Impact of Fraud on Audit Quality

This assignment analyzes the significant impact of fraudulent practices on audit quality. It examines how manipulations in financial records, such as falsifying inventory levels or sales receipts, distort the true and fair view presented by financial statements. The document emphasizes that fraudulent practices necessitate extensive auditing efforts to identify discrepancies and verify information. It further discusses the implications of qualified opinions issued due to substantial uncertainties arising from fraud, potentially casting doubt on management's integrity and impacting stakeholders' trust.

AUDITING

Auditing
Answer – 1
The financial and nonfinancial decision can be taken with the aid of analytical procedure. An
Analytical procedure is of paramount importance to the auditor and the management at large.
In this scenario, the analytical process is conducted for DIPL Ltd that will shed light on the
performance and depict a correct view. Further, this process is of immense help while tracing
any defects in the financial statements and prevents any fraudulent activities. The analytical
procedure can be performed depending upon the nature of the business and the results that are
required (Ghandar & Tsahuridu, 2013). As per the case of DIPL Ltd, the two major analytical
processes undertaken are:
Firstly, the information that is contained in the financial report is compared with the past
figures (three years) to project a trend and to trace any differences that are present. Moreover,
such a comparison can be done with that of the industry standards and the patterns can be
observed. The trend of the business can be noted with the aid of the comparison. Moreover,
any deviations can be easily traced and the reason can be fetched. From the financial
statements, it can be observed that the company made a stupendous increment in sales that
augurs well for the company (Cappelleto, 2010). The figures indicate a strong momentum for
the company, however, if compared with the stock figure there is a big difference because the
stock figures have inflated even considering the fact that the sales have increased. It is a
matter of concern because the sales and the stock figure have increased simultaneously
(Nicolaescu, 2013). Therefore, the auditor needs to consider this difference and trace the
exact reason for the same.
Secondly, the process of ratio analysis can be used to know about the trend and is one of the
major tools for the purpose of evaluation. There are different ratios that can be computed to
find the pattern of movements. For DIPL Ltd, the ratio is computed for a period of three
years ranging from 2013 to 2015. Going through the process of analyzing the ratio
computation must contain profitability, liquidity and solvency ratio that will boast regarding
the performance and the trend. The profitability ratios stress on the profits earned by the
company through net profit and gross profit margin (Porter & Norton, 2014). Secondly, the
liquidity ratio indicates whether the company is in a position to discharge all the obligations.
Thirdly, the solvency ratio indicates whether the company has a higher proportion of debt or
equity.
Profitability ratio – Gross profit and Net profit ratio
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Auditing
Gross profit ratio 2013 2014 2015
Gross profit (I) 6004500 6079500 6604500
Sales (II) 34212000 37699500 43459500
GP ratio = Gross
profit/sales*100 17.55% 16.13% 15.19%
Net profit ratio 2013 2014 2015
Net profit (I) 2359190 2291362 2972183
Sales (II) 34212000 37699500 43459500
NP ratio = Net profit/ Sales
*100 6.90% 6.08% 6.84%
Going by the ratio computation above, the profitability ratio signifies that DIPL Ltd has
performed effectively. However, the gross profit ratio has declined in all the three years and
this can be cited due to a strong increment in the cost of sales. On the other hand, the
company has seen an increase in the net profit ratio that is due to a strong command on the
expenses (Shah, 2013). Hence, the blend of gross profit and net profit indicates that the
company has maintained a consistent level.
Liquidity ratio – Current ratio and Quick Ratio
Current Ratio 2013 2014 2015
Current assets 5385938 7509150 9600929
Current liabilities 3780000 5120250 6397500
Current Ratio = Current assets/ Current
liabilities 1.42 1.47 1.50
Quick Ratio 2013 2014 2015
Quick assets 3129750 4837788 5420429
Current liabilities 3780000 5120250 6397500
Quick ratio = Quick assets/ Current liabilities 0.827976 0.944834 0.847273
Current ratio and the quick ratio has been used to shed light on the liquidity of DIPL Ltd.
The current ratio of the company is more than 1 meaning for every current liability, the
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Auditing
company has 1 current asset. Hence, the computation reveals that the company has more of
current assets in respect to current liability that boasts of the strong liquidity. On the other
hand, the quick ratio is computed ignoring the stock and hence, is a better indicator of the
liquidity. It is near to the standard ratio of 1:1 therefore, the liquidity position is strong and
the company can meet the obligations.
Solvency ratio – Debt Ratio and Equity ratio
Debt Ratio
2013 2014 2015
Total liabilities 3780000 5120250 13897500
Total Assets 12930000 15903900 26147991
Debt Ratio 0.292343387 0.321949333 0.53149
Equity Ratio
2014 2013
Total Equity 9150000 10783650 12250491
Total Assets 12930000 15903900 26147991
Equity Ratio 0.707656613 0.678050667 0.46851
As per the ratio computed above, that is the debt ratio and the equity ratio, it can be
commented that the company’s debt increase in all the three years and is above.50 in 2015
that is an alert for the management. Higher debt will erode the company’s profitability.
Secondly, the equity ratio has dropped considerably and a lower equity ratio strikes that the
company will have more debt financing servicing costs.
The above facts will have a strong impact on the profits and fluctuations can be witnessed.
Therefore, the auditor must ascertain the validity of the ratios and ensure that such ratios are
derived from the genuine figures.
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Auditing
Answer 2
When it comes to the point of inherent risk, there are hardly any remedial actions because the
inherent risk is present in the nature of the business. It does not rely on any act of omission
or faults. In the case of DIPL Ltd, the two major inherent risk are as follows:
1. Error in the new IT system launch
In DIPL Ltd, a new IT system was launched that was completely automated and contained
the features to record everything on its own. As per the IT manager, it was said that the new
system was floated without any previous research. Before any project, it is essential that a
pilot testing needs to be done so that the observations can be made. Before the initial launch
or when the testing was done on a preliminary basis, it was noticed that many transactions
that were appearing at the end of the year were not allocated correctly (Subramanyam &
Wild, 2014). This means the transaction of one period will be reflected in another hence, will
lead to significant differences. In short, the profit figures will be impacted. It is a case of
material misstatement and moreover, the officials in the organization are aware of the fault in
the software and hence can use it for gaining an additional advantage (Niemi & Sundgren,
2012). Hence, such a faulty practice will lead to practice that is unethical and will erase the
company’s goodwill.
2. Appointment stands unethical
When it comes to the appointment process, the management must ensure that the appointment
of CEO must be an independent person who does not have a financial interest in the
company. However, in the case of DIPL Ltd, it was observed that the CEO was appointed
that has a financial interest. The provision stands that the CEO will have 10 percent share in
the profit if the growth of the company surges 10 per cent and more. The inherent risk stands
in the way that is the CEO will try to drive the business so that he attains the desired share in
the profit. However, if the company fails to attain the desired growth then there is a chance
that the CEO will indulge in misstating the records so that profits can be enhanced (Bhasin,
2008). This even impacts the internal audit and manipulations chances are very prominent.
The above two condition seriously pose a big threat to the financial report. The IT system
was launched before any testing and the transactions were allocated incorrectly that is bound
to create problems in the profit figures. Secondly, the appointment of a CEO having a
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Auditing
material interest is altogether against the ethical standards and the appointment is sure to
create problems in the financial statements.
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Auditing
Answer – 3
Going by the prevalent situation in DIPL Ltd, two fraud risks can be observed in the
following scenario:
1. Abandoning the old IT system
When the new system was implemented, the company failed to have a clear cut planning that
leads to a big difference. Many entries that form a part of the last year failed to appear in the
new accounting system. This incident can be due to the practices of accountants and
management who needed a way to tamper the records. It is clearly visible that the cash
balance of the company has had a strong fall (Cappelleto, 2010). No reason for the fall in the
cash scenario has been provided and neither any reasons are visible that projects the new
system was altogether used for fraudulent activities.
2. Valuation of the inventories
It was noted that the sales of the company reached a strong peak in the year 2015 however, in
consideration to that the level of inventories too rose strongly indicating a big issue. The
level of inventory must showcase a fall because the sales increased, however, an opposite
situation was observed. The rise in the level of inventory depicts the deficiency in the practice
(Elder et. al, 2010). This can be an act of management whereby the level of inventory has
been purposely increased to tamper the accounts.
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Auditing
Answer 3 (b)
Fraudulent practice always impacts the conduct of the audit because the auditor needs to
provide a true and fair view. If the statements contain a wrong figure or figures that are
manipulated the auditor will end up giving a different view that might lead to the wrong
judgment. The fraudulent practices mentioned above will have a strong impact on the
financial statements and will deteriorate the audit quality too. It might happen that the amount
that was falsified was huge and that will impact the overall figure (Messier & Emby, 2005).
Moreover, the auditor will need some time to get acquainted with the new system and hence,
this will consume time. The entries will be required to be checked and since the transaction
was recorded for the wrong period will create doubts (Arens et. al, 2013). The auditor will
provide a judgment when the relevant evidence are present. In the case of big differences and
absence of relevant material, the auditor will present a qualified opinion and that will lead to
questions on the management. Such a report is doubted by the outside parties. Further, the
auditor needs to have a detailed research on the inventory level, the sales receipts, etc.
Valuation of inventories will affect the audit quality and hence, it is the duty of the auditor to
conduct a detailed analysis to trace the variations otherwise the auditor will end up giving an
unqualified opinion (Wood, 2011). Therefore, the auditor must apply reasonable skills and
cross check the data to provide an unqualified opinion.
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Auditing
References
Arens, A. A, Best, P. J, Shailer, G. E. P & Loebbecke, J. K, 2013, Assurance Services and
Ethics in Australia, 9th ed, Australia: Pearson.
Bhasin, M. L 2008, ‘Corporate Governance and Role of the Forensic Accountant’, The
Chartered Secretary Journal, vol. 38, no. 10, pp. 1361-1368.
Cappelleto, G. 2010, Challenges Facing Accounting Education in Australia, AFAANZ,
Elder, J. R, Beasley S. M.& Arens A. A 2010, Auditing and Assurance Services, Person
Ghandar, A & Tsahuridu, E 2013, The Auditing Handbook 2013, Australia: Pearson.
Messier, W & Emby, C 2005, Auditing & Assurance Services: A systematic approach,
McGraw-Hill.
Nicolaescu, E., 2013, ‘ Understanding Risk Factors for Weaknesses in Internal Controls over
Financial Reporting’, Psychosociological Issues in Human Resource Management, vol. 1,
no. 3, pp.38-44.
Niemi, L & Sundgren, S 2012, ‘Are modified audit opinions related to the availability of
credit? Evidence from Finnish SMEs’, European Accounting Review, vol. 21, no. 4, pp. 767-
796.
Porter, G & Norton, C 2014, Financial Accounting: The Impact on Decision Maker, Texas:
Cengage Learning
Shah, P 2013, Financial Accounting, London: Oxford University Press
Subramanyam, K & Wild, J 2014, Financial Statement Analysis, McGraw Hill
Wood, D A 2011, ‘The Effect of Using the Internal Audit Function as a Management
Training Ground on the External Auditor's Reliance Decision,’ The Accounting Review, vol.
86. No. 6
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