MAA303 Auditing: Financial Analysis & Risk Assessment - Beautiful Ltd

This report analyzes the financial performance of Beautiful Products Ltd, establishing a materiality benchmark based on provided information. It conducts an analytical review to identify control and inherent risks crucial for audit planning. The analysis involves assessing materiality, with a recommendation to set it at 0.5% of sales due to the company's financial struggles and a pending lawsuit. The analytical review reveals a deteriorating liquidity position, increased leverage, and declining profitability, prompting questions for management. Key inherent risks include the unadjusted lawsuit and potential misstatements due to financial difficulties, while control risks are evaluated through transaction documentation. The report concludes that auditors should scrutinize significant changes in financial performance and carefully plan materiality based on sales.

Running head: AUDITING
Auditing
Name of the student
Name of the university
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Author note

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Table of Contents
Introduction................................................................................................................................2
Answer (a)..................................................................................................................................2
Answer (b)..................................................................................................................................3
Answer (c)..................................................................................................................................4
Conclusion..................................................................................................................................5
Reference....................................................................................................................................6
Appendix....................................................................................................................................8

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Introduction
Main purpose of the report is to analyse the financial performance of Beautiful
Products Ltd and establishing the materiality benchmark based on the given information. The
report will further carry out the analytical review and based on the outcome will identify the
control risk and inherent risks required to be considered while planning the audit for the
entity (Choudhary, Merkley and Schipper 2018).
Answer (a)
Materiality concept is regarded as the principle under financial accounting and
reporting that states that the firms may disregard the trivia matters however, they shall
disclose everything important for reporting to the audience. Items are considered as material
if they can influence economic decision of the users of financial statements. To be more
specific, materiality error may mislead the decisions makers (Eilifsen and Messier 2014).
As basis for auditor’s opinion, auditors are required to obtain the reasonable
assurances regarding whether financial statement are free from the material misstatement.
Hence, the materiality concept is fundamental to audit. The concept is applied by the auditors
at the stage of planning and while performing audit and analysing impact of the identified
misstatement or error on audit, if any (Knechel and Salterio 2016).
Planning materiality is referred to amount of misstatement set up by the auditors at
planning stage of audit on the basis of materiality to the financial statement. It is used by the
auditors for assessing whether misstatement in aggregate or individually misstated the
financial statement materially (Ruhnke and Schmidt 2014). The following table may be used
for establishing the appropriate parameters while calculating the materiality benchmark –

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Base From To
Total sales: 0.5% to 1% $ 47.50 $ 95.00
Total assets: 1% to 2% $ 233.65 $ 467.30
Net profit: 5% to 10% $ 60.50 $ 121.00
However, level of materiality is depended upon the professional judgement of the
auditor and the financial statement presented to them. From the given details it can be stated
that the company is facing tough trading conditions as the consumer spending declined due to
recession in economy. Further, due to the spending on development of new product range
cash flow was also became an issue. However, a court case where the lawyer is estimated the
probable damage amounting to $ 500,000 on the part of the company has not been included
or adjusted in the financial statement (Eilifsen and Messier 2014). Therefore, the risk is
considered to be higher and the materiality level shall be lower percentage. Hence, the auditor
shall establish the materiality level at lowest of the above amount that is 0.5% of the sales or
$ 47,500.
Answer (b)
Analytical review is the audit technique used by the auditor for assessing
reasonableness of the accounts balances or the amounts reported under financial statements.
The procedure is not used for confirming accurateness of amount or balance of the account
rather it is used for assessing that the reported amounts are reasonable as per the knowledge
of the auditor. It refers to the analysis of financial statement through identifying the
relationships among the financial data (Chan and Vasarhelyi 2018).
Ratio analysis is one of the techniques for analytical review and it is used by the
auditors for comparing the current year ratios with previous year. Material difference in the
ratios shall be explained by the management of the entity to the auditors. Looking into the

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liquidity ratios of the entity it can be identified that the current ratio of the company is
expected to be reduced from 1.81 to 0.96 and quick ratio is expected to be reduced from 0.82
to 0.25 from the year 2017 to 2018 (Lessambo 2018). Hence, the liquidity position is
expected to be significantly deteriorated. Further, accounts receivable days are expected to
increase from 30.74 days to 41.06 days and accounts payable days is expected to be increased
from 51.71 days to 85.81 days. Moreover, the debt equity ratio of the entity is expected to be
increased from 1.04 to 1.32. All these ratios are indicating that the efficiency of the company
are reducing and it is becoming more leveraged. On the other hand, if the profitability
position of the company is analysed it can be recognised that the gross profit as well as net
profit both are expected to be dropped significantly in 2018 as compared to 2017 (Kogan et
al. 2014). Moreover, the returns on assets as well as return on equity both are expected to be
dropped considerably in 2018. Therefore, it can be identified that the overall profitability
position of the entity is expected to be deteriorated significantly. Hence, the management
shall be questioned regarding the position and performance of the company.
Answer (c)
Inherent risk is considered as the risk of material misstatement in financial statement
created due to omission or error as a result of the factors other than failure of the controls.
Inherent risk is considered higher where higher level of estimation or judgement is involved
or where the financial statement of the entity involves highly complex transactions (Boyle,
DeZoort and Hermanson 2015). On the other hand, control risk is considered as the risk of
material misstatement in financial statements due to error or fraud. Omission or
misapplication of the critical audit procedures may lead to undetected material misstatement.
Looking into the given scenario of Beautiful Products Ltd not including or adjusting
the amount of lawsuit is considered to be involved with inherent risk. Further, a company like

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Beautiful Products Ltd that is financially struggling is more likely to misstate its financial
statement to mislead the users. In addition to that some items like cash, inventories, sales
revenue are always involved with inherent risk owing to their nature. Further, to assess the
control risks the auditor shall ask for and verify proper records and documents associated
with important transactions like customer invoices, purchase orders for sales and purchases,
cash book and bank book for cash, loan documents for borrowings and asset register for
assets (Antonio 2014).
Conclusion
Based on the above calculation it is concluded that the while planning the materiality
the auditor shall establish the materiality level at 0.5% of sales. Further, based on the
analytical review the auditor shall question the management for significant changes in the
financial performances for the year 2018 as compared to 2017.

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Reference
Antonio, G.R., 2014. Continuous auditing: Developing automated audit systems for fraud and
error detections. Journal of Economics, Business & Accountancy Ventura, 17(1), pp.127-144.
Boyle, D.M., DeZoort, F.T. and Hermanson, D.R., 2015. The effect of alternative fraud
model use on auditors’ fraud risk judgments. Journal of Accounting and Public Policy, 34(6),
pp.578-596.
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.
Choudhary, P., Merkley, K.J. and Schipper, K., 2018. Auditors’ Quantitative Materiality
Judgments: Properties and Implications for Financial Reporting Reliability.
Eilifsen, A. and Messier Jr, W.F., 2014. Materiality guidance of the major public accounting
firms. Auditing: A Journal of Practice & Theory, 34(2), pp.3-26.
Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Routledge.
Kogan, A., Alles, M.G., Vasarhelyi, M.A. and Wu, J., 2014. Design and evaluation of a
continuous data level auditing system. Auditing: A Journal of Practice & Theory, 33(4),
pp.221-245.
Lessambo, F.I., 2018. Audit Risks: Identification and Procedures. In Auditing, Assurance
Services, and Forensics(pp. 183-202). Palgrave Macmillan, Cham.
Mock, T.J. and Fukukawa, H., 2015. Auditors' risk assessments: The effects of elicitation
approach and assertion framing. Behavioral Research in Accounting, 28(2), pp.75-84.

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Ruhnke, K. and Schmidt, M., 2014. Misstatements in financial statements: The relationship
between inherent and control risk factors and audit adjustments. Auditing: A Journal of
Practice & Theory, 33(4), pp.247-269.

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Appendix