CASE STUDY: AUDIT OF DOUBLE INK PRINTERS LTD
In the era of competition materiality and transparency in financial statements stands as the main tool for maintaining long-term consistency in the market. Auditors in this respect accurately examine the materiality and transparency in financial statements and provide opinions that help in ensuring compliance with accounting standards. In the case study, Double Ink Printers Ltd (DIPL) needs to focus on the risk factors that clearly clarify the need for expert audit help for reducing material misstatements. In the case study, earnings base and the revenue from E Books are provided for assisting the audit managers that helps in the smooth conduction of audit planning process.
Question 1: Assessing the need for expert audit service in DIPL
In the case study of DIPL, it is seen that the average print out time is Two days in small orders whereas in case of big orders the turnout time of five to 10 days for large orders. Background information on purchase inventory requirements shows that the company purchase inventory materials (50%) from Australia and 50% from Asian countries. It is further seen that raw materials of the company are measured on average basis. Work in progress is calculated by taking cost of materials, labour and by apportioning manufacturing overhead on normal capacity.
The process of future planning related to smooth functioning of the business auditors plays an important role. According to William et al. (2016, p. 24), ratio analysis is the tool that helps in accessing the current position where experts like, auditors give opinion regarding the consistency and transparency of financial statements. Liquidity analysis of DIPL shows that although the current ratio has increased from 1.42 to 1.5 in the years 2015, 2016 and 2017 still there is a case of material misstatement in the quick ratio. Case study further reveals that in the board meetings it is seen that average valuation of inventory is no longer suitable for estimation of inventory. Adoption of incorrect procedure for inventory calculation has caused fluctuations in quick ratio thereby leading to risk exposure (Knechel, and Salterio, 2016, p. 14). The analysis shows that quick ratio has reported fluctuation from 0.82 to 0.944 and again 0.84. This fluctuation clearly shows that DIPL requires expert audit advice for detecting the risk factors required for reducing this inventory misstatement (Refer to appendix 1)
According to Palepu et al. (2013, p. 15), reduction of material misstatements helps in disclosing information with accuracy that further attracts investors for further investment. Auditors check the growth prospects and give expert opinion regarding the future growth prospects of DIPL. Case study further shows that preliminary testing of transactions has reported discrepancy in recording certain transactions. Report submitted by Andy shows that certain transactions have not been allocated to correct period, which has hampered the profitability position of DIPL. Therefore, based on the case study report it is seen that the response time for larger orders is much higher, therefore, expert advice in reducing the response time can boost the performance of DIPL. Incorrect estimation of inventory and incorrect recording of transactions reduces the efficiency of the company.
As per the case study, Andy, the IT manager has identified that due to non-availability of experts and excess pressure the team of employees has recorded transactions incorrectly in accounting software. This has given rise to material misstatement in statements. IT experts are to be hired who along with the IT manager Andy can guide the employees for conducting accurate testing and reconciliation of transactions in IT system. Therefore, by taking the help of IT expert the misstatements due to inaccuracy in recording transactions in IT system can be reduced easily. Auditors may not be able to detect this error thereby by hiring IT software expert not only correct recording of transactions can be ensured but also handling of Patch software becomes easier for DIPL. According to Hribar et al. (2014, p. 506), experts ensures synchronisation between old software systems with the new software systems thereby reducing the chance of misstatement due to incorrect recording of transaction.
Experts dealing with the valuation of equipment and property can help in performing accurate valuation of fixed assets. According to the case study in the board meetings, it is seen that accurate estimation of life for the printing press is not done accurately by DIPL. As per the New CEO William Jackson printing press originally has life for 30 years as seen in other companies but DIPL has recorded life of printing press as 20 years. Accurate estimation of asset life helps in calculation of salvage value. Accurate estimation of salvage value helps in calculating accurate depreciation expense. Expert help of asset valuation team is required by DIPL so that material misstatement due to incorrect recording of expenses can be reduced. The valuation expert can accurately estimate the life of printing press thereby assisting the auditors in detecting material misstatement due to increased depreciation expense.
According to the case study, expert help of auditors not only ensures the compliance of financial statements in accordance GAAP and IFRS but also helps in identifying the material misstatements found in the reports. According to Griffith et al. (2015, p. 49), auditors check the transparency and authenticity of financial statements that help in making accurate disclosure of financial reports. Audit planning depends on the risk factors and the changes in growth that reduces the efficiency in audit process. Therefore, incorrect disclosure of information reduces the popularity of DIPL thereby reducing the investment opportunities. In Audit planning enhancing efficiency and profitability is kept on the priority list. Achievement of targeted levels of efficiency depends on customers and investors therefore by taking expert help DIPL can rectify the issues related to material misstatements. This can help DIPL to boost the performance levels and can simplify the process of audit planning.
Therefore, DIPL must opt for expert service of auditors for conducting accurate and transparent Audit. Therefore, for checking the future growth prospects and risk detection can be done by taking expert help of auditors. DIPL can include Expert advice of auditors for making the audit planning process more authentic and opt for the company thereby making the audit of 2017 more effective.
Question 2: Assessment of degree of materiality levels
In the Audit Planning Stage assistance to the Auditors are provided regarding the material misstatements that are accessed by checking the trends seen in the preliminary reports. There are certain factors that help in assessing the overall materiality in financial statements based on the preliminary figures.
A. Identification of five factors that are influencing the overall materiality in Audit process
Overall materiality helps in detecting the material misstatements found in the reports. Based on the findings auditors checks the materiality of the transactions that must be reduced for generating accurate and transparent audit reports. The factors that help in detecting the overall materiality of financial reports can be enlisted as follows:
1. Trends in profitability: As opined by Cohen et al. (2017, p. 1178), Profit maximisation is the main element for long-term success in every organisation. Therefore, profitability trends and fluctuations help in detecting the material misstatements that are causing reduction in profitability for the last two years. Incorrect recording of transactions is causing changes in income level thereby changing the profitability level of DIPL. Effects of misstatements hamper the increasing trends of profitability thereby reducing the overall materiality in audit process.
Therefore, trends in profitability not only detect the material misstatements but also assists in evaluation of materiality thereby can be considered as the main factor for measuring overall materiality.
2. Performance and efficiency trends: The trends in efficiency mainly the inventory and debtors trends seen in 2015 and 2016 is reported assessment of overall materiality. Performance benchmark set and the achievement of target set in terms inventory by DIPL helps in determining material misstatements. Performance benchmark set and the target achieved by DIPL helps in detecting material misstatement. Performance benchmark set and the rate of achievement helps in detecting the misstatements that further helps in understanding the overall materiality.
3. Revenue trends: The trend in revenue itself is a factor that helps in detection of material misstatements. According to Lakis and Masiulevičius (2017, p. 118), overall materiality depends on the alignment of earnings reported in financial reports along with the synopsis of issues faced in the board meetings. Board meetings report that incorrect recording of transactions has hampered the earnings thereby leading to material misstatements.
4. Assessment of risk factors: The factors that are affecting the growth in respect of earnings further assist the auditors in detecting the overall materiality of financial reports. Fluctuations in inventory and other expenses can lead to the decision regarding overall materiality in audit. 5. 5.Cash and earnings report: The cash earnings report further shows the cash position of DIPL has reduced, which further requires justification in terms of material misstatements. Results of earnings offsets result in material misstatements. Therefore, fluctuations regarding the cash position fluctuations reduce the transparency of audit planning process.
Therefore, all the above factors help in detecting the trends of the preliminary figures that further helps in assisting the auditors in checking the overall materiality of auditing. Preparation of financial reports by taking incorrect transactions that are not related to current accounting period affects the overall materiality thereby affecting the audit process of DIPL for 2017.The levels of materiality can be determined by assessing the trends of income and expenses over the last two years. Therefore, all the above factors not only assess the yearly trends but also measure the level of materiality.
B. Explanation of identified factors that are relevant for calculating the preliminary figures for dealing with overall materiality
Accuracy in calculating the preliminary figures depends on the material misstatements that are detected by the accountants and the auditors of DIPL. Trends in performance and the profitability levels helps in detecting the material misstatements that are disclosing incorrect information related to earnings. Risk factors like, inventory obsolescence and fluctuations in foreign currency leads to material misstatements that further affects the overall materiality (Christensen et al. 2016, p. 1648).Calculation of preliminary figures helps in understanding the trends of performance shown by DIPL for the last two years. Based on the performance report estimation of figures for 2017 becomes easier for DIPL. The steps of successful audit can be enlisted below:
Accurate planning of transactions and the trends ensures successful completion of audit.
Detection of material misstatements helps in accurate completion of Audit process
Determination of risk factors helps in successful completion of audit procedure
Therefore, for conducting successful audit estimation of correction factors is very essential. Figures relating to material misstatements reduce the accuracy of estimating the preliminary figures. Preliminary figures stand as the benchmark for calculating ratio trends and performance report of 2017. Successful audit depends on the accurate estimation of preliminary figures. Material misstatements like, incorrect recording of transactions and inventory obsolescence (106312 to 125876 pound) detected in reports offsets the earnings figures. Therefore, misstatements reduce the accuracy of inventory calculation thereby leading to manipulation in earnings. Analysing the performance benchmark helps in matching the actual over budgeted figures. This relevance can be concluded from the factors that have been identified above for detecting the level of materiality.
According to Shroff (2017, p. 61), factors like, risk and frauds detection in financial statements serve as the pillar for correcting the preliminary figures that have been calculated inaccurately. Recognising the uncertainties and performance materiality helps in rectifying the preliminary figures that have been calculated inaccurately.
C. Description of identified factors that are influencing preliminary figures required in the planning process of audit
Based on the identified factors that are related to measurement of overall materiality influence the preliminary figures required for conducting authentic planning process of audit. The factors like, inventory obsolescence and incorrect recording of transactions that are not related to current year can reduce the profit for 2015 and 2016. The calculation of net profit ratio report shows that net profit ratio of the company has reduced from 6.89 to 6.07. Due to incorrect recording of transactions, profit has reduced in 2016, which shows the influence of materiality over preliminary figures. Moreover, the calculation of inventory by FIFO method that means first lot of inventory is released first that further leads to manipulation of old inventory thereby causing fluctuations. Inflated margins of First in First out (FIFO) have reduced the profit margin from 2359190 to 2291362. Analysis of commission (108000 to 130500 pound) figures at the time of withheld payments by the publishers has reported positive materiality thereby reducing the chances of material misstatements. The trend of revenue (34212000 to 37699500 pound) that has been set by DIPL has been achieved as in 2016 10% increase in revenue is seen. Therefore, the factors measuring the material misstatements have influenced the preliminary figures of 2015 and 2016 both positively and negatively.
The assignment focuses on the identification of material misstatements that are ensuring the need for expert audit advice. The assignment further focuses on the inventory obsolescence and incorrect method for estimating the inventory are rising the chance of material misstatements in DIPL. the responsibilities of the auditor for checking the transparency and compliance with the auditing standards like, GAAP and IFRS form the main element of this assignment. Risk factors and identification of material misstatements helps in conducting an accurate and authentic audit for 2017. The assignment also focuses on the factors that are required for measuring the level of materiality. Based on the factors the relevance of calculating the preliminary figures and the effect that is seen on preliminary figures due to these material misstatements are reviewed. Incorrect recording the figures that do not belong to the current year can be eliminated by introducing new IT system ‘Patch’. The assignment focuses on the identification of areas where material misstatements have occurred so that by reducing these misstatements transparency in Audit could be established.