Role of Planning Materiality in Audit
The level of materiality which is associated with audit procedures is a key factor in determining whether the financial statements are showing any material misstatements or not. Materiality can be said to be a judgement which is made by the auditor of a company about a significance of an item which is presented in the financial statements of the company (Keune & Johnstone, 2015). The complexity or significance of items decides the materiality judgements which is made by the auditor. It is normally seen that estimation of materiality is done in the initial planning stage of the audit where the auditors need to make a decision as to which items are to be considered as material by the auditor in order to effectively perform his duties. As per ISA 320 which is related to materiality, materiality is considered to be an important factor which influences the decisions of the auditor regarding the fairness of the financial statements of the company. In this case, the company which is considered for analyzing the financial statements is Insurance Australia Group Ltd (Reports | IAG Limited., 2018). The company is engaged in insurance business and therefore, the audit process will not be conducted as in case of general companies.
In order to estimate effectively materiality of different items which are shown in the financial statements of the company, planning materiality is to be computed. Planning materiality is computed at the planning stage of the audit and the estimate is used by the auditor to compute different performance materiality estimates and also judge the materiality levels of different items of the financial statements of the company (Emby & Pecchiari, 2013). In general principles, planning materiality is computed considering a base which is normally the highest value which is shown in the financial statements of the company. The base which is considered is multiplied with a percentage which is also estimated by the auditor depending on other items which are shown in the annual reports and also on the nature of the business (Amiram et al., 2017).
In the case of Insurance Australian Group ltd, the figure of total asset is considered to be to be the base as the value for the same is of significant value (Müller-Burmeister & Velte, 2016). The total asset figure for the year 2017 is shown to be $ 29,597 million. For the purpose of computing the planning materiality, the predetermined rate of percentage is considered to be 2%. The computation of planning materiality is shown in the below equation
The planning materiality of the business is computed to be $ 591.4 million which will be considered to be the base for calculating the materiality for different items which will be considered for estimating whether there are material misstatements in the financial statements of the company.
The draft notes and disclosures which are shown in the financial statements of the company are considered to be important from the point of view of the auditor. The draft notes of the company are shown in the notes to the accounts of the financial statements. The important items which are covered in notes to accounts are discussed below:
- Contingencies: The contingencies of the business represent liabilities which are not actual in nature but can become actual liability in future due to happening or non-happening of certain events (Tseng, Lin & Yen, 2015). In case of the company, the business has litigation for insurance contracts which are considered to v0ontingent liability of the business. The auditor needs to verify whether the financial statements are showing true and fair view in this regard.
- Goodwill and Investment in Joint Ventures:As per the annual report of the business, the business has certain investments in joint venture agreements for the year and rh the valuation of goodwill is also covered in the key audit matters of the business and therefore the auditor needs to ensure that the valuation for such items which are shown in the annual reports of the company are effectively shown and fairly represented.
- Valuation of Reinsurance and other outstanding claims of the business: The auditor needs to check the items and revenues which the business has generated from reinsurance contracts and also the outstanding claims which is received by the business during the year. The auditor needs to apply vouching procedures for the purpose of ensuring that the balances which are shown in the annual reports of the company for such account.
Disclosures and Draft notes
Analytical procedures are also a part of the auditing process where the auditor considers key financial ratios for the purpose of estimating whether the financial statements are showing true and fair view or not and whether the financial statements are free from risks (Titera, 2013).
The ratios of an insurance company will be different in respect of profitability ratios which are shown as above as earnings ratio of the business. The earnings ratios comprise of premium growth, retention risks, return on equity and return on assets of the business. The premium growth indicates how much the business has grown in terms of sales of insurance contracts. There has been significant improvements in the premium growth in comparison to last year analysis. This should be verified by the auditor so as to ensure that there are no manipulations in the same. The risk retention represents the risks which is present with the insurer company and the same has reduced significantly which is a positive sign for the business. The return to assets and return to equity are key financial ratios and both the estimate is shown in the table above to be on the rise which is positive sign for the business (Plumlee, Rixom & Rosman, 2014). The auditor needs to apply vouching practices in order to assess the fairness of the estimates and also identify any risks which the business might be facing.
The assets management ratios show the return generating capacity of the business by utilizing the assets of the business during the period. The asset turnover ratio of the business is shown to be increasing which suggest that the business is using the assets which are available to the business effectively. The auditor however needs to ascertain the valuation of the assets of the business for which he can also take the help of an expert.
The leverage ratio of the business shows the capital structure positioning of the business. The ratios show that the management of Insurance Australia Group ltd is trying to reduce the debt capital of the business and relies more on equity capital of the business. The auditor in this respect needs to check the viability of debts which are taken by the business and also ensure that the equity capital which is shown by the business are reflecting true and fair view.
The valuation ratios of the business show price earnings ratio, dividend yield ratio which are considered to important estimates for the business. The dividend yield ratio of the business shows that the dividends of the business has reduced significantly. The auditor needs to check the balances of dividend and apply confirmations in order to estimate whether the financial ratios are showing true view for the dividends offered by the business.
The cash flow statement of the business shows the cash position of the business and are also a part of the financial statements of the business. The cash flow statement of the Insurance Australia Group ltd are effectively presented (Pavlovi? & Bogdanovi?, 2013). The maximum amount of cash inflows of the business is shown by cash from investing activities of the business and the amount is shown as $ 1,118 million and the highest amount of cash outflows which is shown in the cash flow statements of the business is in cash from financing activities of the business (Chang et al., 2014). The primary cash receipts during the year as shown in the cash flow statement is of premium received which is shown to be $ 11,793 million and the cash payments which is of primary nature is shown to be claims costs paid which is shown to be $ 8,995.
Analytical Procedures in Audit
The business has sold a part of the property plants and equipment which forms a part of the investing activities of the business and as in relation to financing activities of the business, the major item which is shown in the cash flow statement are repayment of loans during the year.
The going concern principle of a business is generally affected by certain negative indicators for which the analysis of the financial statements of the business needs to be considered. The liquidity position of the business is shown to be appropriate considering the cash flow statement of the business (Geiger, Raghunandan & Riccardi, 2013). The business also has an appropriate profitability ratio along with premium growth (Krishnan & Wang, 2014). Therefore, it can be said that the going concern principle of the business is not affected.
As per the auditor report of the company, the auditor has given an unqualified audit report which makes it clear that the report is showing true and fair view of the business and has followed all relevant provisions regarding corporation act 2001 and all relevant accounting standards. The auditor of the company is KPMG firm and they have highlighted certain key audit matters of the business.
The key audit matter of the business as identified are business combinations which related to certain agreements which are undertaken by the business during the year which are considered to significant for the purpose of audit. The key audit matters also include investments in joint ventures and valuation of goodwill which are matters of complex nature and thus should be analyzed effectively by the auditor of the of the company. The auditor needs to apply external confirmation as well as use the help of an expert to value the assets of the business.
Conclusion
As per the analysis of the financial statements of Insurance Australia Group ltd, the financial statements are prepared in an effective and efficient manner considering all the relevant accounting standards which are relevant to the business. The analysis of the financial statements of the business shows that the going concern principle of the business is intact. The cash flow statement of the business is also prepared effectively for the year 2017. It is thus concluded that the financial statements are showing true and fair view along with following all regulations of accounting in Australia.
Reference
Amiram, D., Chircop, J., Landsman, W. R., & Peasnell, K. V. (2017). Mandatorily disclosed materiality thresholds, their determinants, and their association with earnings multiples.
Chang, X., Dasgupta, S., Wong, G., & Yao, J. (2014). Cash-flow sensitivities and the allocation of internal cash flow. The Review of Financial Studies, 27(12), 3628-3657.
Emby, C., & Pecchiari, N. (2013). An Empirical Investigation of the Influence of Qualitative Risk Factors on Canadian Auditors’ Determination of Performance Materiality. Accounting Perspectives, 12(4), 281-299.
Geiger, M. A., Raghunandan, K., & Riccardi, W. (2013). The global financial crisis: US bankruptcies and going-concern audit opinions. Accounting Horizons, 28(1), 59-75.
Keune, M. B., & Johnstone, K. M. (2015). Audit committee incentives and the resolution of detected misstatements. Auditing: A Journal of Practice & Theory, 34(4), 109-137.
Krishnan, G. V., & Wang, C. (2014). The relation between managerial ability and audit fees and going concern opinions. Auditing: A Journal of Practice & Theory, 34(3), 139-160.
Müller-Burmeister, C., & Velte, P. (2016). Increased materiality judgments in financial accounting and external audit: a critical comparison between German and international standard setting. International Journal of Critical Accounting, 8(3-4), 227-245.
Pavlovi?, M., & Bogdanovi?, J. (2013). Cash flow statement. Škola biznisa, (3-4), 129-147.
Plumlee, R. D., Rixom, B. A., & Rosman, A. J. (2014). Training auditors to perform analytical procedures using metacognitive skills. The Accounting Review, 90(1), 351-369.
Reports | IAG Limited. (2018). Iag.com.au. Retrieved 31 August 2018, from https://www.iag.com.au/results-reports?field_content_date_value_selective=All
Titera, W. R. (2013). Updating audit standard—Enabling audit data analysis. Journal of Information Systems, 27(1), 325-331.
Tseng, K. A., Lin, C. I., & Yen, S. W. (2015). Contingencies of intellectual capitals and financial capital on value creation: Moderation of business cycles. Journal of Intellectual Capital, 16(1), 156-173.
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