Audit Planning and Risk Analysis for Axolotl Enterprises

This report discusses the audit planning and risk analysis for Axolotl Enterprises, including the identification of critical accounts, materiality level determination, common size income statement analysis, and steps to be taken by auditors. It also emphasizes the importance of fraud risk analysis in auditing.

Auditing and
Professional Practice
Assignment

1
By student name
Professor
University
Date: 25 April 2018.
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Contents
Introduction.................................................................................................................................................3
Discussion and Analysis...............................................................................................................................4
Conclusion & Recommendation..................................................................................................................8
References.................................................................................................................................................10
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Introduction
A report has been prepared on the audit planning of one of the small entities for which the audit
partner has asked the audit senior to come out with the issues relating to the critical accounts, the
audit steps required, etc. The Trial balance of the company has been given, the same has been
assessed, and the profit and loss account, the comparative analysis for the two given years 2016
and 2017 and the common size income statement has been prepared for the client. With the help
of preliminary analytical review, some of the critical accounts have been identified which would
need immediate attention and thus the audit risk and the necessary audit procedure to get
sufficient and appropriate audit evidences has been suggested (Bae, 2017). Finally, towards the
end the fraud risk analysis has been done for the given client to check if there was fraud in entity
or not.
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Analysis and Discussion
The trial balance of the company “Axolotl Enterprises” was already given in the question and the
difference between the debit and the credit side can be taken to be the suspense account (Trieu,
2017). The same has not been considered in any of the analytical procedures since the nature of
the suspense account is not known:
Axolotl Enterprises
Trial Balance
Particulars Jul 1, 2015 - Jan 31, 2016 Jul 1, 2014 - June 30, 2015
Debit Credit Debit Credit
Cash at Bank 99,251 102,503
Accounts receivable 121,820 112,000
Inventory 189,000 175,000
Machinery 65,000 65,000
Accumulated Depreciation 39,611 24,375
Motor Vehicles 65,000 65,000
Accumulated Depreciation 24,700 20,150
Furniture 7,500 7,500
Accumulated Depreciation 2,775 2,250
Bank Loan 216,000 216,000
Sales 142,187 187,450
Cost of sales 38,130 63,595
Service fees (revenue) 34,271 58,000
Other income 700 25,000
Interest income 28 50
Bank charges 203 350
Depreciation 20,311 15,590
Interest expense 6,300 10,800
Printing 147 250
Miscellaneous 1,400 -
Wages 32,771 53,000
Superannuation 3,113 4,770
Total 550,695 460,273 572,855 533,275
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1. The materiality may be defined as something or the level, which has the ability to change
the decision of the users of the financial statements. It is one of the important aspects of
audit and needs to be determined as part of the audit planning by the auditors as it helps
the auditors in understanding and establishing as to what should be the level till which the
checking should be done, post which the amount is immaterial and can be ignored to
some extent (Vieira, et al., 2017). It helps the auditor in concentrating on the critical and
significant areas of audit. IN the given question, the materiality level, which has been
suggested by the audit partner is $ 15000 but if the same is, being selected then many of
the critical accounts would be left unchecked and unaudited. Many agencies, Big 4’s and
accounting bodies over the world have prescribed certain limits to determine the
materiality level, some of which are percentages of gross receipts, total assets, or fixed
assets or net profit or the shareholder’s equity balance. Based on the same, the materiality
level has been determined below in the table as per which the materiality level for
Axolotl Enterprises should be in between $ 1425 to $ 1450 considering all the possible
scenarios. With these limits, some important accounts like the other income account,
Interest, superannuation and furniture account will also fall in the ambit of audit.
(in $)
Axolotl Enterprises
Quantitative estimate of materiality
Criterion Base Amount Materiality level/range
0.5% to 1% of gross revenue Gross Revenue 142,187 710.94 to 1421.87
1% to 2% of the total assets Total Assets 480,485 4804.85 to 9609.7
1% to 2% of the gross profit Gross Profit 71,287 712.87 to 1425.73
2% - 5% of the shareholders’ equity Equity NA NA
5% to 10% of the net profit Net profit 74,812 3740.59 to 7481.17
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2. The common size income statement and the comparative variance analysis over the 2
years has been shown below for the given entity. This are few of the measures of
analytical review and trend analysis of the company.
Axolotl Enterprises
Income Statement
Particulars 2017 % of sales 2016 % of sales
Sales 142,187 80.2% 187,450 69.3%
Service fees 34,271 19.3% 58,000 21.4%
Other Income + Interest 728 0.4% 25,050 9.3%
Total Revenue 177,187 100.0% 270,500 100.0%
Less: Expenses
Cost of sales 38,130 21.5% 63,595 23.5%
Superannuation 3,113 1.8% 4,770 1.8%
Bank charges 203 0.1% 350 0.1%
Depreciation 20,311 11.5% 15,590 5.8%
Interest expense 6,300 3.6% 10,800 4.0%
Printing 147 0.1% 250 0.1%
Miscellaneous 1,400 0.8% - 0.0%
Wages 32,771 18.5% 53,000 19.6%
Total Expenses 102,375 57.8% 148,355 54.8%
Net Profit 74,812 42.2% 122,145 45.2%
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Axolotl Enterprises
Income Statement
Particulars 2017 2016 Variance
Sales 142,187 187,450 - 45,263
Service fees (revenue) 34,271 58,000 - 23,729
Other income 728 25,050 - 24,322
Total Revenue 177,187 270,500 - 93,313
Less: Expenses
Cost of sales 38,130 63,595 - 25,465
Superannuation 3,113 4,770 - 1,657
Bank charges 203 350 - 147
Depreciation 20,311 15,590 4,721
Interest expense 6,300 10,800 - 4,500
Printing 147 250 - 103
Miscellaneous 1,400 - 1,400
Wages 32,771 53,000 - 20,229
Total Expenses 102,375 148,355 - 45,980
Net Profit 74,812 122,145 - 47,333
Net Profit % 42.22% 45.16%
3. In the given section, the critical accounts in the income statement has been identified
which would need inspection, analysis and audit. Some of these are mentioned below:
Sl. No. Account Name Audit Assertion and risk
1. Sales In the given case, the sales has dropped drastically as
compared to the last year by 24%, similarly the service
income has also dropped by 41% as compared to the last
year (Axelsen, et al., 2017). The reason for the drastic
drop in the sales revenue and needs to be assessed and
reasons to the be established for the same as to whether
it is on account of price decrease or lower sales volume.
It can also be due to competitive pressure in market and
the views of management needs to be taken in this
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regards.
2. Cost of Sales When the sales has decrease by 24% and the cost of
sales decreases by 40%, it raises a question whether the
completeness in booking of the costs has been ensured
and whether there is a decrease in cost of raw materials
or it is an accounting errors. As a percentage of the
sales, it has dropped from 23.5% of sales in 2016 to
21.5% of sales in 2017 (Appelbaum, et al., 2018).
3 Depreciation The depreciation expenses is one which has increased
over the past year as against all the expenses which have
decreased. It raises a question on the assertion if the
accounting has been done correctly as the gross block of
the assets is same and therefore the depreciation was
expected either to be same (being fixed expenses) or on
the lower end (Bumgarner & Vasarhelyi, 2018).
4. Based on the audit assertions and the audit risks highlighted above, the steps to be taken
by the auditors while approaching these accounts are as follows:
a. Sales: The sales as percentage of total receipts increasing from 69% to 80% in 2017
despite a decrease of 24% in absolute terms is one of the critical audit points. To
check the same, the auditor should be doing the vouching of the invoices and should
reconcile the same from sales ledger or register. At the same time, it should also be
checked if the revenue recognition policies have been adhered to (Carlin, 2010).
b. Cost of Sales: The sharp decline in the cost of sales over last year makes it another
critical account. Besides vouching of the invoices, the prices of the raw materials
should be compared with the market comparable and the accounting needs to be
checked if the present costs have not been shifted to future years. The estimates and
judgements in this regards needs to be verified with the management (DeZoort &
Harrison, 2016).
c. Depreciation: The depreciation as a percentage of the sales has increased from 5.8%
to 11.5% over the last year and it is not justified, as the gross block of the assets has
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remained same. Therefore, the management policy with respect to valuation of the
assets, the method and rate of depreciation being used, the useful life assessment and
other assumptions needs to be verified (Knechel & Salterio, 2016).
Conclusion & Recommendation
5. The fraud risk analysis is one of the integral parts of the audit and the same needs to be
considered and done while auditing a client as the auditor’s opinion on financial
statements is considered as reasonable assurance for decision making by investors and
other stakeholders. In the given case, the audit partner has suggested that the fraud risk
analysis need not be done for given client as he is trustworthy (Linden & Freeman, 2017).
However, this suggestion or contention of the audit partner cannot be accepted
considering the professional ethics and the professional scepticism, which needs to be
applied while doing audit as per APES 110. Every client should be checked for fraud and
in the given case; there are several accounts, which falls under the ambit of fraud:
a. Depreciation account for reasons already explained above
b. Cost of sales account considering the monumental decrease of 40% in costs.
c. The fall in the other income from $25000 to $ 700 over the year indicating the
possibility that a section of the business has been closed.
d. The decrease in wages by 38% despite this being a variable cost in percentage of
sales.
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References
Appelbaum, D., Kogan, A. & Vasarhelyi, M., 2018. Analytical procedures in external auditing: A
comprehensive literature survey and framework for external audit analytics.. Journal of Accounting
Literature, 40(1), pp. 83-101.
Axelsen, M., Green, P. & Ridley, G., 2017. Explaining the information systems auditor role in the public
sector financial audit. International Journal of Accounting Information Systems, 24(1), pp. 15-31.
Bae, S., 2017. The Association Between Corporate Tax Avoidance And Audit Efforts: Evidence From
Korea. Journal of Applied Business Research, 33(1), pp. 153-172.
Bumgarner, N. & Vasarhelyi, M., 2018. Continuous auditing—a new view.. Continuous Auditing: Theory
and Application, 20(1), pp. 7-51.
Carlin, T. a. F. N., 2010. Resisting compliance with IFRS goodwill accounting and reporting disclosures
evidence from Australia. Journal of Accounting and Organizational Change, 6(2), pp. 260-280.
DeZoort, F. & Harrison, P., 2016. Understanding Auditors sense of Responsibility for detecting fraud
within organization. Journal of Business Ethics, pp. 1-18.
Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.
Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making. Business
Ethics Quarterly, 27(3), pp. 353-379.
Trieu, V., 2017. Getting value from Business Intelligence systems: A review and research agenda.
Decision Support Systems, Volume 93, pp. 111-124.
Vieira, R., O’Dwyer, B. & Schneider, R., 2017. Aligning Strategy and Performance Management Systems.
SAGE Journals, 30(1).
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