Auditing Report: Creme Limited - Audit Strategy and Testing Analysis

This auditing report provides a comprehensive analysis of Creme Limited's financial audit, focusing on risk assessment, audit strategy, and testing procedures. The report begins with an assessment of inherent risks, considering factors such as industry growth, competition, inflation, and currency fluctuations, and their potential impact on material misstatements. It then delves into the control risks associated with the accuracy of cost of goods sold, evaluating the effectiveness of internal controls like the audit committee and inventory management systems. The report outlines the audit strategy, emphasizing the need for detailed substantive audit procedures due to high inherent and control risks. Furthermore, it examines specific audit tests, including observing cycle counts and recalculating the cost of goods sold to verify accuracy. The analysis highlights the importance of these procedures in ensuring the reliability of financial statements and detecting potential misstatements. The report concludes by emphasizing the importance of identifying and mitigating risks to ensure the integrity of financial reporting.

Running head: AUDITING
Auditing
Name of the Student
Name of the University
Author’s Note

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Table of Contents
Part A: RISK ASSESSMENT AND AUDIT STRATEGY.......................................................2
Answer to Requirement (1)....................................................................................................2
Answer to Requirement (2)....................................................................................................3
Answer to Requirement (3)....................................................................................................5
Part B: AUDIT STRATEGY AND TESTING..........................................................................5
Answer to Requirement (4)....................................................................................................5
Answer to Requirement (5)....................................................................................................6
Answer to Requirement (6)....................................................................................................6
References..................................................................................................................................7

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Part A: RISK ASSESSMENT AND AUDIT STRATEGY
Answer to Requirement (1)
Inherent risks are considered as risks which leads to the increased possibility to
develop material misstatements in the financial reports due to the reasons other than internal
control failure over financial reporting (Ruhnke & Schmidt, 2014). There are certain factors
that will increase or decrease the inherent risk of material misstatements in Crème Limited
and they are discussed below:
Industry Growth – As stated in the provided case study that Creme Limited operates in the
beauty industry of Australia that is a going through a good phase and it is expected that the
industry will register further growth in future. This is a good aspect for Creme Limited that is
one of the market leaders in this industry; and it implies that Creme Limited will perform
well in the future. This aspect reduces the possibility of manipulating with the financial
figures by the management in order to increase its financial performance in manipulative
manner. This decreases the inherent risk of material misstatements (Coetzee & Lubbe, 2014).
Highly Competitive Nature of Industry – The provided information states that the beauty
products industry of Australia is highly competitive where the large competitors take full
advantage of innovation in sustainable product. This is a threat for Creme Limited since there
can be business loss for the competitors. Business loss refers to the decrease in sales,
decrease in profits, increase in expenses and others. This leads to the high probability that the
managements of Creme Limited may involve in manipulating the sales revenue figures by
overstating them and the expenses by understating them for improving the financial
performance and position than its competitors. It is a key inherent risk which can contribute
to material misstatements in the financial reports of Creme Limited (Burk & Hendry, 2014).

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Inflation and Weak Australian Dollar – As per the provided information, Creme Limited is
facing the negative impacts of inflation and weak Australian dollar since the operating costs
and inventory purchase costs have increased. In this situation, the management of Creme
Limited may want to decrease this costs by understating the operating costs in a manipulative
manner. This will increase the profitability of Creme Limited by decreasing the overall
operating costs. It is a key inherent risk of Creme Limited which can cause material
misstatements (Zaiceanu, Hlaciuc & Lucan, 2015).
It can be seen from the above discussion that the industry growth decreases the
possibility of inherent risk; but the presence of high competition along with inflation and
weal Australian dollar increases the possibility of material misstatements in the financial
statements. This also needs to consider that Creme Limited may not involve in accounting
manipulation as they are performing well. In the presence of all these aspects, the level of
inherent risk in Creme Limited needs to be considered as medium in the audit of 2019.
Answer to Requirement (2)
Accuracy is considered as a major assertion associated with costs of goods sold. This
particular assertion states that the management has recorded the transactions accurately at
their appropriate amount in the absence of any error. Control risks is considered as the risk
that material misstatements in an account will not be prevented or detected on a timely basis
by the internal control structure of the clients. The auditors of Creme Limited is required to
undertake three steps. They are identification of misstatements that can take place in the
financial statement assertion, identification of control that could possibly prevent or detect
the material misstatements and acquire appropriate audit evidence from the test of controls.
The auditor is required to perform the third step only when the assessed control risk is below
the maximum (Hale, Guldenmund & Goossens, 2017).

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Accuracy is the assertion that is associated with the costs of goods sold of Creme
Limited and this assertion can contribute to develop material misstatement in the financial
statement of Creme Limited. It is observable that cost of goods sold of the company has
decreased from 2018 to 2019 and it indicates that the value of costs of goods sold has been
reduced intentionally in order to boost the profitability in 2019. Now, the auditor is required
to assess whether Creme Limited has the required internal control to prevent or detect this
misstatement. It is discussed below:
 Creme Limited has an effective audit committee that respects the recommendation of
the auditors and this committee meets on regular basis for discussing auditing related
issues. This committee is also responsible for overseeing different aspects of
financial reporting that include calculation of costs of goods sold. Therefore, any
misstatement in accurately recording cost of goods sold is likely to be detected by
this committee (Issa & Kogan, 2014).
 Creme Limited has a perpetual inventory system and it has restricted the access of
different systems through individual passwords so that the accounting staffs can
access the accounting system and warehouse staffs can access the inventory
management system. Since there is not anyone to oversee the tasks of inventory and
accounting department, the accounting department can involve in manipulating the
inventory systems which is related to costs of goods sold and the internal control
cannot prevent or detect it (Badara, 2013). This makes the control risk high.
 Creme Limited has an internal control policy of cycle count of inventory by a senior
member staff in order to ensure that the inventory count is correct. However, in the
busy seasons, junior warehouse clerk often undertake this cycle count in the absence
of any senior member. In case the junior clerk makes any mistake in the cycle count

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that can affect the calculation of cost of goods sold, the internal control cannot
prevent or detect it (Brown, Pott & Wömpener, 2014).
Therefore, the above discussion indicates towards the presence of high level of control
risk for the accuracy of cost of goods sold.
Answer to Requirement (3)
The presence of two strategies can be seen in auditing that is based on the outcome of
audit risk assessment; they are test of control and substantive tests. It is observable from the
above parts of discussion that the business of Creme Limited are exposed to high inherent
risk. The assessment also shows that the control risk of the company is also high as the
internal controls are likely not to prevent the risk of material misstatement. Since both
inherent and control risks are high in Creme Limited, the auditor is needed to lower the
detection risk. Therefore, the main strategy will be to report the weaknesses in the internal
control of Creme Limited to those charged with governance and increase dependence on
detailed substantive audit procedures for gaining the required audit evidence (Byrnes et al.,
2018).
Part B: AUDIT STRATEGY AND TESTING
Answer to Requirement (4)
As per the provided information, the COGS/Sales ratio has decreased in 2019 which
is a positive aspect for the company due to the decrease in cost of goods sold. In addition, the
interest coverage ratio has dramatically improved from 9.1% to 12.1 that is more than 12%
required by Pestwac Bank. Decrease in cost of goods sold increase the profitability of the
companies and it also indicates decrease in company’s expenses; and increase in profitability
improves the interest coverage ratio. Therefore, there is a high probability that the amount of
cost of goods sold has not been recorded properly that means the amount is understated to

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increase the company’s profitability by the management of Creme Limited. It has the
capability to develop material misstatement in the financial reports where cost of goods sold
is recorded (Appelbaum, Kogan & Vasarhelyi, 2018).
Answer to Requirement (5)
One major internal control associated with the accuracy of cost of goods sold is the
policy of ‘cycle count’ that is used for ensuring that the information in inventory management
is correct. This cycle count ensures that the recorded values of inventory in the financial
statement is correctly recorded. Therefore, the main audit strategy for test of control is
observing the cycle count process in Creme Limited. Under this strategy, the main objectives
of the auditor will be verifying that all inventories are counted, testing a sample of the count
made by the senior staff and reviewing the policies and procedures related to cycle count
(Läikkö-Roto & Nevas, 2014).
Answer to Requirement (6)
Under one substantive audit procedure for acquiring reliable evidence for the
accuracy of cost of goods sold is the recalculation of cost of goods sold for the year ending
2019. In order to do this, it is needed for the auditor of Creme Limited to verify the opening
inventory balance that is the closing balance of 2018, purchase during the year of 2019 and
closing stock balance. After gaining the result of the recalculation of cost of goods sold, the
auditor will be required to match that with the value of cost of goods sold in 2019 calculated
by Creme Limited. This will help the auditor in assessing whether the correct value of
inventory is recorded for the calculation of cost of goods sold (Groomer & Murthy, 2018).

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References
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Brown, N. C., Pott, C., & Wömpener, A. (2014). The effect of internal control and risk
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Byrnes, P. E., Al-Awadhi, A., Gullvist, B., Brown-Liburd, H., Teeter, R., Warren Jr, J. D., &
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Issa, H., & Kogan, A. (2014). A predictive ordered logistic regression model as a tool for
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Läikkö-Roto, T., & Nevas, M. (2014). Auditing local official food control: perceptions of
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Zaiceanu, A. M., Hlaciuc, E., & Lucan, A. N. C. (2015). Methods for risk identification and
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