Auditing Materiality & New Evidence

This auditing assignment delves into the concept of materiality in financial reporting. It presents a scenario where new purchase documents emerge after the initial audit fieldwork, potentially impacting the auditor's assessment of risk and material misstatement. The student is tasked with analyzing the situation, considering the implications for audit procedures and the overall audit opinion, and applying relevant auditing standards (like ISA 315) to reach a conclusion.

AUDIT & ASSURANCE

Audit & assurance
PART-A
Answer- Part A-1
Before accepting an audit engagement, the auditor should consider a number of conditions
with regard to the client and his business. One of such conditions is that the auditor should
consider the facts that whether or not the client is following all the ethical requirements of
conducting business. While conducting a business, the client should consider the
environmental protection and should not use any such technology in business which is
harmful to the environment (Church et. al, 2008). The client firm and its management team
should not indulge in any act which is unethical or illegal.
In the given case, the company Pharmaceuticals Ltd. is under allegations that the chemicals
from the company’s factory are being emitted into the nearby river and hence is creating
environmental pollution. Before accepting the audit engagement, the auditor should consider
this matter and also that the management is involved in the said matter. The auditor will have
to mention all the points relating to environmental hazards in his report as it shall affect the
public in large (Church et. al, 2008). Hence, before accepting the audit engagement, the
auditor needs to judge whether the allegations on the company are correct or not. He should
also communicate with the previous auditor before taking up the audit.
Answer- Part A-2
In the cases where the auditor finds out errors and weaknesses pertaining to hedging where it
is of high level of risk as given in the case of Pharmaceuticals Ltd., such errors were
discovered in the hedging transactions recording and thereafter no actions were taken by the
management, he needs to take following actions:
i. He should perform procedures that he thinks necessary like checking the
authentication of the entries, reconciling with the evidences to determine whether
or not the errors by the management have resulted into any material misstatement
in the financial statements.
ii. In case the misstatement is not material, then also the impact of the same on the
audit report should be determined by the auditor and if the need arises, he should
performer-assessment procedures to check the same (Gay & Simnet, 2015). This
can be done by going to the history of the entires.
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Audit & assurance
iii. He should consider and analyze the information in the financial statements
whether or not the errors may lead to hidden frauds. Any suspect be dealt in a
strong manner and must be provided in the footnote if the management fails to
justify. In case there is any indication of fraud, the auditor needs to consider all
the other aspects of audit as the reliability of management will be under suspicion
in such a situation.
iv. He should in the case of Pharmaceuticals ltd., carry out substantive procedures for
the hedging transactions on a random basis to know the intensity of the errors and
the control weaknesses inherent in the company operations. The auditor shall
deeply study the procedures of hedging transactions of the company as well as the
methods followed to record such transactions.
v. The auditor should be very particular in judging the errors, be it small or large,
due to the given fact that there are weaknesses in the internal control by the
management representatives. Where the internal control of an organization is
weak, the procedures that the auditor performs should be performed with
maximized efforts (Gay & Simnet, 2015).
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Audit & assurance
Answer- Part A-3
Billing & Associates have given audit engagement letter to Reaction Pty Ltd. for
conducting an audit of the said company. The company has accepted the engagement
letter and the audit firm has conducted the audit. As the audit team was not able to gain
sufficient audit evidence of accounts receivable due to lack of documentation, it had
decided to issue a modified audit report.
In such as case, if the client is now requesting the audit team to cancel the engagement
letter as an audit and rather issue an engagement letter in its place for review of the
company, this is a clear case of audit limitation been set by the company. The
management of the company is now claiming that the company is not required to get
audited. If there was no requirement of the audit, the company should not have accepted
the audit engagement letter in the very beginning. Claiming of no audit requirement after
the audit has been conducted itself shows that the management is trying to cover up its
flaws of documentation (ACCA, 2016). Once the audit has been conducted, the auditor
shall not withdraw the procedures performed and shall issue the modified audit report
because of the limitations being set on the audit as the auditors were not provided with
sufficient audit evidence
Hence, the audit team shall go ahead with its modified audit report in this case.
Answer- Part A-4
1) The given case is the case of self-review threat of the auditor independence. The
auditor has suggested the client about many adjustments to account for impairment of
assets. The auditor’s responsibility is to present a fair opinion about the financial
statements prepared by the management team and not to guide the management about
how to manage the adjustments in the books of accounts so that he can present a
positive opinion only (Cappelleto, 2010). In such cases, as the auditor has himself told
about the adjustments, he will not be able to review and comment independently on
such adjustments done.
The safeguard to such self-review threat can be that opinion of another professional
shall be taken along with the auditor so that the audit report shall present an unbiased
opinion.
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Audit & assurance
2) This is a case of self-interest threat as the auditors may be afraid that if they do not
recommend the client’s travel services, the audit firm may lose their client. Here the
client has requested the auditors to give recommendations for travel services provided
by the client firm.
The safeguard is that the auditors should be in a total professional relationship with
the client and shall not undertake any work for the client. If the client initiates any
pressure, the audit firm should leave the engagement so that the auditor’s
independence is not questioned.
3) In this case, there is a familiarity threat to auditor independence as the wife of one of
the auditor has a substantial shareholding in the client company. Familiarity threat
occurs when the auditor becomes very sympathetic to the interest of the clients due to
the reason of close relationship with the client (Philomena, 2015).
The safeguard can be to involve another chartered accountant outside the audit team
to review the work done and monitoring the work of auditor having interest in the
client firm.
4) This is a case of intimidation threat as the auditors are not sure whether or not they
will receive their fees. Although the client has not directly threatened the auditor for
non-payment of fees the same is implied (Philomena, 2015).
The safeguard is that the auditor shall first demand their fees prior to issuing the
report as there is a risk that their fees may remain unpaid once the report is issued in
the hands of the client (Philomena, 2015).
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Audit & assurance
Answer- Part B
a) Business risk b) How it might lead to risk of material
misstatement
i. High lease payments- the company
premises and land have been
rezoned to residential. Due to this,
the land prices had risen and the
lesser demands 50% more rent.
This is a huge increase in
expenditure for the company which
may further increase the losses.
There is a risk of material misstatement as
the company management may try to
manipulate the financial statements and
show increased sales through dummy entries
or increase the same with a corresponding
increase in amount receivable. This may be
done to reduce the losses in the books of
accounts which may arise due to increase in
lease rent (Philomena, 2015).
ii. High level of stock obsolescence-
In an effort to increase profits,
CPPL has recently focused on
expanding the products available in
each store. However, these items
have achieved only limited
acceptance to date among CPPL’s
customers and stock obsolescence
is high.
There is a risk of material misstatement as
the company management may try to
manipulate the financial statements and
show the inventory at inflated rates or may
hide the stock obsolescence (Matthew, 2015).
This may be done to show the company as a
profit making unit so that the stakeholders
and investors do not lose their interest in the
company (Wood, 2011).
iii. Drop in profit margins- the
company in order to cope up with
the cut throat competition has
started providing value added
services to its customers free of
cost, which has although retained
the customers, the gross profit
margins have reduced by 10%. The
risk is that the profits may drop
There is a risk of material misstatement as
the company management may try to
manipulate the financial statements and
reduce the losses in the books of accounts
(Manoharan, 2011). This may be done to
show the company as a profit making unit so
that the stakeholders and investors do not
lose their interest in the company.
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Audit & assurance
down more if such free services are
continued in future.
iv. Constraint on the availability of
credit- CPPL is also experiencing
difficulties with two of its major
suppliers, who have withdrawn
their volume rebates and reduced
payment terms from 30 to 14 days.
There is a risk of material misstatement as
the company management may try to
manipulate the financial statements and
show increased cash sales in the books of
accounts so that cash may be available on
the books to pay off the creditors as the
creditors have reduced credit period (Livne,
2015).
v. High level of Competition- there is
an intense competition in the sector
in which the company operates and
the major supermarket chains are
aggressively purchasing smaller
rivals and discounting products
below cost in order to increase
market share.
The company may have to increase
discounts in order to cope up with the
market competition this shall increase the
expenditure. There may be a possibility that
the management may show the heavy
discounts as bad debts or debts
unrecoverable (Hoffelder, 2012).
Answer- Part –C
(a)Deficiency in
internal
control
Explanation of
business risk arising
due to deficiency in
internal control
(b)Control (c )Test of Control
i. The deficiency in
internal control is
that the website of
the company is
not integrated into
the inventory
system and
The orders received
through the
customers are not
directly linked with
the inventory system
which may result in a
loss to the company
ERP system should
be adopted and
linking should be
done between
inventory system
and order placing so
that when a
The auditors can
assess the control
level by checking
through a dummy
order placing that is a
dummy order will be
placed and then it
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Audit & assurance
inventory levels
are not checked at
the time when
orders are placed.
as the order may get
approved on the
website but there
may not be a
physical inventory of
goods at that time
with the company.
customer orders a
product it directly
gets related to the
physical stock
availability
(Philomena, 2015).
will be checked
whether it is getting
linked to the
inventory records or
not (Philomena,
2015).
ii. Another
deficiency is that
when the product
is delivered, the
courier delivery
person does not
always record
customer
signatures as
proof that the
customer has
received the
goods. There have
been many
customer
complaints about
the delay between
sales orders and
receipt of goods.
The risk is that the
reputation of the
company will get
depleted as there is
no control over the
delivery of goods and
there recording
whether they were
delivered on time or
not. The customers
have already made
complaints about the
same. In future, the
customers might not
get retained with the
company due to this
error and the
company shall have
to bear losses
(Knapp, 2013).
There should be a
proper online system
of recording the
dispatch and
successful delivery
of the products. As
and when the
product is delivered,
signatures of the
customer should be
sent to the company
through online mode
and the delivery
should be recorded.
There shall be online
machine facility
available with every
delivery person so
that he can take
signatures of the
customers as soon as
the product is
delivered and
immediately send
the customer
signature online
The auditor shall
check the website of
the company for
details of orders
placed by the
company and the
delivery dates of the
products to the
customers so that the
process can be
checked.
If the signatures are
done manually, then
random verification/
checking of signed
receipts shall be done
by the audit team
(Hoffelder, 2012).
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Audit & assurance
which shall be
updated on the
company’s website
(Philomena, 2015).
This shall ease the
process of tracking
of in time delivery of
products in future.
iii.The retail
customers check
for credit periods
and credit limits
before placing
orders. The
deficiency is that
the credit limits
are set by the sales
ledger clerks and
not at higher
levels by the sales
area managers or
the sales director.
The business risk is
that the low level of
staff has been
authorized to give the
credit limits and no
accountability has
been set on the
persons charged with
governance
(Geoffrey et. al,
2016). There may be
credit limit given to
those retailers who
have a bad reputation
with regard to timely
payments.
The controls that can
be taken are that the
authority to issue
credits should be
given to the
personnel at higher
levels and not
merely the clerks.
The auditor shall
check the supply
registers and check
the signatures of the
personnel who has
approved the credit
limits.
iv.The company
purchases raw
materials from a
wide range of
suppliers. There
were recent
changes in staff in
the purchase
ledger department.
The risk is that the
supplier
reconciliations are
not performed on a
regular basis which
may result in excess
or short payments to
the suppliers (Black,
2010). The suppliers
The control that can
be performed is that
proper system
should be
incorporated for
reconciling of the
supplier statements
with the records of
the company on a
The auditor shall
check the
reconciliations
maintained by the
company and check
the same from
invoices held by the
company as well.
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Audit & assurance
The reconciliation
statement of the
suppliers and their
reconciliations are
no longer
maintained by the
company.
shall be paid as per
the total statement of
invoices raised by
them as there are no
reconciliations done
to review their
statements.
monthly or quarterly
basis (Geoffrey et.
al, 2016).
v. The
manufacturing
process was
changed by the
company in the
past six months
and as a result,
some new
equipment has
been purchased.
The number of
plant and
equipment are in
excess of the
requirements.
The excess old
equipment were
not sold off and
new equipment
were purchased
with the
authority by
production
supervisors.
The risk is that the
machinery which
may have become
obsolete is still
standing in the books
of accounts but are
not being used
(Carcello, 2012).
This will increase the
depreciation expense
of the company and
may reduce the
operating profits in
the financial
statements.
The control that can
be implemented is
that the obsolete
machinery should be
sold off at the
earliest (KMPG,
2010).
The auditor can
check the same from
the fixed assets
registers and also
from the accounting
entries done to record
the same.
Answer- Part-D
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Audit & assurance
Low Level of materiality indicates that more work is required, more concerns and issues may
be there and the auditor needs to follow more conservative approach.
High Level of materiality indicates that less work is required, fewer concerns and issues may
be there and the auditor needs to follow less conservative approach (Carcello, 2012).
Event Description Impact on Materiality Explanation
1. Sali’s finance
manager had resigned
in June 2017 and
since then no
replacement has been
found.
The impact shall be a
decrease in the
materiality level with
regard to the
misstatements in the
financial records.
As the finance manager has
abruptly resigned and there has
been no financial manager in the
company since past 1 month, there
are higher chances of material
misstatements in the financial
statement that the employees may
have conducted belonging to the
finance department. The finances
must have been handled by the
junior staff of the department in the
absence of finance manager and
there are chances that they may
have manipulated the records of
finance department meanwhile to
hide any fraud or error done by
them (Black, 2010). Hence the
materiality may decrease as more
work will be required to be done to
find out evidence.
2. Sali’s HR manager
had resigned in June
2017, and a
replacement for him
was found in July
2017.
There will be no
impact on materiality.
This is a qualitative factor. There
are many qualitative factors like
the one mentioned in point 1 that
may have an impact on the
financial statements. But the role of
HR Manager is mainly to recruit
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Audit & assurance
and manage the employees. In the
absence of HR Manager, the
recruitments may be done by the
other top officials and hence there
will be no impact on the financial
statements as regards to
misstatements.
3. While performing a
full reconciliation of
data on SuperD to
data on SuperB as at
30 June 2017, two
material variances
were discovered. The
auditor Phil has
inquired with
management for the
same who confirmed
that these were errors
that will be fixed.
The impact shall be a
decrease in the
materiality level with
regard to the
misstatements in the
financial records.
The auditors have found two
material variances in the data
transferred. This may be due to a
technical errors of the software or
may be due to any intentional fraud
is done by the officials who were
responsible for the transfer of the
data from SuperD to SuperB.
Hence, an in depth working is
required to assess the impact of
these material variances in the
financial statements. Hence the
materiality will decrease (Redding
et. al, 2015).
4. The absence of
purchase document of
unlisted investments
from Dune Ltd.
which constitutes
14% of the total
investments which is
a substantial
percentage.
There shall be an
increase in the level of
materiality
The audit was being finalized on 8th
July 2017 and the audit team has
received the purchase document
from the company on 7th July 2017.
Although the purchase document
was not available with the
company when the audit was being
conducted, the same has been made
available before the completion of
audit work. Hence, no more in
depth inquiry has to be made by the
auditors for the purchase
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Audit & assurance
documents (Reding et. al, 2015).
So the materiality shall not
decrease.
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References
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http://www.accaglobal.com/uk/en/discover/cpd-articles/audit-assurance/material-
misstatement.html
Black, W. K 2010, Epidemics of “Control Fraud” lead to Recurrent, Intensifying Bubbles and
Crises, Working paper, University of Missouri-Kansas City.
Cappelleto, G 2010, Challenges Facing Accounting Education in Australia, AFAANZ,
Melbourne
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.
Gay, G & Simnet, R 2015, Auditing and Assurance Services, McGraw Hill
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Hoffelder, K 2012, New Audit Standard Encourages More Talking, Harvard Press.
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pharmaceuticals-disclosures-summary.pdf
Knapp, M.C 2013, Contemporary Accounting, Cengage Learning
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2017 http://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-
independence-and-possible-remedies?full.
Manoharan, T.N. 2011, Financial Statement Fraud and Corporate Governance, The George
Washington University.
Matthew S. E 2015, ‘ Does Internal Audit Function Quality Deter Management Misconduct?’,
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