CC57 Master of Professional Accounting For Analytical Procedures
Questions:
3. As part of your audit of DIPL for the year ended 30 June 2015, you are considering the risk that fraud may have occurred (a) Based on the background information for DIPL contained in the case, identify and explain two key fraud risk factors relating to misstatements arising from fraudulent financialreporting to which DIPL may be susceptible. (b) Explain how the risk factors identified in (a) above would affect the conduct of the (a) audit
Answers:
Analyzing the financial information of DIPL using the analytical procedures:
The audit plan of DIPL (Double Ink printers limited) can be developed by using the analytical procedures that helps in providing guidelines to auditors. Procedures involves propagation of financial information provided by organization by examining the plausible relationship between financial and financial data. Various mechanisms are involved in carrying out the analytical procedures and this involves the tool of ratio analysis, common size analysis and benchmarking. Common size analysis helps in making the comparison of financial declaration and information over a period of time between two different entities or financial performance between two period of times. Using ratio analysis helps in analyzing the financial trend of business. Benchmarking helps in analyzing the cause of any existing variance in business that are causing deviations in actual and expected performance (Bazley et al., 2013). Auditors for analyzing the financial statements of DIPL. can consider different line of items.
Analysis of ratios of DIPL involves calculation of several ratios such as profitability ratio, liquidity ratio, and efficiency ratio.
|
Liquidity Ratio | |||
|
Double Ink Printers Limited | |||
|
2013 |
2014 |
2015 | |
|
Current assets |
5385938 |
7509150 |
9600929 |
|
Current Liabilities |
3780000 |
5120250 |
6397500 |
|
Current Ratio |
1.424851 |
1.466559 |
1.500731 |
|
Double Ink Printers Limited | |||
|
Current assets |
5385938 |
7509150 |
9600929 |
|
Inventory |
2256188 |
2671362 |
4180500 |
|
(Current assets-inventory) |
3129750 |
4837788 |
5420429 |
|
Current liabilities |
3780000 |
5120250 |
6397500 |
|
Quick ratio |
0.827976 |
0.944834 |
0.847273 |
The liquidity analysis of Double Ink printers limited over the period of three years are depicted in the table above that reflects there has been considerable improvement in liquidity position of company.
|
Double Ink Printers Limited | |||
|
2013 |
2014 |
2015 | |
|
Net Income |
2359190 |
2291362 |
2972183 |
|
Net Sales |
34212000 |
37699500 |
43459500 |
|
Net Profit |
6.895796796 |
6.0779639 |
6.83897192 |
|
Double Ink Printers Limited | |||
|
2013 |
2014 |
2015 | |
|
Net Income |
2359190 |
2291362 |
2972183 |
|
Total Assets |
12930000 |
15903900 |
26147991 |
|
Return on assets |
18.24586234 |
14.4075478 |
11.3667738 |
|
Double Ink Printers Limited | |||
|
2013 |
2014 |
2015 | |
|
Net Income |
2359190 |
2291362 |
2972183 |
|
Shareholder Equity |
9150000 |
10783650 |
12250491 |
|
Return on Equity |
25.78349727 |
21.2484827 |
24.2617459 |
The profitability analysis of DIPL has been analyzed using the ratio gross profit, net profit, return on assets and return on equity.
- Gross profit witnesses a considerable decline since three consecutive year and the figure stood at 17.55, 16.12 and 15.19 in year 2013, 2014 and 2015 respectively.
- Net profit for financial year 2015 increased to 6.84% and the reason is attributable to the fact that there has been increase in interest expenses for this particular year. Figure stood at 6.9%, 6.08% and 6.84% respectively.
- Return on equity initially declined and thereafter increased in year 2015. ROE for year 015, 2014 and 2013 stood at 24.26%, 21.24% and 25.78 respectively. Increase in return on equity is generated from increased profit earned by company.
- Return on assets has a substantial decline since year 2013. Fall in ratio is indicative of the fact that assets are not efficiently utilized for generating profit. ROA for year 2013, 2014 and 2015 stood at 18.24%, 14.4% and 11.36% respectively.
|
Solvency Ratios | |||
|
Ratio |
2013 |
2014 |
2015 |
|
Debt Equity Ratio |
0.41 |
0.47 |
1.13 |
|
Debt to Total Assets |
0.29 |
0.32 |
0.53 |
|
Interest Coverage Ratio |
28.96 |
28.39 |
4.68 |
The solvency analysis of DIPL is depicted in above table and this has been done by calculating debt to equity ratio, interest coverage ratio and debt to total assets.
- Debt equity ratio of DIPL stood at 0.41, 0.47 and 1.13 for financial year 2013, 014 and 2015 respectively. Fall in this ratio indicates that financial risk of organization has increased due to increased debt in proportion to equity.
- Fall in interest coverage ratio represents that fact that financial risk of DIPL has also increased. This particular ratio stood at 28.96%, 28.39% and 4.68% in financial year 2013, 2014 and 2015 respectively.
- There has been improvement in debt to total assets of DIPL and the figure stood at 0.29, 0.32 and 0.53 respectively.
|
Efficiency Ratio | |||
|
Double Ink Printers Limited | |||
|
2013 |
2014 |
2015 | |
|
Cost of goods sold |
28207500 |
31620000 |
36855000 |
|
Average inventory |
2256188 |
2671362 |
4180500 |
|
Inventory Turnover ratio |
12.50228261 |
11.8366586 |
8.815931109 |
|
Double Ink Printers Limited | |||
|
2013 |
2014 |
2015 | |
|
Net credit sales |
34212000 |
37699500 |
43459500 |
|
Average accounts receivable |
2482500 |
4320000 |
5073309 |
|
Debtors Turnover Ratio |
13.78126888 |
8.72673611 |
8.566302585 |
The efficiency analysis of DIPL has been depicted in above table and this involves calculation of inventory and debtor turnover ratio.
- Inventory turnover ratio of DIPL for three consecutive year that is 2013, 2014 and 2015 stood at 12.5, 11.84 and 8.82 respectively. Figure shows that there has been fall in ratio that indicates that inventories have not been efficiently utilized.
- There has been significant decline in debtors’ turnover ratio to 8.55, 8.72 in year 2015 and 2014 as compared to 13.87 in year 2013.
Impact of results on audit planning decisions of DIPL for year ending 30th June, 2015:
Based on evaluation and analytical review of financial reports and declaration of DIPL, the audit plan would have substantial impact and each of those effects are discussed below:
|
Ratios |
Impact on audit plan |
|
Current ratio |
Current ratio analysis helps auditors in identifying the factors that is associated with the preferable and under performance of current assets. It is ascertained that the reason behind improvement in performance of current assets is that allowance for writing back inventories have been written back (Booneet al., 2017). |
|
Efficiency ratio |
The efficiency ratio of DIPL has declined and auditors can identify the reasons associated with the decline. It can be seen that management of organization are not able to manage their current assets and it is essential on their part to identify the reason for same. |
|
Profitability ratio |
Analysis of profitability ratio by auditors will help in disclosing the net income earned compared to net sales made. It helps in depicting the factors that are responsible for influencing the profitability position of organization. |
|
Solvency ratio |
Using the solvency ratio assist the auditors in analyzing the financil position of organization. They will be able to ascertain the possible cause that is associated with the unfavorable conditions that leads to unstable position of company (Stojanovic & Andric, 2016). |
Identification of inherent risk factors arising from of Double Ink Printers Limited the nature of business operations
|
Two types of inherent risks |
Explanation |
|
Risks associated with the installation of advanced information technology relating to accounting system |
It has become difficult for DIPL to maintain balance between the existing system of accounting and the newly employed accounting system. For given period of time, it was seen that there was not any proper allocation of transactions and this would have adverse effect on the financil declarations presented by company. Profitability position of organization are not accurately presented, as the accountant did not properly followed the periodicity accounting concept. Furthermore, existing number of employees were not sufficient to handle the installation and reconciliation of the accounting system. Employees did not have proper knowledge and expertise to handle the operations of newly employed accounting system (McPherson, 2015). |
|
Financial risk due to debt covenants |
DIPL has received constant pressure from the management and investors for maintain particular level of current and debt ratio. It is required by the management of organization to maintain current ratio around 1.5 and debt ratio should be less than one. Maintain this particular level of ratio or not easy for DIPL for which it will be forced to manipulate the data for presenting it in the financil statements. from the analysis of case study, it was observed that DIPL has inflated their value of current assets and has deflate their value of current liabilities. Inflation in value of current assets are done by increasing the value of accounts receivables and they have inflated their value of retained earnings (Hoque et al., 2017). |
Impact of identified risks on material misstatements of DIPL:
|
Inherent risks |
Impact of such risks on material misstatements |
|
Information technological risks |
Employment of this particular advance technology has put excessive pressure of existing workers and management of DIPL. All this would result in poor recording of bookkeeping and it results in arising of some of attributes such as poor operating results, encountering of issues in flow of cash and poor liquidity position. There can be simultaneous risks of misinterpretation and risk of conducting errors that would affect the intricacy and reliability of financil statements. |
|
Financial risks |
There is lack of requisite integrity within the management of DIPL and some of them has resulted from the high amount of debts that have been borrowed and fulfillment of meeting the criteria provided by lending institutions. Inherent risks of organization also arises due to its very nature of operations of business that would leads to alteration in the way financil reports are presented by manipulation of financil data. The financil stability of DIPL is hampered by excessive amount of loan that is borrowed in proportion of their equity balance. Operations of business of DIPL would be severely affected if the required amount of loan is not provided to organization (William et al., 2016). |
Explanation and identification of two fraud risks that would arise from fraudulent reporting of financil statements due to susceptibility of business of DIPL and they are as follows:
|
Fraud risks |
Explanation |
|
Fraudulent financial reporting of DIPL |
DIPL has been suffering from poor work segregation of their employees and improper description of jobs. Account payable clerk of organization performs dual task of recording the inventories received and he is in charge of selling and reducing their flows. It is certainly possible on their part to manipulate recording of inventories. This can be done by depicting that there has been less arrival of inventories and thereby manipulating the inventories that are received (Louwers et al., 2015). Moreover, organization also lacks an appropriate system of documentation that would further help in escalating the fraud activities. |
|
Debt covenants |
Debt covenants is another fraud risks to which DIPL is exposed and it would hamper their position of financil stability. Management and investors or shareholders have pressurized the organization to maintain some of ratios at particular level. Furthermore, lenders have asked organization to meet their criteria for availing required loan amount. This would help shareholders to meet their expected return and stabilizing the financial position of DIPL. Current assets of DIPL are required to be maintained around 1.5 and solvency ration should be less than one. Under the given scenario, it can be seen that maintain presecribed level of ratio is somewhat difficult for staff members and management of organization. Therefore, these entire factors would indulge staff to engaging in committing fraud and manipulating the financil results. For maintain ratios at their ideal level, management and workers would be forced to inflate and deflate their assets and liabilities accordingly and thereby depicting inappropriate financil and profitability of organization (Griffin & Wright, 2015). |
Effect of identified fraud risks on conducting the audit plan:
|
Fraud risks |
Impact of risks on conducting audit plan |
|
Fraudulent financial reporting and control environment |
Since fraud activities would arise from workers and staffs by manipulating the financil information’s. the values of inventories recorded in the financil statement needs to be verified at regular interval and this is so because, there is high probability of part of accounts and clerks to manipulate the data as they are equipped with performing dual operations (Cannon & Bedard, 2016). |
|
Debt covenants |
Auditors are required to carry out verification of certain items reported in the financil statements that would help them min monitoring the financial performance of organization. Current assets and current liabilities mentioned in the balance sheet needs to be verged whether there is any inflation or deflation in their values. They are required to adopt proper mechanisms while monitoring the data. Financil declarations would be improperly reflected in order to maintain the given benchmarks relating to current and solvency ratio. For the acquisition of credit from lending institutions and to continue smooth flow of their operating activities, auditors are required to use proper mechanisms for ascertaining the reason for any deviation in the actual results that would lead to some sort of material misstatement and thereby affecting the plan of audit (Beasley, 2015). Therefore, the preliminary analysis of financil declarations helps in making effective audit plan. |
Reference List
Arens, A. A., Elder, R. J., Beasley, M. S., & Hogan, C. E. (2016). Auditing and assurance services. Pearson.
Bazley, M., Hancock, P., Fisher, C., Lovell, A., Berk, J., DeMarzo, P., ... & DeMarzo, P. (2013). Financial Accounting: An Integrated. Thomson Pty Ltd, South Melbourne.
Beasley, M. S. (2015). Auditing cases: An interactive learning approach. Prentice Hall.
Boone, J. P., Khurana, I. K., Raman, K. K., Chen, L. H., Chung, H. H. S., Peters, G. F., ... & Truong, C. (2017). Auditing: A Journal of Practice & Theory A Publication of the Auditing Section of the American Accounting Association.
Cannon, N., & Bedard, J. C. (2016). Auditing challenging fair value measurements: Evidence from the field. The Accounting Review.
Eilifsen, A., Messier, W. F., Glover, S. M., & Prawitt, D. F. (2013). Auditing and assurance services. McGraw-Hill.
Griffin, P. A., & Wright, A. M. (2015). Commentaries on Big Data's importance for accounting and auditing. Accounting Horizons, 29(2), 377-379.
Hayes, R., Wallage, P., & Gortemaker, H. (2014). Principles of auditing: an introduction to international standards on auditing. Pearson Higher Ed.
Hoque, Z., Parker, L. D., & Covaleski, M. A. (Eds.). (2017). The Routledge Companion to Qualitative Accounting Research Methods. Taylor & Francis.
Kaspina, R. (2015). Continuing Professional Development of Accounting and Auditing: Russian Experienceand Challenges. Procedia-Social and Behavioral Sciences, 191, 550-553.
Knechel, W. R., & Salterio, S. E. (2016). Auditing: Assurance and risk. Taylor & Francis.
Louwers, T. J., Ramsay, R. J., Sinason, D. H., Strawser, J. R., & Thibodeau, J. C. (2015). Auditing & assurance services. McGraw-Hill Education.
McPherson, J. A. (2015). Comparing ‘apples with apples’: professional accounting practices in university classroom discourse.
Smith, K. J., & Emerson, D. J. (2016). An Analysis of Professional Competence Indicator Possession among US Accounting Faculty. Issues in Accounting Education, 32(2), 17-38.
Stojanovic, T., & Andric, M. (2016). Internal Auditing and Risk Management in Corporations. STRATEGIC MANAGEMENT, 21(3), 31-42.
William Jr, M., Glover, S., & Prawitt, D. (2016). Auditing and assurance services: A systematic approach. McGraw-Hill Education.
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