Audit Report: Business Risks, Internal Controls for Big Machine Ltd

This report provides a comprehensive analysis of the audit conducted for Big Machine Ltd (BML), a company offering lease services for heavy mining machinery. The report begins with an assessment of financial ratios, including accounts receivable, machinery finance liabilities, plant and equipment, and lease income, highlighting industry benchmarks and identifying potential business risks. It then delves into the company's internal controls, evaluating control processes, risk reduction strategies, and the examination of controls. The report also addresses weaknesses in the internal control mechanisms, specifically for contract payroll, and discusses the business risks that threaten the company. The analysis includes an evaluation of audit steps, audit risks, and mitigation strategies. The report emphasizes the importance of internal control functions within the framework to effectively address problematic scenarios.

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AUDIT

BML
Executive summary
Audit techniques and processes are very pivotal as it assists in creating a path for companies
to progress further. Besides, it is vital for companies to pursue a powerful internal control
function within their framework so that they can cater to problematic scenarios effectively.
This report intends to shed light on Big Machine Ltd (BML) that offers lease services
associated to heavy mining machineries to the gold mines. Moreover, this report starts with
the assessment part wherein computation of ratios has been facilitated. In other words, four
different accounts are disclosed by the audit partner that is again followed by a table wherein
audit steps, audit risk, and evaluation part to decrease risks have been discussed. Further, the
ratios are assessed to depict the business risks posing a threat to the company. Nevertheless,
in the other segment, internal control measures are emphasized wherein control processes,
risk deduction, and examination of control is highlighted through a table. Lastly, the
weaknesses of such mechanism for contract payroll is discussed.
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Contents
1. Planning of audit in BML................................................................................................................3
1B. Business risks that pose a threat to the company...........................................................................7
2a. Recognition of internal controls......................................................................................................7
2B. Weaknesses in the internal control for contract payroll.................................................................9
Conclusion...........................................................................................................................................10
References...........................................................................................................................................11
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1. Planning of audit in BML
This report plays a key role in highlight relevant segments such as business risks and analysis
of rations that are associated with the company’s audit plan. Further, the effectiveness of
current internal control measures prevalent together with the current shortcomings in this
same segment are also intended to be discussed.
Account Evaluation Audit risks Audit steps to
mitigate risk
Accounts receivables The average of
industries in relation
to accounts
receivables in days is
forty-five days.
Further, the company
also had 53 days for
such accounts in the
past tenure that had
enhanced to 62 in
2017.
BML must seek
legitimate reasons to
interpret why it has
not attained industry’s
average in relation to
such accounts.
Furthermore, to
prevent delay or
postponement of
BML’s cash flow and
working capital cycle,
proper precautions
must be undertaken at
the initial stages itself
(Livne, 2015).
In order to supervise
BML’s smoother flow
of operations, it is
necessary that the
company makes
attempts to discuss
and deal the accounts
receivables separately
that have become due
for a longer tenure.
Machinery Finance
Liabilities
The average of
industry in relation to
debt-equity ratio is the
most effective as it
reports at 1.50.
Further, the bank loan
in the company can
also be effectively
interpreted while
accounting for its
The company’s debt-
equity ratio is reported
to have witnessed a
significant decline in
comparison to the past
year. Further, the
company has a current
debt structure of $1.05
for each dollar of its
equity. Moreover, it
In order to confirm the
company’s coverage
of all its liabilities, it
is required that there
prevail accurate and
effective disclosures
that an audit process
must look for
scrutinization from
several resources.
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debt-equity ratio that
was 1.32 for the year
2016 but had declined
to 1.05 for 2017.
cannot be considered a
variation that incurred
overnight.
Nevertheless, the audit
risk has been hidden
from the company’s
balance sheet owing to
being interpreted as a
long-term liability
(Lapsley, 2012).
Plant and Equipment BML attained a big
17% return on its total
assets for the year
2016 that has declined
to 14% for the year
2017. Moreover,
twenty percent of such
return is regarded to
be the aggregate for
the company.
The company has not
been making a proper
utilization of its assets
and the reason behind
this can be attributed
to the fact that the
machines have not
been utilized.
Moreover, to attain
enhanced ratios, the
company must take
accurate actions
together with
accounting for its
written down values
(Lapsley, 2012).
The audit of the
company in relation to
the number of idle
days the machine has
not been utilized, must
take notice together
with the legitimate
rates for the days
when such machines
were used.
Furthermore, the
written down value for
such machines
together with their
closing and opening
figures necessitate
proper verification
(Livne, 2015).
Lease income The company
primarily attains most
of its revenues from
the income that incurs
from leases. Further,
In order to make the
profit margins arrive
at the best possible
extent and its
financials to be
In order to prevent
audit risks to the most
possible extent, the
auditor is required to
facilitate substantive
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the margin on such
lease for the past
tenure was twelve
percent that declined
to eight percent in the
present year. One of
the biggest reasons in
relation to the same
can be attributed to the
fact is the diminishing
capability for
employment of older
machines. Further, the
operation and
installation of new
machineries are also
needed that can
facilitate in incurring
additional
expenditures for
yielding lesser returns.
favourable in the eyes
of others, the company
may depict few of its
revenue expenses as a
part of its revenue
expenditure. Further,
this can be regarded as
the audit risk that is
associated with the
scenario (Kaplan,
2011).
audit processes to
distinguish capital
expenses from the
revenue expenses.
The enhancement in the machine employment that were newly installed accounted to the
decline in the company’s net profit margin by four percent. In contrast to this, the gross
margin was not influenced, thereby indicating that there is no variation in the company’s
direct expense.
In comparison to the last year, the company had achieved lower times of interest in the
present year that is also a lesser figure when compared with the industry average. Therefore,
to surpass or avoid this scenario and attain proper returns, BML must effectively concentrate
on enhancing or developing the employment of its resources that have been kept idle
(Hoffelder, 2012).
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Further, the industry average in relation to return on equity have reported at 26%. Besides,
the return on equity for the company have declined to 15% from 22% that was in the previous
year. Nonetheless, the enhanced shareholding due to the issues that are made to the public
and the decline in profits can be attributed to the causes of decline in return on equity
(Matthew,2015).
BML pursues a favourable and acceptable current ratio and quick ratio that is closer to the
industry average. Furthermore, taking into account the financial performance of the company,
it can be said that the company must make proper amendments for future developments.
Besides, the machines having no use must be disposed or sold off by the company so that
funds can be realized in relation to the same (Geoffrey et. al, 2016).
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1B. Business risks that pose a threat to the company
In order to encounter the situation of present industrialization standards, the employment of
machines that are automatic, and disposal of outdated machines are needed. Such machines
must be computerized in nature and to follow such trend, the company has been interested in
purchasing and installing automated and updated machineries that has facilitated in
enhancing the requirement of massive resources (Manoharan, 2011).
The business risks posing a threat to the company are as follows:
1. If it is considered that the company has kept several of its machines idle and
unemployed for a longer period of time in its yard or warehouse, there must be a
decline in the company’s net realizable amount in relation to such machineries.
Therefore, the books of accounts of the company must acknowledge such necessary
and depreciation write-offs (Gay & Simnet, 2015).
2. The operations of the company are also influenced by the usual fluctuations in the
metal market. Further, the prices of coal have also increased due to the decline in iron
ores and gold. Besides, to encounter such fluctuations in the market, the company
must make required necessary alterations in its mode of affairs and framework.
3. In order to tackle emergence of fraudulent affairs, it is needed for the contracted
personnel, employees, and accountant to be accustomed and updated with the newly
machinery systems installed (Gay & Simnet, 2015). Moreover, regular knowledge
must be facilitated through updating and training to the employees, staff, and
accountants so that they are updated properly. Therefore, not accounting for such
steps can pose a threat to the company.
4. The business risk of enhanced and modern technology advancements is a major
concern for the company because what may be trending in such technology today may
become outdated and old in the future taking into account the speed at which
developments are being made.
2a. Recognition of internal controls
Control Risk alleviated Test of control
Approval of exact working
time- It is needed that the
contract manager must
It can be witnessed that the
employees have reported
working hours that were
It is needed that the auditors
evaluate on what basis the
approval of working hours has
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compare the actual working
hours of employees with the
hours that are entered by him
so that he can approve prior to
the initiation of payment
processes (Fazal, 2013).
untrue and were also approved
and verified by the contract
managers, thereby proving
that the manager is
questionable and accountable
for the frauds on the part of
employees.
been conducted by the
contract managers through
day-to-day timely records that
are maintained by the
manager for such time
reflected by the employee
(Fazal, 2013).
Recruiting new personnel-
The information from hard
copies and authorized revenue
tax declaration must be
verified by the payroll clerk.
It is the responsibility of
employees to monitor and
double check the information
filled by payroll clerks and
accountants to prevent
mistakes. The information
offered by the clerk passes
through various stages, so it is
easy for contract managers,
employees, and payroll clerks
to double check the
information (Elder et. al,
2010).
The information from the hard
copies and authenticated
declaration of income tax
filled by the payroll clerk
must also be verified by the
auditor of the company. This
can be undertaken by
comparing specific details that
are filled by such clerk and
accountants with the
supporting documents (Elder
et. al, 2010).
Bank reconciliation- For the
purpose of payment
processing from bank of both
contract managers and
accountants are engaged
simultaneously.
The accountant must detect
mistakes that are made by the
contract managers whether the
same has been committed
unintentionally or
intentionally.
In order to check the
verifications undertaken by
the contract managers and
accountants, the auditor must
check the reconciliations from
the bank accounts.
Pay-run processing- This is
processed by the clerk and
followed by the approval of
contract managers.
Thereafter, it is sent to the
bank and entered in the
general ledger
The manual approval of
manager and accountants
makes reporting of fraudulent
entries difficult.
The difference betwixt actual
and budgeted hours,
documents, and other
timesheets approved by the
contract managers and
accountants must be verified
by the auditor.
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2B. Weaknesses in the internal control for contract
payroll
The reason behind the usage of internal control is to enhance effectiveness and decrease the
emergence of frauds. If an employee is operating overtime, then they must be liable to attain
a wage for such particular time that is marked by documentation and analysis and
verification. Such kind of risk emerges when this documentation is missing or failed to be
recorded by the management (Baldwin, 2010). If the time duration of such overtime is
terminated, then the ending time is also relevant for the assessment of amount that the
employees are liable to attain. Besides, most of the opening gaps are associated with the
internal control mechanisms.
The loopholes that prevail in the internal controls are:
1. It can be seen that the contract manager can control the information associated to
working hours has access to the salary website of the company. Further, no
verification system is present that can check the stored data. It is relevant for the
company to allow verification of records and data by the accountant but not allowing
to any other person (Cappelleto, 2010).
2. It is usual for an employee to join the company and therefore, payroll clerk is
responsible to set a password and username. This is simple and accurate but it can be
feasible that false entries are made here, thereby resulting in fraud and another
loophole in internal control.
3. For the employees’ working hours, they are to enter their respective timing
themselves that are approved and verified by the contract managers. If the employee
has connection with the manager, false entries can easily be made, and the accountant
may fail to verify the same. It may also happen that the contract manager overlooks a
false record by mistake and this can facilitate in becoming a boon to the employee,
thereby resulting in another loophole of internal control mechanism (Merchant, 2012).
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Conclusion
Considering the previously mentioned scenario and analysis, the several standards of re-
evaluation including data verification by more than one individual must be established by the
company so that it can easily pave a path for mitigating or avoiding such loopholes and
frauds. Besides, an efficient risk management plan must collaborate with the mechanisms of
internal control so that it can assist in eliminating risks, thereby facilitating in smooth flow of
operations. Moreover, it is the obligation of auditors to report significant threats so that it
cannot influence the company and its activities. Nevertheless, various structural changes are
needed in the internal control mechanisms so that the path towards fraud and risks can be
terminated.
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References
Baldwin, S. (2010). Doing a content audit or inventory. Pearson Press.
Cappelleto, G. (2010) Challenges Facing Accounting Education in Australia. AFAANZ,
Melbourne
Elder, J. R., Beasley S. M., and Arens A. A. (2010). Auditing and Assurance Services. Person
Education, New Jersey: USA
Fazal, H. (2013, May 13). What is Intimidation threat in auditing?.Retrieved from:
http://pakaccountants.com/what-is-intimidation-threat-in-auditing/
Gay, G., and Simnet, R. (2015). Auditing and Assurance Services. McGraw Hill
Geoffrey D. B., Joleen K., K. K.S., and David A. W. (2016). Attracting Applicants for In-
House and Outsourced Internal Audit Positions: Views from External Auditors.
Accounting Horizons, 30(1), 143-156. https://doi.org/10.2308/acch-51309
Hoffelder, K. (2012). New Audit Standard Encourages More Talking. Harvard Press.
Kaplan, R.S. (2011). Accounting scholarship that advances professional knowledge and
practice. The Accounting Review, 86(2), 367–383.
https://doi.org/10.2308/accr.00000031
Lapsley, I. (2012). Commentary: Financial Accountability & Management. Qualitative
Research in Accounting & Management, 9(3), pp. 291-292.
https://doi.org/10.1111/1468-0408.00081
Livne, G. (2015, May 12). Threats to Auditor Independence and Possible Remedies. Retrieved
from: http://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-
independence-and-possible-remedies?full
Manoharan, T.N. (2011). Financial Statement Fraud and Corporate Governance. The
George Washington University.
Matthew, S. E. (2015). Does Internal Audit Function Quality Deter Management
Misconduct?. The Accounting Review, 90(2), 495-527. https://doi.org/10.2308/accr-
50871
Merchant, K. A. (2012). Making Management Accounting Research More Useful. Pacific
Accounting Review, 24(3), 1-34. https://doi.org/10.1108/01140581211283904
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