1. Correctly identify 4 controls and explain the purpose of each of those controls.
2. Identify and explain (justify) one test of control for each control from a.
3. Explain any concerns you have about relying on these controls.
Controls of an organization
Under this analysis, a variance between the account balances of the organization in two years is calculated and percentage change in such balances also calculated (Marshall, McManus, & Viele, 2004). Such analysis helps the auditor in getting information regarding the significant change in account balances. Such analysis for Printing solutions Ltd. showing following results,
Income statement
2017 |
2016 |
Movement |
|
Sales |
$ 3,080.00 |
$ 2,660.00 |
$ 420.00 |
Cost of Goods Sold |
$ (2,350.00) |
$ (2,010.00) |
$ 340.00 |
Gross Profit |
$ 730.00 |
$ 650.00 |
$ 80.00 |
Other Expenses |
$ (350.00) |
$ (390.00) |
$ (40.00) |
Interest |
$ (300.00) |
$ (120.00) |
$ 180.00 |
Net Profit |
$ 80.00 |
$ 140.00 |
$ (60.00) |
Balance sheet
2017 |
2016 |
Movement |
|
Assets |
|||
Current assets |
|||
Trade and other receivables |
$ 772.00 |
$ 660.00 |
$ 112.00 |
Inventory |
$ 680.00 |
$ 510.00 |
$ 170.00 |
Total current assets |
$ 1,452.00 |
$ 1,170.00 |
$ 282.00 |
Non-current assets |
|||
Property, plant and equipment |
$ 1,810.00 |
$ 1,500.00 |
$ 310.00 |
Intangible assets |
$ 40.00 |
$ - |
$ 40.00 |
Total non-current assets |
$ 1,850.00 |
$ 1,500.00 |
$ 350.00 |
Total assets |
$ 3,302.00 |
$ 2,670.00 |
$ 632.00 |
Liabilities and equity |
|||
Liabilities |
|||
Current liabilities |
|||
Trade and other payables |
$ 835.00 |
$ 795.00 |
$ 40.00 |
Borrowings - Bank Overdraft |
$ 52.00 |
$ 40.00 |
$ 12.00 |
Total current liabilities |
$ 887.00 |
$ 835.00 |
$ 52.00 |
Non-current liabilities |
|||
Borrowings - Secured loan |
$ 1,500.00 |
$ 1,000.00 |
$ 500.00 |
Total liabilities |
$ 2,387.00 |
$ 1,835.00 |
$ 552.00 |
Net Assets |
$ 915.00 |
$ 835.00 |
$ 80.00 |
Equity |
|||
Share capital |
$ 300.00 |
$ 300.00 |
$ - |
Retained earnings |
$ 615.00 |
$ 535.00 |
$ 80.00 |
Total Equity |
$ 915.00 |
$ 835.00 |
$ 80.00 |
This analysis shows significant changes in interest expenses, inventory, Plant property and equipment and long-term borrowings. Significant changes in the interest expenses, plant property and equipment and long-term borrowings are because of additional borrowings made during the years from purchasing additional plant property and equipment. Inventory account balance needs to make extensive procedures.
This analysis is performed by the organization for making analysis regarding the movement of account balances over the years (Guay, Samuels, & Taylor, 2016). Auditor of the organization detects the unusual movement of account balances under this analysis.
Income Statement |
2017 |
2016 |
2015 |
Sales |
15.8% |
29.1% |
57.3% |
Cost of Goods Sold |
16.9% |
28.4% |
61.6% |
Gross Profit |
12.3% |
31.6% |
44.9% |
Other Expenses |
-10.3% |
44.4% |
92.9% |
Interest |
150.0% |
71.4% |
3400.0% |
Net Profit (Loss) |
-42.9% |
-9.1% |
-22.6% |
Statement of Financial Position |
|||
Current assets |
|||
Trade and other receivables |
17.0% |
52.8% |
13.1% |
Inventory |
33.3% |
45.7% |
70.7% |
Total current assets |
24.1% |
49.6% |
33.2% |
Non-current assets |
|||
Property, plant and equipment |
20.7% |
63.0% |
148.6% |
Intangible assets |
∞% |
||
Total non-current assets |
23.3% |
63.0% |
148.6% |
Total assets |
23.7% |
56.9% |
77.8% |
Current liabilities |
|||
Trade and other payables |
5.0% |
63.6% |
21.5% |
Current borrowings - Bank Overdraft |
30.0% |
90.5% |
31.3% |
Total current liabilities |
6.2% |
64.7% |
21.9% |
Non-current liabilities |
|||
Non-current borrowings - Secured loan |
50.0% |
100.0% |
∞% |
Total liabilities |
30.1% |
82.2% |
142.1% |
Net Assets |
9.6% |
20.1% |
28.5% |
Equity |
|||
Share capital |
0.0% |
0.0% |
0.0% |
Retained earnings |
15.0% |
35.4% |
63.9% |
Total Equity |
9.6% |
20.1% |
28.5% |
In the present case, operating expenses, receivables, inventory, plant, property and equipment, intangible assets, trade and other receivables, trade and other payables, long term and short term borrowings are showing a significant trend of changes.
Ratio analysis of the organization shows the ratios between the various account balances of the organization for making a meaningful conclusion regarding the performance and position of the organization (Weygandt, Kimmel, & Kieso, 2015).
Liquidity ratio
Year ending |
2017 |
2016 |
2015 |
Current assets |
$ 1,452.00 |
$ 1,170.00 |
$ 782.00 |
Current liabilities |
$ 887.00 |
$ 835.00 |
$ 507.00 |
Current ratio |
1.64 |
1.40 |
1.54 |
Current assets ratio of the organization does not show a significant change.
Long-term solvency
Year ending |
2017 |
2016 |
2016 |
Total liabilities |
$ 2,387.00 |
$ 1,835.00 |
$ 1,007.00 |
Total assets |
$ 3,302.00 |
$ 2,670.00 |
$ 1,702.00 |
Debt Ratio |
72.29% |
68.73% |
59.17% |
Earnings before interest and tax |
$ 380.00 |
$ 260.00 |
$ 224.00 |
Interest expenses |
$ 300.00 |
$ 120.00 |
$ 70.00 |
Tines interest ratio |
1.27 |
2.17 |
3.20 |
Debt ratio and interest times ratio is showing significant change due to increase in borrowings of the organization for purchasing plant, property, and equipment.
Efficiency ratios
Year ending |
2017 |
2016 |
2016 |
Sales |
$ 3,080.00 |
$ 2,660.00 |
$ 1,310.00 |
Accounts receivable |
$ 762.00 |
$ 650.00 |
$ 432.00 |
Accounts receivable turnover |
4.04 |
4.09 |
3.03 |
360 days |
360 |
360 |
360 |
Accounts receivable turnover |
4.04 |
4.09 |
3.03 |
Average collection period |
89.06 |
87.97 |
118.72 |
Sales |
$ 3,080.00 |
$ 2,660.00 |
$ 1,310.00 |
Accounts Payable |
$ 799.00 |
$ 744.00 |
$ 486.00 |
Accounts Payable turnover |
3.85 |
3.58 |
2.70 |
360 days |
360 |
360 |
360 |
Accounts Payable turnover |
3.85 |
3.58 |
2.70 |
Accounts Payable turnover in days |
93.39 |
100.69 |
133.56 |
Sales |
$ 3,080.00 |
$ 2,660.00 |
$ 1,310.00 |
Noncurrent assets |
$ 1,850.00 |
$ 1,500.00 |
$ 920.00 |
Fixed asset turnover |
1.66 |
1.77 |
1.42 |
Sales |
$ 3,080.00 |
$ 2,660.00 |
$ 1,310.00 |
Total asset |
$ 3,302.00 |
$ 2,670.00 |
$ 1,702.00 |
Total asset turnover |
0.93 |
1.00 |
0.77 |
Efficiency ratios of the organization are also not showing any significant changes.
Year ending |
2017 |
2016 |
2016 |
Net profit after tax |
$ 80.00 |
$ 140.00 |
$ 154.00 |
Sales |
$ 3,080.00 |
$ 2,660.00 |
$ 1,310.00 |
Net Profit margin |
2.60% |
5.26% |
11.76% |
Net profit after tax |
$ 380.00 |
$ 260.00 |
$ 224.00 |
Common stockholders’ equity |
$ 915.00 |
$ 835.00 |
$ 695.00 |
Return on common stock equity |
8.74% |
16.77% |
22.16% |
Earnings before interest and tax |
$ 380.00 |
$ 260.00 |
$ 224.00 |
total assets |
$ 3,302.00 |
$ 2,670.00 |
$ 1,702.00 |
Return on Total Assets |
11.51% |
9.74% |
13.16% |
Operating profits |
$ 380.00 |
$ 260.00 |
$ 224.00 |
Sales |
$ 3,080.00 |
$ 2,660.00 |
$ 1,310.00 |
Operating Profit Margin |
12.34% |
9.77% |
17.10% |
Net profit margin ratio and return on equity are showing a significant decline, however, return on assets and the operating profit margin ratio is showing a significant increase, this is because of higher interest expenses.
Going concern assumption assumes that business of the organization will continue till the end of unforeseeable time (Amin, Krishnan, & Yang, 2014). If financial reports of the organization do are not mention that organization is not going concern the auditor of the organization assumes that organization is a going concern. Organizations following going concern assumption prepare their financial statements by using historical cost. However, the organization does not follow this assumption make their financial statements as per liquidation basis.
In addition to this for assuming that organization is not a going concern organization must have some indicators. Such indicators can be accumulated losses, enhancing loans, payment of a loan by making more loans, market loss etc.
In the present case, it is seen that organization is having a trend of taking more and more loans every year. Assets of organization do not seem to have as much value as these are reflected in the financial statements. Organization’s receivables balance increased however, provisions declined, inventory also seems to be overcasted, the organization increased a intangibles asset for which there are no clear explanations.
The organization is taking higher loans for purchasing plant property and equipment, however, plant, property and equipment’s balance also not showing such increase. Hence it could be concluded that organization is in debt trap.
Purpose of controls
The organization is taking higher loans for paying old loans. In turn, it also can be concluded that organization is having a serious going concern issue.
- Net income
This account balance shows a negative movement and declining trend. In addition to this, declining trend of this account balance also indicates the issue for going concern assumption.
- Accounts receivable
There is an increase in the current ratio as well as the movement of this account. In addition to this, there is suspicion of overcasting of this account balance.
- borrowings
The debt ratio of the organization is increasing, it seems that organization is in debt trap. Hence this account balance becomes a risk element for the potential misstatement.
- Accounts payables
Accounts payable of the organization is having a significant movement hence this liability also become a reason for assuming material misstatement.
PART D
Net income
Occurrence
This operating account balance is showing a declining trend, however, there is increasing trend in all other expenses of the organization. Hence it increases a doubt for under casting of expense and non recoding of some expenses occurred.
Accuracy
Interest expenses are showing a drastic increase the drastic change in profitability ratios, times interest ratio etc.
Accounts receivables
Existence
Gross receivables of the organization are showing a drastic increasing trend
Accuracy and valuation
Even after increasing in the gross receivables provision for doubtful debts account balance is showing declining trend.
Borrowings
Rights and obligations
short-term borrowings and long term borrowings account balance is showing drastic movement
Completness
This account balance has doubt of under casting of this obligation
Accounts payable
Presentation
Other payables are a short-term liability of the organization however it remains intact from the last 4 years.
Existence
The organization is having current tax expenses liability however organization does not mention tax expenses in the income statement of the organization.
Identification of policies and procedures
Having policies and procedures an organization is a significant internal control. It helps the employees in case of a dilemma during business procedures. The organization identified policies and procedures for regular business activities. In the present case, the organization identified its policies and procedures for calculation of service revenue.
Segregation of duties refers to the internal control under which organization set its operating activities in such a way so that one person could not precede whole business process. This helps in detection of errors and fraud (Kobelsky, 2014). In the present case, organization’s receipts are having this control. Organization’s cash receipts are received by the office assistant however recorded by the bookkeeper.
Cancellation approval
Internal control taking approvals for the significant transactions it a preventive and detective control. It helps in prevention of unfavorable business transaction and detection of the authorized person making such unfavorable transaction. In the present case before making approval and cancellation of any service client, organization’s employee took approval of managing director of the organization.
Reconciliation of cash balances
Reconciliation of cash balances with the bank balances detects the fraud as well as errors made by the employees in recording cash related transactions. In the present case bookkeeper of the organization make monthly reconciliation statement for the cash balances.
- The auditor could make analytical review procedures for making a test of controls for the policies and procedures (Auditing and Assurance Standards Board, 2009). The auditor could make ratio analysis for checking whether the services revenue is calculated as per the pokies or not.
- Segregation of duties control can be tested by the organization by making an observation. Under this control, the auditor needs to observe whether the duties are actually segregated in a way so that one person could not make changes in the transaction processing.
- Approval testing in the organization can be made by the auditor by doing an inspection. In the present case, Auditor can inspect the file of approvals given by the managing directs and actual approval and cancellation of service client file.
- Reconciliation of the cash balances of the organization with the bank balance of the organization can be tested by the auditor of the organization by making re-computation for the reconciliation statement of the organization.
- Segregation of duties controls is effective only if one person could not affect the whole transaction. In the present case office assistant can only receive receipts all, other transaction i.e. recording and deposition of such cash are done by the bookkeeper. Hence he can make deliberate fraud with cash receipts.
- In addition to this, organization records its service revenue by following the cash basis of the accounting system. However, all other transactions of the organization recorded on the basis of accrual basis accounting.
- In the present case, the organization is making system implementation from old payroll system to the new payroll system. However, the organization does not make parallel testing for the output and processing testing for the new payroll processing application system. The absence of this parallel testing organization may face difficulty processing of some significant transaction.
- Additionally, the organization does not make sufficient controls for log maintenance for every update in the data of payroll system. Non-maintenance of such log will make unauthorized changes in the system.
- Occurrence: The occurrence of every employee transaction can be ensured by the organization when a valid data is maintained by the application system for all employee data. As per this control organization should make proper data for every employee joining the organization and their pay scale. In addition to this data must be updated on every employee termination.
- Accuracy: The accuracy of the organization application system can be maintained by implementing input controls. Under this organization, may add any input check control so that output of the system will be accurate.
Occurrence: An auditor can check the employee data file in the application control system, if such file shows that employee data is updated with the change in employment terms then auditor may conclude that all transactions during the period related to payroll updated in a proper manner.
Accuracy: An auditor can implement test data to the application system of the organization as per this control auditor put some test data in the system of the organization and will check the output given by such test data. If test data would give accurate expected output then it can be concluded that application system is error free otherwise it will be concluded as ineffective.
Amin, K., Krishnan, J., & Yang, J. S. (2014). Going concern opinion and cost of equity. Auditing: A Journal of Practice & Theory , 33 (1), 1-39.
Auditing and Assurance Standards Board. (2009, October). ASA 520 Analytical Procedures. Retrieved 23 August, 2017, from www.auasb.gov.au: www.auasb.gov.au/admin/file/content102/c3/ASA_520_27-10-09.pdf
Auditing and Assurance Standards Board. (2013, November 11). Auditing Standard ASA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment. Retrieved April 30, 2018, from https://www.auasb.gov.au: https://www.auasb.gov.au/admin/file/content102/c3/Nov13_Compiled_Auditing_Standard_ASA_315.pdf
Auditing and Assurance Standards Board. (2009, October). Auditing Standard ASA 520 Analytical Procedures. Retrieved April 26, 2018, from https://www.auasb.gov.au/admin/file/content102/c3/ASA_520_27-10-09.pdf
Guay, W., Samuels, D., & Taylor, D. (2016). Guiding through the fog: Financial statement complexity and voluntary disclosure. Journal of Accounting and Economics , 62 (2-3), 234-269.
Kobelsky, K. (2014). A conceptual model for segregation of duties: Integrating theory and practice for manual and IT-supported processes. International Journal of Accounting Information , 15 (4), 304-322.
Marshall, D., McManus, W., & Viele, D. (2004). Accounting: What the numbers mean. McGraw-Hill/Irwin.
Weygandt, J., Kimmel, P., & Kieso, D. (2015). Financial & managerial accounting. John Wiley & Sons.
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