Fulvous Enterprises Audit Report: Materiality, Risk, Procedures

This report presents an independent audit of Fulvous Enterprises, a proprietorship, focusing on key aspects of financial auditing. It assesses the materiality of financial statements, conducting an analytical review to identify potential risks of material misstatement. The report highlights specific financial items, such as indirect expenses, cash, and depreciation, that pose a higher risk, and suggests appropriate audit procedures for each. It also addresses the importance of auditor skepticism in identifying fraud risks, cautioning against relying solely on management's helpfulness as audit evidence. The report concludes that the initial materiality assessment was too high and recommends a more rigorous approach to ensure accurate financial reporting. Access more solved assignments and past papers on Desklib.

Auditing
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Contents
Introduction................................................................................................................................3
Materiality..................................................................................................................................4
Income statement items from trial balance................................................................................4
Risk of material misstatement....................................................................................................5
Audit procedures........................................................................................................................5
Fraud risk...................................................................................................................................6
Conclusion..................................................................................................................................7
References..................................................................................................................................8
Appendix....................................................................................................................................9
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Introduction
This report is prepared for the purpose of conducting an unbiased and independent audit
report on trial balance prepared by Fulvous enterprises that is registered under proprietorship
business structure. There are various factors in respect to external audit that will be
considered in this report such as materiality of financial statements, analytical review of
financial statements, risk of material misstatement, audit procedure and fraud risk. Main
purpose of this report is to get an understanding of all the activities that are required to be
conducted in independent evaluation of financial statements.
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Materiality
Materiality in financial statements can be defined as the level of acceptable material
misstatement in financial statement of a company. It is true that auditor of a company cannot
conduct an audit that covers 100% data presented in financial statements. All the financial
transactions recorded by business organisations are conducted over 12 months of time,
therefore it is not practically possible for an auditor of such business organisation to review
these transactions in limited period of time. There are specific commonly acceptable rules
and regulations in respect to giving a monetary value to materiality in financial statement
(Lakes and Masiulevičius, 2018). One of these commonly acceptable formula to calculate 5%
of total net profits (Calculation of net profit shown in appendix 1) earned by the company and
consider such amount as materiality of financial statement.
In the case of Fulvous Enterprises, total net profit of the company in financial year ending
2016 is $94407. Therefore materiality in this case would be $4720 which indicates that
material statements up to $4720 will not be considered as material from the perspective of
stakeholder’s decision making process. Materiality decided by the audit partner at the start of
financial year is 15000 whereas it should be around $5000. It can be said that auditor of the
company is required to increase the efforts toward the audit procedure in order to decrease
audit risk (Christensen et.al, 2018).
Analytical Review
Particular Last year
Proportiona
l Eleven
month of
last year
First
Eleven
months
of
current
year Analysis
Sales
244500.0
0 224125.00
232671.0
0
Increase in sales of the company is
a positive sign for the company
but it is important that other
variables move in same direction
(Scarborough, 2016).
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Cost of sales 63595.00 58295.42 54129.00
The cost of sales has decreased
substantially in this year as
compared to last financial year
which shows efficiency in
business operations.
Total indirect
expenses 90783.33 83218.05 97871.00
The increase in indirect expenses
in a question of doubt in this
scenario because the rate of
increase is very substantial and
direct expenses has decreased in
similar period of time.
Net profit 86498.33 79290.14 80671.00
The rate of increase in net profit is
not very impressive in this case
due to substantial increase in
indirect expenses (Grant, 2016).
Gross profit
180905.0
0 165829.58
178542.0
0
Gross profit earned by the
company has improved in this
financial year as the cost of sales
has decreased and sales has
increased.
Net profit ratio 35.38 35.38 34.67
There is a requirement of cost
control methods as net profit ratio
has decreased.
Gross profit Ratio 73.99 73.99 76.74
It can be said that company has
power to bargain from its supplier
as cost of sales has improved.
Risk of material misstatement
There are certainly some financial items in trial balance of the company that are at higher risk
of material misstatement as compared to other financial items. In case of Fulvous Enterprises
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three financial item are identified with the help of trend analysis of trial comparing last year
to current financial year (Louwers et.al, 2015). Following are these three financial items-
Particular
Last
year
First 11
months of
current year
Total Indirect
expenses
90,
783
9
7,871
Cash
83,
000
8
9,750
Depreciation 15738.33 32582.91667
Total indirect expenses- in the first 11 months of operation total indirect expenditure has
increased substantially. Total indirect expenses incurred by the company in last 12 month was
higher as compared to the total expenditure in first 11 month of 2016. It clearly shows that
internal control implemented by the organisation in order to control its cost are not very
efficient and there is a requirement to revise the internal controls.
Cash- Cash is always considered as fraud prone area in financial statements of the company
and it should be always considered at the risk of material misstatement (Griffiths, 2016).
Depreciation- There is a possibility of error in recording of depreciation accounting
conducted by management of the company. It is general practice of sole proprietorship to
record depreciation on the basis of straight line method. In this proprietorship business,
amount of depreciation has increased substantially there as total amount of fixed asset in
balance sheet of the company is same.
Audit procedures
Indirect expenses- Auditor of the company is required to assess the nature of indirect
expenses and conduct vouching of all the expenses on sample basis. Vouching is an audit
procedures that is conducted to verify the amount of indirect expenses in a particular financial
year (Ganguly, Al-Faraj and Hancock, 2017).
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Cash- discussion with management of the company should be conducted by Auditor in order
to identify the cash management procedures used by management of the company. These
procedure should be compared by auditor of the company with standard cash management
procedures that should be used by an organisation working in similar industry as Fulvous
Enterprises.
Depreciation- Auditor of the company should assess the methods used for recording of
depreciation in account of the company. Audit procedure that should be used in this scenario
is physical verification of any addition made in total Assets of the company (Knechel and
Salterio, 2016).
Fraud risk
There is a characteristic that should be possessed by every auditor conducting external audit
of a company i.e. scepticism. During the process of Audit and auditors should always
evaluate every action taken by management from the perspective of scepticism. Audit partner
in this scenario has suggested that there is no risk of audit fraud because management of
company seems to be very helpful and friendly. Friendly and helpful nature of management
cannot be considered as sufficient audit evidence in order to make a conclusion that there is
no risk of fraud in the company (Eutsler, Nickell and Robb, 2016). Therefore it can be said
that opinion suggested by audit partner is not appropriate and it is also not in line with duties
of auditor.
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Conclusion
This report has identified various aspects of audit that should be considered by Auditor in
conducting audit engagement of proprietorship business. It is concluded that material it is
decided by auditor was not correct and it way higher as compared to what it should have
been. This report is also identified three factors that are indirect expenses, cash and
depreciation recorded by the company at high risk of material misstatement. Audit
procedures are also suggested to collect appropriate audit evidence in relation to above 3
financial items.
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References
Christensen, B.E., Eilifsen, A., Glover, S.M. and Messier, W.F., 2018. The Effect of
Materiality Disclosures on Investors’ Decision Making.
Eutsler, J., Nickell, E.B. and Robb, S.W., 2016. Fraud risk awareness and the likelihood of
audit enforcement action. Accounting Horizons, 30(3), pp.379-392.
Ganguly, R., Al-Faraj, M. and Hancock, G., 2017, March. Introducing Scenario Based Audit–
A Risk Based Approach to Auditing. In SPE Middle East Oil & Gas Show and Conference.
Society of Petroleum Engineers.
Grant, R.M., 2016. Contemporary strategy analysis: Text and cases edition. John Wiley &
Sons.
Griffiths, P., 2016. Risk-based auditing. Routledge.
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.
Scarborough, N.M., 2016. Essentials of entrepreneurship and small business management.
Pearson.
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Appendix
Particular
Jul 1, 2015 - June
30, 2016 (Previous
financial year)
Jul 1, 2016 -
May 31, 2017
(11 months)
Revenue
Sales
1,
87,450
1,7
8,315
Consultancy fees 57,000
5
4,313
Interest income 50 44
Total revenue
2,
44,500
2,3
2,671
Cost of sales 63,595
5
4,129
Gross profit
1,
80,905
1,7
8,542
Less- Expenses
Bank charges 350 319
Depreciation 15738.33
3
2,583
Interest expense 12000
1
0,542
Printing 375 339
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Repairs and
Maintenance 0 1,320
Wages 53000
4
8,189
Superannuation 5035 4,579
Total indirect cost 86498.33
9
7,871
Net profit 94,407
8
0,671
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