Audit Planning and Internal Control

This study material provides insights into audit planning, internal control, and risk assessment. It focuses on the case scenario of Big Machine Ltd (BML) and discusses potential audit risks associated with plant & equipment, machinery finance liabilities, accounts receivable, and lease income. The material also analyzes ratios and additional information to outline the business risks faced by BML. Furthermore, it identifies effective internal control measures for controlling undesirable acts and highlights weaknesses in the internal control system for contract payroll.

Audit Planning and Internal Control

Executive Summary
In the present era, business units lay focus on conducting audit with the motive to assess
frauds and taking strategic measure for improvements. For this project, Big Machine Ltd (BML)
has been considered which leases and offer mining machinery services to the gold mines in the
region. It can be summarized from the report that strategic actions need to be undertaken for
making improvement in the profitability aspect as it currently lower as compared to the industry
benchmark. Further, it can be presented that liquidity and solvency position of BML was good in
the respective years and in line with the benchmark. It can be depicted from the study that by
applying substantive and test of control process audit risk can be mitigated to a great extent.

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................3
QUESTION 1 A..............................................................................................................................3
Analyzing ratios and additional information associated the with four accounts for assessing
potential audit risks......................................................................................................................3
QUESTION 1 B...............................................................................................................................6
Analyzing ratios and additional information to outline the business risks that BML faces........6
QUESTION 2 A..............................................................................................................................7
Identifying internal controls in the system that are potentially effective and helps in controlling
undesirable act.............................................................................................................................7
QUESTION 2 B...............................................................................................................................9
Identifying the weaknesses in internal control for contract payroll............................................9
CONCLUSION..............................................................................................................................10
REFERENCES..............................................................................................................................11

INTRODUCTION
Audit plan implies for specific guideline which need to be followed while evaluating
financial statements of the business unit. In the context of business organization, audit plan is
highly significant which in turn assists in identifying frauds and taking strategic measure for
improvements. Audited financial statements are prominent which provides suitable and accurate
view of financial information. By taking into account audited financial statements stakeholders
would become able to take suitable decisions for the near future. The present report is based on
the case scenario of Big Machine Ltd (BML) which leases and offer mining machinery services
to the gold mines in the region. In this, report will provide deeper insight about the potential
audit risk associated with the plant & equipment, machinery finance liabilities, accounts
receivable and lease income. Further, report also depicts tests which can be used for alleviating
audit risk. It also entails weaknesses which take place in the internal control system.
QUESTION 1 A
Analyzing ratios and additional information associated the with four accounts for assessing
potential audit risks
Ratio 2017 (Unaudited) 2016 (Audited) Industry average
Return on equity % 15 22 26
Profit/lease income % 8 12 No data
Return on total assets
%
14 17 20
Gross margin % 25 25 30
Net profit margin % 14.5 18.5 20.27
Times interest earned 1.90 3.51 4.10

Days in accounts
receivable
62 53 45
Current ratio : 1 1.02 1.54 1.66
Quick asset ratio : 1 0.70 0.78 0.82
Debt to equity ratio : 1 1.05 1.35 1.50
The above mentioned table of ratio analysis presents that profitability position of BML
was near to the industry average at the end of accounting year. Audited financial statements
clearly present that ROE and ROA of BML was 22% and 17% in the FY 2016. However, as per
unaudited financial statements profitability position is showing decreasing pattern and lower as
compared to the industry average. Further, gross margin generated by BML was constant such as
25% as per both audited (2016) and unaudited financial statements.
Further, considering audited statements and industry average it can be entailed that
liquidity position of BML was good. However, in 2017, as per unaudited financial statements,
capability of firm in relation to meeting financial obligation decreased in against to 2016 and
benchmarks.
Debt-equity measure of BML decreased from 1.35 to 1.05 at the end of 2016. In
accordance with the industry benchmark debt-equity position can said to be suitable when it
accounts for 1.5:1 respectively. Referring such outcome it can be mentioned that in the year of
2016 optimal capital structure was built and maintained by BML over 2017.
Further, in FY 2016 and 2017, accounts receivable days imply for 53 and 62 respectively.
Industry benchmark shows that firm should focus on receiving money from debtors. Hence, from
the perspective of working capital management and industry benchmark current position cannot
say to be good. Time interest ratio may be served as a most effectual measure which in turn
presents company’s ability in relation to meeting debt payments (The use of ratios and
comparisons in auditing, 2018). In the financial year 2016 and 2017 time interest earned ratio of

the firm was 3.51 & 1.90 respectively. As compared to industry benchmark company’s ability
was found to be lower in the year of 2017.
Audit risk and criteria’s for mitigation under the category of plant & equipment, accounts
receivable, leasing income and machinery finance liabilities include following aspects:
Account Analysis Audit Risk Audit steps to reduce
risk
Plant and Equipment In business unit, plant
& equipments are used
for manufacturing
purpose. Such non-
current assets are used
by the firm in
production activities
which in turn has
direct impact on sales
and thereby profit
level.
Materiality risk takes
place in the context of
plant & equipment
(Asiedu and Deffor,
2017)
Identified risk level
can be reduced
through applying
substantive testing and
tests of control (5
Types of Audit Tests,
2018). Hence, using
test of control, material
misstatements can be
prevented or detected.
Further, substantive
testing focuses on
examining financial
statements and
supporting document
to assess whether it
includes error or not.
Machinery Finance
Liabilities
Company is taking
machinery through
taking bank loan.
Lack of evidence
regarding the
depreciation charged
to the relative asset
class.
By testing details of
the balance risk
associated with
machinery finance
liabilities can be
reduced to a great

extent.
Accounts Receivable When company offers
products or services to
the customers on credit
basis then it may result
into high accounts
receivable (Accounts
receivable, 2018).
Currently, receivables
in days are increased
which in turn places
direct impact on the
working capital
management.
Audit risk in relation
to accounts receivable
includes inaccurate
balances; allowance s
for doubtful debts may
not properly reflect or
present bad debt
experience.
Through undertaking
tests of control BML
would become able to
audit risk regarding
accounts receivable.
By examining
documents, records
and reports accounts
receivable risk can be
avoided (Tests of
control and
substantive testing,
2018).
Lease income It implies for the
earnings which
business unit generates
by giving assets on
lease. Outcome of ratio
analysis presents profit
to lease income %
declined from 12% to
8% respectively. Rent
pertaining to assets
given on lease is
periodical in nature.
Thus, there is a need to
assess the amount
which is due by lessee.
Such area includes
risk in relation to not
clear presentation of
amount that is owed to
lessee.
Substantive tests of
transactions highly suit
to such risk level. On
the basis of this, by
verifying cash receipt
transaction risk can be
minimized to a great
extent.

QUESTION 1 B
Analyzing ratios and additional information to outline the business risks that BML faces
Ratio analysis is the most effectual techniques which in turn provide high level of
assistance in summarizing and evaluating performance from several perspectives such as
profitability, liquidity as well as solvency. Hence, using such technique BML can easily assess
its performance and thereby would become able to take strategic action or measure for
performance improvement. Through assessment, it has identified that significant difference takes
place between audit and business risk (Rönkkö, Paananen and Vakkuri, 2018). Moreover, audit
risk includes factors which may cause of material misstatement and omission takes place in the
financial statements. However, business risks are highly associated with the organization and its
stakeholders. In accordance with the given case situation, by doing ratio analysis, it has
identified that several business risk associated with BML such as:
 Profitability position of BML was lower in comparison to the industry standard. Net
profit margin, return on assets and equity of the firm was lower in against to the
benchmark. Thus, due to small increase level in the gold past year and declination in the
metal market such as 9.71% profit margin generated was lower. Thus, effectual measure
needs to be undertaken for coping up with the fluctuations take place in the metal market.
 Referring liquidity position pertaining to the accounting year 2017, it can be mentioned
that company had not enough funds for meeting obligations. Thus, BML needs to make
focus on maintaining enough assets within the business unit for improving ability in
relation to meeting obligations.
 BML also needs to make focus on tighten its credit policies which in turn helps in
receiving money from debtors within the suitable time period. Moreover, ineffectual
policies have significant impact on the working capital and day to day functioning.
 Further, as per ratio analysis pertaining to the year 2017 presents that debt-equity position
of BML was lower as compared to the industry average. Thus, in the near future for
meeting financial needs company should make focus on taking resort of equity shares
rather than debt. Moreover, debt imposes fixed burden in front of the company in terms
of interest payment and thereby impacts profitability aspect.

Hence, by developing suitable policies and strategies BML would become able to reduce the
level of business risk to a great extent.
QUESTION 2 A
Identifying internal controls in the system that are potentially effective and helps in controlling
undesirable act
Control Risk alleviated Test of control
Integrity and ethical values There will be management of
the activities through the
actions, attitudes and
demonstration of the
professionals in analysing it.
Therefore, it considers the
ethical and moral value for
sound integrity (Ismael and
Roberts, 2018). Therefore, it
will be helpful to the business
in terms of analysing the
standard conduct for better
financial reporting.
To analyse such kinds of risks
there is need to provide the
employee code of conduct.
Moreover, it also incorporated
with the methods of presenting
the violations reports (Wu and
et.al., 2017).

Commitment to competence It has been proposed that the
entity must be committed to
the competence level which in
turn helps in executing the
appropriate business activities
as well as judge the
performance of entity.
Therefore, such information
will be translated and
communicated among other
departments and all the
professionals (Tatiana and
Umar, 2018).
There will be need of
implicating the employee
training and evaluation
technique to overcome with
such requirements
(Understanding internal
control, 2018).
Approval from contract
manager
For ensuring effective control
and avoiding risks pertaining
to monthly payments specific
internal control system will be
followed. On the basis of case
scenario when clerk will select
process pay run then it
automatically calculates
monthly payments by taking
into account hourly and
current tax rate.
In order to control risk
regarding such area and avoid
deficiencies report will be sent
to the Australian Bankers
Association after the approval
of contract manager.
Management's perspective There has been consistency in
the management philosophy as
well as operating style which
will help in sustaining the
sound internal environment
(Gros, Koch and Wallek,
There has been degree of care
taken into consideration which
comprises with effective
policies and procedures which
will be relevant with the
financial reporting.

2017). It can be said that the
management will be helpful in
analysing the risks as well as
benefit which in turn will be
effective in efficient control
over the business activities.
Therefore, it will be helpful to
the business as if they make
favourable communication
with employees and
managerial professionals as to
have accurate control over the
business activities.
QUESTION 2 B
Identifying the weaknesses in internal control for contract payroll
 In consideration with the internal control of the organisation mainly with the payroll
department there is need to have adequate safeguard and better collection of information.
Therefore, it aims at balancing the internal control of the organisation which will be
helpful in protecting the financial resources. Moreover, the main weakness of such
technique is that it increases the chances of data entry errors which in turn affect the
payroll records of all the employees (Yee and et. al., 2017). Therefore, there will be
misrepresentation as well as manipulation of the fines, penalties, discrepancies as well as
poor managements of the work. Moreover, in relation with managing the payment system
as well as have proper records of all the details such as employee leaves etc.
 However, there are various areas which are need to be managed and controlled by the
managers in terms of having better internal audits such as Payroll schemes, Ghost
employees, prevention control, inflated expenses and falsified time sheets and
considerations.

 Most of the time the payroll departments has loopholes which were relevant with the
inadequate management of the pay slip and payments made to the professionals mostly at
the time appraisals (van Gelderen and et.al., 2017). Therefore, to have the adequate
development of internal control there can be use of various techniques and strategies
which will help in improving the effective internal control.
 By doing assessment, it has identified that after getting approval from contract manager,
personnel are allowed to enter their own hours. In this, there is a risk that employees fill
more hours worked in comparison to the actual. Further, If clerk fails to check the
concerned document in an appropriate manner then it may also result into ineffectual
payment summary. Thus, for ensuring effectual internal control system emphasis need to
be placed on automation
CONCLUSION
By summing up this report, it has been concluded that audit tool assists in assessing
deficiencies and thereby helps in taking suitable action for resolving the same. It can be seen in
the report that by undertaking significant risks are associated with the auditing aspects under
different categories. It can be seen in the report that using tests of control, substantive process etc
auditor of BML can minimize risk level. Along with this, it has been articulated that profitability,
liquidity and solvency position of BML was not good. Thus, strategic measure needs to be
undertaken for making improvement in the current position and performance.


REFERENCES
Books and Journals
Asiedu, K. F. and Deffor, E. W., 2017. Fighting corruption by means of effective internal audit
function: Evidence from the Ghanaian public sector. International Journal of Auditing. 21(1).
pp.82-99.
Gros, M., Koch, S. and Wallek, C., 2017. Internal audit function quality and financial reporting:
results of a survey on German listed companies. Journal of Management & Governance.
21(2). pp.291-329.
Ismael, H. R. and Roberts, C., 2018. Factors affecting the voluntary use of internal audit:
evidence from the UK. Managerial Auditing Journal. 33(3). pp.288-317.
Rönkkö, J., Paananen, M. and Vakkuri, J., 2018. Exploring the determinants of internal audit:
Evidence from ownership structure. International Journal of Auditing. 22(1). pp.25-39.
Tatiana, R. A. A. and Umar, H., 2018. Pengaruh Pengendalian Internal dan Audit Internal
Terhadap Kinerja Penjualan Perusahaan (Studi Pada PT B&K Baja Utama. Jurnal Riset
Perbankan Manajemen dan Akuntansi. 2(1). pp.79-96.
van Gelderen, S. C. and et.al., 2017. Optimal governance of patient safety: A qualitative study on
barriers to and facilitators for effective internal audit. Journal of Hospital Administration.
6(3). p.15.
Wu, T. H. and et.al., 2017. The effect of competencies, team problem-solving ability, and
computer audit activity on internal audit performance. Information Systems Frontiers. 19(5).
pp.1133-1148.
Yee, C. S. and et. al., 2017. Perceptions of Singaporean internal audit customers regarding the
role and effectiveness of internal audit. Asian Journal of Business and Accounting. 1(2).
pp.147-174.

Online
5 Types of Audit Tests. 2018. [Online]. Available through: <https://quizlet.com/21426977/5-
types-of-audit-tests-flash-cards/>.
Accounts receivable. 2018. [Online]. Available through:
<https://www.iia.org.uk/resources/auditing-business-functions/finance/accounts-
receivable/>.
Tests of control and substantive testing. 2018. [Online]. Available through:
<https://www.icas.com/education-and-qualifications/tests-of-control-and-substantive-
testing-student-blog>.
The use of ratios and comparisons in auditing. 2018. [Online]. Available through:
<https://opentuition.com/articles/f8/use-ratios-comparisons-auditing/>.