Auditing Report: Financial Analysis of RAR Company's Performance

This report emphasizes the importance of auditing practices in organizations, focusing on the financial analysis of RAR Company. It utilizes horizontal analysis of the income statement and balance sheet to assess the company's net profit and overall financial position. The report selects and evaluates six key accounts, including sales, interest expenses, accounts receivable, cost of sales, fixed assets, and depreciation, recommending specific audit procedures for each to maintain efficiency and profitability. The analysis includes calculations of gross and net profit margins, as well as the current ratio, providing insights into the company's financial health and performance over two financial years. The report concludes by offering detailed audit procedures for each selected account, covering internal auditing, transactional testing, and substantive tests to ensure accuracy and compliance.

Running head: IMPORTANCE OF AUDITING
IMPORTANCE OF AUDITING
Name of the Student
Name of the University
Authors Note

1IMPORTANCE OF AUDITING
Executive Summary
This report aims to show the importance of auditing practices within the organization.
Auditing practices for ascertaining the true and fair view of the company is emphasized. Through
the given company, RAR Company, horizontal analysis of income statement and balance sheet is
done to determine the company’s net profit value. Furthermore, six different accounts have been
chosen from the income statement and balance sheet of the company to measure the company’s
fair position. The financial position of the company is obtained by comparing the income
statement of two financial years. The audit practices required to evaluate the account is further
recommended for maintaining its efficiency and profitability in long-run.

2IMPORTANCE OF AUDITING
Table of Contents
1. Audit planning.............................................................................................................................4
1.1 Analytical review..............................................................................................................4
1.2 Preliminary judgment of materiality......................................................................................5
2. Sales Accounts.............................................................................................................................6
2.1 Rationale for selection...........................................................................................................6
2.2 Assertion and explanation......................................................................................................6
2.3 Recommended audit procedure.............................................................................................6
3. Interest Expenses Accounts.........................................................................................................7
3.1 Rationale for selection...........................................................................................................7
3.2 Assertion and explanation......................................................................................................7
3.3 Recommended audit procedure.............................................................................................8
4. Accounts receivables...................................................................................................................8
4.1 Rationale for selection...........................................................................................................8
4.2 Assertion and explanation......................................................................................................8
4.3 Recommended audit procedure.............................................................................................9
5. Cost of Sales Account..................................................................................................................9
5.1 Rationale for selection...........................................................................................................9
5.2 Assertion and explanation......................................................................................................9

3IMPORTANCE OF AUDITING
5.3 Recommended audit procedure...........................................................................................10
6. Fixed Asset account...................................................................................................................10
6.1 Rationale for selection.........................................................................................................10
6.2 Assertion and explanation....................................................................................................11
6.3 Recommended audit procedure...........................................................................................11
7. Depreciation Account...............................................................................................................12
7.1 Rationale for selection.........................................................................................................12
7.2 Assertion and explanation....................................................................................................12
7.3 Recommended audit procedure...........................................................................................12
List of References..........................................................................................................................14

4IMPORTANCE OF AUDITING
1. Audit planning
1.1 Analytical review
An analytical procedure in accounting is one of the financial audit processes that help to
understand the business and relevant changes that are required in the business1. This includes the
comparison of data in financial statement and financial information with the prior periods and
forecasts. Horizontal analysis of the Income statement and Balance sheet of the given company,
RAR Company is made to ascertain its financial growth in the year 2017 as compared to the
previous year 2106.
The gross profit margin of the company is determined by calculating the sales percentage
that exceeds the cost of goods sold. This helps in evaluating the efficiency of a company that
uses its labor and material for producing and selling its products more profitably2. The gross
profit for the assessment year 2017 is 179,848 and the margin is ascertained by using the
formulae, Gross Profit margin= (revenue- cost of goods sold) / revenue. The margin is 0. 69 or
69%. This shows that RAR Company earns 69 cents on the dollar that is gross margin. The net
profit margin of the company is the ratio of the company’s net profits to the given revenues. The
margin is evaluated by the formula of Net Income/ Net Sales, which is 0.55 or 55%. The net
1Glover, Steven M., Mark H. Taylor, and Yi-Jing Wu. "Current practices and challenges in auditing fair value
measurements and complex estimates: Implications for auditing standards and the academy." Auditing: A Journal of
Practice & Theory36.1 (2016): 63-84.
2 Stewart, Danielle. "‘Auditing private companies’: a practitioner view." Accounting and Business Research 47.5
(2017): 585-587.

5IMPORTANCE OF AUDITING
profit has improved as the revenue has increased and expenses decreased for the year3. The net
margin of the company is 55%. Current ratio of the company is further evaluated by dividing the
company’s current assets with current liabilities, which is 0.24. This gives an idea about the
organization ability to pay back its debt and determines the company’s financial health.
1.2 Preliminary judgment of materiality
Audit risk and materiality puts a great impact on the application of generally accepted
accounting standards. Both materiality and audit risk is to be considered together for determining
the timing, nature and extent of the procedures related to auditing and further evaluates the
results of the auditing procedures4. Proper review of the accounting procedures helps in
identifying and ascertaining the potential risks areas and planning the audit procedures more
effectively. The auditor’s standard report should show true and fair view regarding all the
material aspects of the organization.
3 Rikhardsson, Pall, and Richard Dull. "An exploratory study of the adoption, application and impacts of continuous
auditing technologies in small businesses." International Journal of Accounting Information Systems 20 (2016): 26-
37.
4 Krahel, John Peter, and William R. Titera. "Consequences of Big Data and formalization on accounting and
auditing standards." Accounting Horizons 29.2 (2015): 409-422.

6IMPORTANCE OF AUDITING
2. Sales Accounts
2.1 Rationale for selection
The Sales account is one of the most important accounts of the business. The Sales
account reflects the sales, which the company has made in a given year. Sales formulates as one
of the core aspects of the business. If a company does not incur adequate sales, it will not be able
to survive in the business organization5 . The given account consists of both cash as well as
credit sales. Once these sales transactions are recorded in the sales account, the company then,
pairs the account with the returns and various allowances in order to derive the net sales figures.
The sale of various years is tracked to estimate the growth of the business. Hence, this
account was chosen for the calculation.
2.2 Assertion and explanation
As seen from the horizontal analysis which has undertaken, it was observed that during
the year 2016, the sales amount was 11500$, however, in the year 2017, this amount dropped to
10541.67. It can be observed that there has been a considerable decrease in the sales amount.
The difference in the amount has been 958$ and the percentage decrease has been 8.33%. This
kind of decrease in percentage cannot be taken to be an acceptable amount. The sales of the
company should always be increasing; however, this is not the case here for the RAR Company.
2.3 Recommended audit procedure
Internal Auditing: The Company also checks out for any internal physical loopholes.
5 Horngren, Charles T., et al. Introduction to financial accounting. Pearson Higher Ed, 2013.

7IMPORTANCE OF AUDITING
Transactional Testing: In the given auditing, the auditor shall check the validity of the
statements by checking each transaction separately6. He sends out confirmation message to the
customers, to verify the existence of all transactions.
3. Interest Expenses Accounts
3.1 Rationale for selection
A bank needs capital for its operations. Hence, it often takes up certain loans and
debentures in order to make up for its business. Due to this, it has to pay high amount of interest
expenses to the company. The company RAR company, has taken a bank loan of around
277220$ in 2016, and 392699$ in 20177. Hence, one it takes up these loans, in order to fulfill its
requirements, the company has to incur high amount of interest expenses. This account has been
taken to see to it that how the expenses of the company have been doing.
3.2 Assertion and explanation
The interest expenses in 11500$ in 2016 and 10541 in 2017. Hence, the difference in the
two different amounts is equal to 958$. The percentage difference between the two years is
8.33%. This is a decrease. Hence, it can be stated that a decrease in the interest expenses is good
for the company.
6 Horngren, C. B., W. T. Harrison, and M. S. Oliver. "Financial & Management Accounting." (2015).
7 Datar, Srikant M., Madhav V. Rajan, and Charles T. Horngren. Managerial Accounting: Decision Making and
Motivating Performance. Pearson Higher Ed, 2013.

8IMPORTANCE OF AUDITING
3.3 Recommended audit procedure
Internal auditing: The auditing has to see to it that the company has entered the accounts in a
proper manner and that all loans have been considered carefully before entering8.
The auditor can also check with banks to make sure that their calculations match up to the
company`s statements.
4. Accounts receivables
4.1 Rationale for selection
Accounts receivables is often the largest asset of the company, therefore it is important to
identify the validity of the stated asset for future forecast9. Accounts receivables are always
reviewed in detail to obtain the fair position of the company.
4.2 Assertion and explanation
Accounts receivables have increased from $1, 74,000 to $185,000 in the financial year
2017. Therefore, increasing the current asset of RAR Company by 6.3%. The rate is good for the
growth and productivity of the company.
8 Miller-Nobles, Tracie L., Brenda L. Mattison, and Ella Mae Matsumura. Horngren's Accounting: The Managerial
Chapters. Pearson, 2017.
9 Rhee, Amanda J., et al. "Team training in the perioperative arena: a methodology for implementation and auditing
behavior." American Journal of Medical Quality 32.4 (2017): 369-375.

9IMPORTANCE OF AUDITING
4.3 Recommended audit procedure
Calculating receivables report total: the invoices in the account receivables report should be
added. Furthermore, the receivables report should be traced to general ledger10.
Investigating reconciliation items: the journal entry made for the account receivables should be
fully documented.
5. Cost of Sales Account
5.1 Rationale for selection
Cost of sales ascertains and measures the cost of good produced and sold within the time
period for the company11. It includes only the direct costs and does not show include any kind of
overhead costs. It reflects the method for allocating the inventory costs of the organization.
5.2 Assertion and explanation
The cost of sales for the year 2107 of RAR Company has decreased by 12%. The direct
cost related with the sales of the product has reduced as compared to the previous year. Though
the cost of inventory has slightly risen by 1.6%. Effective control over inventories needs
10 Vinnari, Eija, and Peter Skærbæk. "The uncertainties of risk management: A field study on risk management
internal audit practices in a Finnish municipality." Accounting, Auditing & Accountability Journal 27.3 (2014): 489-
526.
11 Lenz, Rainer, and Ulrich Hahn. "A synthesis of empirical internal audit effectiveness literature pointing to new
research opportunities." Managerial Auditing Journal 30.1 (2015): 5-33.

10IMPORTANCE OF AUDITING
appropriate control over receiving, purchasing and issuing materials. A perpetual inventory
system is effective for the organization12.
5.3 Recommended audit procedure
Inventory cut off test: The inventory should be measured after the year end. The information for
last shipped item should be received and shipped at the year end. All the inherent risks are to be
considered.
Avoiding inherent risks: proper determination of cost of sales is to be valued according to the
standards of GAAP. As audit of inventory is directly linked with cost of sales.
Substantive test for inventory account: there is immense possibility of the overstatement of the
company’s year end balances. All the obsolete units while counting of inventory should be
written down13.
6. Fixed Asset account
6.1 Rationale for selection
Fixed assets of an organization are the vital asset account elements and the major target
for asset audit14. Auditing fixed assets facilitates in uncovering the valid asset transaction. The
12 Simon, Alexandra, et al. "An empirical analysis of the integration of internal and external management system
audits." Journal of cleaner production 66 (2014): 499-506.
13 Cahan, Steven F., and Jerry Sun. "The effect of audit experience on audit fees and audit quality." Journal of
Accounting, auditing & finance 30.1 (2015): 78-100.
14 Bowlin, Kendall O., Jessen L. Hobson, and M. David Piercey. "The effects of auditor rotation, professional
skepticism, and interactions with managers on audit quality." The Accounting Review 90.4 (2015): 1363-1393.

11IMPORTANCE OF AUDITING
tangible assets are the major areas of management that requires adequate involvement for the
efficiency and growth of the business in the long-run.
6.2 Assertion and explanation
The total fixed assets of RAR Company have increased by $7000 in 2017 through the
purchase of machinery as it increased from $64,000 to $ 71,000. While machinery and furniture
values are still the same. The increment of 5% in assets is good sign for the company
effectiveness.
6.3 Recommended audit procedure
Risks of material misstatement: the risk for material misstatements should be properly assessed
for the growth of the business and the title deeds, ownership agreements and documents should
be properly verified15.
Avoiding fraud and errors: purchase of assets at higher prices should be properly verified and
value of impairment should be determined.
The cut off costs for transaction should be properly verified affecting the fixed assets. Proper
allocation or valuation of fixed assets should be established.
15 Appelbaum, Deniz, Alexander Kogan, and Miklos A. Vasarhelyi. "Big Data and analytics in the modern audit
engagement: Research needs." Auditing: A Journal of Practice & Theory 36.4 (2017): 1-27.