Auditing of Always Precise Instruments (API): Risk Analysis

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This report, prepared for the audit manager of Always Precise Instruments Pty Limited (API), analyzes the audit risks associated with the company's financial statements. The report examines various financial ratios, including current ratio, quick ratio, return on equity, return on total assets, gross margin, marketing expenses, admin expenses, times interest earned, days in inventory, days in accounts receivable, and debt to equity ratio, identifying potential misstatements and their impact on the financial position of the business. For each ratio, the report outlines the audit procedures, such as test of details and test of controls, that the auditor should undertake to mitigate the identified risks. The report also addresses weaknesses in inventory internal control, detailing associated audit risks and recommended audit procedures to improve the system. The report emphasizes the importance of accurate financial representation and the auditor's role in ensuring the validity and fairness of the financial statements.
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Running head: AUDITING
Auditing
Name of the Student:
Name of the University:
Author’s Note
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1
AUDITING
Memo
To: Wayne Wiadrowski
From: The Audit Manager
Date: 8th May, 2019
Subject: Discussion Regarding Audit risks of API
Purpose and Scope
The business of Always Precise Instruments Pty Limited (API) needs to focus on
appropriate representation of the financial information of the business in the annual reports of the
business. The memo contains analysis of the different risks which is faced by the business of API
which would be established on the basis of ratios of the business. The major risks and the audit
procedures which the auditor would undertake would be highlighted below. The various risks
which is faced by the business by analysing the ratios of the business is provided below in
details:
Current ratio: The current ratio of
the business shows
that there has been an
increase in the
estimate which is
mainly due to
increase in the
current assets of the
business or a
decrease in the
current liabilities of
the business.
The major risks
which can be
identified from the
analysis of the ratio is
that the current assets
of the business might
be misstated (Mio,
2013). In such a case,
the balance sheet of
the company would
not be showing a true
and fair view
regarding the
financial position of
The auditor needs to
apply test of detail
approach for
understanding the
valuation process of
the current assets and
also refer to all the
records of the
business in order to
assess the validity of
the transactions.
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AUDITING
the business.
Quick asset ratio: The quick ratio of the
business is quite
similar to current
assets of the business
and reflects the
liquidity position of
the business. The
estimate which is
shown represent that
there has been an
increase in the
estimate during the
period.
Misstatement in the
current asses and
current liabilities of
the business creates
risks for the business.
This has an impact of
the financial position
of the business.
The auditor in such
situation has the
option of applying
test of details as well
as test of controls of
the business. The test
of details would be
checking each and
every transaction of
the business and the
potential impact
which a misstatement
might have on the
annual report of the
business. In addition
to this, the test of
control would be
assessing the
effectiveness of the
internal control
system and whether it
is strong or weak.
Return on equity % The return on equity
of the business shows
how much profit the
business can earn by
using the equity fund.
There has been a
decrease in the
estimate of return of
The main risk which
can be associated
with this ratio is
misstatement in
income statement and
shareholder’s fund of
the business. This
would affect the
The auditor needs to
apply test of details in
such an approach for
assessing whether
there is material
misstatement in the
income or expenses
of the business. The
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3
AUDITING
equity which suggest
that either the profits
of the business have
declined or the equity
of the business is
overvalued slightly.
accuracy of the
income statement and
also affect the
financial position of
the business as a
whole.
auditor can also apply
couching practices in
the business so as to
ascertain that the
income and expenses
figures are accurate.
Return on total assets
%
The return on total
asset represent the
profit which is
generated by using
the assets. This is
considered to be one
of the financial
indicators of the
business. There is a
decrease in the ratio
which might be due
to fall in profits of the
business or
overvaluation of the
assets of the business.
The main risks in
such case is related to
misstatement in
income and expenses
account and there
might also be an
overvaluation of the
assets of the business.
The misstatement in
profits would affect
the entire financial
statements thereby
affecting genuineness
of the ratio
The test which the
auditor of the
business can apply in
such a case is test of
details for analysing
the items of income
or expenses of the
business. In addition
to this, the auditor of
the business also
needs to apply
verification practices
in the business so that
the assets of the
business are properly
recorded and
appropriately valued.
The auditor can also
use the opinion of an
expert for valuing the
assets of the business.
Gross margin % The gross profit
margin is a very
important estimate
which reveals the
The risk which is
created with such a
ratio is the risk of
misstatement in the
The auditor needs to
apply both test of
control and test of
details which would
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4
AUDITING
performance of the
business in terms of
profitability of the
business. The gross
profit margin of the
business is shown to
have declined in
comparison to
previous year
estimate which may
be due to decline in
sales of the business
or hike in the cost of
sales of the business.
income and expense
account which might
not be showing
accuracy in the
business. The gross
profit margin is based
on the sales and costs
of the business which
can be easily
manipulated.
include checking of
all transaction
relating to sales of
costs incurred by the
business. In addition
to this, the auditor
would also apply
vouching practices
for confirming the
balances which is
represented in the
income statement of
the business.
Marketing expense
%
The marketing
expenses of the
business forms a part
of the sales expenses
and the same is
shown to have
increased (Johnstone,
Gramling &
Rittenberg, 2013). It
is to be noted that
such an increase in
the marketing
expenses can affect
the profitability of the
business severely.
Misstatement in the
marketing expenses
of the business would
give rise of material
misstatement as the
same would affect the
net profit which is
shown by the
business in the profit
and loss statement.
In this case, the
auditor would apply
test of details to
check all the
marketing expenses
of the business and
ensure that proper
reporting of the
expenses of the
business is shown.
Admin
expenses/sales %
The admin expenses
of the business show
The audit risk which
arises in such a case
The auditor needs to
apply test of details
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AUDITING
the relationship
between the expenses
and sales of the
business (Bratten et
al., 2013). There has
been a decrease in the
estimate in 2018 for
API and the same is
shown lower than
industry benchmark.
is related to
misstatement or
undervaluation of the
expenses of the
business. If the
expenses of the
business are
undervalued than the
same would have an
impact on the profits
which is generated by
the business. In such
a way books of
account would not be
showing true and fair
view
which can help the
auditor to identify the
risks which is
associated with the
business. The auditor
needs to conduct test
on every balance of
expenses so as to
ensure that the same
are showing true and
fair view.
Times interest earned There is a decrease in
the times earned
interest ratio of the
business in
comparison to
previous year
analysis which
suggest that the
business has reduced
the payment of
interest during the
period.
There is a possibility
that the interest
expenses of the
business might be
understated which
would automatically
create discrepancies
in the annual reports
of the business and
thereby cause
discrepancies in the
annual report of the
business.
The auditor must
apply both test of
control and test of
details in this respect
as the interest might
be understated
affecting the
profitability of the
business. In addition
to this, the auditor of
the business would
also check the
internal control of the
business for any
flaws in the same.
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AUDITING
Days in inventory The estimate shows
that there has been a
decrease in the
inventory days of the
business which
suggest that the
management of the
company is trying to
clear the stocks of the
business.
Misstatement can be
noticed in the value
of the inventory
which can affect the
overall profitability
of the business and
thereby affect the
valuation of the
inventory of the
business.
The auditor needs to
apply test of control
to the estimates so as
to ensure that the
management of the
company has
formulated
appropriate policies
for valuing the
inventories of the
business.
Days in accounts
receivable
As per the estimate
there is an increase in
the days of inventory
which is a sign that
the management of
the company has
amended the policies
of debtors of the
business.
The misstatement in
debtor balances
would affect both the
profit and loss
account as well as
balance sheet of the
business (Newton et
al., 2015). As per the
case, there is a high
chance that the
balances might be
overstated.
Test of details and
test of control can be
applied by the auditor
of the company for
ascertaining whether
the financial
statement are
showing true and fair
view or not.
Debt to equity ratio There is a decrease in
the estimate of Debt
to equity ratio which
may be due to change
in capital structure of
the business. The
management might
have increased the
Misstatement in the
amount of debt of the
business can lead to
material misstatement
in the financial
accounts of the
business.
Test of details is the
main audit procedure
which can be
undertaken by the
auditor in the case.
The auditor needs to
ascertain whether the
company has taken
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AUDITING
proportion of debt
capital in the capital
mix of the business.
additional debts
during the year or
not.
Weaknesses in Inventory Internal Control, Audit Risk and Procedures
Internal Control Weakness Audit Risk Audit Procedure
The weakness in the system
which has been identified in
the process is that the stock
of raw materials of the
computers has been lowered
to about 70 percent where it
was the responsibility of the
department to generate the
purchase orders. This kind
of errors will lead to dispute
in the purchase orders.
The audit risk which is
associated here is that it
creates major implication on
the purchase orders.
Improper adjustments in the
purchase orders of the can
lead to loss for the API.
The significant audit
procedures must be acquired
in this case to further test the
internal control system and
the risk associated with it.
Testing must be conducted
on an interval basis through
the computerised system
which will further reduce the
chances of fraud and error in
the system (Chang et al.,
2019).
Another major weakness in
the system which is
identified in such a situation
is that the inventory internal
control system of API is
further dependent on the
orders which is computer
generated. Hence, in such
circumstances the disputes
in the computer can hamper
the overall production
This kind of weakness
further crease audit risk with
the potential impact on the
system. There will be high
chance of failure regarding
the placements of the raw
material or the finished
products of the firm. The
date of the production might
show error in the system can
automatically hamper the
It is hence needed to reduce
the risk by ensuring that the
internal control management
of the company enhances the
computerised system by
removing the glitches
associated in the same.
Regular upgrading in the
system is needed to make
sure that the system remains
error free. This will further
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AUDITING
process. production related to the raw
material or the finished
products of the firm.
reduce the audit risk as per
the required audit procedure.
The computerised system of
API is further responsible
for the raw material or the
finished products which is
supplied by the company.
Such kind of fraud and error
has not been identified by
the management dealing
with the order printing and
GRN printing.
The audit risk which is
related to such kind of
weakness is supply of raw
material and finished
products of the company.
Appropriate supplier of raw
material is needed to
enhance the overall
production of the business in
that case.
The internal control risk
must be analyzed by the
auditors and further it rest
upon the duty of the auditors
to imply conductive test of
the computer system on an
interval basis.
The representatives of the
accounts department of API
further have the access of
the passwords which further
consists the confidential
files of the company and
filling the two copies of the
purchase orders and GRN in
the system of the company
falls under the major
weakness in the internal
control management
(Bentley-Goode, Newton &
Thompson, 2017).
This kind of manipulation of
the confidential files of the
business by representatives
of the accounts department
of the company is a major
audit risk in that case.
It is needed to test the
documents related to the
confidential and further the
significant files falls under
the audit procedures of the
company in that case. Such
kind of testing will reduce
the frauds and the errors of
the associated with the
system.
By analyzing it is found that
the controller of the overall
production has access
The audit risk which is
associated here is that
certain drawbacks in the
As per the responsibilities of
the auditors it is needed to
adopt necessary audit steps
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AUDITING
regarding the orders of
printing and production and
further the files associated
with it. Hence, it can be said
that it is a weakness of the
internal control management
regarding such manipulation
of the production and the
printing orders of the
company (Christensen et al.,
2016).
production process of the
company can create negative
impact due to the high
manipulation in the
production than the actual
requirement predicted by the
business.
in order to prevent the
production controller from
having such kind of
responsibilities.
Another drawback which is
noted during the process is
that the stores staffs has
access over the passwords
related to the GRN printing
and the raw material
purchase orders. Hence,
such drawback is not
detected as staffs have the
responsibility of both the
order and the GRN printing.
The audit risk which is
associated in this case is
regarding the drawback in
the raw material and the
production of finished goods
which will definitely create
negative impact on the
production of the company.
The responsibility of the
auditor in this case is to
separate the staff from the
responsibility which is the
purchase order printing and
GRN printing respectively.
Based on the master file, the
orders will be generated
accordingly to the suppliers
and sub-contractors. The
drawback which is identified
here is that there remain
chances of manipulation
Due to such kind of
manipulation in the
production process of the
company it will further
definitely put negative
impact on the performance
of API. Hence, the
Effective internal control in
the management system
must be ensured by the
auditor so that there must be
a single person password
access can automatically
remove all sort of casualties
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AUDITING
regarding the selection of
suppliers and contractors.
manipulation of the
contractors and suppliers is a
major drawback in the
system.
or the chances of fraud and
errors in the system
(Donelson, Ege, & McInnis,
2016).
Another drawback in the
system is that in the stock
sheet report of the company
does not include the
complete records of the
quantities of stock in the
production process (Khelil,
Hussainey & Noubbigh,
2016).
The audit risk associated in
this case is that this kind of
drawback will definitely put
negative impact on the
inventory management
system of API. This can
further lead to the over and
understatement inventory
management of the company
(Cameran, Prencipe, &
Trombetta, 2016).
The responsibility of the
auditor as a part of audit
procedure in that case is to
make sure that the inventory
has been properly evaluated
and maintained as per the
records so that the errors can
be identified and detected at
the same time.
Sampling Methods
Assertion Which Population Sample Selection
Method
Justification for
Sample Selection
Method
Completeness In the assertion of According the purpose Regarding the sample
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AUDITING
completeness there must
be the record of all the
financial transaction in
the financial statement of
the company. This
particular assertion is
related to the
understatement of the
inventories of the
company. In such a
situation it is the duty of
Wayne to collect the
required information’s
regarding the purchase of
raw material and the
finished products
(Knechel 2016).
of assertions, the
required sample
selection process of
the company must be
in a systematic way.
This further requires
identifying the
uniformity in the
physical units from the
evaluation of the
entire system (William
Jr, Glover & Prawitt,
2016).
selection method, it is
the most suitable
method which must be
undertaken by the
auditor. In this method
it can further be
ascertained by Wayne
is that there must be
implication of the even
system for sampling
the entire population of
the selected samples in
such circumstances.
On behalf o f the
company, Wayne will
further be able to
regulate the sampling
of raw material
purchased and finished
goods produced in
such a positive way.
Hence in such
circumstances, the
detection of frauds and
errors in the inventory
account of API
increases which is
positive point as per
the business
perspective. This kind
of sampling methods
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