Analyzing Income Statement Discrepancies

This audit-focused assignment tackles a situation where other income has dramatically decreased by 96%. It instructs auditors to compare past and present income sources, investigate reasons for the reduction with management, and evaluate the validity of those explanations. The emphasis is on identifying potential income manipulation through underreporting or omission.

Running head: ISSUES IN AUDITING
Issues in auditing
Name of the student
Name of the university
Author note

AUDITING THEORY AND PRACTICE 1
Table of Contents
1.0 Audit planning.................................................................................................................2
1.1 Analytical review.............................................................................................................2
1.2 Preliminary judgement for materiality.............................................................................2
2.0 First account selected – Gross profit margin...................................................................3
2.1 Rational for selection.......................................................................................................3
2.2 Assertion and explanation................................................................................................3
2.3 Recommended audit procedure...................................................................................3
3.0 2nd account selected – Net profit.....................................................................................4
3.1 Rational for selection.......................................................................................................4
3.2 Assertion and explanation................................................................................................4
3.3 Recommended audit procedure........................................................................................4
4.0 Third account selected – Inventory.................................................................................5
4.1 Rational for selection.......................................................................................................5
4.2 Assertion and explanation................................................................................................5
4.3 Recommended audit procedure........................................................................................5
5.0 Fourth account selected – Wages....................................................................................6
5.1 Rational for selection.......................................................................................................6
5.2 Assertion and explanation................................................................................................6
5.3 Recommended audit procedure........................................................................................6
6.0 Fifth account selected – Superannuation.........................................................................7

AUDITING THEORY AND PRACTICE 2
6.1 Rational for selection.......................................................................................................7
6.2 Assertion and explanation................................................................................................7
6.3 Recommended procedure.................................................................................................7
7.0 Sixth account selected – Other income................................................................................8
7.1 Rational for selection.......................................................................................................8
7.2 Assertion and explanation................................................................................................8
7.3 Recommended procedure.................................................................................................8
Reference....................................................................................................................................9

AUDITING THEORY AND PRACTICE 3
1.0 Audit planning
Audit planning is the procedure under which various strategies are developed for
conducting the projected result that also defines the audit scope within the company. The
nature, size and time for audit plan can be varied. It further depends on the size of the
business. If the company has large scale business the planning of strategies and their
implementation will take large time and overall scope of the audit may also go up (King and
Oracle International Corp 2014). Further the audit plan includes the plan for assessing the
risk and responses to those risks for analysing the material misstatement. However, the plan
is not discrete phase of the audit rather it is the iterative and continuous process that started
immediately after the completion of previous audit and then continues till the completion of
current audit.
1.1 Analytical review
It is the auditing process based on the ratios among the accounts and it tries to
recognize the significant changes. This can be useful in focussing the general areas under
which the financial statements are not correct or where the transactions are misclassified.
Once the evaluation recognizes the concern areas, the auditor shall conduct further
investigation for focussing on the source of underlying concerns (Moeller 2013). The
procedure of analytical review includes the comparison of the ratios or recorded amounts
with the expectation developed by auditor. The expectations are developed by the auditor
through identification prior period financial information, anticipated results and available
information.
1.2 Preliminary judgement for materiality
Preliminary judgement regarding materiality is established by the auditor through
choosing the base that is multiplied by the percentage factor for determining initial qualitative

AUDITING THEORY AND PRACTICE 4
judgement regarding materiality (Arens et al. 2015). Further, the amount can be updated for
the quantitative factors that are relevant for engagement. Materiality is the judgement on how
much important the item is under the financial statement. It is the misstatement of the item
that may affect the opinion of the auditor on whether the statement represent true and fair
view of state of affairs (Gurov and Milgunova 2016).
2.0 First account selected – Gross profit margin
2.1 Rational for selection
It can be identified that from the trial balance of Mattjon Corp that the sales of the
company has been increased from 187,450 in 2015 to 203,125 in 2016. However, the cost of
sales has been increased reduced from 63,595 to 54,471. This resulted into the increase of
gross profit from 123,855 to 148,654 that is by 20% as compared to the previous year.
2.2 Assertion and explanation
Generally the cost of sales increases with the increase in sales level unless the
maximum part the costs are fixed. Here in the given case of Mattjon Corp though the sales
have been increased, the cost of sales has been reduced as compared to the previous year.
Therefore, chances are there that the management has manipulated sales and cost of sales to
record higher profit so that the potential investors make decisions for investing in the
company (Titera 2013). Chances are also there that the transfers of goods within the
company are treated as sales to third party.
2.3 Recommended audit procedure
The auditor shall analyse the sales cycle of the company for determining the
reliability of that. If the sales cycle of the company is strong then the testing number for
transaction can be reduced by the auditor. The auditor shall select random sample from the

AUDITING THEORY AND PRACTICE 5
transaction and analyse the associated invoice, purchase orders and the customer statements.
Further, the numbered invoices for sales shall be analysed to ensure that all the invoices are
taken into consideration (Eilifsen and Messier 2013). Another thing that must be checked is
that the cash sales shall be matched with the cash receipts and the credit sales shall be
matched with the account receivables of the company. If any errors or fraud is found then the
auditor shall increase the number of transaction for testing purpose.
3.0 2nd account selected – Net profit
3.1 Rational for selection
It can be identified that the instead of increase of sales and gross profit as compared to
the previous year, the net profit of the company reduced. The net profit of the company for
the year 2015 was 122,145 whereas the net profit for the year ended 2016 was 106,874 and
the reduction was by 12.5% as compared to the previous year.
3.2 Assertion and explanation
Generally the net profit of any company goes up with the increase in sales level and
gross profit if the expenses are maintained at the same level. Here in the given case of
Mattjon Corp though the sales as well as gross profit have been increased, the net profit of the
company has been reduced by 12.5% as compared to the previous year (Legoria, Melendrez
and Reynolds 2013). Therefore, chances are there that the management has manipulated
expenses to record lower net profit.
3.3 Recommended audit procedure
In the very 1st step the auditor shall re-calculate the major calculation to find out the
calculations is not misstated. It shall be started with income part to confirm the total revenue
equates the total of income lines. The same process shall be repeated for the categories of

AUDITING THEORY AND PRACTICE 6
expenses. The difference among income and expenses shall be calculated manually. Once the
calculation is complete, the vouchers for expenses shall be checked and matched with the
recorded amount. Further, proper authorization on each voucher shall be checked properly
(Hayes, Wallage and Gortemaker 2014).
4.0 Third account selected – Inventory
4.1 Rational for selection
It can be recognized from the trial balance that the inventory has been increased from
175,000 in 2015 to 189,000 in 2016. The increase is 8% as compared to the previous year.
Therefore, there shall be new purchases on account of inventories.
4.2 Assertion and explanation
Inventory is an item that is susceptible to the intentional or unintentional error, fraud
or misstatement. Amount of inventory also varies on the basis of the method of valuation
used by the company. Further, the physical inventory is exposed to the risk of theft or
embezzlement. The costs of the inventories are also exposed to miscomputation if the
appropriate rate is not applied while calculating the value of inventory.
4.3 Recommended audit procedure
Physical inventory shall be checked to assure that the inventory count matches with
the recorded inventory quantity. Further, the auditor shall check that the method used for
inventory sell that is LIFO or FIFO has been applied consistently throughout the year for all
the items. As it can be seen that the inventories have been increased as compared to the
previous year the increase must be checked with the purchase invoice and physical count of
the same. Further, the cost of each item and purchase numbers for each item shall be analysed
so that it matches with the total inventory. Moreover, the inventory with high value and high

AUDITING THEORY AND PRACTICE 7
purchase cost shall be re-calculated to check that appropriate amount has been recorded under
inventory.
5.0 Fourth account selected – Wages
5.1 Rational for selection
The wages has been reduced from 53,000 in 2015 to 46,816 in 2016 that comes to
reduction by 12%. Chances are there that the payroll system has been misstated to record
higher profit.
5.2 Assertion and explanation
As most part of the audit work with regard to wages are performed under the internal
audit, the external auditor may place some reliance on the work of them. However, owing to
the volume and nature of the payroll transaction chances are there that the internal auditor
may overlook some transactions unintentionally (Albertini 2013). Therefore, the external
auditor shall go through all the transactions or the transactions with higher payment to assure
that no misstatement exists there.
5.3 Recommended audit procedure
To analyse the control system on wages the auditor shall start with considering the
objectives that the control activities are designed to achieve. Te important control objectives
with regard to the wages are ensuring that the employees are paid for the work done only,
ensuring that wages are paid only to the valid employees (Moroney and Trotman 2016).
Further, as the wages of the company has been reduced as compared to the previous year the
auditor shall check the name of the employees who have retired or left during the year. This
shall be checked to assure that no employees remained unpaid or paid at lower amount than
they are entitled to get.

AUDITING THEORY AND PRACTICE 8
6.0 Fifth account selected – Superannuation
6.1 Rational for selection
Expenses with regard to the superannuation have been reduced to 4,447 in 2016 as
compared to 4,770 for the year 2015. Therefore the superannuation has been reduced by 7%
that may have direct association with the payroll expenses and number of employees in the
company.
6.2 Assertion and explanation
Superannuation expenses are carried out by the employer to provide retirement
benefits to the employees. It has been identified from the trial balance that the wages have
been reduced by 12% as compared to the previous year whereas the superannuation expenses
have been reduced only by 7%. Generally, if the wages expenses have been reduced there
must be reduction of the number of employees (Mao 2014). Therefore, the superannuation
expenses shall also be reduced accordingly with the reduction in wages. However as the case
for Mattjon Corp is not same therefore, the superannuation expenses must be analysed.
6.3 Recommended procedure
The auditor must ensure that the payment of superannuation is as per the regulation of
superannuation. Further the auditor shall analyse the accuracy and validity of the financial
records with regard to the superannuation and shall make sure that the fund is compliant with
the rules of superannuation (Brown-Liburd, Issa and Lombardi 2015). The analysis shall
include the registration of the company and its employees, cancellation of registration, if any,
changes in any details, reporting obligations and ongoing requirements. Thereafter the
superannuation register shall be matched with the employee register to match the details like
retirement of any employee and new addition of any employee and make it sure that the
superannuation payment matches with the employee register. It will further ensure that the

AUDITING THEORY AND PRACTICE 9
payment is not mad for any fictitious employee or higher payment is not made as compared
to the entitlement.
7.0 Sixth account selected – Other income
7.1 Rational for selection
The amount of other income has been reduced from 25,000 in 2015 to 1,000 in 2016.
It results into the reduction by huge 96% as compared to the previous year.
7.2 Assertion and explanation
As the other income has been reduced by huge 96%, chances are there that the
incomes are manipulated to lower the amount of profit. There may be instances that the
incomes have not been recorded or recorded at lower amount than actually received (Arens et
al. 2016).
7.3 Recommended procedure
The auditor shall compare the other income sources for the previous year with the
current year. The sources from where the income has not been received in the current year or
very low income received shall be analysed. The auditor further questions the management
regarding the possible reason of income reduction. The validity of the possible reasons must
be evaluated before taking any final decision.

AUDITING THEORY AND PRACTICE 10
Reference
Albertini, E., 2013. Does environmental management improve financial performance? A
meta-analytical review. Organization & Environment, 26(4), pp.431-457.
Arens, A.A., Elder, R.J., Beasley, M.S. and Hogan, C.E., 2016. Auditing and assurance
services. Pearson.
Arens, A.A., Elder, R.J., Beasley, M.S. and Jones, J., 2015. Auditing: The Art and Science of
Assurance Engagements. Pearson Canada.
Brown-Liburd, H., Issa, H. and Lombardi, D., 2015. Behavioral implications of Big Data's
impact on audit judgment and decision making and future research directions. Accounting
Horizons, 29(2), pp.451-468.
Eilifsen, A. and Messier Jr, W.F., 2013, May. Materiality guidance of the major auditing
firms. In International Symposium on Audit Research Conference.
Gurov, V. and Milgunova, I., 2016. Improving of assessment methodology of the audited
organizations performance at the stage of audit planning. Економічний часопис-ХХІ, (157),
pp.115-118.
Hayes, R., Wallage, P. and Gortemaker, H., 2014. Principles of auditing: an introduction to
international standards on auditing. Pearson Higher Ed.
King, N., Oracle International Corp, 2014. Audit planning. U.S. Patent 8,712,813.
Legoria, J., Melendrez, K.D. and Reynolds, J.K., 2013. Qualitative audit materiality and
earnings management. Review of Accounting Studies, 18(2), pp.414-442.

AUDITING THEORY AND PRACTICE 11
Mao, M., 2014, June. Experimental Methods of Materiality Judgment on Auditor’s
Experience and Performance. In 3rd International Conference on Science and Social
Research (ICSSR 2014). Atlantis Press.
Moeller, R.R., 2013. Role of Internal Audit in Enterprise Risk Management. COSO
Enterprise Risk Management: Establishing Effective Governance, Risk, and Compliance
Processes, Second Edition, pp.247-266.
Moroney, R. and Trotman, K.T., 2016. Differences in Auditors' Materiality Assessments
When Auditing Financial Statements and Sustainability Reports. Contemporary Accounting
Research, 33(2), pp.551-575.
Titera, W.R., 2013. Updating audit standard—Enabling audit data analysis. Journal of
Information Systems, 27(1), pp.325-331.