Auditing and Assurance services at API

This document provides an analysis of the financial ratios of Always Precise Instruments Pty Limited (API) to identify potential audit risks. It also suggests audit procedures that can be undertaken to reduce the audit risk. The document discusses various ratios such as current ratio, quick asset ratio, return on equity, return on total assets, gross margin, marketing expense ratio, admin expenses/sales ratio, times interest earned, days in inventory, days in accounts receivable, and debt to equity ratio. It also highlights internal control weaknesses in the inventory system and suggests audit procedures to reduce the risk.

Auditing and Assurance services at API 1
AUDITING AND ASSURANCE SERVICES AT API
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Auditing and Assurance services at API 2
Auditing of Always Precise Instruments Pty Limited
Question 1 8%
Analysis of Always Precise Instruments Pty Limited (API) ratios to identify potential
audit risks and identifying audit procedures that could be undertaken to reduce the audit risk.
TO: WAYNE WIADROSKI, SENIOR AUDITOR
FROM: AUDIT MANAGER
DATE: 12TH MAY 2019
Always Precise Instruments Pty Limited (API),
SUBJECT: AUDITING OF ALWAYS PRECISE INSTRUMENTS PTY LIMITED (API)
I have checked the financial statements and the underlying books of account for Always
Precise Instruments Pty Limited (API) for the financial year ending 31st December 2018 and I
have come up with the following analysis. I have arrived at these analyses by comparing the
financial performance for the company reported in the financial period ending 31st December
2018 against the budget, the previous year's performance and the industry benchmark. From the
analysis, I have realized that there are a number of audit issues that need to be examined during
the audit. These issues are summarized in the tables below. They include analysis of the financial
ratios to establish the audit risks associated which each type of ratio, assessing the internal
control weaknesses in the inventory system for the company and the potential audit risks that are
posed by the weaknesses and the Internal control weaknesses in the inventory system for API
company and potential audit risks posed and test counts for year-end stocks that needs to be done
through audit sampling to test the completeness and existence assertions.

Auditing and Assurance services at API 3
Ratio Analysis Audit risk Audit procedure to Reduce risk
The current ratio of
1.64
The current ratio for API has
increased slightly from 1.54 in
2017 to 1.64. This increase can
be due to the build-up in the
inventory. Although the current
ratio is slightly below the
industry benchmark of 1.84, it
is a bit higher than the budget.
Additional audit attention is
required here because there
might have been potential
manipulation of the current
assets so as to boost the current
ratio. It is also possible that
there might be an
overstatement of receivables
and inventory either following
a change in the accounting
method for inventory from
FIFO to average cost method
or to LIFO, which is likely to
have contributed to part of the
increase in the value of
inventory.
Control Risks Recalculate the accounts
receivables balances and inventory
turnover ratio to ensure that it is
reasonable compared with the
industry benchmark and the
previous year.
Gather sufficient., reliable and
appropriate audit evidence to
ensure that the true value of the
accounts receivable and inventory
has been reported.
Assess also whether all short terms
liabilities have been reported and
at the correct amounts.
Quick asset ratio of
0.91
The quick asset ratio of 0.91
recorded in 2018 is an increase
of 0.04 from 2017 and it is
slightly below the industry
benchmark of 1.1. This
, therefore, needs to be
counterchecked as any
variance could indicate that the
company can experience
problems with paying its
creditors and hence a potential
sign of going-concern. In any
case, the ratio might actually
be worse if there was a
possible overstatement of
receivables as has been
suspected above. In this case,
therefore, more audit attention
should be given to the cash
flows of the company.
Detection risks Trace all sales receipts and other
banking’s to identify whether they
‘are recorded correctly in the
books. Look at details including
the amounts, in particular, dollar
amounts, descriptions and
document dates are recorded
correctly and in an organized
manner.

Auditing and Assurance services at API 4
Return on equity:
14.7%
The return on equity for API
reduced from 16.6% in 2017to
14.7% in 2018. This is way
below the budget of 18.4% and
the industry benchmark of
17.3%. The decrease in the
return on equity is attributed to
the reduction in the gross
margin and an increase in debt
to equity ratio. This means that
the company’s reliance on debt
increased in 2018 as depicted
by the debt to equity ratio.
Detection risks Assuming that the reduction in
return on equity is attributed to a
decline in gross profit for the
company, it would be worth
investigating and evaluating what
the borrowings did in 2018 by the
company was meant for. Check
the loans balances to verify if there
are loans that are not being repaid.
Verify that there are proper
records for authorization before
loans are borrowed.
Return on total
assets:12.5 %
The return on total assets
reduced from 14.9% in 2017 to
12.5 % in 2018 which is also
below the budget and industry
benchmark which are at 16.0%
and 16.3 % respectively. The
decrease in return on equity is
due to the decrease in gross
margin. However, attention
should be given on how the
assets were valued and
recognized in the books
(whether they conform to
International Accounting
Standards, IAS)
Inherent risks Examine the documentation that
records the assets purchased and
revaluation(depreciation) of the
existing assets. Recalculate the
accounts of property plant and
equipment to ensure they are
accurate and reasonable as
compared with the previous
period. Check the underlying
books that support the purchasing
of more assets during the year.
Gross margin of 6.5
%
The gross margin for the
company reduced from 10.3%
in 2017 to 6.5% in 2018. This
is below the budget provision
and industry benchmarks. A
reduction in gross profit means
that there is a possibility for
some inventory being obsolete
due to slow sales. It could also
mean that some of the stock
could be sold by discount due
to avoid obsolescence.
Inherent risks Examination and verification of
the significance of fixed assets
additions and/ or investments in
generation of additional income
and consequently profit.
Marketing expense
4.4 %
The marketing expense ratio
for API in 2018 was at 4.4 %
an increase of 0.6% from 3.8%
in 2017. The ratio is above the
budget provision and industry
benchmarks set at 3.6% and
Control risks Scrutinize the marketing expense
accounts in the books to establish
if there are amounts that should
have been capitalized or
reclassified as developments costs
in the trial balance. Countercheck

Auditing and Assurance services at API 5
4.0% respectively. Audit
attention is required to
establish the reason for an
increase in marketing expenses
despite the decline in sales
amounts and consequently the
gross profit.
if all the expenses classified as
marketing expenses related to the
direct promotion of the core
products of the company.
Scrutinize to establish if there
were any unnecessary marketing
expenses not directly related to
marketing of the company’s
products.
Admin
expenses/sales 3.4 %
The admin expenses to sales
ratio for API company in 2018
was 3.4% which is at par with
the budget but slightly less
than the ratio for 2017. The
ratio is also below the industry
standard which is set at 3.8%.
There is no serious audit
concern for this but attention
should be placed on how the
expenses were classified.
Detection risks Examine the expense control
accounts and verify the procedures
that are taken before an expense is
incurred (paid) and the control
measures set to bar unnecessary
expenditure. This will help to
determine if the admin expense
figures arrived and recorded in the
trial balance are relevant and
accurate
Times interest earned
3.6
The time's interest earned for
API reduced from 4.6 in 2017
to 3.6 in 2018. This is against
the budget provision set at 6.3
and industry benchmark at 4.2.
A reducing times interest
earned that the ability of the
company to cover its interest
charges based from gross
income is decreasing. Audit
attention is required to
establish if the company will
be able to meet its interest
portfolio in the near future.
Control risks Countercheck how much the
company is required to repay in
terms of interest on loan,
overdrafts, bonds and other
contractual debt to establish
whether the times on interest
earned ratio is showing a true and
fair value of the company’s state
of affairs.
Days in inventory:
34.9
Days in inventory increased
from 32.9 in 2017 to 34.9 in
2018. This is below the budget
line set at 32.3 and industry
benchmark at 31.8. An increase
in the days in inventory means
that the company’s stock is
moving slowly. Audit attention
is required to establish why the
stocks are taking too long to
clear.
Detection risks The audit needs to examine the
reasons for slow-moving
inventory. Given that the days in
accounts receivable has increased,
sales should be moving faster due
to more lenient credit terms.
Documentation of all discount
sales made should be
counterchecked to establish if the
slow-moving inventories were
cleared at discounted prices.

Auditing and Assurance services at API 6
Days in accounts
receivable: 53.0
The ratio has increased over
the two years from 51.5 in
2017 to 53.0 in 2018. This is
way above the budget and the
industry benchmark which
were set at 49.8 and 46.9
respectively. An increase in the
days in inventory means there
could be increasing leniency in
terms of credit policy in a bid
to generate more sales.
Audit attention is required as
lenient credit terms may have a
subsequent effect on the
collectability of accounts
receivable.
Control risks Checking the documentation for
terms of sales, the authorization of
credit to credit customers,
counterchecking if the credit
policy for the company is adhered
to by selecting a sample of debtors
accounts checking their credit
balance in reference to their limit
and credit terms.
Debt to equity
ratio:0.61
The debt to equity ratio for API
increased 0.52 in 2017 to 0.61
in 2018. This is against the
budget which was set at 0.43
and the industry benchmark. A
higher debt ratio means that the
company’s reliance on debt as
compared with equity is
increasing.
Assuming that much of the
borrowings in the earlier years
were used to purchase assets
and boost production, it would
be worth examining what the
recent borrowings were meant
for.
Detection risks Examining the reason for
increased borrowings and the
company’s increasing dependence
on debt. Documentation for
borrowings needs to be
counterchecked to assess the
ability of the company ability to
repay the debt.
Question 2 8%

Auditing and Assurance services at API 7
Internal control weaknesses in the inventory system for API company and potential audit
risks posed.
Internal control weakness Audit risk Audit procedure to reduce risk
Production orders for finished
goods are not being authorized
prior to be sent
Inherent risks Since there might be historical events that could adversely
affect the valuation of inventory, the examination needs to be
done on the number of days that stock is being held. The risk
of obsolete stock should also be counterchecked by
inspection of production order documents and reports.
The inventory system produces a
stock sheet that lists and describes
all the items held in the finished
goods store but does not record the
quantities.
Control risks Countercheck the records kept by the finished goods store
staff with those kept in the Masterfile maintained by the
accounts clerk.
There is no credit approval Inherent risks Examine if there is any form of signed approval by the credit
manager or the Chief Financial Officer acknowledging the
sale on credit. Check if credit limits for debtors are
maintained and if so if the limits match the balances in the
signed forms.
There are no established
procedures for the review of
purchase orders amounts.
Detection risks Verification of any supporting documentation on the
purchase of raw materials and examine if there is any
evidence of review of purchases amount.
Quantities of finished goods are
not invoiced by the accounts clerk
at the point they are being
delivered. Copies of production
orders ought to be kept by the
Control risks Inspect the reconciliation of sales invoices to the shipments
by comparing the purchase order balances from the records
kept by the finished goods store staff and those maintained
by the accounts clerk both in the master file and from Goods

Auditing and Assurance services at API 8
accounts clerk and reconciled with
quantities in the Goods Received
Note produced by the suppliers.
Received Notes.
Supplier statements are not being
e-mailed monthly to customers to
facilitate queries and follow up of
payments. This could be the
reason for the increase in the days
in accounts receivable. The system
should be designed to
automatically sent statements to
the suppliers to assist them in their
reconciliation and also enable
them to know the amounts of their
debts.
Inherent risks The audit should check whether the debtors account balances
are correct and are reconciled every month to ensure that
suppliers are aware of the amounts they are supposed to pay.
The evaluation also needs to be done to assess whether
suppliers get access to their statements to assist them to settle
their debts.
No segregation of duties. The
accounts clerk has the rights to
effect Masterfile amendments.
This means that the same person is
tasked with receiving sales
invoices, entering them into the
system, checking the correctness
of purchase invoices and payment
of suppliers.
Inherent risks The audit needs to observe and confirm how the functions to
do with receiving, entering and payment of suppliers are
performed by the accounts clerk. It is not ideal for the same
person to check, pay and approve the same process.

Auditing and Assurance services at API 9
There are no physical requisitions
forms from the production
departments to accompany the
automatic system generated
purchase orders which means that
if there is a system disorder,
ordering of raw materials can be
delayed
Control risks Pick a sample of purchase orders filed in the production
department and compare with the purchase requisitions made
by the company filed in the master file to ensure that the
corresponding purchases are correct.
The lack of hard copy
documentation of sales.
Detection risks The audit needs to check the automatic controls of the
system to verify that all the posting of sales is done
appropriately to the right accounts. In this case, Computer
Assisted Auditing Techniques (CAAT's) needs to be used.
Purchase requisition being done by
the purchasing department instead
of being done by the department
that requires the raw material. The
procedure of having the store
department issuing voluntary
requisitions should not be the case
as this can result in the ordering of
unwanted stock, therefore,
reducing the cash flow of the
company.
Inherent risks Examination of purchase requisition sheets to establish if
indeed the purchased raw materials were as a result of
demand by the relevant department or not. The system
should be checked if it is efficient in terms of raising
production orders when finished goods fall below the set
benchmark.

Auditing and Assurance services at API 10
Question 3 4%
API test counts of year-end stocks through sampling to test the existence and
completeness assertions.
Assertion Which population? Sample selection method Justification for the sample selection method
Completeness  Purchase
orders (raw
materials)
 Suppliers’
invoices
 Finished
goods stock
 Statistical method
 Non-statistical
method
 Statistical Method
The statistical method of sampling is applicable
here as the accounting of the numerical figures
and sequence of the purchase order reports need
to be reviewed here.
The non-statistical method is appropriate here
because judgment can be used to assess the
evidence for the numerical sequence created by
the system in the numbering of invoices.
This method is appropriate as it helps the audit to
compare the goods received by the store's
department after counterchecking for any
damage or substandard quality with those kept
by the purchasing department or the accounts
clerk. Assessment should also be done to
establish if the goods supplied are vouched to the
supplier in reference to goods type and quantity.
Existence  Purchase
orders
 Variable sampling Variable sampling is required here to verify that
there is a documentary trail of evidence to
support all the purchases made. This sampling is
intended to evaluate whether there is physical
evidence of order forms and whether it has
signatures showing approval.

Auditing and Assurance services at API 11
 Suppliers
Invoices
 Finished goods
stock
 Attributive
sampling
 Variable sampling
This method is appropriate as it enables the audit
to check to estimate the existence and occurrence
of the supplier's invoice numbers both in the
system and in hard copy. This assists to establish
the proportion of accuracy for the existence of
suppliers invoices as a point of interest.
The variable sampling method is appropriate
here as it can be used to verify the existence of
finished goods physically present in the finished
goods store. This method also can help the audit
to establish if the finished goods physically
presented in the store are matching those in the
system.

Auditing and Assurance services at API 12
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