Financial Statement Analysis: Variance - Trend

Question:

Read the Presentation section of the assessment in the subject outline carefully

? Use professional/business language

? Include a title page

? Start each question on a new page (use headers/subheaders)

? Please be careful with font size and line spacing

? Ensure your student name and number appear on all pages of your assignment.

If tables are used they must be formatted correctly and they do not cross pages (Horizontally)

Financial figures, numbers, are right aligned (never centred).

? You need to use aspects of all three sets of ratio analysis here.

? Do not forget to use the background information here as well.

? Identify four accounts or account areas only

? 2 assertions for each account (total of 8 assertions)

? Do not provide all the assertions – we are looking for the assertions relevant to the risk identified.

? Assertion must match the account type (transaction assertions for income statement related accounts and balance assertions for balance sheet accounts)

Answer:

Question 1

Part 1

Variance analysis of the financial statements

This analysis provides a comparison between financial statements of two years by making calculations of change in financial figures from one year to another (Marshall, McManus, & Viele, 2004). It also calculates the percentage change in the financial figures from one year to another.

Variance analysis for income statement

	2017	2016	Variance $	Variance %
			Increase or (decrease)
Sales	$ 3,080	$ 2,660	$ 420	15.789%
Cost of Goods Sold	$(2,350)	$(2,010)	$ (340)	-16.915%
Gross Profit	$ 730	$ 650	$ 80	12.308%
Other Expenses	$ (350)	$ (390)	$ 40	10.256%
Interest	$ (300)	$ (120)	$ (180)	-150.000%
Net Profit	$ 80	$ 140	$ (60)	42.857%

Variance analysis for financial position

	2017	2016	Variance $	Variance %
			Increase or (decrease)
Assets
Current assets
Trade and other receivables	$ 772	$ 660	$ 112	16.970%
Inventory	$ 680	$ 510	$ 170	33.333%
Total current assets	$ 1,452	$ 1,170	$ 282	24.103%
Non-current assets
Property, plant and equipment	$ 1,810	$ 1,500	$ 310	20.667%
Intangible assets	$ 40	$ -	$ 40	∞ %
Total non-current assets	$ 1,850	$ 1,500	$ 350	23.333%
Total assets	$ 3,302	$ 2,670	$ 632	23.670%
Liabilities and equity
Liabilities
Current liabilities
Trade and other payables	$ 835	$ 795	$ 40	5.031%
Current borrowings - Bank Overdraft	$ 52	$ 40	$ 12	30.000%
Total current liabilities	$ 887	$ 835	$ 52	6.228%
Non-current liabilities
Non-current borrowings - Secured loan	$ 1,500	$ 1,000	$ 500	50.000%
Total liabilities	$ 2,387	$ 1,835	$ 552	30.082%
Net Assets	$ 915	$ 835	$ 80	9.581%
Equity
Share capital	$ 300	$ 300	$ -	0.000%
Retained earnings	$ 615	$ 535	$ 80	14.953%
Total Equity	$ 915	$ 835	$ 80	9.581%

This variance analysis raise various concerns related to the significant variance

Organization’s revenue increased by the 15.79%, on the other hand, this increase is not reflected by an increase in gross profit. Gross profit of the organization shows increase on by12.31% due to a significant increase in the cost of goods sold by 16.92%.
Inventory and receivables of the organization both showing a significant increase of 33.33% and 16.97% respectively. These balance sheet balances do not have a tendency for such significant increase.
Increase in Plant, property, and equipment and bank liabilities is because of new investment by the way of bank liabilities.

Trend analysis is the financial analysis of calculating trends of historical financial balances (Guay, Samuels, & Taylor, 2016). Under this analysis, any significant change in such trend is observed by the auditor of the organization.

Trend analysis for income statement

	2017	2016	2015	2014
Sales	100.00%	100.00%	100.00%	100.00%
Cost of Goods Sold	-76.30%	-75.56%	-76.02%	-73.97%
Gross Profit	23.70%	24.44%	23.98%	26.03%
Other Expenses	-11.36%	-14.66%	-13.11%	-10.69%
Interest	-9.74%	-4.51%	-3.40%	-0.15%
Net Profit (Loss)	2.60%	5.26%	7.48%	15.19%

Trend analysis for financial position

	2017	2016	2015	2014
Assets
Current assets
Trade and other receivables	23.38%	24.72%	25.38%	39.92%
Inventory	20.59%	19.10%	20.56%	21.42%
Total current assets	43.97%	43.82%	45.95%	61.34%
Non-current assets
Property, plant and equipment	54.82%	56.18%	54.05%	38.66%
Intangible assets	1.21%	0.00%	0.00%	0.00%
Total non-current assets	56.03%	56.18%	54.05%	38.66%
Total assets	100.00%	100.00%	100.00%	100.00%
Liabilities and equity
Liabilities
Current liabilities
Trade and other payables	25.29%	29.78%	28.55%	41.80%
Current borrowings - Bank Overdraft	1.57%	1.50%	1.23%	1.67%
Total current liabilities	26.86%	31.27%	29.79%	43.47%
Non-current liabilities
Non-current borrowings - Secured loan	45.43%	37.45%	29.38%	0.00%
Total liabilities	72.29%	68.73%	59.17%	43.47%
Net Assets	27.71%	31.27%	40.83%	56.53%
Equity
Share capital	9.09%	11.24%	17.63%	31.35%
Retained earnings	18.63%	20.04%	23.21%	25.18%
Total Equity	27.71%	31.27%	40.83%	56.53%

This trend analysis raise various concerns related to significant trend variance

Operating expenses showing a decline in the present year however in all other three years it is having increasing trend.
Interest expenses showing a significant increase due to increase in bank liabilities.
Plant, property, and equipment are showing declining trend even after having a significant investment in this asset.

Ratio analysis is the analysis which shows profitability, liquidity, solvency etc. relationship between various financial figures (Weygandt, Kimmel, & Kieso, 2015).

Year ending	2016	2017
Profitability ratios
Net Profit margin	5.26%	2.60%
Operating Profit Margin	9.77%	12.34%
Return on common stock equity	16.77%	8.74%
Return on Total Assets	5.24%	2.42%
Efficiency ratio
Accounts receivable turnover ratio	4.09	4.04
Average collection period ratio	87.97	89.06
Accounts Payable turnover ratio	3.58	3.85
Accounts Payable turnover in days ratio	100.69	93.39
Fixed asset turnover ratio	1.77	1.66
Total asset turnover ratio	1.00	0.93
Long-term solvency ratio
Debt Ratio	68.73%	72.29%
Times interest ratio	2.17	1.27
Liquidity ratio
Current ratio	1.40	1.64

This ratio analysis raises various concerns

Operating profit ratio showing an unexpected increase
Accounts payable ratio shows an unexpected decline
Asset turnover ratios are also showing decline due to new investment in assets
The debt ratio is showing an increase due to increase in debt liabilities
A current ratio showing an unexpected increase

Part 2

Going concern is a significant accounting assumption. As per this assumption, every analyst for the economic business assumes that such business will continues till the end of unforeseeable future period (Amin, Krishnan, & Yang, 2014). Every organization prepares financial statements using historical values due to this concept. The organizations which are not expected to remain going concern in future will make their financial statements by using realization values in place of historical value.

Moreover, if an organization shows some indicators effecting going concern assumption adversely for the organization then such organization does not expect to remain going concern. Such indicators can be accumulated losses, nonpayment of dues, loss of market etc.

Furthermore, in the present case, the organization is having additions in the long term as well as short-term liabilities. Additionally, net income generated by the organization is showing a significant decline hence it can assume that organization may have some going concern issues.

Part 3

Following Account, balances have a potential risk of misstatement

Account balance	Justification
Net income	a. Significant negative variances b. The significant declining trend is a risk for going concern
Receivables	a. Significant increase in variance, b. significant increase in current ratio
Total liabilities	a. Increase in debt ratio, b. continually increasing trend is a risk for going concern
Noncurrent assets	a. Significant variance, b. Significant increasing trend, c. on the other side, asset turnover ratios have declining trend

Part 4

Following assertions are of primary interest

Account balance	Justification
Net income
Operating expenses	Unexpected declining trend and unexpected increasing operating margin ratio emerge the risk of understatement of operating expenses.
Income expenses	a. A significant increase in variance and trend b. Percentage Variance change for interest balances is higher than the percentage variance change in debt liabilities
Receivables
Gross account balance	A significant increase in variance and current ratio hence doubt of overstatement of the account balance
Provision for doubtful receivables	A significant increase in the variance of gross amount and current ratio hence doubt of underestimation of provisioning
Total liabilities
Bank liabilities	The significant increasing trend, increasing debt ratio emerges the doubt regarding the utilization of funds from such external funding
Payables	Payables have an unexpected declining trend and declining payable turnover ratio hence emerges doubt of payment for payables by an increase in bank liabilities
Noncurrent assets
Plant property and equipment	Showing a declining trend even after having a huge investment in this asset
Intangibles	This asset emerges from the current year hence need to make extensive procedures regarding this

Question 2

Part 1

Key control

Segregation of duties	The organization required this internal control for the execution of the transaction. Single-handed execution of cash transaction emerges the risk of cash theft and cash fraud (Kobelsky, 2014). In the present case receipts of cash cheques is made by office assistant and recoding is done by the bookkeeper.
Policies and procedure identification	The organization needs to identify policies and procedures for the significant financial transaction. Service charge calculation is the significant procedure for the organization. In the present case, the organization defined the procedure for making calculations of service charges i.e. 300% of hourly rates. This control helps in fairly and accurate service revenue calculation.
Approval for contract cancellation	Every organization must have approval policies for the significant transactions. A service contract is a significant business activity for the clinic. In the present case acceptance and cancellation of any service contract is made by managing director. Hence it seems that organization is having control of policies and procedures.
Recording and reconciling cash	Real-time recording of cash transaction and periodical reconciliation of cash transaction results in a reduction in a misstatement of cash. In the present case, such recording and reconciliation are made by the bookkeeper.

Part 2

Test of controls

Test of controls are the procedures which performed by the auditor for testing actually the internal control is working appropriately or not (Auditing and Assurance Standards Board, 2013).

Observation	Segregation of duties can be tested by the auditor by making an observation. Under this auditor needs to observe how activities and operations are performed in the organization. In the present case, the auditor will observe how cash receipts and recoding of such receipts is actually performed in the organization. Are the receipts actually have control of segregation of duties or not?
Analytical review procedure	Analytical review procedures are ratio calculations, trend calculations and another financial number crunching (Auditing and Assurance Standards Board, 2009). In the present case service fee is charged at 300% of hourly rates. The auditor can make check service charge calculation by making analytical review procedures.
Inspection	In the present case acceptance and cancellation of any service contract is made by managing director. The auditor should check whether all cancellations of service contract and acceptance of service contracts have the approval of managing director or not. Hence for this test of control auditor should make an inspection of service contract file.
Re-calculations	In the present case, cash recording and reconciliation are made by the bookkeeper. The auditor needs to check whether such reconciliation is free from error or misstatement or not. Thus, for making this check auditor needs to make re-computation of the reconciliation statement.

Part 3

Concerns about the controls

Segregation of duties for cash receipts and cash recording exists, however, cash depositing, reconciliation preparation, and cash transaction recording are under the control of the bookkeeper. Hence there is concern that improper segregation of duties may result in cash frauds or misstatements.
Revenue recording is done by the organization on the cash basis, however; the organization is following accrual basis system of accounting. Hence there is a concern that revenue account balance of the organization will show wrong balances.

Question 3

Part 1

Concerns for relevant control

Nonperformance parallel test	Parallel test refers to the parallel running of the old and new system and makes identification of errors, wrong outputs, and bugs created by the new system. In the present case, the organization does not make this test hence new system have expectations of inefficient output.
Inefficient access control	In system implementation, access controls are most significant control. In the present case, the organization does not provide access to transaction file to the supervisor, the only master file can be accessed by supervisor. If a supervisor needs to access transaction file for making rechecking of any master file assertion then such access is denied by the system.

Part 2

Application controls

Existence control for the occurrence of a transaction	Organization’s application system should have an existence for all employee data which are currently working. Such data must be updated on each new recruitment and termination. Such data existence will help in the occurrence of payroll transactions for all current employees.
Input controls for the accuracy of transactions	The system must have input controls so that accuracy of transaction processing and output can be ensured. The organization can implement input controls of format check, check digit and reasonableness check. Such control helps in making an accurate input to the application system.

Part 3

The appropriate test of control for the application system is test data. Under this control auditor of the organization put some dummy data and observes the output from such dummy inputs. If such dummy inputs become eligible to provide expected correct output then it is concluded that application system is eligible to provide correct output otherwise not. In addition to this auditor can put some unacceptable input to check input controls.

References

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. (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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