Properties And Implications For Financial Reporting

Materiality in financial statements

The function of auditing has various advantages for internal as well as external stakeholders of a company. Main objective of an auditor is to identify material misstatements, frauds and errors in financial statements of a particular company. It is not possible for every shareholders to examine the financial statements of the company as they might not have sufficient knowledge to examine and analyse financial statements (Louwers et.al, 2015). This is the reason that shareholders and management of the company appoints auditor for examination of financial statements and give their Independent and objective views on financial position of the company. Important that an auditor implement due diligence and avoid gross negligence while conducting his or her roles and responsibilities as an auditor (Cohen and Simnett, 2014). We have prepared this report for Cadmium Enterprises which is an individual organisation. Audit is required to be conducted and specific points are to be discussed in this report with respect to trial balance given energy scenario. As an auditor we have also discussed the fraud risk and material misstatements in the trail balance of the company. Possible areas of material risk are account receivable, inventory, repair and Maintenance and sales. We should include these factors in key auditor matters statement which will be then discussed with those charged with governance.     

Materiality for financial report can be defined as the level of risk that is acceptable by the auditor of the organisation represented in financial terms. Calculation of material it is totally dependent upon the skill and experience of the auditor working on an organisation. For example, a particular auditor that is working in the organisation for past 3 years is expected to calculate more accurate materiality as compared to auditor that is just started conducting audit of the company. There are specific calculations that are required in determination of materiality of particular financial statement. Following are some of the commonly acceptable formulas for calculation of materiality-

1. 5% of total net profit from primary business
2. 5% of net profit distributable to equity shareholders
3. .5% to 2% of total revenue earned by whole Organisation in a financial year
4. 2 to 5% of total shareholder’s equity (Lakis, V. and Masiulevi?ius, 2017).

One of the audit partner engaged in auditing of Cadmium Enterprise has suggested that materiality of $15000 should be set before starting the process of auditing. Setting materiality at the starting of the audit is totally out page from the judgement of auditor that is conducting such audit but there are some commonly acceptable criteria for calculation that should be considered by auditors before setting this limit. According to commonly acceptable calculations following Maternity should be calculated-

1. 5% of total profit= (5%* 90122)= $ 4506.1

Analytical review

At the end of the financial year total profit earned by the company is $90122. Calculation of the properties represent in appendix at the end of the report.  

1. 2% of total revenue for the last year= 187450* 2%= $3749 (Choudhary, Merkley and Schipper. 2018)

It can be said that estimation on part of audit partner is not as per the normal acceptable market practices. Therefore it can be said that this estimation can affect audit process used by audit team. Change in preliminary estimation on part of the auditor will definitely affect the overall audit budget prepared by the auditor. If the risk of material misstatement is not appropriately estimated by the management then there are chances that audit has to introduce additional audit staff in the audit process will increase overall budget of the audit firm.

Following table shows the items in trial balance of the company that might be at the risk of material misstatement during current financial year.

Account receivable-it is General procedure for any business organisation to collect amount due from sale of goods and services 2 months of when the sales are made by the company. it can be estimated with the help of given information that majority of sales made by the company are on credit basis as total account receivable at the end of 1st year was 111000 where is hotel sales in made in that particular year was 18 7450. Which shows that around 63% of the total sales made by the company are in form of credit sales. At the end of first 5 months of operation in current year, total balance of account receivable is 118 340. This amount shows that there is a substantial part of last year outstanding balance in current year outstanding balance. Therefore there can be some deficiencies in collection process of the company which should be evaluated by auditor.

Inventory- Total Inventory of the company in first five months of operation in current year has also increased as compared to last financial year. This shows that substantial part of inventory related to last financial year has been remaining unsold in current financial year (Contessotto, C. and Moroney¸2014). It can be a result of deficiency in inventory management all the company.

Repair and maintenance- total repair and maintenance expenditure conducted by the company are substantially lower as compared to last financial year as it has decreased form $5050 in last years to just $600 in first five months of operation. In the analytical review of financial items in trial balance it was also evaluated that total direct expenditure has also increased in current 5 months. Repairs to machinery and increase in direct expenditure can be directly related to each other in this scenario. Every machinery involved in the production process required regular repair and maintenance as it can decrease efficiency of machine which will ultimately increase direct cost of production.

Trend analysis

Sales- It can be evaluated that proportional things of the company for 5 months as decrease the as compared to last financial year but management of the company has purchased new machinery worth $6000 in current financial year. Generally, increasing capacity of the company also increasing the sales of the company as main purpose of acquisition of new machinery is to boost up the sale. Quality of machinery purchased by the company should be evaluated (Graham, Bedard and Dutta, 2018).

Account receivable

Auditor of the company should evaluate collection procedure of the company from account receivables. This can be done by auditor with the help of discussion with management or person in charge of account receivable (Chan and Vasarhelyi, 2018). External confirmation can also be obtained by management to verify that all the account received by the management has been recorded in books of accounts.

Inventory    

First of all auditor of the company should conduct physical verification of the elementary available with the management. Auditor of the company should evaluate process used by management to value their stocks and weather such policies are as per industry policies or not. In addition to that it should also be evaluated that person that is conducting physical review of inventory is not in in charge of recording inventory in financial statements (Makarenko and Yardanova, 2015).

Auditor shows conduct whether management of the company has prepared policies and procedure for maintenance of plant and machinery. In addition to that, auditor should check if these plans are properly followed by the management. All the repair and maintained should be scheduled in accordance with the repair and maintenance guidelines provided by the management.         

Sales

Auditor should evaluate what are the main reasons that have resulted in downfall of sales in current financial year and reason that acquisition of new machinery has not resulted in increase of sales. Auditor today also finds out the current market value of the machinery and other such machinery is efficient with the business processes conducted by the company.    

Main objective of an auditor is so identify material misstatements and fraud conducted by management of organisation for any other employees working in the organisation. Audit suggestion given by audit partner that there is no fraud risk in the company just because management of the company seems trustworthy is not appropriate. Every conclusion made by the auditor should have substantial amount of supporting evidence. Evaluation of fraud is one of the most primary responsibilities of the company and any conclusion made on such behalf should be supported by proper audit evidence (Knechel and Salterio, 2016). Therefore in this case also auditing to conduct proper audit procedures to identify the level of fraud risk in the organisation. From an overall analysis of trial balance of the company, it can be said that risk of fraud in the business organisation is very low.

Conclusion 

It can be concluded that role of Auditor in inspection of books of accounts of the company is very substantial and all the audit procedures should be conducted in order to identify any material misstatement, error and fraud. In this case, materiality of financial statement determined by the audit partner is very high and it should be corrected. In addition to that this report has implemented various factors that should be considered by auditor during the process of audit.

References

Chan, D.Y. and Vasarhelyi, M.A., 2018. Innovation and practice of continuous auditing. In Continuous Auditing: Theory and Application (pp. 271-283). Emerald Publishing Limited.

Choudhary, P., Merkley, K.J. and Schipper, K., 2018. Auditors’ Quantitative Materiality Judgments: Properties and Implications for Financial Reporting Reliability.

Cohen, J.R. and Simnett, R., 2014. CSR and assurance services: A research agenda. Auditing: A Journal of Practice & Theory, 34(1), pp.59-74.

Contessotto, C. and Moroney, R., 2014. The association between audit committee effectiveness and audit risk. Accounting & Finance, 54(2), pp.393-418.

Graham, L., Bedard, J.C. and Dutta, S., 2018. Managing group audit risk in a multicomponent audit setting. International Journal of Auditing, 22(1), pp.40-54.

Griffiths, P., 2016. Risk-based auditing. Routledge.

Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Routledge.

Lakis, V. and Masiulevi?ius, A., 2017. Acceptable audit materiality for users of financial statements. Journal of Management, 2(31).

Louwers, T.J., Ramsay, R.J., Sinason, D.H., Strawser, J.R. and Thibodeau, J.C., 2015. Auditing & assurance services. McGraw-Hill Education.

Makarenko, A.P. and Yardanova, T.H., 2015. Development of a program of inventory audit. Naukovi pratsi Poltavskoyi derzhavnoyi ahrarnoyi akademiyi, 2(11), pp.40-48.

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