Issues in Auditing Practice: Materiality, Risk of Fraud, and Audit Procedures

This report discusses various aspects of auditing procedures for Chamoisee Enterprises, including materiality, risk of fraud, and audit procedures for accounts at risk of misstatement. The report identifies financial items that have the possibility of material misstatement and suggests audit procedures to form an accurate audit opinion. The concept of materiality and its impact on audit budget are also discussed.

Issues in Auditing Practice
1

Contents
Introduction................................................................................................................................3
Materiality for the financial report.............................................................................................4
Four income statement accounts that appear to be at risk..........................................................7
Audit procedure..........................................................................................................................8
Risk of Fraud..............................................................................................................................9
Conclusion................................................................................................................................10
References................................................................................................................................11
Appendix..................................................................................................................................12
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Introduction
Preparation of financial statements has specific purpose and objectives that should be
achieved by such statements for growth and development of a company. Main purpose of
these financial statements is to satisfy the demands of stakeholders. For example,
shareholders of the company expect that financial statements of the company should
represent its actual financial position in market. This is the main reason that audit of the
financial statements are conducted at the end of financial year (Louwers et.al, 2015). There
are specific rules and responsibility that an auditor of the company should follow while
conducting financial audit. This report is prepared in order to conduct audit of Chamoisee
Enterprises. Various aspects of auditing are included in this report with respect to errors and
material misstatements that can be evaluated form trail balance of the company.
3

Materiality for the financial report
Concept of materiality is applied by auditor of the company during the planning stage of
audit. This concept is related to minimum level of financial amount which could be
considered as threshold limit for taking relevant decisions by stakeholders. In simple words,
Maternity in financial statement can be defined as the limit of discrepancy in financial data
after audit is conducted on financial statement which can affect decisions to be taken by
stakeholders (Choudhary, Merkley and Schipper, 2018). For example, let's assume that
material at in financial statement is $5000 then stakeholder’s decision in relation to business
will not be affected by discrepancy in financial data below $5000 but if it exceeds $5000 then
it might change decision of stakeholder. There are commonly used percentages of financial
items in balance sheet that are considered by auditor before setting Maternity threshold limit.
Financial item Limit
Total net profit 5%
Net profit distributable to equity
shareholders
5%
Total revenue earned .5% to 2%
Total shareholder's equity 2% to 5%
According to the above data following threshold limit should be decided by auditors of
Chamoisee Enterprises. (Calculation of Net profit are given in Appendix)
Particular Amount and
Percentage
Materiality
Net profit 57,00
0 & 5%
$2850
Total revenue 1,87,45
0 & 2%
$3750
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During the planning stage of auditing Chamoisee Enterprise, audit partner decided to set the
limit of materiality at $15000 which is very high as compared to commonly acceptable limit
for an organisation like currently in consideration.
Above step taken by the audit partner can affect the audit budget prepared by auditors in a
negative manner. According to the threshold limit of $15000, shareholders will not be
affected if there is a discrepancy in financial statements prepared by the management up to
15000 but in actually they will be affected if this discrepancy goes beyond $4000. Therefore
management of audit firm is required to conduct more audit procedures as compared to audit
procedure decided in planning stage. This will require more human capital and time which
will increase overall audit budget (Lakis and Masiulevičius, 2017).
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Trend analysis
Particular
Precedin
g
financial
year
Proportiona
l Eight
months for
last year
Eight
months
of
current
year Trend Analysis
Sales
2,44,5
00 163000.00
1,65,
532
Sales of the company in current
financial year has increased as
compared to last financial year. It
might be due to increase in
demand of the products and
services offered by the company to
its customer.
Cost of goods sold 63595.00 42396.67 46333.33
Cost of goods sold has also
increased in current as compared
to last financial year. This is
common trend in business that if
sales of the company increases
then cost of goods also will also
increases as it is a variable expense
proportional to total revenue.
Total indirect
expenses 90783.33 60522.22 54193.33
Management of the company has
adopted effective management and
cost control strategies for bringing
efficiency in business operations
that has resulted In decrease of
overall indirect expenditure.
Net profit 90121.67 60081.11 65005.33 Net profit earned by the company
has increased as revenue has
increased and indirect expenses
has gone down as compared to last
6

year (Arens, Elder and Beasley,
2014).
Gross profit
180905.0
0 120603.33
119198.6
7
Gross profits earned by the
company has decreased as
compared to last financial years
because the rate of increase in cost
of goods sold is higher as
compared to rate of increase in
total revenue.
Net profit ratio 36.86 36.86 39.27
As company has controlled its
total indirect expenditure, net
profits of the company has
increased as compared to last
financial year.
Gross profit Ratio 73.99 73.99 72.01
Rate of increase in cost of goods
sold is higher as compared to rate
of increase in total revenue that
has resulted in decreased in gross
profit margin.
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Four income statement accounts that appear to be at risk
Identification of fraud and errors is one of the basic and primary responsibility of auditor of
the company. At the initial state of auditing, auditor is required to identify the financial items
that can have material misstatements just by observation of financial statement. Here
following financial items are identified that seems to be at risk of material misstatement.
After identification odd these statement, an auditor is required to implement additional audit
procedures to acquire audit evidence so that opinion on financial data can be formed (Arens
et.al, 2015).
Particular
Preceding financial
year Eight months of current year
Cash 80000 85000
Accounts
receivable 1,11,000 1,18,340
Inventory 1,74,000 1,87,500
Bank loan 2,30,000 2,30,000
Cash – Cash is always considered as a financial item that is most prone to fraud and errors.
Majority of the frauds conducted by management of the company are related to cash.
Therefore it is important for every auditor to examine cash management policies and
procedures in detain. Management should evaluate roles and responsibilities of employees
that are handling cash in the organisation (Ashley-Smith, 2013).
Account receivable- account receivable are the amount dues from customers that have
consumed goods and services of the company on credit and company is expecting to receive
money from such customer. Generally there are specific policies and procedures that
management prepared in order to recover amount from customer. In given case, inventory
outstanding at end of accounting period is very high if sales made by the company in a year is
considered. This can mean that management is selling majority of goods and services on
credit but amount of total receivable outstanding should not be more that 20-30% of sales
which generally represents sale made in last 2-3 month. This large outstanding amount of
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receivable can suggest that management is giving special relaxation period to certain
customers without getting approval from management.
Inventory- amount of inventory has also increased as compared to financial year.
Management of the company should evaluate inventory management of the company. It is
general practice of business organisations to adopt FIFO method as it reduces wastage of
inventory (Melikhova, and Nikolayenko¸ 2017). In current year outstanding inventory is
increased, therefore management should evaluate the reason for such.
Bank loan- In case of bank loan, management of the company is required to make annual
instalment and such payments should be deducted from total amount of loan in the balance
sheet. In case of Chamoisee Enterprises, the amount of bank loan is similar in both financial
years. This can be a result of error or omission in accounting.
9

Audit procedure
Cash
1. Audit of the company should check the bank statement of the company and compare it
with cash register maintained in the books of accounts.
2. Bank confirmation should be taken by auditor from banking institution for closing balance.
3. This can be done with the help of preparing a Bank Reconciliation statement.
Accounts receivable
Auditor should evaluate the steps and procedures taken by the company in order to recover
money from these accounts and determine whether such policies are in the interest of the
company or not. In addition to that management should also evaluate that such polices are
applied for recovery from each account (Knechel and Salterio, 2016).
Inventory
Best audit procedure to conduct to evaluate fraud and errors in inventory is through physical
verification. Auditor should evaluate proper records are maintained by the management in
respect to inventory or not (Makarenko and Yardanova, 2015).
Bank loan
Audit should check the terms and conditions of the loan between organisation and banking
institution to make sure that records are maintained according to such terms and conditions.
10

Risk of Fraud
Identification and estimation of fraud is one of the most important function of audit and it is
included in roles and responsibilities of an auditor. It is important that proper evidences are
collected by auditor before making the audit opinion that there are no risk of fraud in a
particular business organisation (Arens et.al, 2013). In this case of Chamoisee Enterprises,
audit partner is of the opinion that there is no risk of management fraud just on the basis of
his interaction with the management. This is not sufficient audit evidence to make such
conclusion. Therefore it can be said that audit is not correct in making such suggestion.
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Conclusion
This report has discussed various aspect of auditing procedures to be conducted in a
proprietorship firm. This report has identified some financial items that have possibility of
material misstatement on the basis of trend analysis of trial balance of the company. In
addition to that various audit procedures are also suggested to auditors of the company to
form accurate audit opinion on such expected material misstatements. In addition to that this
report has also discussed the concept of materiality with its impact on audit budget.
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References
Arens, A., Elder, R. and Beasley, M., 2014. Auditing and assurance services-An integrated
approach; includes coverage of international standards and global auditing issues, in addition
to coverage of. Boston: Aufl.
Arens, A.A., Best, P., Shailer, G. and Fiedler, B., 2013. Auditing, Assurance Services and
Ethics in Australia. Pearson Higher Education AU.
Arens, A.A., Elder, R.J., Beasley, M.S. and Jones, J., 2015. Auditing: The Art and Science of
Assurance Engagements. Pearson Canada.
Ashley-Smith, J., 2013. Risk assessment for object conservation. Routledge.
Choudhary, P., Merkley, K.J. and Schipper, K., 2018. Auditors’ Quantitative Materiality
Judgments: Properties and Implications for Financial Reporting Reliability.
Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Routledge.
Lakis, V. and Masiulevičius, A., 2017. Acceptable audit materiality for users of financial
statements. Journal of Management, 2(31).
Louwers, T.J., Ramsay, R.J., Sinason, D.H., Strawser, J.R. and Thibodeau, J.C.,
2015. Auditing & assurance services. McGraw-Hill Education.
Makarenko, A.P. and Yardanova, T.H., 2015. Development of a program of inventory
audit. Naukovi pratsi Poltavskoyi derzhavnoyi ahrarnoyi akademiyi, 2(11), pp.40-48.
Melikhova, T.O. and Nikolayenko, N.S., 2017. Development of an inventory audit program
to increase financial security of the enterprise. Ekonomika ta derzhava, 1, pp.51-55.
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Appendix
Particular
Jul 1, 2015 -
June 30, 2016
(Previous
financial year)
Jul 1, 2016
- Nov 30,
2016 (Eight
months)
Revenue
Sales
1,8
7,450
1,26,
000
Consultancy fees
5
7,000
39
,500
Interest income 50 32
Total revenue
2,4
4,500
1,65,
532
Cost of sales
6
3,595
46
,333
Gross profit
1,8
0,905
1,19,
199
Less- Expenses
Bank charges 350 232
Depreciation 15863.33
10
,793
Interest expense 11500
7
,667
Printing 250
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168
Repairs and
Maintenance 5050 960
Wages 53000
32
,000
Superannuation 4770
2
,373
Total indirect cost 90783.33
54
,193
Net profit
9
0,122
65
,005
15