Audit Case Study Analysis

This case study analyzes the audit process of DIPL, a printing press, highlighting the importance of risk identification and mitigation in auditing. It discusses inherent, control, and detection risks, emphasizing the need for proper internal controls and the potential for fraud. The study also includes a ratio analysis to assess the company's financial health and the implications of recent changes in accounting policies and IT systems.

By student name
Professor
University
Date: 27 August 2017.

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Contents
Question no 1…………………………………………………………………...2
Question no 2…………………………………………………………………...6
Question no 3…………………………………………………………….....….8
Refrences.....……………………………………………………………….......10
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Question no 1
Audit of the entity may be defined as an independent examination of the books of accounts of
an entity, whether profit making or not, small or big, government or private, prepared by the
management. It is using accounting policies and procedures and making use of the estimates and
judgements with the view to express and opinion on the financials, whether it is showing the correct
view and has been prepared on an unbiased basis. This activity post the closing of the books gives a
reasonable assurance to both the internal and external users of the financial statements, a certainty and
confidence on the figures quoted. Auditors may use diverse procedures during the audit of an entity
depending on the nature of the entity like for a manufacturing concern, emphasis would be on the
production areas, sales, purchases of raw material, for a software entity, the emphasis would be on the
manpower costs and subcontracting costs, etc. For this, they may use both the substantive and
compliance audit procedures, besides checking compliance with the regulatory and reporting norms
prescribed by Accounting board and IFRS committee. Substantive audit procedures include the checking
the recording of the incomes and expenses in the books with the respective evidences, invoices, bills,
delivery challans, whether they are properly dated and signed and stamped, whether appropriate tax
has been calculate and paid on it. Furthermore, it also includes within it ambit the verification of the
assets and liabilities recorded in the statement of affairs. This includes checking the basis on which
respective assets have been recorded, the basis on which the provision is accounted for, etc. This is
mainly performed with the objective of determining and confirming that whatever has been recorded in
the books materially exists and a false representation or the window dressing has not been done. In case
any discrepancies are noted upfront, these are brought to the notice of the management and proper
justification is asked for. All the substantive audit procedures are done with the methods including
inspection of books of accounts and calculations, observation of the records, external confirmation to be
taken from the debtors, creditors, banks, etc., inquiry from the external parties, recalculation and
reperformance of significant adjustments, etc. All these substantive procedures are mainly aimed at
getting the comfortability on the five basic assertions i.e., completeness, rights, existence, valuation and
existence of the assets and liabilities (DeZoort & Harrison 2016).
If the materiality of the errors is found to be more, the auditor has to increase the extent of the
audit procedures and apply further checking through the use of analytical audit procedures which
generally include analysis of key financial ratios, comparison of the actual from the expected and the
budgeted figures, variance analysis, etc . Besides this, the auditor also takes note of the internal control
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existing in the organisation, if it is strongly built, then the risk would be low and hence the level of
checking required would be less. Similarly, if the internal control processes and test of designs are
adequately built in the organisation, then automatically the risks would be low and hence the level of
checking would be low. All this helps the auditor to plan the audit and to determine the nature, extent
and timing of the audit (Sonu, Ahn & Choi 2017).
In the case study, DIPL is a printing press, which is being subject to audit by Stewart and Kathy,
the newly appointed auditors of the company. The company has undergone many changes with respect
to the change in the accounting policies and internal IT system, which again was implemented without
much testing and validation by the management, therefore the need to do the extended verification and
checking arises so that they can give the reasonable assurance about the financials to its users. We have
done the ratio analysis based on the information given for the last three financial years to check the
status of liquidity, asset management, debt management and solvency, etc (Raiborn, Butler & Martin
2016).
2013 2014 2015
Total current assets 5,385,938 7,509,150 9,600,929
Total current liabilities 3,780,000 5,120,250 6,397,500
Result 1.42 1.47 1.50
2013 2014 2015
Total current assets - Inventory - Prepaid expenses 3,129,750 4,837,788 5,420,429
Total current liabilities 3,780,000 5,120,250 6,397,500
Result 0.83 0.94 0.85
Ratio Analysis
1. Short term solvency or liquidity Ratios
Current Ratio = Total current assets/ Total current liabilities
Liquid ratio /Quick Ratio = (Total current assets - Inventory - Prepaid
expenses)/ Total current liabilities
2013 2014 2015
Total Debts 3,780,000 5,120,250 13,897,500
Total Assets 5,120,250 15,903,900 26,147,991
Result 74% 32% 53%
2013 2014 2015
Total Debts 3,780,000 5,120,250 13,897,500
Total owners' equity 9,150,000 10,783,650 12,250,491
Result 41% 47% 113%
2. Debt Management Ratios
Debt ratio = (Total Debts / Total Assets) or ((Total assets- total owners'
equity)/total assets)
Debt to Equity Ratio = (Total Debt/Total owners' equity) or ((Total
assets- total owners' equity)/total owners' equity)
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2013 2014 2015
Sales 34,212,000 37,699,500 43,459,500
Accounts Receivable 2,482,500 4,320,000 5,073,309
Result 13.78 8.73 8.57
2013 2014 2015
No. of days 365 365 365
Receivable turnover 13.78 8.73 8.57
Result 26.49 41.83 42.61
2013 2014 2015
COGS 28,207,500 31,620,000 36,855,000
Inventory 2,256,188 2,671,362 4,180,500
Result 12.50 11.84 8.82
2013 2014 2015
No. of days 365 365 365
Inventory turnover 12.50 11.84 8.82
Result 29.19 30.84 41.40
2013 2014 2015
Sales 34,212,000 37,699,500 43,459,500
Net Fixed Assets 7,544,062 8,394,750 15,572,062
Result 4.53 4.49 2.79
2013 2014 2015
Sales 34,212,000 37,699,500 43,459,500
Total Assets 12,930,000 15,903,900 26,147,991
Results 2.65 2.37 1.66
3. Asset management Ratios
Inventory Turnover = COGS/Inventory
Days' Inventory = 365/Inventory Turnover
Fixed Assets Turnover = Sales/net Fixed Assets
Total Assets Turnover = Sales/Total Assets
Receivables Turnover Ratio = Sales/Accounts Receivable
Days Receivable = 365/Receivable turnover
2013 2014 2015
Net income 2,359,190 2,291,362 2,972,183
Sales 34,212,000 37,699,500 43,459,500
Result 6.90% 6.08% 6.84%
2013 2014 2015
Operating Profit 6,780,000 7,230,000 8,308,088
Sales 34,212,000 37,699,500 43,459,500
Result 19.82% 19.18% 19.12%
2013 2014 2015
Net income 2,359,190 2,291,362 2,972,183
Total owners' equity 9,150,000 10,783,650 12,250,491
Result 25.78% 21.25% 24.26%
4. Profitability ratios
Profit Margin / Net Profit ratio = Net income / Sales
Operating Margin ratio = Operating Profit/Sales
Return on Equity = Net income/total owners' equity
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Observations from Ratio Analysis:
1. From the above analysis, it can be inferred that both the current and the liquid ratio are well
below the industry trends of 2 & 1 respectively. However, it has somehow reached the figure of
1.5 in current ratio in the last financial year which was required to be maintained as per the loan
terms for the loan taken from BDO Finance Ltd.
2. The debt equity ratio here has increased almost thrice from 41% to 113%, which shows that the
company iis now focusing on meetng its financing needs from the outside sources rather than
own souces, However, in road to this, the ratio has exceeded the limit of maximum 1 as was
asked to do by the loan financing company.
3. Both the critical asset management ratios, i.e., the receivables cycle and the inventory turnover
cycle have shown a drastic increase by approximately 50%, which shows that the company has
lost control in maintaining its lag period and collections as a result of which these have
increased.
4. In profitability ratios, all the three ratios show that the company’s profitability has remained
more or less constant over the 3 years indicating there is no growth, i.e., stagnancy in the
company. (Jones 2017).
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Solution 2.
Risk identification and mitigation is an important part of nay audit. It is very important that auditor must
verify all the records properly so that any kind of risk can be mitigated. It is important on part of the
management to support the auditor in all these cases. Three types of risk are a part of the overall
auditing process. The first type of risk is inherent risk. Inherent risk in cases where even if the
management establishes control, it is not in its hand. This risk does not occur in the general day-to-day
activities. These risks cannot be eliminated from the system, they can only be reduced. The second type
of risk is the control risk, which occurs when the management has not installed that proper internal
control measures, it occurs because of lack of proper management. The management can be held
responsible for any kind of damage that might occur because of the same. The last major type of risk is
the detection risk which happens when the management, accountant or the auditors fails to identify the
errors and flaws in the accounting books and system. The auditor can be held responsible for the same,
and it occurs due to lack of professional scepticism on his part (Grenier 2017).
The case study of DIPL has many risk factors, the major amongst which are two. First, the company is
changing the routine transactions and methods that are used in the course of accounting. The company
is adopting new methods without any proper research. It is highly possible that it will lead to
misstatement in the books of account of the company. Here, the company has calculated the
depreciation using 20 years useful life of the assets as compared to the industry where the useful life
has been assumed to be 30 years. It is also changing the method of valuation of the inventories (Knechel
& Salterio 2016). All these might lead to over or undervaluation of the accounts and affect the overall
functioning of the company. Thus, it is the duty of the company that proper disclosures are given in the
books of account, the auditor must check the validity of the same and then make an opinion. It will help
in reduction of the overall risk factor that might be involved. The major inherent risk that the company is
suffering with is the installation of the new IT system without proper planning, testing and control. The
company is undertaking the same, without conducting nay reconciliation or research. It might affect the
overall productivity of the company. The books might be over or dune valued because of the same. It is
thus important that before applying such changes, the management of the company must take expert
opinion from outsiders, must judge the overall profitability of the system and then take a decision on
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the same. The auditor must verify the records properly so that any chances of material misstatement
are reduced and the company is able to show the true view of its financials (DeZoort & Harrison 2016).
Solution 3
Fraud is generally entered into for the profitability puposes by any of the employee or management of
the company in order to make the profist by window dressing the books of acounts. Often there are
certain personal motives involved behind taking such actions. It is important that while conducting
audit, the auditor must apply all kind of procedures so that fraud risk factor can be easily identified and
mitigated by the company. This is the most important work of an auditor and it is very necessary that
the management of the company provide full support to the auditor. In the given case study of DIPL,
there are many fraud risk factor which indicates that there may be material misstatement. Some of
them are identifiable and can be mitigated. The major one of them is non segregation of duties amongst
the management. Single person handles all the major departments, if that person defalcates the
accounts. It will be very difficult for the management to ascertain the same. In this case, we can see that
a single personnel has been given all the responsibilities of invoicing, collection, verify the payment,
manging all the ledger accounts and reconciliation of the accounts at the end of the period. Moreover
the entire cash department which is one of the critical resouces is being handled by a single person in
the organisation is there is no control over it. Thus, what is important that the company properly
segregate the work, so that proper authority and responsibility can be established? The auditor must
see to it that the boos of the company and checked weekly and surprise checks must be undertaken to
judge the sincerity of the employees. If any of the employees is found guilty, he must be restricted form
the work. Proper it security locks and control system moist be there so that any somewhat mis-
happening can be easily avoided (Fay & Negangard 2017).
The second fraud risk factor might be present in the installation of the new It system; the management
of the company installed the same without taking any precautions. The management may themselves be
directly responsible for all this as there might be personal hidden motives behind all this such that no
one is able to track the frauds, if any, amidst all this. It is thus important as an auditor to gets all the
necessary information regarding the new system and reconcile the overall cost and profit. In such a case,
it becomes immensely significant that nothing is undervalued or overvalued. The management must
take expert opinion, pre installation cost and the management must properly segregate post installation
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result. It is not only the responsibility but the control mechanism which must be set and practiced by
both the company as well as the auditors to have a surprise audit and continuous tracking of the major
financials to avoid any fraud by the employees of the company. All this will lead to paving the way for
quality audit and follow up procedures and clean books of accounts. (Bae 2017)
References
Bae, SH 2017, 'The Association Between Corporate Tax Avoidance And Audit Efforts: Evidence From
Korea', Journal of Applied Business Research, vol 33, no. 1, pp. 153-172.
DeZoort, FT & Harrison, PD 2016, 'Understanding Auditors sense of Responsibility for detecting fraud
within organization', Journal of Business Ethics, pp. 1-18.
Fay, R & Negangard, EM 2017, 'Manual journal entry testing : Data analytics and the risk of fraud',
Journal of Accounting Education, vol 38, pp. 37-49.
Grenier, J 2017, 'Encouraging Professional Skepticism in the Industry Specialization Era', Journal of
Business Ethics, vol 142, no. 2, pp. 241-256.
Jones, P 2017, Statistical Sampling and Risk Analysis in Auditing, Routledge, NY.
Knechel, WB & Salterio, SE 2016, Auditing:Assurance and Risk, 4th edn, Routledge, New York.
Raiborn, C, Butler, JB & Martin, K 2016, 'The internal audit function: A prerequisite for Good
Governance', Journal of Corporate Accounting and Finance, vol 28, no. 2, pp. 10-21.
Sonu, CH, Ahn, H & Choi, A 2017, 'Audit fee pressure and audit risk: evidence from the financial crisis of
2008', Asia-Pacific Journal of Accounting & Economics , vol 24, no. 1-2, pp. 127-144.
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