Audit and Ethics: Materiality, Scope, and Analytical Review of Financial Statements

This article discusses the importance of materiality and scope in the audit process, as well as the analytical review of financial statements. It includes a review of draft notes and disclosures, and provides a chart of significant ratios for Caltex Australia Ltd from 2014 to 2017.

Running head: AUDIT AND ETHICS
Audit and Ethics
Name of the Student:
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Author’s Note

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Table of Contents
Section 1..........................................................................................................................................2
Materiality and Scope of Audit....................................................................................................2
Review of Draft notes and Disclosures.......................................................................................4
Section 2..........................................................................................................................................5
Analytical Review of the Financial statements...........................................................................5
Section 3..........................................................................................................................................9
Analysis of Cash Flow Statement................................................................................................9
Review of the Auditor Report....................................................................................................10
Reference.......................................................................................................................................12

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Section 1
Materiality and Scope of Audit
The main purpose of this assessment is to undertake audit procedures for the purpose of
reviewing the materiality which is to be considered by the auditor for detecting material
misstatements in the financial statements (Louwers et al., 2015). The concept of materiality is
considered to be important in the scope of audit as the same determines which misstatements are
to be considered minor misstatements and which are to be considered significant misstatements.
Significant misstatements are judged on the level of materiality of the item and how it will affect
the decisions taken by potential investors and also other estimates which are shown in the
financial statements (Reid, 2015). The company which is selected for this assessment is Caltex
Australia ltd which is engaged in operations in Australia (Caltex Australia., 2018).
The concept of materiality is fundamental in the scope of audit as the auditor needs to
consider material items and if the same are reported accurately by the management or not. The
auditor needs to apply his judgements for the purpose of setting the materiality of the business.
The auditor considers materiality on the basis of qualitative characteristics and quantitative
characteristics. In qualitative aspect of materiality, the auditor considers significant items of the
business such as net profit, inventory of the business, changes in accounting method and
significant legislations. In the quantitative aspect of judging materiality, the auditor considers
estimated percentages which are charged on appropriate bases in order to determine the
materiality level for different items which are shown in the annual report of the business. The
percentage which is to be charged for determining materiality are up to the judgements of the
auditor depending on the size of the business and nature of its operations. The auditor compute
the planning materiality at the initial planning stage of the audit and on the basis of such

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planning materiality estimate performance materiality of different items are computed (Eilifsen
& Messier, 2014). Therefore, it is clear that the concept of materiality is essential in the overall
planning process of the audit process.
In quantitative materiality estimation different bases may be considered for the purpose
of estimating the planning materiality and performance materiality of the business. The different
bases which are considered are based on significant items which are shown in profit and loss
statement and balance sheet of the company. As per profit and loss statement, the bases which
are to be considered net profit before tax, total revenue, total sales generated. As per the balance
sheet, the bases which are considered are the total assets of the business.
The annual report which is shown for Caltex ltd for the year 2017 is considered for
estimating the materiality of the business for the year. The annual reports of the business shows
that the sales revenue of the business have improved significantly from the last year estimates. It
is usually the practice of most of the businesses to consider the item which highest value as bases
for estimating materiality level of the business (Jacoby and Levy, 2016). The total asset can be
considered to be the base for calculating the planning materiality of the business and the same is
shown to be $ 6,355,220 for the year 2017. An estimate which is assumed to be the percentage
for calculation the planning materiality is considered to be 5% of the bases. The computation of
planning materiality is shown below:
Planning Materiality=Total Asset∗5 %
¿ $ 6,355,220∗5 %
¿ $ 317,617

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Therefore, the planning materiality for the company considering the total asset as base
and 5% as the percentage based on the judgement of the auditor (Coppage & Shastri, 2014). On
the basis of planning materiality, performance materiality of different items is shown.
Review of Draft notes and Disclosures
The draft notes and disclosures which appear in the annual report of Caltex ltd also have
a level of significance on the audit process as the notes section contains certain treatments and
explanations of items which are shown in the financial statements of the business. The
significant items which are shown in the notes to account section of the annual reports are listed
below:
 Dividend: The breakup for the dividend is shown in the notes to account section of the
annual report which is important from the perspective of audit as misstatement or
manipulations can take place in the same. The auditor can check the accuracy of the
information by applying audit procedures and also with the help of external confirmation.
 Business Combinations: The annual reports also show business combination
commitments of the company which can be affect the audit process and therefore, the
auditor needs to check the same by verifying the deeds and analyzing management
representations (Müller-Burmeister & Velte, 2016).
 Financial leases: The financial leases of the business are also disclosed in the notes to
account section and the auditor needs to check the viability and treatment of such lease
item and ensure that the management has treated the same consider relevant Australian
accounting standard.

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Section 2
Analytical Review of the Financial statements
Analytical review is one of the techniques which is available to the auditor in which
significant ratios are computed from the financial statements which informs about various
aspects of the business. The ratios which are computed cover different areas such as efficiency,
profitability, solvency and capital structure of the business (Jans, Alles & Vasarhelyi, 2014). A
chart below shows significant ratios of the business for 4 years period that is from 2014 to 2017.
Particulars 2014 2015 2016 2017
Current Assets 2,099,336 2,005,239 2,143,655 2,727,623
Current Liabilities 1,503,900 1,217,749 1,502,456 2,358,669
Current Ratio 1.40 1.65 1.43 1.16
Particulars 2014 2015 2016 2017
Total Current Assets 2,099,336 2,005,239 2,143,655 2,727,623
Less: Inventories 1,118,084 969,885 1,080,920 1,694,915
Quick Assets 981,252 1,035,354 1,062,735 1,032,708
Current Liabilities 1,503,900 1,217,749 1,502,456 2,358,669
Quick Ratios 0.65 0.85 0.71 0.44
Particulars 2014 2015 2016 2017
Current Assets 2,099,336 2,005,239 2,143,655 2,727,623
Less: Current Liabilities 1,503,900 1,217,749 1,502,456 2,358,669
Net Working Capital 595,436 787,490 641,199 368,954
Particulars 2014 2015 2016 2017
Gross Profit 1,501,586 1,988,873 1,992,969 2,160,426
Sales 24,231,200 20,027,284 17,933,201 21,398,251
Gross Profit Margins 6.20 9.93 11.11 10.10
Net Profit 22,670 522,621 610,480 620,752
Sales 24,231,200 20,027,284 17,933,201 21,398,251
Net Profit Margin 0.09 2.61 3.40 2.90
Net Income 22,670 522,621 610,480 620,752
Average Assets 5,574,702 5116638 5203738 5828977
Return on Assets 0.41 10.21 11.73 10.65
Net Income 22,670 522,621 610,480 620,752
Shareholders Equity 2,532,591 2,787,805 2,810,215 3,107,901
Return on Equity 0.90 18.75 21.72 19.97
Caltex Australia Ltd
Liquidity Ratios
Profitability Ratios

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Particulars 2014 2015 2016 2017
Cost of goods sold 22,729,614 18,038,411 15,940,232 19,237,825
Average Inventory 1572970.5 1043984.5 1025402.5 1387917.5
Stock Turnover 14.45 17.28 15.55 13.86
Particulars 2014 2015 2016 2017
Sales 24,231,200 20,027,284 17,933,201 21,398,251
Average Net Fixed Assets 2244644.5 2483268.5 2646865 2754609
Fixed Asset Turnover 10.80 8.06 6.78 7.77
Particulars 2014 2015 2016 2017
Sales 24,231,200 20,027,284 17,933,201 21,398,251
Average Total Assets 5562805.5 5116637.5 5203737.5 5828977
Total Asset Turnover 4.36 3.91 3.45 3.67
Particulars 2014 2015 2016 2017
Total Debt 639,157 431,596 453,617 814,400
Total Assets 5,128,534 5,104,741 5,302,734 6,355,220
Debt Ratio 0.12 0.08 0.09 0.13
Particulars 2014 2015 2016 2017
Long Term Debt 639,157 431,596 453,617 814,400
Total Equity 2,532,591 2,787,805 2,810,215 3,107,901
Debt – Equity Ratio 0.25 0.15 0.16 0.26
Particulars 2014 2015 2016 2017
Net Debt 639,157 431,596 453,617 814,400
Total Equity 2,532,591 2,787,805 2,810,215 3,107,901
Total Capital 3,171,748 3,219,401 3,263,832 3,922,301
Gearing Ratio 20% 13% 14% 21%
Particulars 2014 2015 2016 2017
Market Price per share 34.21 37.7 30.46 34.05
Earnings per Share 7.4 193.2 231.6 237.4
Price / Earnings ratio 4.62 0.20 0.13 0.14
Particulars 2014 2015 2016 2017
Market Price per share 34.21 37.7 30.46 34.05
Book Value per Shares 10.01 10.17 10.04 11.11
Price / Book Value Ratio (P/BV) 3.42 3.71 3.03 3.06
Particulars 2014 2015 2016 2017
Dividend per Share 0.7 1.17 1.02 1.21
Market Price per share 34.21 37.7 30.46 34.05
Dividend Yield 2.05 3.10 3.35 3.55
Valuation Ratios
Asset Management Ratios
Leverage Ratios
Profitability Ratios
The profitability ratio of business which is shown in the above table shows current ratio,
quick ratio and net working capital of the business. The current ratio of the company has
decreased over the years and the estimate is shown to be 1.16 for 2017 and the same was 1.43 in

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2016 which suggest that the liquidity situation of the business has fallen. The auditor needs to
apply verification procedures to verify the values of current assets of the business. Similarly, the
quick ratio of the business has fallen which is also related to liquidity position of the business.
The net working capital of the business has also fallen which is a serious matter and the business
might be facing liquidity risks. The auditor can look in the assets and verify the values to ensure
that everything is showing true and fair view.
Profitability Ratios
The profitability ratios are directly linked with the profit generating capability of the
business. The gross profit margin and net profit margin of the company has slightly decreased
from 2016 estimates. The overall sale has increased for the business but the management has not
be able to control the expenses of the company and therefore the profits have fallen (Pike, Curtis
& Chui, 2013). The return on assets of the business and return on equity are considered to
financial indicators of business performance and the same have decreased from previous year’s
estimates. This can be due to the high costs and low profits which are earned by the business.
The auditor needs to ensure that the profits are not understated or overstated in the
financial reports for which the auditor needs to check the sales figure including both cash and
credit sales of the business. The auditor then must apply vouching procedures to check the
viability of the expenses incurred by the business as all the ratios under profitability is affected
by sales and total expenses figures (Elder et al., 2013). The auditor can use external confirmation
for determining the extent and amount of expenses which the business actually owed.
Asset Management Ratios

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The asset management ratio comprises of stock turnover ratio, asset turnover ratio of the
business. Th inventories are considered to be important items of the business and are most
vulnerable to material misstatement. The assets of the business also need to be appropriate
regarding misstatements.
The auditor of the business needs to verify the inventory accounts and records and if need
be arise conduct physical stock take to appropriate value the stocks of the business. The auditor
needs to apply verification process for assets of the business and in order to undertake effective
valuation of the assets, the auditor can also take the help of experts for the same reasons.
Leverage Ratios
These are significant ratios of a business and the same inform whether the business is
using more of a debt capital and equity capital. The ratios show debt ratio, debt to equity ratio.
The debt ratio of the business has increased which suggest that the borrowing of the business has
also increased as per the annual report of the business. The business has not made much changes
in the equity capital of the business and therefore it is clear that the business is putting more
reliance on the application of debt capital.
The auditor needs to assess the risks which are associated with debt capital of the
business and ensure that the same are not affecting the business in any way (Appelbaum, Kogan
& Vasarhelyi, 2017). Moreover, the auditor needs to check whether the debt capital are
appropriately stated in the financial statement.
Valuation Ratios

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The valuation ratio of the business comprises of price-earning ratio, price to book value
ratio which are considered to be significant indicators for overall success of a business. The
price-earning ratio and price to book value ratio are shown to have increased from previous
year’s estimates which indicates that the business is developing.
The auditor needs to check the earning per shares of the business and the dividends which
is offered by the business to the shareholders for the period. The auditor also needs to verify the
share capital which is accumulated by the business.
Section 3
Analysis of Cash Flow Statement
The cash flow statement of the business shows the cash inflows and outflows of the
business during a particular year and the same is also a display of the liquidity position of the
business. The cash flow statement for Caltex ltd for the year 2017 shows cash from operating
activities, investing activities and financing activities.
The cash flow from operating activities of the business show the maximum cash inflows
of the business due to the receipts from the customers which is shown to be $ 23,693,457 for the
year. The cash from operating activities of the business is shown to be $ 735,032 which as
slightly fallen from previous year. The cash flow from investing activities show the maximum
cash outflow of the business (Bhandari & Iyer, 2013). This is because the business has acquired a
new business plant, property equipment and also made investments during the year. The primary
cash receipts which is shown in the operating section which is receipts from the customers which
is from the sales and the primary cash payments which is shown in the cash from operating
activities of the business is from cash payments made to the creditors of the business.

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The main cash flow from investing and financing activities are mainly from purchase of
business net of cash in case of investing activities and the main cash which is acquired by the
business in case of financing activities is shown as borrowings of the business which is shown to
be $ 5,001,095.
The going concern principle is the fundamental principle in accounting process and the
auditor needs to report any factor which can affect the going concern principle of the business.
The liquidity ratio of the business shows that liquidity position of the business has deteriorate
from the previous year’s estimate which is not a favorable sign. The profits of the business has
fallen from previous year estimates and the overall cost of operations has increased. In addition
to this, the debt capital of the business has increased as well which increased the risks of debts. It
can be said that the indicators suggest that the going concern principle of the business might be
affected (Goh, Krishnan & Li, 2013). The auditor can advise the business to improve the
liquidity position and putting more reliance on equity capital rather than debt capital of the
business.
Review of the Auditor Report
The auditor of the company is one of the big four auditing firm KPMG who has prepared
the audit report of the business. As per the opinion of the auditor the financial statements are
prepared following relevant accounting standards and followed provisions of Corporation Act
2001 and therefore are also showing true and fair view. This means that the financial statements
are free from any material misstatements.
The key audit matter section of the audit report emphasizes on taxation issue which is
related to entities in Singapore for which certain uncertainties are there for the timing of the

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transactions as per the provisions of Australian Tax office (ATO). Another recognized key audit
matter relates to site remediation matters for oil and exploration projects which are of complex
nature and thus included in the key audit matters of the business.

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