Auditing: Risk of Material Misstatements in Cochlear Limited's Financial Statements

Running head: AUDITING
Auditing
Name of the Student:
Name of the University:
Authors Note:

1AUDITING
Executive summary:
In Australia the auditors have to abide by the auditing and assurance standards issued by
Australian Auditing and Assurance Standards Board (AAUSB). The standards on auditing
applicable in the country are abbreviated as ASAs. In this document a detailed discussion on the
risk of material misstatements in the financial statements of Cochlear Limited has been made by
conducting analytical procedures on the financial information of the company. The corporations
established under the Corporations Act, 2001 must follow Accounting standards (AASBs) issued
by the Australian Accounting Standards Board. It shall also be verified whether the accounting
information compiled by Cochlear Limited is in accordance with the AASBs.

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Contents
Executive summary:........................................................................................................................1
Introduction:....................................................................................................................................3
Part 1:...............................................................................................................................................3
Effects on audit planning due to the results of analytical procedures:........................................3
Part 2:...............................................................................................................................................6
Inherent risks:..............................................................................................................................6
Integrity of management:.............................................................................................................6
Experience and knowledge of the management and changes in the management:.....................7
Pressure on directors and management from higher authority:...................................................8
Entities business and nature of such business:............................................................................9
Part 3:.............................................................................................................................................10
Risk of material misstatement:..................................................................................................10
Conclusion:....................................................................................................................................15
References:....................................................................................................................................16
Appendix:......................................................................................................................................19

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Introduction:
A medical device company, Cochlear Limited is a manufacturing company situated in
Sydney, Australia. The auditor of the company has decided to conduct analytical procedures on
the financial statements of the company for last three financial years including the current
financial year ending on June 30, 2018. The analytical procedures would help the auditor to
identify possible risks of misstatement and frauds in the financial information of the company.
Part 1:
An auditor conducts analytical and substantive procedures to complete audit of an entity
efficiently. Analytical procedures involve calculation of different ratios of an organization for
last two or three financial years including current financial year with the objective to identify any
unnatural fluctuations in any of the financial ratios to indicate possible vulnerable areas for the
audit. In case there is significant fluctuations in any of the profitability ratios such as gross profit
ratio, net profit ratio or any other profitability ratio without any valid reason then this could
indicate the risk of material misstatement or fraud in financial statements (Jans, Alles &
Vasarhelyi 2014). Auditor accordingly, will use substantive procedures of items of revenue and
expenditures to the maximum extent possible to unearth the misstatement or fraud.
The financial information containing in the annual reports of the company for last two
years have been used to calculate various for analytical purposes. The table below contains the
profitability, efficiency, solvency and liquidity ratios of the company (Chan & Vasarhelyi 2018).
Effects on audit planning due to the results of analytical procedures:
The changes in gross profit ratios over the last three years have increased at a constant
pace. In 2018 the company has earned a gross profit of 73.46% whereas it was around 71.37% a

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year back. However, the change in operating margin is quite significant. The company has
earned an operating income of AUD 207 million in 2018 whereas in the last two previous years
the operating incomes were negative. The change in operating margin from -10.79% in 2016 to
15.18% in 2018 certainly indicate that there could be some misstatement in recording operating
expenses of the company (Cao, Chychyla & Stewart 2015). Thus, the auditor will specifically be
extra attentive of operating expenditures while conducting substantive audit procedures. The
inventory turnover ratio, asset turnover ratio do not indicate any unnatural fluctuations and so are
the debt to equity and liquidity ratios. The changes in these ratios have been insignificant and
does not raise an eyebrow (The analytical ratio calculations have been provided in table
attached as appendix).
Hence, the analytical procedure and the results of such procedure has provided the
auditor with a possible area in financial statements that could have material misstatements or
even fraud. Using extensive substantive procedures on each items of operating expenditures will
enable the auditor to evaluate the material risks of misstatements and possibility of fraud in this
area of financial statements (Chiu, Liu & Vasarhelyi 2018).
It is important to note that the standard procedures that an auditor needs to perform as per
the Auditing and Assurance Standards of the country (AUASB) those shall be performed
irrespective of the results of analytical procedures. However, in addition the auditor might decide
to conduct other verifications and tests of items of expenses and revenues depending on the
results of analytical procedures conducted on the financial information of the company. The
auditor on the basis of analytical procedures must extend his review and verification of items of
expenditures and revenue, especially the operating expenditures to find out whether there is any

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material misstatement in reporting these expenditures in the books of accounts (Abernathy,
Hackenbrack, Joe, Pevzner & Wu 2015).
The simple comparison between amount of revenue, gross profit and net income of the company
of last three years would help the auditor to make important assertion about the company and its
performance.
All amounts are in rounded off to nearest AUD million
Fiscal year ends in June. AUD in millions except per share
data.
2016-
06
2017-
06
2018-
06
Revenue 1,131.
00
1,254.
00
1,364.
00
Gross profit 797.
00
895.
00
1,002.
00
Operating income (122.
00)
(78.
00)
207.
00
Net income 189.
00
224.
00
246.
00
All the performance indicators of the company indicate that over the years the performance of
the company has improved. The revenue of the company was AUD 1,131 million in 2015-16.
This increased to AUD 1,254 million in 2016-17 and AUD 1,364 million in 2017-18. Similarly