Impact of Incomplete Testing on Auditor's Decision Making

The article discusses the importance of auditing in a company, particularly when management is involved in fraudulent activities. The CEO may have an undue advantage to manipulate accounts for personal gain, and the auditor must take extra precautions to ensure accuracy. Additionally, the adoption of new IT systems requires auditors to be familiar with their operations to avoid inefficient judgments. Incomplete testing procedures can lead to issues like data piracy and breach, compromising the audit process. Therefore, it is crucial for auditors to address these concerns before arriving at a final judgment.

AUDIT & ASSURANCE

Auditing
Answer-1
Substantive processes play a vital role in the auditing process because it assists an auditor to
identify material misstatements prevalent in the financials of a company so that relevant
judgement can be provided. Besides, such processes can also assist in compliance with
qualitative attributes like completeness and efficacy of the financial statements. Nevertheless, in
relation to DIPL Ltd, before conducting such procedures to arrive at a judgement, several
concerns must be taken into account (Gay & Simnet, 2015). However, it must be noted that an
auditor must go through various authenticated documents in order to qualify as an effective
substantive process that can, in turn, assist in identification of material misstatements.
There are many analytical procedures that can be conducted in order to analyze the background
information of DIPL Ltd. The first analytical process that can be utilized in this case is trend
analysis wherein the future results of the company can be easily anticipated with the help of past
results. The second process is associated with the evaluation of the financial information of the
company based on the financial and non-financial information. This can assist in the
implementation of relevant and effective decisions upon the financials of DIPL Ltd. The last
analytical process in this regard is the implementation of ratio analysis so that a perfect
comparison can be made with that of the last financial outcomes of the company, thereby
assisting in effective financial decisions (Matthew, 2015). Thus, these three analytical processes
can be taken into account in relation to the company’s background information.
Ratio analysis has been conducted in this scenario in order to assess whether the financial
outcomes depicted in the financials of DIPL are efficient or not.
Ratio Formula 2013 2014 2015
Current Ratio Current Assets/
Current
Liabilities
1.42 1.47 1.50
Gross Profit
Ratio
Gross Profit/
Sales
17.55 16.13 15.20
Net Profit Ratio Net Profit after
tax/ Sales
6.89 6.07 6.84
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Auditing
Debt Equity
Ratio
Debt / Equity _ _ 0.61
In the liquidity segment of the company, current ratio has been calculated that can assist in
ascertaining its liquidity position. From the figures, it can be observed that the current ratio of
DIPL had consistently remained in an average phase. This can be proved by the fact that the ratio
remained below two over the years that concludes effective liquidity status on the company’s
part (Heeler, 2009). The second part is the debt equity ratio that assists in ascertaining whether
the company has an adequate balance of debt and equity in its capital structure (Davies &
Crawford, 2012). It can be seen that the debt equity ratio of DIPL is nil in both 2013 and 2014
that signifies zero liabilities in these years. However, the reason behind an increment of 0.61 in
the year 2015 can be attributed to the fact that the company had procured liabilities in such year.
Furthermore, in relation to profitability ratio, it can be seen that on one hand, the net profit ratio
of DIPL have depicted an effective result as it has decreased but on a slight note. However, it
further increased in the year 2015. Similarly, the gross profit ratio has depicted a declining trend
over the years that are a negative indicator on the part of company’s performance. It shows that
the profitability status of the company is at stake and the management as soon as possible must
address it.
After assessing the above calculations, it can be said that it is the moral responsibility of an
auditor to take into account other concerns before undertaking such analytical procedures to
provide a judgement. This is because it can be witnessed from the financials of the company that
its debts have shown an enormous increment over the years that is a negative indicator of its
performance. Further, the balances of cash have also depicted a declining trend that signifies lack
of adequate resources to finance major working capital requirements. In addition to this, owing
to lack of resources, the payables of the company have also portrayed an increasing trend that
shows the inability of the company in addressing its usual transactions (Guerard, 2013). Lastly, it
can also be seen that the accounts receivables of the company have depicted an increasing trend
that signifies inappropriate functioning of the recovery policy of the company. Therefore, the
auditor must also evaluate all these concerns before implementing analytical processes, as it may
assist him in making decisions that are more valuable. Besides, these concerns are clearly present
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Auditing
in the financials of DIPL that gives rise to the fact that if these are not addressed properly, future
problems or complications may tend to arise. Moreover, the key reason behind the assessment of
these concerns before implementation of analytical procedures is that these concerns can assist
the auditor in completing the auditing process effectively so that an enhanced observation
regarding the true and fair view of the company’s performance can be attained. In simple words,
if the auditor may be influenced by any such material misstatement prevalent in the financials of
the company, then the audit opinion offered may not be true in every respect and hence, it will be
better to consider such concerns before making a judgement (Roach, 2010).
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Auditing
Answer-2
Evaluation of inherent risk is very vital for the success of an enterprise. However, such risks
cannot be fully mitigated or avoided because these are present in the financials of a company
despite efficient measures like internal control mechanisms, etc. The major inherent risks that
form part of the financial statements of DIPL are as follows:
i. Unethical appointment
The appointment of the CEO of DIPL is considered unethical in nature because such appointed
person must not pursue any kind of interest with the company. However, the company has not
taken this into account because the CEO appointed has a financial interest in the company that is
the major cause of the creation of inherent risk. It can be observed that the CEO has been
allowed to gain ten percent of the profits of the company if the company also witnesses growth
by ten percent or more. The major inherent risk in this scenario is that the CEO is in a position
wherein he may attempt to operate the company’s affairs in such a way that may grant him the
agreed profit. Besides, this attempt may either be moral or immoral because if the company does
not witness a growth of ten percent or more, the CEO may influence the records to depict the
opposite.
ii. Inadequacies in the adoption of new system
The company has adopted a new information technology system into its operations so that
automated entries can be made, thereby enhancing the pace of operations. However, there was no
prior research conducted by the company so that proper adoption can be undertaken. Besides, the
prior examination may assist in reflecting ineffectiveness or problems that may create future
problems (Reding et. al, 2015). However, the company did not implement the same and as a
result, several transactions that appeared at the year-end were not appropriately allocated. In
simple words, the transactions that appeared at one period were depicted in another period,
thereby creating major differences. This clearly gives rise to the fact that a material misstatement
was prevalent in the financials of the company, thereby giving rise to inherent risks. Moreover,
the management may use such opportunity for their own benefits and the auditor may even be
incapable in detecting such problems (Church et. al, 2008). On a whole, such fraudulent strategy
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Auditing
may result in a practice that is clearly immoral, thereby hampering the reputation of the company
as a whole.
Therefore, these two inherent risks are prevalent in the financials of DIPL that may hamper its
goodwill in future. Furthermore, the auditor may also prove incapable in detecting such risks if
the management itself is involved in the situation. Thus, it must be noted that the auditor must
exert his professionalism and expertise to assess the prevalence of such risks so that relevant
decisions can be made.
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Auditing
Answer-3
a. The major fraud risk that exposes the operations of the company to fraud is the
appointment of the new CEO and improper functioning of the information technology
system. In relation to the appointment of the new CEO, it can be seen that the same has
been done with a profit motive but the CEO possessing a financial interest may
fraudulently use such opportunity for his own benefit. Besides, this may result in
indifferences in the account balances of the company, as the CEO may have influenced
the figures in a way that may grant him additional profits. This also gives rise to the fact
that the internal control strategy of DIPL is not effective as the executives are given an
opportunity wherein they can manipulate the accounts for their own advantages. The
second fraud risk is the adoption of the new information technology system wherein
adequate testing was failed to be conducted. The most relevant fraud risk that may tend to
arrive in this scenario is that the entire information from the past system may not be
entered into the new system (Carcello, 2012). Besides, such information may also be
wrongly entered into the system for the purpose of gaining an undue advantage. This may
be the reason why the accounts receivables and payables have depicted a weird trend over
the years even though there were massive sales. Hence, this can directly result in
accounting figures that are inappropriate. Moreover, the accountants of the company are
also under an undue advantage to derive access into the system and manipulate the
accounts based on their profit motives (Johnstone et. al, 2014). For instance, the
outstanding balances of the debtors may be written off for the purpose of concealing the
income figures.
b. The materials that are offered by the company are taken into account by an auditor to
make relevant decisions. However, if the management conducts fraudulent affairs, the
auditor’s decision may become inefficient. Hence, the management must possess a strong
authority over the company’s financial statements so that code of ethics is not put at
stake. Further, the auditor comes under a responsibility wherein he must track every
minute detail especially when the management is also involved. Hence, proper judgement
and skills of an auditor are very relevant in this scenario (Elder et. al, 2010). For effective
judgement, the auditor can take authenticated documents like bank statements into
account so that truthfulness of the accounting entries can be determined. Besides, since
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Auditing
the CEO is under an advantage to manipulate the accounts for his own benefit, the auditor
may need extra time to ascertain the truthfulness of the figures. Moreover, if such matters
are not properly observed by the auditor, then an inefficient judgement may be offered on
his part. The second consideration in this regard is related to the adoption of new IT
system wherein the auditor must be properly accustomed with the operations of the
system so that his decision cannot be questioned. Further, the biggest risk in this scenario
is that proper allocations of the past entries were not made to their correct period and the
auditor may not identify such issues, thereby failing to offer an efficient opinion (Gilbert
et. al, 2005). Nevertheless, this concludes the fact that when prior testing was absent
before adoption of the system, concerns like piracy, and breach of data may have
occurred that can result in a wrong auditor’s opinion. Further, if the auditor relies on such
automated and new information technology system, there may be a possibility that the
entire decision offered based on the background information of DIPL, is wrong. On a
whole, since the testing procedure was incomplete, the audit process is clearly at stake in
the given scenario and therefore, the auditor must address such issues before arriving at a
final judgement (Geoffrey et. al, 2016). This will assist in a proper audit process as a
whole.
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Auditing
References
Carcello, J 2012, ‘What do investors want from the standard audit report?’, CPA Journal vol.82,
no. 1, pp. 7-12
Church, B, Davis, S & McCracken, S 2008, ‘The auditor’s reporting model: A literature
overview and research synthesis’, Accounting Horizons vol. 22, no. 1, pp. 69-90.
Davies, T. & Crawford, I 2012, Financial accounting, Harlow, England: Pearson.
Elder, J. R, Beasley S. M.& Arens A. A 2010, Auditing and Assurance Services, Person
Education, New Jersey: USA
Gay, G & Simnet, R 2015, Auditing and Assurance Services, McGraw Hill
Geoffrey D. B, Joleen K, K. Kelli S & David A. W 2016, ‘Attracting Applicants for In-House
and Outsourced Internal Audit Positions: Views from External Auditors’, Accounting Horizons,
vol. 30, no. 1, pp. 143-156.
Gilbert, W. Joseph J & Terry J. E., 2005. The Use of Control Self-Assessment by Independent
Auditors. The CPA Journal, vol. 3, pp. 66-92
Guerard, J. 2013, Introduction to financial forecasting in investment analysis, New York, NY:
Springer, pp. 78-81
Heeler, D 2009, Audit Principles, Risk Assessment & Effective Reporting. Pearson Press
Johnstone, K, Gramling, A & Rittenberg, L.E 2014, Auditing: A Risk Based-Approach to
Conducting a Quality Audit, 10th Edition, Cengage Learning
Matthew S. E 2015, ‘ Does Internal Audit Function Quality Deter Management Misconduct?’,
The Accounting Review, vol. 90, no. 2, pp. 495-527
Reding, H.R, Sobel, P.J, Anderson, U.L, Head,M.J, Ramamoorti, S, Salamasick,M &
Riddle, C 2015, Internal Auditing: Assurance & Advisory Services, Third Edition 3rd Edition,
The Institute of Internal Auditor Research Foundation
Roach, L 2010, Auditor Liability: Liability Limitation Agreements, Pearson.
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Auditing
Appendix
2013 2014 2015
Current Ratio
Current assets 5385938 7509150 9600929
Current liabilities 3780000 5120250 6397500
Current Ratio = CA/CL 1.424851 1.466559 1.500731
Debt Equity Ratio
Debt - - 7500000
Equity 9150000 10783650 12250491
0.61222
Quick Ratio
Quick assets 3129750 4837788 5420429
Current liabilities 3780000 5120250 6397500
Quick ratio 0.827976 0.944834 0.847273
Gross profit ratio
Gross profit 6004500 6079500 6604500
Revenue 34212000 37699500 43459500
GP ratio 17.55086 16.12621 15.19691
Net profit ratio
Net profit 2359190 2291362 2972183
Revenue 34212000 37699500 43459500
NP ratio 6.895797 6.077964 6.838972
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