Auditors are obliged to develop the initial analytical process prior to the time of planning as part of the risk assessment procedures in accordance with ASA 315.6. The meaning of the preliminary analysis is that ‘comparison of rations for clients to benchmarks from competitors or industry gives an indication of the business’s performance’. The goal of the preliminary analytical procedures is to get an insight into the client’s business and the industry. (textbook)
Commonly, two major stages, simple comparisons as well as ration analysis are employed by auditors in the course of analysis but ration analysis offers a more thorough analysis of the company. Based on the information from question 6.33 the process of analysis is divided into two main phases. (textbook)
The simple comparison involves comparing the amounts of the financial statements of 2009 and the 2010 financial statements for Gourmet Pty Ltd.
The “net profit” grows from $56 240 000 dollars from 2009 to $63 5562 by 2010 and the rising amounts have reached $73220 million.
The “total equity of shareholders” increased from $141300 000 in 2009 to $204-862 thousand in 2010. The increasing amounts reach the sum of $63 562 000.
The company’s performance is more successful from 2009 to 2010 with respect to the above data due to an experienced and steady management team. They are trying to expand the range of its products in order to increase competition in the industry and are dependent on the right strategies to acquire smaller competitors. Simple comparisons are an overall analysis but auditors need to utilize ratio analysis to get the exact information.
Based on 6.33 The following ratios can be calculated to aid in analysis.
“The” actual ratio” is 0.195 in 2009 and 0.280 in 2010. Both ratios are lower than the higher benchmark of 2 and are even lower than the positive current ratio 1.5 and 1.5.
“Quick asset ratio” or “quick asset ratio” is 0.070 in 2009, and 0.096 in 2010.
“Gross profit ratio” or “gross profitability percentage” was 0.481 in 2009, and 0.463 in 2010.
“Net Profit Ratio “net profits proportion” has been 0.183 in 2009, and 0.193 in 2010.
“The “debt to equity ratio” is
(a) “The principal risk is the vulnerability of a balance on an account the type of transaction or the disclosure of a material error due to the inherent characteristics of the environment with no regard for internal controls.’ (textbook) Based on the background information provided in 6.33 the following variables could affect your risk of committing fraud:
An additional finance director has been appointed to the firm. The move to a more senior managerial position will increase the inherent risk. In the same way, the finance director in the new position is likely to be under pressure to beat previous performance; the pressure could create an incentive to be involved in the false statement or falsification of financial reports. The risk of fraud will rise.
The company was home to 25 outlets with different sizes and geographic locations. This could increase the risk inherent to it as it is difficult to control by the management of the entity.
The company has signed a contract for the development and construction of an entertainment and restaurant complex which will increase risks inherent due to the inexperience of the current market.
The company upgraded its computer system. However, the new version of technology might not be as effective as anticipated or could be inaccurate and affect the accuracy of financial reports. Thus, the risk is greater.
(b)(i) According to the model of audit risk three elements comprise auditor risk: inherently risk control risk, and detection risk. The rise in inherent risk could lead to misstatements that are likely to be made in the financial statements of the company, which will result in a rise in audit risk also. (textbook)
(c) The degree of materiality must be considered as a crucial element to determine the type, timing, and scope of the audit process, and the relation between risk of audit and materiality is reversed. (textbook)Therefore the preliminary materiality is decreased from $5000000 to $3200000 following a review of the inherent risk due to the fact that the risk that is inherent is greater than the auditor’s expectation. Therefore, auditors should expand the number of auditing procedures, deciding on an audit method that is more efficient and implementing audit procedures close to the date of balance, especially in relation to the account. audits. (textbook)
(a) The main goals of internal auditors are that internal auditing functions are an independent and objective, and objective process of assurance and consultancy that is designed to increase value to and enhance an organization’s processes.’ (Adam Cunningham). The scope of the internal auditor’s work is extensive. It aids the business by helping it achieve its goals and by improving the efficiency of operations including risk management, internal controls, and governance practices.’
External auditors must ensure that the annual reports are accurate and provide a fair account of the company’s financials and also that the usage of the funds is in line with the goals and objectives in the Constitution.
The role of auditors outside of the company
(b) External auditors are able to take the information from the internal auditor, which includes:
Internal audit, as an element of internal control, will affect the assessment of external auditors on the risk of control and the nature of auditing procedures.
Descriptions and any other records of internal control can help the auditor’s external perspective to gain knowledge of internal control.
The direct assistance of internal auditors will assist external auditors to conduct substantive tests and tests on controls(textbook)
(c) Together with the internal auditors who are engaged in assessing the business strategy and identifying risks, this an external auditor with the information when it comes to implementing an approach to business risk during the audit. Internal auditors should have the appropriate abilities, expertise, and integrity to ensure that they provide the most accurate information to the external auditor. (textbook) According to the information in 8.34, Gourmet Pty Ltd has an experienced and competent Internal Auditing Team. The external auditor needs to be cautious of the information provided, considering it is believed that “the goals for the auditor’s internal audit need to be identical to the goals of the company” (David Wood, A. Wood). Therefore the external auditor has to pick the right information as per the requirements of an independent audit.
(d) (d) objectives 1 2, objective 2, and goal 4 are linked in order to ensure that the operation is efficient and a maximum benefit for the business but are not part of the control actions. Control activities are policies and procedures that relate to reviews of performance as well as physical controls, information processing, and segregation of tasks’. (Textbook) So the objectives three, objective five, and objective 6 relate to internal control processes that must be relevant to the external auditor.
(a) The associated internal control needs to be verified for efficiency if auditors are planning to depend on this control. Thus, auditors must perform tests to verify the effectiveness of the controls. Based on this an auditing partner chose to rely on the efforts that are done by the Internal Audit Group (LAG). One of the papers that came from LAG is to look at the amount of all the payments made to creditors during the year and to assess whether the guidelines laid out within the Accounting Manual have been properly implemented. In the opposite way, this paper is linked to the control tests regarding payments. The results of this test suggest some mistakes:
(i) The payment was not in accordance with an approved purchase order but all other documents were attached.
The goal of this exercise is to determine the likelihood of transactions involving inventory purchases. This indicates that the transactions are not likely to occur or the transaction may not be authorized.
(ii) (iii) Payments that were not paid to a supplier who was approved.
The goal of this exercise is to determine the likelihood of transactions involving inventory purchases. This indicates that the transaction is not happening or that the transaction is not authorized.
(iii) (iii) Payments that were authorized by a different person, even though it was not mandatory.
The notes describe the new accountants for financial accounting are unaware of the firm’s policy. While it was corrected but the related transactions could not take place or are not authorized.
(iv) (iv) Payments with no documentation to support them.
The goal of this study is to examine the possibility of cash transactions for disbursements. This means that the transactions may not take place or that the transaction was not authorized or the product or service might not be received.
(v) (v) Payments that do not show proof that the calculations on the invoices of creditors were examined.
The purpose of this test is to check the reliability of the purchase of inventory transactions. The issue is that the transactions were not properly recorded.
These errors also suggest that the internal control for payments isn’t particularly effective, since the percentage of errors is nearly 28% in 60 samples. This means that the chance of failure in the internal control that is related to this is higher than the normal level.
(b) In this scenario external auditors need to be able to determine if the documents used by internal auditors meet in their sufficiency and adequacy. Particularly, the correctness, of the issue should be addressed in this section. Gourmet Pty Ltd is a large private business, which means that it has to have a significant amount of transactions. If internal auditors selected only 60 samples, this should be viewed by external auditors to be that the sample sizes are not enough and the risk of control is higher than the actual amount. They can therefore decide to increase the amount of the control test in order to lower the risk to a manageable amount. In the event that controls not perform as they had hoped it is possible to intensify the scope of testing to ensure continued confidence in the control. If the risk of control cannot be mitigated through this type of testing, the external auditors will end the trust in the control. In essence, auditors have concluded that the control is not in place or that the existence of control is not substantiated by evidence.