Audit Risks, Internal Control and Sampling Method of API

This memorandum discusses the potential audit risks in API through analysis of ratios and inventory-related internal control. It also explains the sampling methods required for performing the audit of API.

Running head: AUDITING
Auditing
Name of the Student:
Name of the University:
Author’s Note:
Course ID:

1AUDITING
Table of Contents
Audit risks from ratios and audit procedures:..................................................................................2
Inventory control loopholes, audit risk and audit procedures:......................................................10
Methods of sampling:....................................................................................................................14
References:....................................................................................................................................17

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Memorandum
To: Wayne Wiadrowski
From: The Audit Manager
Date: 10/05/2019
Subject: Audit Risks, Internal Control and Sampling Method of API
Scope and purpose:
In the current era, the auditors are needed to investigate and evaluate the financial reports
of the business organisations for finding any material misstatements owing to frauds and errors.
This is because such misstatements could have significant material impact on the financial
statements. As a result, the users of the financial reports could be misguided in terms of
undertaking decisions. The situation is similar for Always Precise Instruments Private Limited
(API). The memorandum intends to highlight the potential audit risks in the organisation via
analysis of the provided ratios and inventory-related internal control. Moreover, it explains the
sampling methods required for performing the audit of API. The considered aspects are
discussed in the below-stated sections:
Audit risks from ratios and audit procedures:
Ratio Analysis Audit Risk Audit Procedures
Current Ratio API has experienced
an increase in this
ratio; however, it is
lower than the
The misstatement in
current assets and
current liabilities is
identified as the likely
The auditor needs to
conduct document test
having connection
with payment as well

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industrial standard. It
might due to decline
in current liabilities or
increase in current
assets.
audit risk like rise or
fall in the above-
stated assets and
liabilities from
management
(Alzeban, 2015).
as acquisition of
current assets and
current liabilities.
This would help in
ascertaining thee
accurate values of the
same (Ball, Tyler &
Wells, 2015).
Quick asset ratio According to the
provided information,
this ratio has risen in
the present year
implying increased
ability of API in
converting its most
liquid assets into cash
that would help in
settling short-term
dues timely.
If there is material
misstatement in quick
assets or liabilities, it
would lead to audit
risk.
The auditor has to
conduct the detailed
test and controls
associated with quick
assets and liabilities.
For this, accounting
entries and books
have to be checked to
find out if there is any
misstatement in quick
assets or liabilities
(Brown, Preiato &
Tarca, 2014).
Return on equity The ratio has declined
in the current year by
Any misstatement in
equity capital could
The auditor has to
examine the

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falling below the
industrial average.
The reason might be
either rise in equity or
fall in net profit of
API.
lead to potential audit
risk resulting in rise or
decline in the ratio.
The misstatement of
equity could result in
debt minimisation as
well (Bryce, Ali &
Mather, 2015).
accounting records,
transactions and
books to find out the
treatment of equity
that would confirm
whether there is any
misstatement or not
leading to fall in risk.
Return on total assets The fall in this ratio
implies the inability
of API to generate
adequate profit from
its assets.
The material
misstatements in the
asset balances of API
could be the
significant audit risk,
as decline in the ratio
indicates the earnings
of the organisation
(Carson, Fargher &
Zhang, 2016).
The auditor is
required checking the
balances of accounts
as well as accounting
transactions of the
assets of the
organisation. This
process is beneficial
to identify material
misstatements in the
balances of assets
(Carson, Redmayne &
Liao, 2014).
Gross margin The trend is observed
to be declining and it
The potential audit
risks include
The auditor has to
check all sales and

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is below the industrial
average, which is
mainly attributed due
to fall in sales and rise
in cost of revenue.
misstatements in sales
and cost of revenue
values. The intention
might be to keep low
gross profit (Dowling,
Knechel & Moroney,
2018).
cost of revenue-
related transactions
along with examining
the internal control for
sales and gross profit
with the intent of
identifying material
misstatements.
Marketing expense API has experienced
increase in marketing
expense more than the
industrial average,
which would impact
net profit. With rise in
marketing expense,
there would decline in
operating income and
ultimately, the net
profit of the
organisation would
fall as well.
The misstatements in
marketing expense of
API could be
overstatement of the
same where API
could show lower
sales-related expenses
by representing
increased marketing
expense (Farooq &
De Villiers, 2017).
The auditor needs
checking the
accounting entries and
accounting books of
the organisation
associated with
marketing expense,
which would help in
detecting any
misstatement.
Admin expenses/sales Fall in this ratio is
inherent in 2018 and it
There could be
potential audit risk in
The auditor needs to
carry out the

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is below the market
standard. It is possible
to increase profit level
by reducing these
expenses.
this situation, as the
expenses of API
might be understated
deliberately.
accounting details and
information
associated with
payment and
occurrence of
administrative
expense of API. Such
audit procedure would
enable the auditor to
identify misstatements
in admin expenses
needed for risk
minimisation
(Ferguson, Pinnuck &
Skinner, 2016).
Times interest earned This particular ratio
has fallen in the
current year by going
below the industrial
average. Thus, it
denotes lower interest
expense of the
organisation
The misstatements in
interest payments of
API could be
identified as
considerable audit
risk, in which there is
a chance of
understatement of
The tests of control
and details are the
significant audit
procedures for this
situation. The auditor
has to review
accounting
transactions and other

7AUDITING
compared to the past
year. The inability to
manage considerable
earnings could be the
reason.
interest expense
leading to minimised
interest payment.
information related to
interest expense.
Therefore, the
misstatements would
be identified in the
interest expenses of
the organisation (Gay
& Simnett, 2017).
Days in inventory There is fall in
inventory days of API
in 2018 where the
organisation has
undertaken additional
time for settling its
inventory in the
existing year.
The significant
misstatements in the
closing balances of
inventory in API
could be the potential
audit risk. Therefore,
there is chance of
closing inventory
overstatement that
could minimise gross
profit.
The control test is the
major audit procedure
for the potential audit
risk, in which the
auditor is required
testing the process of
internal control of the
organisation. With the
help of such test, the
auditors would have
the scope of
identifying
misstatements in stock
in order to reduce risk
(Hay, Stewart &

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Botica Redmayne,
2017).
Days in accounts
receivable
Days in accounts
receivable of API
have increased in the
existing year. This
implies decline in
accounts receivable
turnover ratio of the
organisation in the
existing period.
The potential audit
risk includes accounts
receivable balances,
which could have
been overstated in the
present year owing to
weakness in internal
control and other
influential dynamics.
The tests of control
and details are the
significant audit
procedures, which
have to be applied in
this situation. In
accordance with the
processes, the auditors
need to test internal
control of the
organisation
associated with
accounts receivable
and accounting
records such as
transactions and
others associated with
accounts receivable to
be tested in the
current year. This
would assist in

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identifying accounts
receivable
misstatements (Kend,
Houghton & Jubb,
2014).
Debt to equity ratio This specific ratio is
observed to decline in
the existing year
possibly due to
increase in debt
The debt amount
misstatement is the
significant audit risk,
in which the debt
balances of API could
be overstated leading
to increase in the ratio
(Knechel, 2016).
The details test is the
significant audit
process, which needs
to be conducted for
investigating account
balances and
transactions
associated with debts
of the organisation in
order to identify any
type of material
misstatements. As a
result, there would be
reduction in audit risk.
Inventory control loopholes, audit risk and audit procedures:
Internal control weakness Audit risk Audit procedure

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Computer is accountable in
order to generate purchase
orders; in case, there is fall in
raw material stocks below
70%. This is a loophole, since
any error in the system could
result in disputed purchase
orders.
According to audit risk, this
specific deficiency has
significant effect on purchase
orders. These orders might be
lower than the requirements,
which could cause loss to API
(Loyeung et al., 2016).
Since this risk is related to
internal control, internal
control test is deemed to be
necessary. Therefore,
periodical testing is to be
performed by the auditor for
the computerised system that
would assure no scope of error
in the system and the update
of the system.
Depending only on the
computerised system for
production order generation is
a significant weakness in the
internal control of inventory in
API. The production orders
could be affected negatively
by any glitch or error in the
computer system.
Such weakness results in
specific audit risk, in which
the production process of the
organisation could be affected
significantly. As a result, there
might be either under-
placement or over-placement
of raw materials or finished
goods or both. It is possible to
change the date as well, which
could decrease the usability of
the ordered finished goods and
This situation has relationship
with control risk and the
internal control test would be
the necessary audit procedure.
In addition, the computerised
system has to be tested
periodically for assuring no
scope of error and update of
the overall system (Omoteso,
2016).

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raw materials (Nicoll, 2016).
It could be observed that the
API’s computer system is
accountable to choose the raw
material and finished good
suppliers depending on current
price as well as delivery time.
This is deemed to be a
deficiency owing to any fault
or error in the computer
system resulting in the choice
of incorrect suppliers.
This weakness could be
related to control audit risk
having the ability of impacting
the supply of finished goods
and raw materials. The right
suppliers might not be
selected, if there is any error.
Since this risk is identified to
be control risk in nature, there
needs to be application of
substantive audit procedure, in
which the accountability on
the auditor is to conduct the
computer system test
periodically (Pitt, 2014).
The accounts clerk of API has
access to password of the
amendments in master file and
the individual is liable to file
Copy 2 of purchase orders as
well as GRN.
There is chance of audit risk in
this situation, in which the
master file could be
manipulated by the accounts
clerk.
The needed audit procedure in
this situation is the test of
details, in which the auditor
has to test all master file
documents for detection of
fraud (Ruhnke & Schmidt,
2014).
It could be observed that the
production controller has the
password to print production
orders along with amending
Audit risk persists owing to
this internal control weakness,
in which under-production or
over-production could result
Appropriate division of
responsibility is the accurate
audit step, in which it is
needed for deterring the

12AUDITING
master file. This is an internal
control weakness, since it is
possible to amend the master
file by the production
controller through
manipulative printing of
incorrect production order.
in adverse impact on the
production of the organisation
compared to the requirement
(Salehi, 2016).
production controller from
having the two duties.
It could be witnessed that the
store staff has access of
password of both GRN
printing for finished products
and purchase orders of raw
materials. This is viewed as a
weakness, since fraud would
not be identified owing to the
fact that the employee bears
the accountability of both
GRN printing and purchase
orders.
Audit risk is related to this
weakness, in which the
production of finished goods
and raw material purchase
could be affected negatively.
The significant audit step in
this case is the division of
duty, in which two employees
would be accountable for
GRN printing and purchase
orders (Stewart, Kent &
Routledge, 2015).
The suppliers would be
provided with the sub-
contractors and suppliers
depending on the master file.
This weakness is associated
with audit risk, in which the
entire production method of
API could be affected
The accurate audit procedure
of internal control is to assure
that a single individual has
access to the master file,

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This is perceived as a
deficiency, as many
individuals have the authority
of amending the master file,
which develops the potential
for manipulation in choosing
sub-contractors and suppliers.
negatively owing to the
chance of manipulation in
selecting the sub-contractors
and the suppliers (Ferguson,
Pinnuck & Skinner, 2016).
which would reduce the
chance of manipulation and
frauds.
It could be observed that the
stock sheet report does not
take into account the stock
volumes, since they are
completed by count teams.
This could be seen as an
internal control weakness,
since wrong stock takes could
occur owing to the absence of
quantities.
A specific audit risk is
associated with such
weakness, which could have
negative effect on inventory
account. The inventory could
be either understated or
overstated in the organisation
(Dowling, Knechel &
Moroney, 2018).
The auditors are needed to
assure observation of physical
stock count as portion of audit
procedure owing to the
absence of misstatement in
inventory count. The quantity
inclusion is to be assured in
stock listing.
Methods of sampling:
Assertion Which Population Sample Selection
Method
Justification for
Sample Selection

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Method
Completeness This assertion implies
that the presence of all
accounts and
transactions have to
be made in the
financial reports. Such
assertion is associated
with inventory
understatement.
Owing to this reason,
Wayne needs to
collect sample from
purchased raw
materials as well as
finished goods.
Depending on the
nature of assertion,
the suitable method of
sample selection for
API would be the
systematic sampling
method. This needs
the determination of
uniform interval by
separating the entire
physical units from
the entire source
(Knechel, 2016).
This is the easiest
sample selection
method from the
perspective of the
auditors. In
accordance with this
specific method of
sample selection, it
could be ensured to
Wayne that an even
system would be
applied for sampling
of the overall
population of the
chosen sample.
Existence This assertion is
related to verify the
fact that transactions
about inventories have
taken place. This is
deemed to be a critical
assertion in relation to
Based on the nature of
assertion, the suitable
method of sample
selection for Wayne is
random sampling, in
which it is required
for the individual to
The major
justification for
choosing this method
is the presence of
equal opportunity for
the entire purchase
order population to be

15AUDITING
inventory. The auditor
is needed to choose
the sample from raw
material purchase, as
it offers the scope of
vouching them
opposed to the
purchase requisition.
This is a significant
process, in which the
auditors identify a
specific amount to the
supporting document.
choose the sample
from purchase orders
of API haphazardly.
This mandates the
need of using random
number tables (Bryce,
Ali & Mather, 2015).
chosen by Wayne
under the method of
simple random
sampling, which is
required for correct
audit sampling. It is
noteworthy to state
that API has large
amount of inventory
and thus, all of them
could not be taken, for
which random
sampling method
would be the best
procedure (Hay,
Stewart & Botica
Redmayne, 2017).

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emergence of the Big 4: Evidence from Australia. Chicago Booth Research Paper, (14-
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