Auditing Materiality And Analytical Procedures Essay.

When calculating PM based on interim figures, it may be necessary to annualise the results.This allows the auditor to plan the audit properly based on an approximate projected year-end balance. Then at year-end the figure is adjusted, if necessary, to reflect the actual results.

(a) Using the 30 September 2011 trial balance calculate planning materiality and include the justification for the basis that you have used for your calculation.

(a) Using analytical procedures and the information provided in the appendix, perform ananalysis of Cloud 9’s financial position and its business risks. Discuss the ratios indicating a significant or an unexpected fluctuation.

(b) Prepare a common-size statement for the balance sheet of Cloud 9, use total assets as the basis for the balance sheet. Comment on any audit implications revealed by your statement.

(c) Which specific areas do you believe should receive special emphasis during your audit? Consider your discussion of the analytical procedures results, comments on the common-size statement and as well as your preliminary estimate of materiality. Prepare a memorandum to Suzie Pickering, Audit Senior, outlining potential problems areas (that is, where possible material misstatements in the financial report exist) and any other special concerns (for example, going concern). Specify the accounts and related assertions that would require particular attention.

Part 1- Materiality

According to Australian Auditing Standard (ASA) 320 in Para 9, it is the responsibility of the auditors to take into consideration the aspect of materiality while determining timing, nature and extent of the audit processes (Houghton and Campbell 2013). The aspect of materiality is an important factor while evaluating the material misstatements in the financial reports of the companies. As per Australian Auditing Standard (ASA) 320 in Para 12, a preliminary assessment of materiality is required from the side of the auditors (Sanderson 2014). Australian Auditing Standard (ASA) 320 in Para 13 states that materiality determination is an aspect of professional judgment of the auditors and it can be affected various qualititative as well as qualitative factors (Eilifsen and Messier Jr 2014). The calculation of materiality is provided below:

Table 1: Statement of Materiality

(Source: as created by Author)

The above table indicates various level of materiality that the auditors can choose. In case of W & S Partners, there was a loss for the company. Thus, based on the profit before tax, the auditors cannot select the level of materiality. The determination of materiality is considered as a difficult process as both the qualitative as well as quantitative factors need to be analyzed and evaluated (William Jr, Glover and Prawitt 2016). The determination of materiality is totally based on the judgments of the auditors, as there is not any exact guidance for determination of materiality. Hence, for the company, revenue or turnover needs to be the base to determine materiality as there is various reason to select revenues or turnover. The size of the business organizations can be determined by the amount of revenues or turnovers. It implies that the large organizations have large amount of revenues and expenditures (Stewart and Kinney Jr 2012). Thus, the determination of materiality with the help of revenues ensures that the size of the organization reflects the level of materiality. In this particular case, 5% is the selected materiality level that amounts to $1877712.53. It implies that the auditors will develop the unqualified opinion in case the misstatements are lower than the level of materiality. In case, the misstatements are bigger than the materiality level, the auditors need to conduct further audit processes to determine the truthfulness and fairness of the financial documents of the company (Edgley 2014).

Analytical procedure refers to the evaluation of the financial information of the companies depends on non-financial as well as financial data (Titera 2013). In addition, with the help of ratios, the financial situation and risk assessment of the companies can be evaluated. The calculations of the ratios are shown below.

Part 2- Analytical Procedures

Table 2: Statement Showing Financial Ratios

(Source: as created by Author)

The above table shows the calculation of rations of the company. Three major rations have been calculated and they are liquidity ration, profitability ratio and solvency ratio. The ability of the company to pay the current obligations with the assistance of assets can be measured with the help of liquidity ratios (Bogdan, Bareša and Ivanovi? 2012). These assets can easily be converted into cash. For this particular organization, the liquidity ratios are measured with the help of current ratio and quick ratio. The ability of the company to fulfill the short-term liabilities with the help of current assets can be measured with the help of current and quick ratios. As per the above table, both the current and liquid ratios of the company have increased. It indicates that the ability of the company to pay its current and short-term obligations has also increased (Higgins 2012).

The above table also shows the calculation of solvency ratios that are used to measure the ability of the company to sustain various business operations by make a comparison between the debt level and equity level (Bredart 2014). Two specific ratios are taken into consideration for this company and they are dent-to-equity ratio and times interest earned ratio. These rations help to determine the solvency position of the company. The job of debt equity ratio is to compare the relationship between the total debt and equity of the company (Bodie 2013). The above calculation shows that there is a hike in the debt equity ratio of the company. In indicates the presence of more debts in the capital structure of the company. It needs to be mentioned that reasonable debts helps to increase the profitability of the companies with the help of reduction in the cost of capital. Risk uses to increase when there are more debts in the capital structure. Time interest earned ratio measures the ability of the companies to pay the liability related to the interest payments (Higgins 2012). As per the above table, the company had the ability to pay interest in the year 2010. There was a loss for the company in the year 2011 and it indicates that the company does not have enough funds to make payment of the interests.

The profitability ratios measure the ability of the companies to generate profits from their various business organizations. The profit of the company based on per dollar of sales can be measured with the help of net profit ratio (Hartlage 2012). As per the above calculation of ratios, the company has positive net profit ratio in 2010 and there was a loss in 2011. The return on equity ratio measures the capability of the companies to generate profit from the investments in shareholders. As per the above calculation, there is a decline in the retune on equity ratio from 2010 to 2011.

Answer to [a]

The calculation of the common size statement is shown below:

Table 3: Common Size Statement

(Source: as created by Author)

The above table is the common size statement of the company. The common size statement measures each financial item based on percentage and it is considered as an important tool for the comparison of the balance sheets of different years (Brigham and Houston 2012). As per the above table, it can be seen that there is a decrease in the noncurrent assets from 2010 to 2011 by 2%. There is a decrease in the total current liabilities from 2010 to 2011. In addition, there is a decrease and increase in the proportion in the total noncurrent liabilities in the year 2010 and 2011 respectively. Hence, from the above analysis, it is suggested that the auditors need to focus on the highlighted areas of the table.

In this particular memorandum, the main highlighted areas are the material misstatements in the financial documents of the companies. These material misstatements have been found after the evaluation of the financial statements. The evaluation of the financial statements states that there is an increase in the revenues of the company and it can be considered as a positive side. However, there is still mismatch between the revenues and profits of the company as with the increase in the revenues, there is a decrease in the profitability of the company. 42% and 23% increase in the borrowing costs and other expenses of the companies respectively can be considered as the major reason of the decrease in profitability. Thus, the auditors need to give more emphasis on the areas of expense of the company. The application of effective analytical procedures need to be implemented by the auditors to determine the reasons behind the increase in various costs like advertisement, sales and promotion, insurance and others.

The previous level of materiality determined by the auditors is considered as the appropriate method and it is suggested that the company need to follow this particular method in order to identify the level of materiality. Based on the whole evaluation of the financial statements, it can be said that the auditors need to provide special emphasis on the increase of the expenditures of the company.

Table 4: Profit & Loss Account

(Source: as created by Author)

References

Bodie, Z., 2013. Investments. McGraw-Hill.

Bogdan, S., Bareša, S. and Ivanovi?, S., 2012. Measuring liquidity on stock market: Impact on liquidity ratio. Tourism and Hospitality Management, 18(2), pp.183-193.

Bredart, X., 2014. Bankruptcy prediction model using neural networks. Accounting and Finance Research, 3(2), p.124.

Brigham, E.F. and Houston, J.F., 2012. Fundamentals of financial management. Cengage Learning.

Edgley, C., 2014. A genealogy of accounting materiality. Critical Perspectives on Accounting, 25(3), pp.255-271.

Eilifsen, A. and Messier Jr, W.F., 2014. Materiality guidance of the major public accounting firms. Auditing: A Journal of Practice & Theory, 34(2), pp.3-26.

Hartlage, A.W., 2012. The Basel III liquidity coverage ratio and financial stability. Michigan Law Review, pp.453-483.

Higgins, R.C., 2012. Analysis for financial management. McGraw-Hill/Irwin.

Higgins, R.C., 2012. Analysis for financial management. McGraw-Hill/Irwin.

Houghton, K. and Campbell, T., 2013. Ethics and auditing (p. 354). ANU Press.

Sanderson, J., 2014. Audit issues. SMSF Guide: Current Issues and Strategies for the Self-Managed Superannuation Funds Adviser, p.377.

Stewart, T.R. and Kinney Jr, W.R., 2012. Group audits, group-level controls, and component materiality: How much auditing is enough?. The Accounting Review, 88(2), pp.707-737.

Titera, W.R., 2013. Updating audit standard—Enabling audit data analysis. Journal of Information Systems, 27(1), pp.325-331.

William Jr, M., Glover, S. and Prawitt, D., 2016. Auditing and assurance services: A systematic approach. McGraw-Hill Education.