_Accounting_Course, 2017). The two inherent risk factors are DIPL’s acquisition of Nuclear Publishing Ltd. with an aim to earn higher profit margin and the shift from the manual system to the new computerized system installation. The reason behind the acquisition of the organization was uplifting the level of DIPL’s profit margin of medical textbooks. The latest news related to the textbooks that it will turn obsolete will result in fall in the return and increase in the level of DIPL. The company will face fall in its revenue and profit margin simultaneously. Since the acquisition is the most relevant part of DIPL’s undertaking, it may face threat to going concern in the near future.

With the new IT system, chances of errors are quite high because of the pressure involved amongst the employees. The new system has its own limitations like the software may crash or there might be any coding error. Due to the prevalence of the system errors, the financial statements will be materially misstated in an unintentional or intentional manner. Due to the pressure and coding error, some of the transactions might not enter into the system. Undue advantage can be taken of this situation. Employees may skip entering some revenue transactions and they can use it for their personal benefit. This will ultimately lead to fraud and it will be very difficult to trace who has actually committed the fraud. It is classified as the intervention of human nature in conducting fraud in an organization (Hirst & Koonce, 1996).

The above two inherent risk can misstate the financial statements in their own manner. The report will be misleading and the decisions made on its basis will turn out to be a failure for the organization. These two are quite a risky component and it has the potential to create a volatile situation in the financial statements. Due to system change, some errors have been found in terms of the incorrect accounting period. It is an inherent nature of the system which is also very difficult for an auditor to trace it and take the necessary course of action.

As per the background information of DIPL, its two fraud risk factors are loan taken from BDO Finance Ltd. and another is the adoption of new IT system in their course of operations. DIPL us under the pressure to pay off such a heavy amount of loan. Secondly, it is under pressure to maintain or follow the conditions as stated by BDO Finance Ltd. The funds are supposed to serve the purpose of growth but under immense pressure, the scope of manipulating the financial statements stands high. This will eventually lead to a situation of internal and external fraud of DIPL (Payne & Ramsay, 2005).

Due to the ineffective installation of the new IT system, it has developed a scope to gain undue advantage out of it. False transactions can be made in the name of the company or transactions of the heavy amount can be deleted which will falsify the financial statements. As far as the limitation on the auditor while conducting an audit is concerned, the above risk factors have their own role play in it. The loan of $ 7.5 million requires careful attention towards it. As an auditor, it is required to thoroughly check for the reason behind such loan and its application into the business. In the case of any suspicious activity found during the scrutiny, the same can be informed and discussed with the management. If the fraud cannot be easily traced, the auditor’s report will stand invalid and against the conceptual framework of auditing (Knapp & Knapp, 2001).

In order to check for the effectiveness and efficiency of the newly adopted IT system, various IT tools are available for the purpose of conducting an audit. One of the methods is of Computer Assisted Audit Technique which helps in locating loopholes of such kind of systems. It will also help in effectively maintaining audit trail during the course of the audit. Thus, the debt component and the newly adopted IT system are two major fraud risk factors of DIPL which has the potential to materialize the fraud at any moment of time (Anderson & Koonce, 1998).

References

Accounting_Financial_Tax, 2009. Analytical Procedures in Auditing. [Online] Available at: https://accounting-financial-tax.com/2009/10/analytical-procedures-in-auditing/[Accessed 15 August 2017].

Anderson, U. & Koonce, L., 1998. Evaluating the sufficiency of causes in audit analytical procedures. Auditing- A Journal of Practise and Theory, 17(1), pp. 1-12.

Glover, S., Jiambalvo, J. & Kennedy, J., 2000. Analytical procedures and audit-planning decisions. Auditing: A Journal of Practice & Theory, 19(2), pp. 27-45.

Hirst, D. & Koonce, L., 1996. , 1996. Audit analytical procedures: A field investigation.. Contemporary Accounting Research, 13(2), pp. 457-486.

Johnstone, K., Gramling, A. & Rittenberg, L. E., 2012. Auditing: A Risk-Based Approach To Conducting a Quality Audit. 9 ed. New York: Cengage Learning.

Knapp, C. A. & Knapp, M. C., 2001. Knapp,The effects of experience and explicit fraud risk assessment in detecting fraud with analytical procedures. Accounting, Organizations and Society, 26(1), pp. 25-37.

My_Accounting_Course, 2017. What is Inherent Risk?. [Online] Available at: https://www.myaccountingcourse.com/accounting-dictionary/inherent-risk[Accessed 15 August 2017].

Payne, E. A. & Ramsay, R. J., 2005. Fraud risk assessments and auditors’ professional skepticism. Managerial Auditing Journal, 20(3), pp. 321-330.

PCAOB, 2017. Analytical Procedures. [Online] Available at: https://pcaobus.org/Standards/Archived/Pages/AU329A.aspx[Accessed 15 August 2017].

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