Auditing Inventory Transactions and Risk

This assignment delves into the crucial aspect of auditing inventory transactions within organizations. It emphasizes the auditor's responsibility to investigate financial data related to assets and liabilities, particularly inventory balances, to ensure accurate recording and minimize fraud risks. The assignment also highlights the importance of evaluating operational processes and planning audit steps to mitigate potential issues and provide a faithful opinion on financial declarations.

Running head: AUDITING THEORY AND PRACTICE
Auditing theory and practice
Name of the University
Name of the student
Authors note

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AUDITING THEORY AND PRACTICE
Answer to Question 1:
Auditors are able to plan their audit by conducting preliminary analysis using
analytical procedures. Such plan helps in cutting unreasonable cost associated with audit and
clarifies any facts for accomplishing the verification of financial declaration of DIPL. There
are many analytical procedures available to auditor for carrying out analysis and this involves
common size analysis, benchmarking and ratio analysis. Application of ratio analysis tool
would help auditor in providing information about trend of financial performance of
organization (Boone et al. 2017).
Application of analytical procedures to the financial declaration of DIPL:
For the analysis of financial performance, auditor uses ratio analysis tool. Analysis is
done by calculation profitability, liquidity, solvency and efficiency position of company.
Profitability analysis:
Table 4: Profitability Ratios
Ratio 2013 2014 2015
Gross Profit Ratio 17.55% 16.13% 15.20%
Net Profit Ratio 6.90% 6.08% 6.84%
Operating Profit Ratio 19.82% 19.18% 19.12%
Return on Assets 18.25% 14.41% 11.37%
Return on Equity 25.78% 21.25% 24.26%
The above table depicts profitability position of DIPL over the period of three years.
It involves calculation of gross profit, net profit ratio, return on assets, return on equity and

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AUDITING THEORY AND PRACTICE
operating profit margin. Gross profit ratio has decreased since year 2013. Ratio stood at
17.55% in financial year 2013 as compared to 16.13% and 15.2% in year 2014 and 2015
respectively. Net profit ratio stood at 6.9% and 6.08% in year 2013 and 2014 as against
6.84% in year 2015. There was significant decline in return on assets from 18.25% in year
2013 compared to 11.37% in year 2015. Return on equity declined from 25.78% in year 2013
to 24.26% in year 2015.
Liquidity analysis:
Table 1: Liquidity ratios
Ratio 2013 2014 2015
Current Ratio 1.42 1.47 1.50
Quick Ratio 0.83 0.94 0.85
Liquidity analysis is evaluated by calculating current ratio and quick ratio. Liquidity
position of DIPL has marginally improved since year 2013. Current ratio of DIPL stood at
1.42 in financial year 2013, 1.47 in year 2014 and 1.5 in year 2015 respectively. On other
hand, quick ratio has initially increased and subsequently decreased in year 2015. Ratio stood
at 0.83 in year 2013 as compared to 0.94 and 0.95 in year 2014 and 2015 respectively.
Solvency analysis:
Table 2: Solvency Ratios
Ratio 2013 2014 2015
Debt Equity Ratio 0.41 0.47 1.13
Debt to Total Assets 0.29 0.32 0.53
Interest Coverage Ratio 28.96 28.39 4.68

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AUDITING THEORY AND PRACTICE
Solvency position of DIPL is analysed by calculating by interest coverage ratio, debt
to equity ratio and debt to total assets. Debt to total assets of DIPL stood at 0.29, 0.32 and
0.53 in year 2013, 2014 and 2015 respectively. Figures represents that there has been decline
in ratio since year 2013. There has been increase in debt to equity ratio to 1.13% in year 2015
compared to 0.41% and 0.47% in year 2014 and 2015 respectively. Interest coverage ratio
has fallen significantly to 4.68% in year 2015 compared to 28.96 and 29.39 in year 2013 and
2014 respectively.
Efficiency analysis:
Table 3: Efficiency ratios
Ratio 2013 2014 2015
Inventory Turnover Ratio 12.50 11.84 8.82
Debtors Turnover Ratio 13.78 8.73 8.57
Efficiency analysis is calculated using ratios such as inventory turnover and debtor
turnover ratios. Inventory turnover ratio has declined to 8.82 in year 2015 compared to 12.5
and 11.84 in year 2013 and 2014 respectively. Debtor turnover ratio of DIPL has reduced
significantly to 8.57 in year 2015 as against 8.73 and 13.78 in year 2014 and 2013
respectively. Fall in efficiency ratio depicts that DIPL has been efficiently utilizing their
assets.

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AUDITING THEORY AND PRACTICE
Influence of results on audit planning decisions:
Ratios Impact of identified ratios on audit plan
Current ratio Analysis of current ratio will help auditors in
evaluating the factors affecting liquidity position
of DIPL. It can be ascertained from the given
case study that reason attributable to increase I
liquidity position is writing back of inventories
allowance.
Solvency ratio
Financial risk of DIPL has increased in recent
year and it assist auditors in identifying factors
that are considered undesirable or desirable for
organization’s financial position.
Profitability ratio Analysis of profitability position assist auditors in
analysing factors that would impacts the
profitability position of DIPL and whether
sufficient steps are taken by management
regarding (Quick 2016).
Efficiency ratio Analysis of this ratio depicts that whether
organization has been efficiently utilizing assets.
Answer to Question 2:
Identification of inherent risks affecting operations of DIPL:
Inherent risks Explanation
Risks arising from using system of information Installation and reconciliation of novel IT system

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AUDITING THEORY AND PRACTICE
technology required additional knowledge and extra staff
members. DIPL has shortage of employees and
they were not capable of handling the system.
This would exert excess pressure on employees
who might be forced to get involved in fraudulent
activities. Deterioration of accounting system
would hamper the operational activities of DIPL.
Several threats are posed to organization due to
integration of noel accounting system with
general ledger system
Financial risk Several accounting transactions are improperly
recorded by accountants of DIPL. External and
internal factors of organization are also
responsible for creating financial risk. In order to
secure loan from lending institutions, it is
required by company to maintain particular level
of ratio that is regarded as eligibility criteria for
granting loan amount. There is pressure from
external parties as well as management to
maintain ratio at particular level. This would
force accountants and staff members if DIPL to
get engaged in fraudulent activities and
manipulate presented data or cause material
misstatement in the financial declaration.
Impact of inherent risk on material misstatement and audit plan:

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AUDITING THEORY AND PRACTICE
It is evidence from the analysis of case study that the financial transactions would be
subjected to manipulation and there is a possibility of inflating the value of assets. Staff
members would get engaged in manipulation of financial declarations in order to meet
requirement of lenders and investors. It is also evident from the given case that management
of organization has the inflated the retained earning value and accounts receivable for
meeting the prescribe current ratio level (Chiu et al. 2014). There has been manipulation in
value of payables for maintaining debt ratio.
Workers responsible for reconciliation of accounting software find it difficult to
maintain balance between exiting ledger system and employed novel accounting system.
Inappropriate recording of some financial transactions have material statement of financial
declarations (Byrnes et al. 2015). Furthermore, the periodicity concept of accounting is not
properly followed by DIPL that has further added to material misstatement.
Answer to Question 3:
Identifying two fraud risks arising from fraudulent financial reporting of DIPL:
Fraud risks Explanation
Risks of fraud of financial reporting Description of job within DIPL has not been
properly defined and there is lack of segregation
of works. Dual functions are performed by
account payable clerk as he is responsible for
recording transactions and making entry for
same. It is certainly possible on his part to
inappropriately represent financial data that
would have damaging effect on operations and
financial performance of company (Moroney

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AUDITING THEORY AND PRACTICE
and Trotman 2016).
Excessive pressure on staffs leading them to
get engaged in fraud activities
There exists pressure from management and
stakeholders of organization to have proper
financial declarations that suits their business
requirements and maintaining ratios at particular
level. Incapability of DIPL for maintaining debt
ratio less than one and current ratio around 1.5
would adversely affect the business operations of
DIPL.
Fraud risks impact on audit plan:
It is essential on part of auditors to plan audit in such a way that they are able to
reduce the impact of any associated risk to minimum possible level. For evaluation of
financial statements, it is required by auditors to make investigation of financial data
presented in terms of assets as well as liabilities. Balance of inventories should be
investigated and they should check for any improper recording of transactions. Different
activities in operational phase of organization should also be evaluated and their reliability
should also be determined. While planning audit, it is required to evaluate each and every
steps of recording transactions of inventories. Fraud risks would help in modifying audit plan
to conduct faithful opinion of their financial declarations (van Buuren et al. 2017).

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AUDITING THEORY AND PRACTICE
References:
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