Auditing and Ethical Practices

This study material provides insights into auditing materiality, significant items for audit, and preliminary analytical review. It also includes an analysis of key ratios of Rio Tinto and their implications.

Running head: AUDITING AND ETHICAL PRACTICES
Auditing and ethical practices
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1AUDITING AND ETHICAL PRACTICES
Table of Contents
Section 1..........................................................................................................................................2
Level of materiality......................................................................................................................2
Items those can be considered as significant for the purpose of audit.........................................4
Section 2..........................................................................................................................................5
Section 3........................................................................................................................................11
Reviewing statement of cash flows...........................................................................................11
Reviewing audit report..............................................................................................................11
Reference.......................................................................................................................................13

2AUDITING AND ETHICAL PRACTICES
Section 1
Level of materiality
One of the major concepts of audit is audit materiality that is the misstatement in the
financial statement taken place due to intentional error. Main objective of auditing is to express
opinion on the financial statement of the entity based on the presented financial information. The
auditor express the opinion regarding whether the information presented is not involved with any
material misstatement (Lai, Melloni & Stacchezzini, 2017). AUS 202 stated that the auditor shall
state in the auditor’s report that whether the report is prepared in accordance with the required
framework and all the material aspects have been taken care of (Auasb.gov.au, 2019). However,
various other factors those are taken into consideration while materiality is established are
reliability of the information those are provided by the entity’s management, accountant and
internal auditors, any significant changes taken place as compared to the previous year and other
qualitative and quantitative factors. There is an inverse relationship among the risk and
materiality level. If the level of materiality is high the audit risks level is low whereas the risk
level is high when the materiality level is low (Byrnes et al., 2015).
Planning materiality is the preliminary estimate made by the auditors in the audit
planning stage for financial statement items amounts. Level of planning materiality is the highest
amount by which it is believed by the auditors that the statements are likely to be misstated by
known as well as unknown frauds. In the preliminary stage the materiality impact of the item is
assessed individually and then in aggregate. Some of the bases are there those can be taken into
consideration while computing the materiality (Arens et al., 2016). These include net profit,

3AUDITING AND ETHICAL PRACTICES
gross revenue, shareholder’s equity and total assets. Higher and lower level for the mentioned
bases on which materiality is to computed are as follows –
Basis High level Low level
Net profit 5% 10%
Total revenue 0.5% 1%
Shareholder’s equity 2% 5%
Total assets 1% 2%
Materiality is generally established at the highest amount among all those are considered
as the bases. However, the tolerable level of misstatement varies between 20% and 80%. The
final level is determined based on the items, judgments, assumptions and estimates used by the
management for reporting the items in the financial statements. In case of Rio Tinto the level of
tolerable misstatement can be 40% of the materiality (William, Glover & Prawitt, 2016).
Rational behind choosing the materiality level
Materiality is the matter of professional judgments and the above mentioned items are
most significant items and are major items in the income statement and balance sheet. Hence,
these items can be taken as the bases for computing materiality. The level of materiality is
selected for Rio Tinto based on the fact that high amount involved in case of the items reported
in the balance sheet and income statement. Further, some of the items were there those required
the management’s judgmental approach and estimates (Eilifsen & Messier, 2014).
Quantitative estimate

4AUDITING AND ETHICAL PRACTICES
Taking into consideration all the above mentioned factors following amounts can be
considered for determining the level of materiality to be applied in case of audit of financial
statements of Rio Tinto.
Basis Amount
(million)
Materiality
Low level High Level
5% to 10% of the net profit $ 13,925.00 $ 696.25 $ 1,392.50
0.5% to 1% of the sales revenue $ 40,522.00 $ 202.61 $ 405.22
2% to 5% of the shareholder’s equity $ 49,823.00 $ 996.46 $ 2,491.15
1% to 2% of the total assets $ 90,949.00 $ 909.49 $ 1,818.98
Hence, from the above table materiality can be established at $ 2491.15 million.
However, the tolerable misstatement amount will be $ 2491.15 million * 40% = $ 996.46 million
or $ 1000 million approximately (Riotinto.com, 2019).
Items those can be considered as significant for the purpose of audit
Evaluating the financial statement of Rio Tinto it can be found that in case of reporting or
disclosing some of the items the judgments, assumptions and estimates made by the management
are used for reporting the items in the financial statements and hence the items are considered as
significant for the purpose of audit. These items are –
Provisions – provisions made by the entity for pension and post retirement healthcare,
entitlements of other employees, restoration and close down of environmental and other. Major
assumption used for determining the provision for pension as well as post-retirement benefits
includes expected level for payment of future funding for these accounts. Further, the provision
for entitlements of other employee includes provision for the ling service leave amounting to $
242 million (Riotinto.com, 2019). It is made on the basis of the assumption regarding
entitlements of group operation. Further, total amount of provision reported by the entity during

5AUDITING AND ETHICAL PRACTICES
the year closed 2018 amounted to $ 13,608 million. As huge amount and various assumptions are
used for providing provision this is regarded as significant item (Riotinto.com, 2019). For
auditing provisions following audit procedure shall be followed –
 Assuring that all the items under contingencies that will take place are considered for
providing amount as provisions
 The accounting treatment that is charging the amount of provision against the profit and
loss shall be verified
 Auditor shall look into the account and shall assure that amount for all the items of
provisions are properly disclosed with appropriate amount.
Commitments and contingencies – the entity committed to purchase as well as market a part of
output the Sohar Aluminium Company LLC and the entity immediately sells the product
purchased to 3rd parties. In addition to this it is committed for providing emergency funding to
Sohar Aluminium Company LLC, if required (Riotinto.com, 2019). For auditing Commitments
and contingencies following audit procedure shall be followed –
 Analysing the likelihood of occurrence – likelihood of the event to determine the impact
on the financial statement 1st its chances of taking place is to be estimated. There are
different levels of occurrence - remote, reasonably probable and probable. Events those
are reasonably probable and probable shall be considered as contingencies and disclosed
accordingly.
Section 2
Preliminary analytical review is carried out by the auditor to gain knowledge of the
client’s business and is carried out at the level of audit planning. It assists the auditors to assess

6AUDITING AND ETHICAL PRACTICES
the material risk involved in the financial statements and its operation to set up the extent, time
required and nature of the audit to be planned. It involves both management’s investigation as
well as analytical procedure that is established at the time when planning the audit for the client.
Various methods are there to perform the analytical procedure and one of such method is key
ratio analysis that helps in identifying the risk area and the trends of the ratios to understand the
overview (Coetzee & Lubbe, 2014).
Calculation of key ratios of Rio Tinto
Rio Tinto
2018 2017 2016 2015
Profitability ratio
Net income/sales
Net income 13925 8851 4776 -1719
Sales 40552 40030 33781 34829
Net profit margin
34.34
%
22.11
%
14.14
%
-
4.94
%
net income/total equity
net income 13925 8851 4776 -1719
total equity 49823 51115 45730 44128
Return on equity
27.95
%
17.32
%
10.44
%
-
3.90
%
Liquidity ratios
Current assets/current liabilities
Current assets 90949 95726 15055 15261
Current liabilities 10571 11225 9362 10046
Current ratio 8.60 8.53 1.61 1.52
(current assets-inventories)/current liabilities
Current assets 90949 95726 15055 15261
Inventories 3447 3472 2937 3168
Current liabilities 10571 11225 9362 10046
Quick ratio 8.28 8.22 1.29 1.20

7AUDITING AND ETHICAL PRACTICES
Leverage Ratios
Total debt/total equity
Total debt 41126 44611 43533 47436
Total equity 49823 51115 45730 44128
Debt Equity Ratio 0.83 0.87 0.95 1.07
EBIT/Interest
EBIT 18200 14474 7116 3976
Interest 552 848 1111 750
Times interest earned 32.97 17.07 6.41 5.30
Profitability –
2018 2017 2016 2015
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
Profitability
Net profit margin
Return on equity
Profitability ratios are used for measuring the earning ability of the entity from its sales
revenue and generating sales using shareholder’s equity. Analysing the last 4 year’s profitability
ratio it can be established that the profitability ratio of the entity are in increasing trend (Titera,
2013). Net profit margin of the company reached to 34.34% that was in negative in 2015. On the
other hand, the return on equity increased to 27.59% that was in negative in 2015. It indicates the
likelihood of overstatement of sales by the company (Riotinto.com, 2019).

8AUDITING AND ETHICAL PRACTICES
Liquidity –
2018 2017 2016 2015
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
Liquidity
Current ratio
Quick ratio
It is used for measuring the short term liquidity position of the company. Analysing the
last 4 year’s liquidity ratio it can be established that the liquidity ratio of the entity are in
increasing trend (Ruhnke, Pronobis & Michel, 2014). Current ratio of the company reached to
8.60% that was only 1.52 in 2015. On the other hand, the quick ratio increased to 8.28 that was
only 1.07 in 2015. It indicates the likelihood of overstatement of current assets like cash by the
company (Riotinto.com, 2019).
Leverage ratio -

9AUDITING AND ETHICAL PRACTICES
2018 2017 2016 2015
0.00
5.00
10.00
15.00
20.00
25.00
30.00
35.00
Leverage
Debt Equity Ratio
Times interest erned
Leverage ratios are used to assess the financial stability and long term sustainability of
the entity as very high level of debt equity ratio and lower time’s interest earned signifies that the
entity is not stable financially (Louwers et al., 2015). Analysing the last 4 year’s leverage ratio it
can be established that the leverage ratio of the entity are in reducing trend. Debt equity of the
company reduced to 0.83 that was as high as 1.07 in 2015. On the other hand, the time’s interest
earned increased to 32.97 times that was 5.30 times in 2015 (Riotinto.com, 2019).
Taking into consideration the findings from the ratio it can be determined that the
following accounts are required to be selected for the purpose of analytical review –
Revenues – revenues of the entity are continuously in increasing trend and reached to $ 40,552
million in 2018 from $ 34,829 million in 2015.
Key assertions –
 Cut off – sales revenue considered for the current period does not include any amount
that pertains to other period

10AUDITING AND ETHICAL PRACTICES
 Accuracy – amount of sales transactions reported are error free and reported at the full
amount (Kharisova & Kozlova, 2014).
Audit procedure –
 Cut off – sales balances shall be simultaneously verify with the amount of account
receivables and cash
 Accuracy – reported balance of sales revenues shall be verified with the amount in sales
register (Knechel & Salterio, 2016).
Cash – though much change are not there in cash balance, however being the most liquid item it
shall be considered for analytical review.
Key assertion –
 Completeness – all cash related receipts and payments have been taken into consideration
while prepared the statement
 Existence – all cash receipts and payments reported are error free and reported at the full
amount (Coetzee & Lubbe, 2014).
Audit procedure –
 Completeness – cash register transactions shall be matched with bank balance and
reported amount of cash in balance sheet
 Existence – all the payment invoices and bill receipt shall be matched with reported
balances (Christensen et al., 2016).

11AUDITING AND ETHICAL PRACTICES
Section 3
Reviewing statement of cash flows
 Cash flows from operating activities provided major cash inflows
 Cash used in financing activities were major outflows of cash
 Disposal of unincorporated joint operations, subsidiaries, joint ventures and associates
was primary source of cash receipt amounted to $ 7753 million and purchase of plant,
equipment and property and intangible assets was primary cash payment amounted to $
5430 million (Riotinto.com, 2019).
 Non-cash investing and financing activities were equity dividend paid to the owners of
the entity
 From the cash flow statement of the company it is identified that for all the activities
big differences are not there in cash inflows and outflows. However, cash used in
investing activities for past 2 years has been converted to cash inflow in 2018. Further
the cash balance is increased from $ 10,550 million to $ 10,773 million in last 2 years.
Hence the positive changes are signifying that the going concern assumption of the
entity is in order (Riotinto.com, 2019). However, cash from operation is indicating risk
for which the auditor shall reconcile all the operational payments and receipts with the
respective invoices and bill receipt and with the day’s cash register as well as bank
account.
Reviewing audit report
For the year closed at 30th June 2018, the audit of the company’s financial statement
carried out by PricewaterhouseCoopers. They expressed unmodified opinion stating that the

12AUDITING AND ETHICAL PRACTICES
financial statements provide true and fair view of the entity’s financial position (Riotinto.com,
2019).
Additional section that indicates the audit issue is the following key audit matter reported
in the auditors –
 Impairment charges for property plant and equipment amounting to $ 56,361 million and
intangible asset with finite lives amounting to $ 1,095 million for the year closed on 30th
June 2018 reported in the previous year
 Provisions made by the company on the basis of restoration and rehabilitation activity,
however there were limited number of restoration and rehabilitation activity and were not
sufficient to be considered as the benchmark for future years (Riotinto.com, 2019).

13AUDITING AND ETHICAL PRACTICES
Reference
Arens, A.A., Elder, R.J., Beasley, M.S. & Hogan, C.E., 2016. Auditing and assurance services.
Pearson.
Auasb.gov.au. (2019). Retrieved 15 May 2019, from
https://www.auasb.gov.au/admin/file/content102/c3/AUS_202.pdf
Byrnes, P.E., Al-Awadhi, C.A., Gullvist, B., Brown-Liburd, H., Teeter, C.R., Warren Jr, J.D. &
Vasarhelyi, M., (2015). Evolution of auditing: From the traditional approach to the future
audit. Audit Analytics, 71.
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internal audit engagements. International Journal of Auditing, 18(2), pp.115-125.
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14AUDITING AND ETHICAL PRACTICES
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http://www.riotinto.com/documents/RT_2018_annual_report.pdf
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