Important Aspects to Consider in the Audit of API

This memo addresses three specific aspects in the audit of API: potential audit risks from ratios, weaknesses in internal control for inventory system, and specific audit assertions and sampling procedures.

Running head: AUDITING AND ASSURANCE IN AUSTRALIA
Auditing and Assurance in Australia
Name of the Student
Name of the University
Author’s Note

1AUDITING AND ASSURANCE IN AUSTRALIA
Memo
To: Wayne Wiadrowski
From: The Audit Manager
Date: 07/05/2019
Subject: Important Aspects to Consider in the Audit of API
The responsibility of the auditors is to take into consideration all the necessary aspects at the
time to conduct the audit operations. The main aim of this memo is to address the areas of
concern in the financial statements and internal control of Always Precise Instruments Pty
Limited (API) which involves in manufacturing and supplying small arms military
equipment. This memo addresses three specific aspects. First, it undertakes the analysis of
each of the provided ratios in order to identify the potential risks so that effective audit
procedures can be outlined. Second, it undertakes identifying the weaknesses in API’s
internal control for inventory system so that potential audit risks can be identified and audit
procedures can be developed. Third, it undertakes analysing two specific audit assertions and
the appropriate sampling procedures for them.
Potential Audit Risks from Ratios and Appropriate Audit Procedures
Ratio Analysis Audit Risk Audit Procedures
Current Ratio
The current ratio of
API has increased in
the current year
which is an indicator
that the current
assets of API has
increased as
compared to the
current liabilities.
This is good for the
company’s working
This increase in
current ratio is
related to audit risk
where the current
assets of API have
been overstated in
order to improve the
whole working capital.
The key motivations
for the management of
API to do so is to
improve the working
The audit procedure
in this situation will
include reviewing
the liquidity position
of the company
while checking the
balances of current
assets and liabilities.

2AUDITING AND ASSURANCE IN AUSTRALIA
capital (Khadafi,
Heikal & Ummah,
2014).
capital and to
decrease the debt
position (Gay &
Simnett, 2012).
Quick Asset Ratio
The increase in this
ratio is an indicator
of the speedy
conversion of
different current
assets in the quick
assets in order to
meet the short-term
business obligations.
The going concern
status of API can be
at risk since this
ratio is less than the
industry benchmark
(Babalola & Abiola,
2013).
This aspect is linked
with certain audit
risk where the
current assets of API
have been misstated
by converting them
into quick assets
which has led to the
increase in this ratio.
The audit procedure
in this regard will
include reviewing
and checking the
current assets that
have been recently
converted to quick
assets; they also
need to check the
balances of quick
assets along with the
necessary documents
in order to find any
kind of
misstatements.
Return on Equity
Decrease in this
specific ratio is an
indicator of the
increase in
shareholder’s equity
in API and decrease
in debt capital at the
same time (Ichsani
& Suhardi, 2015).
This situation is
connected with an
audit risk where
there can be
overstatement in the
balance of
shareholder’s equity.
The main incentive
of the management
of API behind this is
that it will
demonstrate
decrease in the debt
capital as per their
undertaken strategy
(Gay & Simnett,
2012).
In this situation, the
audit procedure will
include checking
and reviewing API’s
Board of Director’s
resolution for the
issue of equity share
along with checking
the register
maintained for the
issue of equity
shares. This
procedure will help
in finding any kind
of misstatement in
the values of equity
share of API in the
current year.
Return on Total
Though decrease in
this ratio is not good
for API, but it
implies that there is
decrease in the net
profit of the
This is related to the
potential audit risk
of misstatement of
their gross profit that
contributes towards
the misstatement in
The audit procedure
include checking the
necessary documents
and financial
statements related to
assets so that actual

3AUDITING AND ASSURANCE IN AUSTRALIA
Assets company and there
might be increase in
the company’s total
assets (Kurniasih &
Sari, 2013).
net profit. More
specifically, profit
may have been
understated.
Management’s
incentive behind this
step can be the
intention to stay
competitive (Gay &
Simnett, 2012).
increase or decrease
in the assets can be
ascertained. In
addition, the
profitability position
of the firm needs to
be observed to
identify any kind of
misstatements in the
profit (Kurniasih &
Sari, 2013).
Gross Margin
The main reason
behind the decrease
in this ratio is the
decrease in gross
profit and decrease
in sales might be
another major reason
for the decrease in
this ratio (Delen,
Kuzey & Uyar,
2013).
This aspect is related
to a specific audit
risk where there can
be misstatements in
the sales as well as
gross profit of API
in the current year.
Staying competitive
by decreasing the
gross profit can be
the main incentive of
the management or
this (Gay & Simnett,
2012).
The audit procedure
would include
reviewing the trend
of gross profit
margin as well as the
sales of the company
for past years. In
addition, the audit
procedure also
include examining
as well as checking
the sales invoices,
receipts and other
documents for
identifying the
material
misstatements in the
sales figures of the
company.
Marketing Expense
There is increase in
the marketing
expenses of API in
the current year and
it does not match
with the industry
standard. Net profit
of the company gets
affected with the
increase in
marketing expenses.
This aspect is
connected with the
potential audit risk
where the marketing
expenses may have
been overstated that
has an impact on
API’s profitability.
Increase in these
expenses provide the
scope to the
management to
decrease the sales
related expenses as
The main audit
procedure in this
aspect would include
thorough review and
check the marketing
expenses of API in
order to find any
kind of misstatement
in them. For this, the
auditor is needed to
examine the
vouchers, bills and
receipts related to
the marketing

4AUDITING AND ASSURANCE IN AUSTRALIA
per the adopted
strategy (Griffiths,
2016).
expenses (Gay &
Simnett, 2012).
Admin
Expenses/Sales
Decrease can be
seen in these
expense of API in
the current year and
this ratio matches
the budgeted ratio of
API. Decrease in
this ratio has
positive implications
on the company’s
profitability.
This ratio is related
to a potential audit
risk of
understatement in
the
administrative/sales
expensive that is in
line of the
undertaken strategy
of API. The main
incentive for the
management of API
behind this could be
their cost-cutting
strategy, especially
reduction in the sales
related expenses
(Johnstone,
Gramling &
Rittenberg, 2013).
The audit procedure
in this regard will be
the examination of
the documents such
as vouchers,
receipts, bills and
others related to the
administrative/sales
expenses in API in
order to identify any
kind of misstatement
in these kinds of
expenses in the
company (Gay &
Simnett, 2012).
Times Interest
Earned
Decrease in this
particular ratio is the
indicator that API
might not have
adequate earnings
for making the
interest payments.
Decrease in the
amount of long-term
debts can also be
another reason for
this.
This risk is related to
the potential audit
risk of earnings
manipulation by the
management that has
reduced API’s
ability to pay
interest. There is
also risk of
understatements in
API’s debt position
as a part of the
company’s existing
strategy (Aghghaleh,
Iskandar &
Mohamed, 2014).
In this situation, the
audit procedure will
include the
examination and
inspection of the
earnings of API in
order to identify
manipulation in
them. Moreover, the
auditor needs to
review the debt
position of the firm
in order to find any
kind of material
misstatements in
them (Johnstone,
Gramling &
Rittenberg, 2013).
Increase in days in
inventory implies
that API has taken
This particular
situation leads to the
potential audit risk is
Under this case, the
main audit
procedure will be the

5AUDITING AND ASSURANCE IN AUSTRALIA
Days in Inventory
more time to clear
their inventory in the
current year.
Increase in days in
inventor leads to the
decrease in
inventory turnover
of API.
misstatement in the
closing balance of
inventory of API in
the current year
which could be
responsible for the
decrease in
inventory turnover
ratio. This is a major
audit risk (Gay &
Simnett, 2012).
examination of the
inventory internal
control of API. More
specifically, the
auditor will be
responsible for
observing as well as
inspecting the
physical inventory
count process in
order to find any
kind of material
misstatement in the
closing inventory
balances of the firm
(Byrnes et al., 2018).
Days in Accounts
Receivable
Increase in the days
in accounts
receivable of API
implies that the
receivables have
been collected in
slow manner in the
current year as
compared to the
previous year.
This aspect is
connected with the
potential audit risk
of misstatements in
the closing balances
of accounts
receivable which
does not support the
policy of API to
reduce the level of
accounts receivable.
This is a crucial
aspect that the
auditor of API needs
to consider (Gay &
Simnett, 2012).
The appropriate
audit procedure for
this risk would be
methodically
checking as well as
examining all the
accounts receivable
due at the current
situation. In
addition, the auditor
would also be
required to check the
invoices, receipts
and other documents
related to the
collected accounts
receivable in the
current year. These
processes would be
helpful in
identifying any kind
of material
misstatement in the
accounts receivable
of the company
(Kuenkaikaew &
Vasarhelyi, 2013).

6AUDITING AND ASSURANCE IN AUSTRALIA
Debt to Equity
Ratio
Increase in the debt-
to-equity ratio
indicates towards the
fact that the
company is high
leveraged and it is a
good indicator for
the stable cash flow
of the company. At
the same time, this
also implies that
there is increase in
debt while decrease
in equity capital of
the firm.
The increase in this
ratio leads to the
potential audit risk
of misstatement in
the balances of debt
with the aim to make
the cash flow of the
firm better. In
addition, the
possibility of
misstatement in the
value of equity share
capital cannot be
ignored in this
situation (Gay &
Simnett, 2012).
The appropriate
audit procedure in
this case is the
examination of all
the documents and
agreement papers
related to term loans
in order to ascertain
the misstatement in
loan amount. In
addition, the value
of equity share
capital also needs to
be verified by
examining the
related documents of
share issue (Gul, Wu
& Yang, 2013).
Identification of Weaknesses in Inventory Internal Control, Audit Risk and Procedures
Internal Control Weakness Audit Risk Audit Procedure
The authorization to fill the
purchase orders and the
Copy 2 of GRN is on the
same person that is the
accounts clerk of API.
This internal control
weakness has the ability of
creating a potential audit
risk of misstatements in the
purchase orders. This
provides the accounts clerk
with the scope of
manipulating the purchase
orders which can lead to
excess or less orders of raw
materials (Abbott et al., ,
2016).
The audit procedure is the
proper segregation of duties.
It implies that two different
person will be responsible
for filling the purchase
orders and filling the Copy 2
of GRN. This will reduce
the risk of misstating the
purchase orders of the
company (Gay & Simnett,
2012).
The copy of the production
controller which he fill is
considered in order to match
the production orders and it
is weakness in the internal
control.
In this case, the potential
audit risk can be the
placement of wrong
production orders in the
presence of the fact that it is
not possible to verify the
fact that whether there is any
mistake or error in the
production report filled by
the production controller
The correct audit step in this
case is to establish an
approval of authority in this
system in which a specific
personnel will be authorized
for checking the production
report filled by the
production controller. This
will lead to the reduction of
this audit risk (Pizzini, Lin

7AUDITING AND ASSURANCE IN AUSTRALIA
(Gay & Simnett, 2012). & Ziegenfuss, 2014).
The computerized system of
API is responsible for the
selection of the suppliers of
raw materials and finished
goods on the basis of their
latest price as well as
delivery time. The whole
computerized system is a
weakness because errors in
the computer programming
can affects this whole
process.
This weakness leads to the
potential audit risk where
the supply of raw materials
and finished goods can be
misstated due to the errors in
the computer program
(Haislip, Peters &
Richardson, 2016).
The audit process regarding
this risk is to test and review
the computer system so that
any kind of errors in the
system can be detected and
avoided (Gay & Simnett,
2012).
The accounts clerk of API
possesses the access of
password of the master file
amendment. Thus, he can
make amendments in the
master file with the help of
the password. This is a
major weakness in the
internal control system.
This internal control
weakness can lead to the
potential audit risk where
the accounts clerk may do
unwanted amendments in
the master file in the areas of
existing stock items and
approved suppliers and sub-
contractors (Gay & Simnett,
2012).
Proper segregation of duty is
the required audit in order to
minimize this risk. This step
would involve in providing
the password access of the
master file to a personnel
who does not have access to
the transactions such as
finished goods, purchase
orders, raw materials and
others (Chen et al., 2014).
The suppliers as well as sub-
contractors mentioned in the
master file are entitled to
receive orders.
This leads to the potential
audit risk where the
employees with the access to
the master file as well as
other transactions can alter
the suppliers and sub-
contractors in a wrong
manner which can affects
the whole selection process
(Arnold Sr et al., 2013).
Proper segregation of duties
is the main audit procedure
in this case where the
employees having the
master file access will not
have any other accesses
related to master file since it
is needed to avoid the illegal
changes in the master file
(Gay & Simnett, 2012).
The production controller of
API has the authority or
right to make amendments
in the finished goods and
raw material related
transitions in the master file.
This is a major weakness
that can create the potential
audit risk of master file
misstatement since there is
not any standard process to
check the amendment made
by the production controller
(Gay & Simnett, 2012).
Since the production
controller has the access to
other production related
transactions, the audit
procedure would include
removing his access to bring
the changes in the master
file. The presence of an
employee needs to be

8AUDITING AND ASSURANCE IN AUSTRALIA
ensured for bringing
changes in the master file
and this employee must not
have any connection with
the other transactions (Tunji,
2013).
Another major weakness of
the inventory control of API
is that the inventory system
can produce a complete
stock listing at any time that
shows aspects like code of
stock, location wise
quantity, cost per unit and
others.
This particular internal
control weakness can create
the potential audit risk of the
issue of misstated stock
listing in the presence of the
problems such as wrong
master file amendments and
many others (Djordjevic &
Đukić, 2016).
To ensure the arrangement
of periodic reconciliation of
the whole inventory control
system would be the proper
audit step in this regards
since it would expose the
internal control weaknesses
of the inventory system
(Gay & Simnett, 2012).
The quantity of stock is not
included in the stock sheet
reports as the count team has
the separate responsibility to
complete this count.
This internal control
weakness can create the
potential audit risk of not-
identifying the errors in the
inventory counting process
that has negative impact on
the stock sheet report (Gay
& Simnett, 2012).
Thorough observation of the
physical inventory count is
the appropriate audit process
in this case which includes
re-performing the inventory
count process. This would
lead to the reduction in the
issues in the physical
inventory count of API
(Karim, Nawawi & Salin,
2018).
Sampling Methods
Assertion Which Population Sample Selection
Method
Justification for
Sample Selection
Method
Completeness
According to this
assertion, all transactions
and accounts need to be
presented in the financial
reports and
understatement of
inventory is addressed by
this assertion (Kharisova
& Kozlova, 2014). It is
needed for Wayne to
collect sample from the
inventories of finished
For the selection of the
sample from the
inventory of finished
goods, Wayne needs
to go for Systematic
Sampling method.
This particular method
demands Wayne for
the determination of
uniform interval by
dividing the total
number of physical
One major positive
aspect for the selection
of this particular
sampling method is the
fact that it adds
simplicity in the whole
auditing procedures.
At the same time, the
selection of systematic
sampling provides the
assurance that the
whole selected

9AUDITING AND ASSURANCE IN AUSTRALIA
goods. units in the whole
population at same
size (Gay & Simnett,
2012).
population of finished
goods will be sampled
in an even manner
which is considered as
a crucial factor for
examining the
assertion of
completeness.
Moreover, the presence
of more randomness
can be ensured under
this sampling method
by re-computing the
intervals every time
through using the
random number tables.
All these aspects have
major positive impact
on the whole audit
process of Wayne
(Sandvig et al., 2014).
Existence
As per this particular
assertion, it needs to be
tested whether the
inventory related
transactions have taken
place or not. For
addressing this particular
assertion, the sample
needs to be selected from
the items of inventory
purchase orders so that
they can be vouched to
purchase requisition
along with the receiving
reports. In the process of
voicing, a certain amount
is tracked back to the
supporting documents
(Griffith, Hammersley &
Kadous, 2015).
For the selection of
sample from inventory
purchase orders, the
method of random
sampling needs to be
selected. This method
of sampling will put
the obligation on
Wayne to select
samples from the
purchase orders on
random basis. Under
this method, it is
needed to use random
number table along
with document
number (Zhu et al.,
2013).
It is needed for Wayne
to select the random
sampling method in
the presence of the fact
that this sampling
method provides the
selected population the
equal chance to be
selected by the use of
random number tables.
This helps in bringing
accuracy in the whole
sampling process. This
is considered as the
easiest method to
extract large
population. In the
presence of these
reasons, random
sampling method
needs to be used in
order to test the
assertion of existence

10AUDITING AND ASSURANCE IN AUSTRALIA
(Gay & Simnett,
2012).

11AUDITING AND ASSURANCE IN AUSTRALIA
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