Being Audit manager for the audit firm, receiving a package from the manager from one of the clients whose audit was to be performed for the first year named Rachel Jones, the Financial Controller of Telechubbies Ltd., and a toy manufacturer. The package contained the current year financial position and the income statement produced for a board of meeting for the year ended 31st December 2021. It is analysed that performing the substantive procedures, auditor shall set the tolerable error as on item and as a company as a whole and determine the proper auditing issues. If during the audit, if the variance is more than the tolerable error than the auditor shall record them in their report and modify the report accordingly.
Rachel has provided us with the following information:
The Company has taken up the long-term loans and it does not exceed the Debt: Equity ratio of 2:1 at any time. The loan is reviewed at the end of every year.
The industry practice is to make provision on Inventories at 5% but the company on a conservative side used to make a provision at 20%. During the previous year the company has changed its accounting estimate and has started to maintain a provision on Inventory obsolescence at 10% (Schmidt, et al. 2016).
There is a long-term loan given to one of the directors’ companies for the development and production of computer software.
PART – a
The possible sources of the information that would be helpful to perform the audit of the Telechubbies Ltd. are:
A detailed audit report of the previous auditor along with the financial statement and the board report including the observations made by the auditor along with the comments of the board thereon.
The title belonging to the name of the company for the assets shown in the year ended the financial position of the company.
The contract for the long-term loan extended to the company owned by the director since the inception of the loan.
The contract for the long-term loan taken by the company since the inception of the loan.
The statement of every bank through which corporate transactions were done.
The detail of the inventory and the valuation report of the inventory.
Details of the Trade receivables and trade payables.
There are several methods for performing the analytical procedures, based on which the auditors shall take their decisions. The different types of analytical procedures are:
Trend Analysis – Changes that have been made over some time.
Ratio Analysis – The comparison of financial accounts with other accounts or Non-Financial data (Mock, Ragothaman, & Srivastava,). The ratio analysis shows that the GP ratio of the company has been stable since last three year. However, the overall sales has decreased. The current ratio has increased to 2.63 points in 2019 which is .40 points lower since last three year comparison. The debt equity ratio has shown that company could decrease its financial leverage which would be good indicator for its business growth.
If the auditor needs a high level of assurance, then the auditor shall make the tolerable error as low as possible to verify every data. The type of analytical procedures to be used is based on a total judgment of a professional.
The above is the preliminary analytical procedures performed by us as per the financial position and income statement received of telechubbies ltd. The G.P. Ratio of the company is maintained during the past years. The G.P. Ratio is to be calculated by Gross Profit /Sales. But the N.P. Ratio has significantly fallen over the years from 8% to 3% in two years, states that the company is incurring more administrative costs. The N.P. ratio is to be calculated by Net Profit / Sales. So a thorough check is required (Kend, & Basioudis, 2018).The current ratio is maintained around is over 2. The current ratio is to be calculated by Current Ratio / Current Liabilities. The trade payable to purchase has increased over the years, there might be a probability that the company is purchasing through the other related company which is not being disclosed. The same is the situation with the trade receivables as it has also increased there might be some suspicious transaction going between the company. The debt is to the equity is to be maintained at a ratio of 2:1 which is reviewed by the company every year. The auditors shall also check the long-term agreements of both receivable and payable.
PART – c
The other ways in which the analytical procedures can be performed could be extended using the information collected as per “part-a”.
The detailed study of the audit report that was asked by the auditor, the auditor shall perform the analytical procedures of the expenses with the previous year balances and compare it with the current year ratios.
The assets turnover ratio shall be calculated and compared with the current year.
The term loan extended by the company to the directors shall be compared with the years and checked upon whether the loan was given after passing of a proper resolution.
Based on the valuation report, the analytical procedures should be performed by performing the inventory turnover ratio comparing it with the past years and with the industry. If there is too much variance then the question should be asked from the management and the reasons for the same shall be recorded (Knechel, & Salterio, 2016).
PART – d
The analytical procedures can be used to identify the Nature, Timing, and extent in the substantive procedure. By substantive procedure the auditors have to perform the test of details for further audit procedures. By substantive procedure the auditor has to perform the vouching of the transactions and verifications of the balances. Substantive procedures examples can be:
External confirmation with the receivables & payables.
Physical count of the inventories.
Observation of Fixed Assets (Johnston, et al. 2010).
To obtain audit evidence the auditor shall perform one or combination of the following-
Inspection – By inspection we would have to inspect the assets.
Inquiry & Observation – Through inquiry and observation we should inquire about the company with the employees by the checklist and the inventory count shall be observed.
External Confirmation – The external confirmation shall be taken with the balances. The reason for the variance in the balances shall be taken from the management of the company shall be noted.
Reperformance – the auditor shall be reperforming the calculations such as the bank reconciliation statement.
Recalculation – The calculation such as be Depreciation shall be recalculated and be verified that the calculation performed by the company is correct or not.
Analytical procedures – The auditor shall perform the analytical procedures by calculating various ratios and comparing it with the industry and the previous years.
By performing the substantive procedures, based on the company and industry the auditor shall set the tolerable error as on item and as a company as a whole. If during the audit, if the variance is more than the tolerable error than the auditor shall record them in their report and modify the report accordingly. If during the audit, the variance is within the tolerable error but is material in nature the auditor shall consider them in the audit report accordingly (Baker, et al. 2015).
The auditor to document all the audit planning, observations, and findings performed during the audit. The auditor shall also document all the information collected by them from the management and keep the records for future purposes.
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