Analysis of Audit Risk in Always Precise Instruments Pty Ltd

This memorandum provides an analysis of the audit risk in Always Precise Instruments Pty Ltd based on financial ratios and internal control testing.

Always Precise
Instruments Pty Ltd
Memorandum
To: Wayne Wiadrowski
From: Audit Manager
Date: 8th May, 2019
Subject – Analysis of Audit risk
Scope and Purpose
The first and primary duty of the auditor is to find whether the company
financial statements are free from material misstatement or not and also to check
whether the company accounts are showing true and fair view or not. As per the
case of the company Always Precise Instruments Pty Limited, the aim of the
memorandum is to analysis of the audit risk which are there in the company
financial statements and the above analysis is been done on the basic of the ratio
of the company as well as the internal control testing. It also content the
sampling process, which used by the auditor for the same. The detailed analysis
shown below in table presentation.
Analysis of Audit Risk from Audit Procedure and Financial Ratio
Ratio Analysis Audit Risk Audit
Procedures
STREET ADDRESS, CITY, ST ZIP CODE
T TELEPHONE U WEBSITE

Return on
Equity
It can be seen
that the company
return on equity
have been
decreased as in
2018 it is 14.7
but in 2017 it was
16.6 so it can
termed as bad for
the company. As
it is unable to
meet the
benchmark set by
the industry so
this signify that,
there is material
misstatement in
debt. The
increase is the
equity can be the
reason for the
decrease in the
ratio of the
company (Gay &
Simnett 2012).
Material
misstatement can
be a risk in the
ratio, it is the
reason of the
fluctuation of the
ratio, and it can
be because of the
company unable
to record all the
data related to
equity capital
(DeFond &
Zhang 2014).
As per ASA 500-
it will, carry the
process of the
audit is should
test the
accounting
process of the
company and
should verify
each transaction
so that it able to
minimize the
potential risk
(Auasb.gov.au,
2019).
2

Quick Ratio It can be seen
that the company
is having a good
amount of quick
ratio so this
signify the
company is
having good cash
liquidity and can
pay off their
short term due
easily (Gay &
Simnett 2012).
Material
Misstatement can
be there in the
ratio as there can
be overvaluation
of the quick asset
or undervaluation
of short term
liabilities which
will create a
potential risk
(Knechel &
Salterio 2016)
As per ASA 330
it will identify
the material
misstatement the
auditor have to
check the entries
related to the
balance sheet so
that it can able to
know the reason
of the material
misstatement in
the balance sheet
(Auasb.gov.au,
2019).
Current Ratio The ratio of the
company is
increasing as in
2018 it is 1.64
but in 2017 it was
1.54 which a
good sign as it is
able to increase
its liquidity but
there is not able
to match the
industry norms so
company should
try to match it.
The increase in
the ratio can be
because of
increase in
current asset or
decrease in
current liability
(Gay & Simnett
2012).
The misstatement
can in the short
term liability or
current asset as
the management
may have
overvalued the
current asset or
undervalued the
short term
liabilities so this
increase the risk
in the company
(Furnham &
Gunter 2015)
As per ASA 450
-The auditor
should verify the
market value
with the book
value so that it
will able to now
the real value of
the asset abd
liabilities and
then it will able
to minimize the
material
misstatement in
the financial
accounts
(Auasb.gov.au,
2019).
3

Return on Total
Asset
It can seen that
the company is
not able to use
their asset
effectively as the
ratio has been
decrease as in
2018 it is 122.5
but in 2017 it was
14.9, so the
company is not
able to utilize it
properly in
regards with the
profit (Gay &
Simnett 2012).
Material
misstatement can
be a big risk in
the ratio as it
depend upon the
earning of the
firm so it can
affect the
decision of
investors (Hall
2015).
As per ASA 450
- The test, which
should carried by
the auditor, is
that it should
verify the asset
utilization
process so that it
able to know how
the company is
able use those
and is there any
material
misstatements in
the accounts
(Wang, Li & Li
2015).
Gross Margin It can be seen
that the company
is unable to
secure a good
business in the
current year
which is been
reflected by the
decrease in the
gross profit as in
2018 it was 6.5
but in 2017 it was
10.3 so it is not
able to match the
benchmark of the
industry. The
reason of
decrease is that
the company has
low amount of
sale and increase
Material
misstatement is
been found in
this case by
decrease in the
gross profit
company can
able to save some
amount of
taxation and it is
a potential risk in
the audit
(Griffiths 2016)
As per ASA 450
-The procedure
which the auditor
should check it
should check the
reason of
decrease in sale
by vouching sale
invoice and also
should vouch the
cost of that it can
know the reason
of increase in the
cost of the
company
(Auasb.gov.au,
2019)
4

in the cost of sale
Administrative
Expenses
It is a good sign
that the ratio is
been decrease as
in 2018 it is 3.4
but in 2017 it was
3.8 so it will able
to increase the
overall profit of
the company
(Sandvig et al.,
2014)
Misstatement can
be found in the
expense as the
company
expenses are
below than the
industry
benchmark so
this show that the
company had
understated the
expenses to
increase the
profit of the
company (Power
& Gendron
(2015)
As per ASA 450
- Auditor should
vouch all the
expenses related
to the
administrative so
that it can know
the reason behind
the decrease of
the ratio and also
able to get the
material
misstatement of
the company
(Auasb.gov.au,
2019)
Marketing
Expenses
It can be seen
that the company
is having an
increase in the
ratio as in 2018 it
is 4.4 but in 2017
it was 3.8 so it
will directly
affect the
company net
profit of the
company
Misstatement can
be found in this
ratio as there is
an increase in the
ratio in compare
to benchmark of
the industry so
this signify that
company is doing
overvaluation of
the expenses (Xia
et al., 2015).
As per ASA 330
-The auditor
should vouch all
the bills related to
the company
marketing
expense so that it
can know the
reason of the
increase and also
it will able to
know the reason
of material
misstatement
(Auasb.gov.au,
2019)
5

Times Interest
Earned
It show that the
company is not
able to earn
sufficient to pay
its borrowing
cost as there is a
decrease in the
ratio as in 2018 it
was 3.6 but in
2017 it was 4.6
so it show
company is not
having a good
financial position
Material
misstatement can
be found in this
ratio as the
company is not
able to pay its
borrowing cost so
it lead to a
potential risk
(He, Zeadally &
Wu 2018)
As per ASA 450
-Auditor should
perform test of
control in this
situation, as it
should do an in-
depth analysis
upon the reason
of the company
decrease in the
earning, which is
effecting this
ratio
(Auasb.gov.au,
2019).
Days in
Accounts
Receivable
It can be seen
that the company
had increase its
day of lending to
the debtor so as a
result of this
company account
receivable ratio is
decreasing
The material
misstatement
which can be
found in this ratio
as company had
overstated the
value of trade
receivable which
is due to having
weakness in the
internal control
of the company
(Li et al,. 2016).
As per ASA 500
-Auditor should
check the internal
control of the
company as then
it will able to
know the real
reason of the
material
misstatement in
the company
trade receivable
accounts
(Auasb.gov.au,
2019)
Days in
Inventory
As the company
is not having a
proper business
so that is the
reason company
is having a
decrease in the
Material
Misstatement can
found in the
balance as the
company may
able to increase
the closing
As per ASA 450
-Auditor should
able to use the
test of control
process as it
should check the
internal control
6

inventory days as
it is not able to
make proper
business in the
current year
inventory so it
can affect the
profit of the
company (Adler
et al., 2018).
weakness of the
company and so
it will check all
the activities
related to the
inventory
(Auasb.gov.au,
2019)
Debt to Equity
Ratio
It can be seen
that the company
has decrease in
the ratio as in
2018 it was 0.61
but in 2017 it was
0.52 so this is
because of the
due to the
increase in the
debt proportion
in the company
Misstatements
can be the found
in the account ads
the company may
have overstated
the debt amount
so that it can
show a good ratio
to the financial
users (Vaitzblit et
al., 2014).
As per ASA 330
-Auditor sh ould
process test of
details in regards
of the company
accounts as it
should check and
examine the
transaction in
related to the debt
of the company
so that it able to
know the reason
of increase in
debt
(Auasb.gov.au,
2019)
Internal Control Weakness in the Inventory
Internal Control
Weakness
Audit Risk Audit Procedure
7

It can be seen that the
company purchasing
system is automatically
generate the bills so it
can be consider as a
weakness as if any
problem occur than it
will affect the company
as whole
As it does not take into
consideration in regards
of the demand of the
product so it can be a
loss to the company (Yu
et al., 2015).
As per ASA 450 -
Auditor should check in
the internal control as it
should analysis the
technology system and
should ensure that it
able to test the system
by doing some internal
level of the company
(Auasb.gov.au, 2019)
The company is only
depend on the software
for generating the
production order. It
does not have any other
alternative so if any
problem arise in the
system than it will
directly stop the
company process and it
will also affect the
company overall
performance
The risk is related to the
production of the
company as the system
is been connected to the
purchasing order so it
hold a good position of
the risk. As if due to
system failure company
able to go in over or
under utilization of the
raw material and it can
affect the quality of the
product and also loss
can be increased by the
company (Zhang, Yang
& Appelbaum 2015)
As per ASA 500 -The
auditor should check the
internal control of the
company as it should
test and check the
system carefully as it
should ensure that
company have no error
or affect in the
inventory system of the
company (Wang et al.,
2015).
The company system
automatically generate
the invoices in related to
the suppliers as per the
latest price so it is
termed as a weakness as
the company is nor
checking the other
details of the suppliers
like the reputation and
also the term contract of
The risk regard with this
is control risk as it can
be affected by thy flow
of the raw material and
finished product so if
the company is unable
to select proper supplier
than it will have to incur
huge loss (Kumar &
Sharma 2015)
As per ASA 330 -As the
risk involve in the case
is the control risk so the
auditor have to apply
substantive procedure in
regards with the risk and
the auditor should
examine the company
accounting software to
ensure that there is no
error or omission in the
8

the raw materials company system
(Auasb.gov.au, 2019)
As the company clerk
have the password of
the access to the master
file but he only have
responsibility related to
file copies of purchase
order so it is been
consider as a weakness
in the internal control of
the company as it
should not be given
access to the master file
As the company have
given it the access so it
can easily manipulate
the account and able to
create a wrong
impression of the
company in the eyes of
the financial user of the
company (Reeves,
Culverwell & Wittman
2017).
As per ASA 450 -The
auditor should use test
of detail process as it
should test all the
document with are there
in the master file so that
it can easily detect the
fraud in the company
(Yuan & Yu 2015)
The company has given
the password of
production order as it is
only responsible for the
printing so it is consider
as a weakness of the
internal control as it can
easily manipulate the
file and it also make
misstatement in the
accounts
The audit risk, which is
associated with it, is that
could change the
production unit of the
company so that it can
easily do under and over
statement of the
production unit (Kaizuka
et al., 2016).
As per ASA 500 -
Auditor should check
how the person perform
the duties as it is the one
who had assign of two
duties so the auditor
should able to segregate
the responsibility done
to him (DeFond &
Lennox 2017).
The company have
given the password to
the store staff in regards
of the printing of the
raw material purchase
order as well as GRN
printing of the finished
goods. So this is
consider as a weakness
The risk which is
associated with it the
company have given
both access so it can
easily able to
manipulate the
document and can affect
the financial statement
of the company (Newton
As per ASA 450 -The
auditor should ask the
management to
distribute the duties
between two staff so
that no human error can
occur and the financial
statements are free from
any type of the risk
9

as the person can easily
manipulate the
document and it have
both the access so it can
easily cover it fraud in
between the two
accounts
et al., 2015) (Auasb.gov.au, 2019)
As it can be seen that
the company had given
access to many person
in regards with the
master files so as the
order are generated with
the help of master file
so it is consider as a
weakness as the
company may
manipulate the file and
it chose different
supplier and sub-
contractor
The risk which is
associated in the
production process as
the company is able to
manipulate the whole
task and can directly
able to change the
suppliers and the
contractor so it can be
treated as a huge risk
and the auditor have to
check it properly (De
Simone, Ege &
Stomberg 2014).
As per ASA 330 -The
auditor should ensure
that the company is able
to give the access to
single person so that no
manipulation of the
accounts can take place
and the auditor can
easily available to carry
the audit process in the
company
(Auasb.gov.au, 2019)
The company does not
include the stock in
their stock sheet report
so it is considered as a
weakness as the
company will unable to
know the proper
quantity in the business
and it will directly
affect the inventory of
the company
As the company does
not record the number
so the management can
easily able to make
overstatement and
understatement of the
inventory and can make
an adverse effect on the
financial statement of
the company (Gay &
Simnett 2012)
As per ASA 450 - The
auditor should ensure
that the company follow
the counting process of
the inventory and its
able to record in the
stock sheet of the
company so that it able
to know the real value
of the stock and can
record properly in the
financial statement of
the company
(Auasb.gov.au, 2019)
10

Methods of Sampling
Assertion Which
Population
Sample Selection
Method
Justification for
Sample Size
Method
Existence It is in the
regards of the
inventory of the
company so it
check the facts in
regards of the
same. The
auditor have to
deeply analysis
the transaction
related to the
inventories as it
have to vouch
each inventory
transaction so
that it can know
what are the
reason of
inventory
increase or
decrease and also
it should able to
know the actual
price which the
company invest
The basis of the
assertion, the
auditor select the
selection method
of the sample
size. In this case
the auditor
Wayne select the
random selection
process so as per
the random
selection method
the auditor have
to select a sample
size in regards of
the purchase
order as the
auditor will select
the sample size as
per the risk
involve in the
company and in
regards of it the
auditor will
increase or
As per ASA 500
-it can be seen in
the case there is
huge risk in the
purchase order of
the company so
this the reason
the auditor have
select the random
sampling process
as it in this the
auditor will able
to vouch the
whole amount of
the purchase
order. As the
company have a
huge amount of
inventory so this
is the best
possible way of
sampling to be
done to the
company
(Auasb.gov.au,
11

in the cost of the
inventory (Gay &
Simnett 2012)
decrease the
sample size
(Auasb.gov.au,
2019)
2019)
Completeness This is the
assertion which is
taken as their
should all the
transaction are to
be presented in
the financial
statement. It help
them to
understand the
level of the
inventory, which
the company has,
and how they
account them in
the balance sheet.
As per this
reason only,
Wayne is able to
collect the
sample related to
the raw material
purchased and
the production of
the finished
goods (Gay &
Simnett 2012).
As per the nature
of the assertion,
the sample
selection method
most appropriate
for the company
is systematic
method of
sampling as in
this method the
auditor have to
make an assertion
of the interval by
dividing the
physical unit
form the original
source (Gay &
Simnett 2012).
As per ASA 500
-It is one of the
most important
and simple
method of
sampling. It also
help them for the
selection of
particular amount
of sample size in
regards with the
company
inventory and
also help them to
know the risk
which is there in
the financial
statements of the
company
(Auasb.gov.au,
2019).
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