Auditing and Ethics: Materiality, Audit Materiality, Disclosures, Ratios, Cash Flow Statement, and Audit Report

This article discusses the concept of materiality in auditing, how to calculate audit materiality, and the importance of disclosures and draft notes. It also includes a table of ratio computation and an analysis of the cash flow statement. The article concludes with an overview of the audit report for Perpetual Limited.

Running head: AUDITING AND ETHICS
Auditing and ethics
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Table of Contents
Section 1.....................................................................................................................................2
Materiality..............................................................................................................................2
Audit materiality for Perpetual Limited.................................................................................3
Disclosures and draft notes....................................................................................................4
Section 2.....................................................................................................................................5
Ratio computation..................................................................................................................5
Section 3.....................................................................................................................................8
Cash flow statement...............................................................................................................8
Audit report............................................................................................................................8
Reference..................................................................................................................................10

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Section 1
Materiality
While the auditor carries on the audit procedure the main objective is to express the
opinion regarding whether the financial reports are presented in all the material aspects, as
per the applicable framework for financial reporting. This is separate decision and separate
responsibility that is made by the company while preparing the financial reports (Christensen,
Glover & Wolfe, 2014). In auditing context, the term materiality is the threshold limit above
which the incorrect or missing information related to financial statement is deemed to have
impact on the user’s decision making aspect. Sometimes it is construed in terms of the total
impact on the profits reported or changes in percentage for some specific items included in
financial statement (Moroney & Trotman, 2016). Steps involved in determining the
materiality are as follows –
 Identifying external as well as internal shareholders
 Conducting initial outreach for the shareholders
 Identifying and prioritizing what needs to be measured
 Designing the materiality survey
 Launching the survey and starting with insight collection
 Evaluating the insights
 Putting the insights into action (Legoria, Melendrez & Reynolds, 2013).
At the stage of planning the auditor is required to analyse the materiality with regard
to the financial statements. Calculation of the materiality involves both qualitative as well as
quantitative methodologies. Once the materiality involved in financial reports are identified
and assessed by the auditor, performance materiality that is the tolerable misstatement with

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regard to financial statements are set (Eilifsen & Messier, 2014). However, the planning
materiality must be higher than the performance materiality. The quantitative factors used for
computing the materiality planning are –
 2% of sales revenue
 1% of total assets
 2% of shareholders equity
 5% of net profit
Therefore, for Perpetual Limited the planning materiality amount will be as follows –
 2% of sales revenue = $ 520,881 * 2% = $ 10,417.62 thousand
 1% of total assets = $ 11,71,545 * 1% = $ 11,715.45 thousand
 2% of shareholders equity = $ 634,381 * 2% = $ 12,687.62 thousand
 5% of net profit = $ 137,238 * 5% = $ 6,861.90 thousand (Perpetual.com.au, 2018).
While calculating the materiality planning the auditor may choose to take highest
amount from the above. However, the auditor must understand qualitative factors related to
materiality involved in the financial statements before concluding the planning materiality
size. Therefore, in the given case of Perpetual Limited materiality can be planned at the
amount of $ 11,000 thousand. However, an amount ranging from 50% to 75% of materiality
planning is considered as the performance materiality or tolerable misstatement for Perpetual
Limited (Johnstone, Gramling & Rittenberg, 2013). It is based on the determination of lower
level of significant items involved in the financial reports like cash and cash equivalents,
receivables and payables.

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Audit materiality for Perpetual Limited
Cash and cash equivalents – Perpetual Limited’s cash and cash equivalents included the
short-term deposits that represent rolling for 30 days to 90 days term deposits. The company
mainly holds the cash and cash equivalents for supporting the regulatory requirement of
capital that was amounted to $ 151.2 million. However, there are no specific rules regarding
the amount and by nature cash is regarded as material item. Cash is considered as material
item as it forms integral part in user’s view for the company (Ruhnke & Schmidt, 2014). It is
recognized from the annual report of the company for the year closed on 30th June 2017 that
the cash and cash equivalent of the company has been increased from $ 278,230 to $ 323,487
over the past year. The auditor shall analyse all the receipts and payment related vouchers and
records. The auditor shall further verify the authorisation on payments to satisfy him that no
material misstatement or error has been taken place (Perpetual.com.au, 2018).
Receivables – It is recognized from the annual report of the company for the year closed on
30th June 2017 that the trade receivables of the company has been increased from $ 86,611 to
$ 90,046 over the past year. As receivable is always exposed to risk of bad debt and
misstatement the auditor shall verify all the data related to receivables. It shall carry out the
debtor ageing analysis for verifying the payments due for more than the allowed credit period
(Kanapickienė & Grundienė, 2015). In case of any suspicious transaction the auditor can
confirm the balance from third party also.
Payables – It is recognized from the annual report of the company for the year closed on 30th
June 2017 that the payables of the company has been increased from $ 38,523 to $ 51,850
over the past year. Payables are considered as material as it plays important role in analysing
the company’s liquidity position.

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Disclosures and draft notes
Contingencies – under the ordinary business course, the contingent liabilities are disclosed by
the company with regard to potential claims and existing claims. The company is not sure
regarding the material impact of the contingencies on the financial position or operation of
the company for the year closed on 30th June 2017. When it is not possible to project the
amount in terms of materiality the auditor must project the chances of the contingencies to
take place. However, while projecting the likelihood of occurrence of the event the auditor
must use his professional experience and judgement. Contingent liability shall be disclosed in
the notes associated with the financial report if it is found that the liability is not probable but
reasonably possible or the liability is probable but the amount cannot be estimated. However,
if the occurrence or probability is remote, the contingent liability shall not be disclosed or
recorded.
Provisions – the company recognizes provisions under the financial statements while it has
present constructive or legal obligation owing to the past event and which can be reliably
measured. Further, it shall be probable that the economic benefit outflow is required for
settling down the obligations. Judgements are exercised by the management for estimating
the amount of provisions. There is a chance that outcome in the future year will differ from
the amounts provided s provision in the current year. Hence, the amount will have to be
adjusted for the carrying amount of the liability. While auditing the provisions the auditor
shall verify is with regard to contingencies and liabilities. The auditor shall further assure that
the provided amount is adequate and all the provisions are recorded through debiting profit
and loss account. Moreover, the auditor shall assure that all provisions are properly utilized
for intended purpose. All provisions shall be disclosed properly in financial reports.
Moreover, if the auditor is in the view that the created provisions are not adequate or in
excess, the management shall be advised for providing exact amount.

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Section 2
Ratio computation
Ratio Formula 2017 2016 2015 2014
Profitability ratio
Net profit margin Net profit/Sales * 100 26.35% 25.00% 24.60% 19.14%
Return on Asset Net profit/Total assets * 100 11.71% 11.00% 11.19% 7.44%
Stability ratio
Debt to asset ratio Total liabilities / total asset 0.46 0.47 0.48 0.50
Debt equity ratio Total liabilities / total equity 0.85 0.90 0.92 0.99
Liquidity ratio
Current ratio
Current assets / Current
liabilities 1.78 1.65 1.67 1.64
Quick ratio
(Current assets -
prepayments) / current
liabilities 1.30 1.22 1.65 1.62
Profitability ratios – it is used by the investors and analysts for evaluating and measuring the
company’s ability to create income with regard to revenue, operating expenses, assets and
shareholder’s equity under particular period of time. It shows how the company utilizes the
assets for creating return and value for the shareholders. It can be found from the ratio
computation table of Perpetual Limited over the periods from 2014 to 2017 that the net profit
margin of the company was in improving trend and reached to 26.35% from 19.14%. It
indicates that the company’s profitability has been improved over the past years (Delen,
Kuzey & Uyar, 2013). Return on assets that indicate the profit percentage earned by the
company as compared to overall resources. Looking into the company’s return on assets it
can be identified that the ROA of the entity was in improving trend and reached to 11.71%
from 7.44%. It indicates that the company’s profitability has been improved over the past
years.

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Key assertion involved with the profitability ratio is accuracy that is the amount of
transaction has been recorded in full without any error. Required audit procedure for
removing this assertion is to check all the vouchers and receipts associated with the receipts
and payments and the amount shall be matched with books of accounts.
Liquidity ratio – it is used for measuring the ability of the entity to pay off the short term
liabilities when it will become due. It has direct impact on the credit rating and credibility of
the entity. Current ratio as well as the quick ratio of the company states whether the current
assets of the company are adequate to meet its short-term obligation. From the ratio
computation table of Perpetual Limited over the periods from 2014 to 2017 it is identified
that the current ratio of the company was in improving trend and reached to 1.78 from 1.64.
However, the quick ratio of the company is reduced from 1.62 to 1.30.
Key assertion involved with the liquidity ratio is completeness that is the amount of
assets and liabilities has been recorded in full without any error. Required audit procedure for
removing this assertion is to check all the transaction associated with the liabilities and assets
and the amount shall be matched with the reported amounts in balance sheet.
Stability ratio – the stability ratios are used to investigate the level of support provided to the
entity through debt and whether the equity and debt are balanced. Debt equity ratio of the
company states the proportion of liabilities as compared to the equity under the capital
structure (Pervan & Kuvek, 2013). On the other hand, debt to asset ratio states the percentage
of debt used by the company purchase its assets. Both the stability ratios of the company are
stating that both the ratios are in improving trend and the debt and equities of the company
are balanced.
Key assertion involved with the stability ratio is valuation that is the amount of assets
and liabilities has been recorded at proper valuations. Required audit procedure for removing

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this assertion is to check all the borrowing related documents and shall be matched with the
amount recorded in balance sheet. Further, the asset amount shall be verified with the asset
register (Lessambo, 2018).
Section 3
Cash flow statement
Looking into the statement of cash flows released by the company for the year ended
30th June 2017 it is found that operating cash flows provided majority of the cash inflows. On
the contrary, cash used for financing led to majority of the cash outflows (Bhandari & Iyer,
2013).
Further, it is observed that proceeds from investment sale amounted to $ 40,925,000
was primary receipts of cash for the company. On the contrary, payment towards dividend
amounted to $ 121,094,000 was primary payments of cash for the company (Chang et al.,
2014).
Non-cash financing expenses was the payment of dividend amounted to $
121,094,000.
On the basis of the company’s financial performance over last 4 years that is from
2014 to 2017 it can be stated that the entity’s profitability ratio improved over the past years.
Further, the stability ratio is indicating that the debt and equity of the company are balanced
(Mock & Fukukawa, 2015). However, to improve the quick ratio is shall pay off the short
term liabilities. Therefore, no major risk regarding going concern is observed in case of
Perpetual Limited.

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Audit report
From the audit report of the company included in the annual report for the year closed
on 30th June 2017 it is observed that the auditor of the company that is KPMG expressed
unqualified opinion. Further, they stated that the financial report has been prepared as per the
requirement of Corporations Regulations 2001 and (AAS) Australian Accounting Standards
(Pucheta‐Martínez & García‐Meca, 2014). However, any additional section has not been
included regarding any audit issue.

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Reference
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based measures. Managerial Finance, 39(7), 667-676.
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professional skepticism, and interactions with managers on audit quality. The
Accounting Review, 90(4), 1363-1393.
Chang, X., Dasgupta, S., Wong, G., & Yao, J. (2014). Cash-flow sensitivities and the
allocation of internal cash flow. The Review of Financial Studies, 27(12), 3628-3657.
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