Issues in Auditing Practices: Income Statement Analysis, Audit Risk

This report provides an audit procedure based on the unadjusted trial balance of Amarnath Enterprises. It assesses the suitability of a $15,500 materiality figure and its impact on the audit budget. The report conducts an analytical review of income statement items, identifying sales revenue, service fees, miscellaneous expenses, and depreciation as high-risk areas. It outlines audit procedures for each account, considering relevant management assertions such as accuracy, completeness, valuation, and existence. The report also addresses fraud risk, emphasizing the importance of professional skepticism despite employee integrity, and concludes that the auditor has deemed an appropriate materiality amount for Amarnath Enterprises. The report highlights the application of skepticism to detect variations in events.

Running head: ISSUES IN AUDITING PRACTICES
Issues in Auditing Practices
Name of the Student:
Name of the University:
Author’s Note:
Course ID:

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Executive Summary:
The report is prepared to conduct the audit procedure based on the unadjusted trial balance of
Amarnath Enterprises. It has been found that sales revenue, service fees, miscellaneous expenses
and depreciation are four items of the income statement, which are prone to different types of
risk and materiality. Hence, various management assertions as well as other assertions are
considered for the audit work. Lastly, these accounts contain fraud risk, even though the
employees of the organisation conduct fair practices. Therefore, the auditor is required to rake
into account professional scepticism.

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Table of Contents
Introduction:....................................................................................................................................3
1. Suitability of materiality figure and impact of preliminary assessment on audit budget:...........3
2. Analytical review using the items of the income statement from the trial balance:....................4
3. Identification of three accounts of income statement at material misstatement risk, audit risk
and relevant assertions:....................................................................................................................7
4. Explanation of the audit procedures for the identified accounts and assertions:.......................10
5. Fraud risk according to the appropriateness of the suggestion of the audit partner:.................12
Conclusion:....................................................................................................................................13
References:....................................................................................................................................14

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Introduction:
The report is prepared with the intent of assisting the planning stage of small audit client
from the viewpoint of an audit firm. The audit firm would be carrying out the audit work of
Amarnath Enterprises by using its preliminary trial balance. The first part would emphasise on
ascertaining whether the materiality amount of $15,500 is suitable along with the impact of
materiality assessment on audit budget. The next segment would conduct an analytical review of
the items in the income statement from trial balance by utilising trend analysis. After this, three
items from the income statement at risk would be detected based on which audit processes would
be recommended for each account. Finally, the report would focus on fraud risk and the
suitability of suggestion provided from the end of the audit partner.
1. Suitability of materiality figure and impact of preliminary assessment on audit budget:
As commented by Aobdia, Lin and Petacchi (2015), materiality could be explained as the
threshold beyond which missing or wrong information in the financial statements would affect
the decision-making procedures of the users. It is necessary for the auditors to modify three audit
risk components while making preliminary material evaluation. The components are described as
follows:
The users of the financial statements such as investors, suppliers, shareholders,
employees, creditors, regulators, customers and others
The size of the financial statement elements such as current assets, total revenues, current
liabilities, net profit and total assets

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The trends of the organisation in relation to revenues, cash flows and earnings (Bowlin,
Hobson and Piercey 2015)
In order to ascertain the average amount of materiality for a small company such as
Amarnath Enterprises, the materiality amount should be applied between 5% and 10% of sales
revenue. In this case, the materiality amount is assumed as 7.36% of the total sales revenue of the
organisation in 2017. In this regard, Cannon and Bedard (2016) cited that if the amount of
materiality does not include a significant proportion of net income, the loss would be considered
as immaterial. The reason is that the average financial statement users would not be worried with
the loss, which could be 0.1% of the net income of the organisation.
However, it is noteworthy to mention that due to the small size of Amarnath Enterprises,
there is high probability that majority of the random expenses might not be recorded in separate
accounts. This could be validated by the fact that credit amount of $148,906 could not be tracked
in 2017, due to which it has been recorded as suspense account. For example, if an assumption is
made that the omitted expenses of the organisation amount to $15,500, it could be material to the
financial condition and appropriate justification of the expenses is necessary. Hence, the material
amount of $15,500 could be considered as accurate by the auditor.
2. Analytical review using the items of the income statement from the trial balance:
Since the debit side and the credit side of the trial balance of Amarnath Enterprises do not
match with the each other in both 2016 and 2017, suspense account is used for matching the
balances of both sides.
Adjusted trial balance:

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Income statement:

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Trend analysis as a percentage of revenue:

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3. Identification of three accounts of income statement at material misstatement risk, audit
risk and relevant assertions:
Accounts Names of
accounts
Risk of misstatement Audit risk Relevant
assertions

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1 Sales For Amarnath
Enterprises, increase in
sales revenue could be
observed over the period.
In case, revenue
recognition criteria are
not followed effectively
by the organisation or
the allowances are
overstated, material
misstatement risk might
take place (Chambers
and Odar 2015).
Certain deficiencies
might be inherent
in Amarnath
Enterprises, since it
is a small company.
The reason is that a
single person might
be associated with
billing customers,
obtaining money
from the customers,
undertaking
deposits, recording
ledger payments
and reconciliation
of the associated
bank account
(Edwards and
Chandler 2014). As
a result, the auditor
might experience
an increase in
control risk.
The pertinent
assertions, in this
case, include
accuracy and
completeness. The
reason is that there
is high probability
that there might be
omission of certain
transactions by the
book-keeper. In
opposition, the
revenues might be
shown deliberately
higher in order to
represent better
financial
performance of the
organisation.

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2 Service fees Amarnath Enterprises
offers other services on
various technical aspects.
This might constitute of
new guidelines for
auditing or tax
regulations (Ettredge, Xu
and Yi 2014).
In this situation,
there is high
probability for
manipulation,
which might be due
to the largest
threats to advisory
services and their
credibility. As a
result, the audit risk
might be increased.
The other advisory
services contain
more independence
risk for the audit
organisation. Along
with this, the audit
organisation would
not carry out its
obligations in the
form of an external
auditor correctly.
Hence, the
significant
assertions at risk
comprise of
valuation,
completeness and
accuracy.
3 Depreciation If any asset sale is not
recorded appropriately,
there is increased chance
of asset
misappropriation. Along
The most
significant audit
risks are associated
with accurate
valuation of
The main
assertions at risk
for depreciation
take into account
valuation,

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with this, if the
capitalisation of
expensed costs is not
conducted properly,
material misstatement is
bound to take place.
property, plant and
equipment along
with depreciation
and disposal of the
stated asset. In
addition, when the
accounts
department could
not find evidence
of stock take and
chance of theft, the
audit risk might
increase.
existence, rights
and completeness.
4 Miscellaneous The accountants have
omitted certain
transactions, which could
have been recorded as
miscellaneous expenses.
This might result in
material misstatement
risk.
In this case, certain
transactions might
have been omitted
deliberately, which
might reduce the
overall expenses
and this might lead
to audit risk.
The significations
assertions at risk
include existence,
valuation and
completeness.

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4. Explanation of the audit procedures for the identified accounts and assertions:
Accounts Names of
accounts
Management assertions Audit procedures Explanation of the audit
procedures
1 Sales The sales revenue is to be
incorporated in the
assertion of completeness
under transaction classes.
Transaction testing In order to verify the sales
figure accuracy, it is
necessary for the auditor to
review all transactions
associated with sales ledger
approximate to the financial
statement date in order to
ensure that Amarnath
Enterprises has considered
sales before the date
(Glover, Taylor and Wu
2016).
2 Service fees In this case, classification
is identified as the
management assertion for
verifying whether correct
posting of transactions is
made at the accurate
accounts (Griffiths 2016).
Re-calculation This process takes into
account conducting the
work made from the end of
the client so that the
difference could be analysed
between the auditor’s work
and that of the organisation

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3 Depreciation For depreciation, the
management assertions
include rights, valuation,
completeness, disclosure,
existence and
presentation.
Observation and
inquiry
When any asset is observed,
it is crucial for the auditor to
determine the existence of
the audit. Moreover, it
needs to be checked
whether contrast could be
made between the condition
and the remaining useful
life depending on the
schedule of depreciation.
4 Miscellaneous The management
assertions for
miscellaneous expenses
include existence,
valuation and
completeness.
Inquiry and re-
calculation
The auditor is required to
check whether the omitted
transactions form part of the
miscellaneous expenses.
5. Fraud risk according to the appropriateness of the suggestion of the audit partner:
In order to discuss the fraud risk, it is necessary to provide an overview of scepticism.
Scepticism could be explained as an attitude that takes into account a questioning mind of any
individual (Johnson 2016). This signifies likely misstatements due to errors or frauds along with
considerable evaluation of audit evidence. The financial reports often contain material

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misstatements that take place due to frauds or errors Lenz, R. and Hahn, U., 2015). The latter is
deemed to be intentional so that personal benefits could be obtained. On the contrary, fraud risk
involves the conditions or events signifying incentive or pressure in order to commit fraud. In
accordance with the above analysis, the main accounts at risk in case of Amarnath Enterprises
constitute of sales revenue, service fees and depreciation. The maximum chance of fraudulent
activities is possible with these accounts, since increase in revenue would denote better financial
performance of the organisation (Louwers et al. 2015).
Conversely, the service fees for other advisory service would assist in improving the
brand image of Amarnath Enterprises, which might not be appropriate. Lastly, if lower
depreciation is charged for property, plant and equipment, the fair value of the asset might show
increased value, which would be misleading for the investors. It is noteworthy to mention that
the auditors are not expected to show doubts on past experience of honesty and integrity
associated with the employees responsible for company governance (Power and Gendron 2015).
However, the auditors are required to act accordingly towards scepticism in considering the risks
related to material misstatements to detect variations in events.
Conclusion:
The above discussion makes it apparent that the auditor has deemed an appropriate
materiality amount of $15,000 for Amarnath Enterprises, since it has a significant amount of
credit balance missing in its unadjusted trial balance. Due to such missing information, suspense
account is used for tallying the debit side and credit side of the trial balance. The four accounts in
the income statement at risk include sales revenue, service fees, miscellaneous expenses and
depreciation, as they are subject to risks associated with audit and material misstatements.

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Hence, various pertinent assertions as well as management assertions are considered in the
context of the organisation. Finally, it has been evaluated that the three identified accounts
contain fraud risk. Although the employees are deemed to be diligent and honest, it is necessary
for the auditor to take into account professional scepticism.

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References:
Aobdia, D., Lin, C.J. and Petacchi, R., 2015. Capital market consequences of audit partner
quality. The Accounting Review, 90(6), pp.2143-2176.
Bowlin, K.O., Hobson, J.L. and Piercey, M.D., 2015. The effects of auditor rotation, professional
skepticism, and interactions with managers on audit quality. The Accounting Review, 90(4),
pp.1363-1393.
Cannon, N.H. and Bedard, J.C., 2016. Auditing challenging fair value measurements: Evidence
from the field. The Accounting Review, 92(4), pp.81-114.
Chambers, A.D. and Odar, M., 2015. A new vision for internal audit. Managerial Auditing
Journal, 30(1), pp.34-55.
Edwards, J.R. and Chandler, R.A., 2014. Recurring Issues in Auditing (RLE Accounting):
Professional Debate 1875-1900. Routledge.
Ettredge, M.L., Xu, Y. and Yi, H.S., 2014. Fair value measurements and audit fees: Evidence
from the banking industry. Auditing: A Journal of Practice & Theory, 33(3), pp.33-58.
Glover, S.M., Taylor, M.H. and Wu, Y.J., 2016. Current practices and challenges in auditing fair
value measurements and complex estimates: Implications for auditing standards and the
academy. Auditing: A Journal of Practice & Theory, 36(1), pp.63-84.
Griffiths, P., 2016. Risk-based auditing. Routledge.
Johnson, T.J., 2016. Professions and Power (Routledge Revivals). Routledge.

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Lenz, R. and Hahn, U., 2015. A synthesis of empirical internal audit effectiveness literature
pointing to new research opportunities. Managerial Auditing Journal, 30(1), pp.5-33.
Louwers, T.J., Ramsay, R.J., Sinason, D.H., Strawser, J.R. and Thibodeau, J.C., 2015. Auditing
& assurance services. McGraw-Hill Education.
Power, M.K. and Gendron, Y., 2015. Qualitative research in auditing: A methodological
roadmap. Auditing: A Journal of Practice & Theory, 34(2), pp.147-165.