Issues in Auditing Practice

This article discusses the preliminary assessment about the materiality level, analytical review, possible areas of misstatement in income statement, and audit procedures for identified accounts in auditing practice. It also includes a fraud risk suggestion by the audit partner.

Running head: ISSUES IN AUDITITNG PRACTICE
Issues in Auditing Practice
Name of the Student:
Name of the University:
Authors Note:

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ISSUES IN AUDITITNG PRACTICE
Executive Summary:
Trial Balance of an entity contains information about account balances as on the date of
which the Trial Balance relates. An auditor will be able to access significant amount of
information from the Trial Balance. The preliminary assessment about the financial state and
performance of an entity can be made from the Trail Balance and accordingly an effective
strategy for the audit can be formulated from the same. The preliminary assessment about the
materiality levels for certain accounts and balances have been made in this document for the
audit purpose of Fuchsia Enterprises. Analytical review has also been conducted with an
objective of understanding the areas where misstatements may have occurred.

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Contents
Executive Summary:........................................................................................................................1
Introduction:....................................................................................................................................3
Appropriateness of Materiality level:..............................................................................................3
Analytical review:............................................................................................................................5
Possible areas of misstatement in income statement:......................................................................8
Audit procedures for identified accounts:......................................................................................10
Procedure for sales revenue:......................................................................................................10
Procedure for cost of sales:........................................................................................................10
Procedure for Depreciation:.......................................................................................................10
Fraud risk suggestion by audit partner:.........................................................................................11
Conclusion:....................................................................................................................................11
Recommendation:..........................................................................................................................12
References:....................................................................................................................................13

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Introduction:
The audits of entities operating in the country are subjected to the auditing and assurance
standards issued by the Auditing and Assurance Standards Board (AAUSB). ASA 320 provides
guidelines for the auditor to be followed for determination of materiality level. It is the amount
that an auditor considers material for the purpose of the audit.
Appropriateness of Materiality level:
Materiality level has to be determined taken into consideration the nature of transactions
in an organization thus, for transactions of particular nature the standard benchmark might not be
the correct procedure to determine materiality level in an audit. To determine materiality levels
in an audit generally certain percentages are used on profit before tax, revenue, net assets and on
equity. However, specific account balances and classes of transactions for their nature might be
treated differently. 5% of revenue with little higher percentage for profit before can be used as
benchmark for determining materiality levels in audit of financial information.
In case of Fuchsia Enterprises the amount of gross revenue earned from sales for the financial
year 2016-17 is $162,104. Thus, the suggestion of setting $15,000 as material amount for the
financial report as whole seems quite high. Even if the standard benchmark of 5% is used for the
amount of revenue then the preliminary materiality level comes at (162,104 x 5%) = $8,105. The
following table would indicate the various standard benchmark and appropriate materiality levels
for Fuchsia Enterprises.
Particulars Amount ($) Amount
($)
Materialit
y level

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@5%
Sales 162,104.
00
8,105.20
Total expenditure
Cost of sales 49,208.00
Bank charges 290.00
Depreciation 29,620.83
Interest expense 9,583.33
Printing 308.33
Miscellaneous 1,200.00
Wages 43,808.33
Superannuation 4,162.63
138,181.
46
6,909.07
Effects of changing preliminary assessment:
If the preliminary assessment is changed then the audit budget would increase as the
extent of checking and verification of account balances and transactions would increase

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significantly. This is because the materiality level set at $15,000 is significantly higher compared
to the materiality as per the benchmark provided in ASA 320. The materiality level for items of
revenue will be $8,105 and for expenditures at $6,909.
Analytical review:
Analytical review: Analytical review is the method to analyse ratios of an organization to
identify significant fluctuations in financial reports to evaluate risk of material misstatements and
frauds in financial statements.
Profitability ratios: Profitability ratio includes gross profit ratio, net profit ratio. Any significant
fluctuations in profitability ratios shall be evaluated by the auditor to assess the risk of material
misstatements in financial information (Lakis and Masiulevičius, 2017).
Particulars 2016-17 2015-16
Profitability ratios
Gross profit ratio
Sales 162,104.
00
187,450
.00
Less: Cost of sales 49,208.
00
63,595
.00
Gross profit 112,896. 123,855

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00 .00
Gross profit ratio (Gross profit x 100/
Sales)
69
.64
6
6.07
Net profit ratio
Sales 162,104.
00
187,450
.00
Less: Total expenditures 138,181.
46
150,093
.33
Net profit 23,922.
55
37,356
.67
Net profit ratio (Bet profit x
100/sales)
14
.76
1
9.93
The gross profit ratio of the organization for 2016-17 is 69.64%. In 2015-16 it was 66.07% thus,
there is no unnatural fluctuation in gross profit ratio. However, the net profit ratio of the
company has reduced in 2016-17 at 14.76% compared to 19.93% of 2015-16. Considering that
the company earned a higher margin of gross profit the reduction in net margin must be
evaluated (Edgley, Jones and Atkins, 2015).

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Particulars 2016-17 2015-16
Efficiency ratios
Inventory turnover ratio
Sales 162,104.
00
187,450.
00
Average inventory 169,250.
00
174,000.
00
Inventory turnover ratio (Sales / Average inventory)
0.96
1
.08
Accounts receivable turnover ratio
Sales 162,104.
00
187,450.
00
Average accounts receivable 106,717.
50
103,585.
00
Accounts receivable turnover ratio (Sales / Average accounts
receivable) 1.52
1
.81
(Choudhary, Merkley and Schipper, 2018)
Efficiency ratios:

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Efficiency ratios help an auditor to assess the ability of an organization to use its operating assets
in day to day to business operations. Both inventory and accounts receivable turnover ratios of
the company have reduced in 2017-18 compared to 2015-16. However, the reduction in
inventory and accounts receivable turnover ratios are quite insignificant for the audit (Moroney
and Trotman, 2016).
Possible areas of misstatement in income statement:
Sales account:
Simply because of the significance of the account sales must be verified in details to evaluate
whether there is any material misstatement in the amount of sales recorded in the books of
account. Also the fact that despite increase in gross profit ratio for the financial year ending on
April 30, 2017 the organization end up quite low in its net profit ratio compared to the previous
year also raise suspicion about the amount of sales recorded in the books of accounts. Thus, sales
of $162,104 for 2016-17 shall be verified properly (Lakis and Masiulevičius, 2017).
Cost of sales:
The gross profit ratio of the organization for 2016-17 is 69.64% is quite high compared to the
66.07% of previous year. Despite the increase in gross profit ratio the organization end up only
earning a net profit margin of 14.76% in the period compared to almost 20%, i.e. 19.93% of net
profit in 2015-16. This definitely raises suspicion about the amount recorded as cost of sales and
thus, in order to evaluate whether there is any misstatement the account must be verified properly
(Sultana and Mitchell Van der Zahn, 2015).
Depreciation:

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The amount of depreciation for 2016-17 is $29,620 whereas in 2015-16 it was $15,738. Since the
organization has not made any addition to Machinery, Motor Vehicle and Furniture during the
course of 2016-17 thus, the reason for increase in amount of depreciation in the year has to be
evaluated. There could be misstatement in reporting the amount of depreciation in the profit and
loss account. Since the amount of difference between the depreciation amounts of two years is
quite significant thus, it has to be evaluated correctly (Gaynor et. al. 2016).
Consultancy fees:
The amount of consultancy fees earned by the organization in 2016-17 has reduced to $49,375
from $57,000 of previous period. The reason for the same has to be properly evaluated. Is it
mainly due to the difference in accounting period between two financial statements or due to
other reason? Evaluation by the auditor will be helpful in determining whether there is any
material misstatement in financial information (Knechel and Salterio, 2016).
Audit procedures for identified accounts:
Procedure for sales revenue:
The sales orders received has to be evaluated with the actual deliveries made in the
period. The accounting entries recorded subsequent to the credit and cash sales have to be
evaluated properly to check whether these have been correctly recorded in the books of accounts
of the organization. In case of any sales return whether the same has been accounted for and due
effects have been given to the relevant cash or accounts receivable accounts for such returns.
Procedure for cost of sales:
Verification of cost of sales requires the auditor to verify the inventory management
system, i.e. procurement and issue of materials and goods. The auditor would evaluate the

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inventory valuation model used by the entity to determine cost of sales and closing inventory.
Whether the inventory has been correctly debited subsequent to the procurement and credited
subsequent to issue for sales has to be verified. Apart from that subsequent to sales return
whether inventory has been recorded in books of accounts as return shall be evaluated properly.
In case of any error in recording the procurement, issue and return of inventories then the amount
of cost of sales would be affected and so would be the profit and loss of the organization (Chan
and Vasarhelyi, 2018).
Procedure for Depreciation:
The amount of depreciation recorded in the books of accounts of the organization for the
period ending on 30th April, 2017 is $29,620.83 whereas in 2015-16 the amount of depreciation
charged in the profit and loss account was $15,783.00. A closer verification of the Trial Balance
of the organization reveals that there has been no acquisition of additional fixed assets such as
Machinery, Motor Vehicles and Furniture during the period between July 014, 2016 and April
30, 2017. Thus, the reason for such increase in the amount of depreciation must be evaluated to
determine whether there is any material misstatement in the books of accounts of the
organization during the period ending on April 30, 2017 (Badolato, Donelson and Ege, 2014).
Fraud risk suggestion by audit partner:
As per s307C of Corporations Act, 2001 an auditor must express his opinion on the
financial information of an organization. The auditor must state whether the financial
information is correctly reflects the performance and position of the organization as on a
particular date. In order to conduct an audit as per the requirements of Corporations Act, 2001 an
auditor must conduct an audit in accordance with the auditing standards applicable in the
country. ASA 240 guidelines the responsibilities of an auditor to consider fraud in an audit of

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financial statements irrespective of the feeling of an auditor about the client and its staffs (Cao,
Chychyla and Stewart, 2015).
It is immaterial whether a senior partner feels that the staffs of the client are trustworthy or not.
Auditor must carry out his standard procedures to consider the risk of fraud in an audit of
financial statements to accumulate substantial evidence to come to a conclusion on the risk of
material misstatements due to fraud in financial information. Hence, in this case also the
suggestion of the audit partner to not consider fraud risk in the audit of Fuchsia Enterprises is
inappropriate and irrelevant. The audit must consider the aspect of fraud risk as per the
guidelines provided in ASA 240 issued by the AAUSB (Louwers et. al. 2015).
Conclusion:
Summarizing the above discussion it is easy to understand that the preliminary
assessment about the materiality level set by the audit partner at $15,000 is quite high
considering the amount of revenue and other items of Trial Balance. Similar the view of the audit
partner to not consider the fraud risks for the audit of the entity is also inappropriate. It would be
harsh to suggest that there had been any particular indication of fraud from analytical review.
However, the risk of material misstatement in the financial information is indicated from
analytical review. This is because despite significant increase in gross profit ratio the net margin
of the organization has deteriorated significantly.
Recommendation:
Thus, the auditor is recommended to reduce the materiality level for account balances and
should conduct the audit without any preconceived notion about the entity and its staffs. The
audit should be conducted in accordance with relevant standards on auditing to ensure that the

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audit opinion is appropriate and valid. Also the huge increase in amount of depreciation despite
no addition to fixed assets indicate possible area of misstatement in the financial statements of
the organization.

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References:
Badolato, P.G., Donelson, D.C. and Ege, M., 2014. Audit committee financial expertise and
earnings management: The role of status. Journal of Accounting and Economics, 58(2-3),
pp.208-230. [Online] Available at:
https://www.sciencedirect.com/science/article/pii/S0165410114000470 [Accessed 15 September
2018]
Cao, M., Chychyla, R. and Stewart, T., 2015. Big Data analytics in financial statement
audits. Accounting Horizons, 29(2), pp.423-429. [Online] Available at:
http://www.aaajournals.org/doi/abs/10.2308/acch-51068?code=aaan-site [Accessed 15
September 2018]
Chan, D.Y. and Vasarhelyi, M.A., 2018. Innovation and practice of continuous auditing.
In Continuous Auditing: Theory and Application (pp. 271-283). Emerald Publishing Limited.
[Online] Available at: https://www.emeraldinsight.com/doi/abs/10.1108/978-1-78743-413-
420181013 [Accessed 15 September 2018]
Choudhary, P., Merkley, K.J. and Schipper, K., 2018. Auditors’ Quantitative Materiality
Judgments: Properties and Implications for Financial Reporting Reliability. [Online] Available
at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2958405 [Accessed 15 September 2018]
Edgley, C., Jones, M.J. and Atkins, J., 2015. The adoption of the materiality concept in social
and environmental reporting assurance: A field study approach. The British Accounting
Review, 47(1), pp.1-18. [Online] Available at:
https://www.sciencedirect.com/science/article/pii/S0890838914000729 [Accessed 15 September
2018]

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Gaynor, L.M., Kelton, A.S., Mercer, M. and Yohn, T.L., 2016. Understanding the relation
between financial reporting quality and audit quality. Auditing: A Journal of Practice &
Theory, 35(4), pp.1-22. [Online] Available at: http://www.aaajournals.org/doi/abs/10.2308/ajpt-
51453 [Accessed 15 September 2018]
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).
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. [Online] Available at:
http://app1.hkicpa.org.hk/students(NEW)/e-Newsletter/2009-05/images/
FeaturedBooks_May_2009.pdf [Accessed 15 September 2018]
Moroney, R. and Trotman, K.T., 2016. Differences in Auditors' Materiality Assessments When
Auditing Financial Statements and Sustainability Reports. Contemporary Accounting
Research, 33(2), pp.551-575.
Sultana, N. and Mitchell Van der Zahn, J.L., 2015. Earnings conservatism and audit committee
financial expertise. Accounting & Finance, 55(1), pp.279-310.

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