Calculation Of Materiality, Statement Of Financial Ratios, Common Size Balance Sheet Essay.

Calculation of Planning Materiality

a) As per the Australian Auditing Standard 320 Para 9, it is mentioned in the standard that the auditor should consider materiality at the time of determining the nature as well as timing and extent of audit procedure (William Jr, Glover and Prawitt 2016). Addition to that, the materiality concept has to be taken into consideration when it is required to evaluate the effect of misstatement of financial statements. As mentioned in the Para 12 of Australian Auditing Standard 320, the standard explains how an auditor should establish initial preliminary assessment of the materiality. The Standard takes into consideration determining the concept of materiality that is a matter of professional judgment by the auditor as well as affected by the quantitative and qualitative factors (Whittington and Pany 2016).

Calculation of Materiality is as follows:

Table: Planning Materiality

(Source: Created by Author)

The above table indicates the various level of materiality where an auditor can select over other available alternatives (Ricchiute 2015). In other words, it is viewed at the time when any company suffers losses and materiality level cannot be determined simply upon the PBT (Profit before tax). It is the responsibility of the auditors for determining the materiality as well as process that actually are evaluated after considering the qualitative and quantitative factors (Garner 2014). Materiality concept cannot be determined as it has no particular guidance and is entirely dependent upon the auditor judgment as a whole. Hence, the materiality level is particularly based on revenue or turnover. The main reason for selecting the revenue is based upon the level of materiality. It is the revenue or turnover that actually reflects upon the size of any business organization (Gay and Simnett 2015). It has been assumed in most of the cases that high revenues are generated from large-size business enterprise. Determination of materiality actually based upon the generated revenue as it talks about the size of the organization as well as reflection upon its scale of operations (Louwers et al. 2013).

In this particular case scenario, materiality level is selected at 5% from the total turnover that comes around $1877712.53 (Elder, Beasley and Arens 2012). Addition to that, the figure reveals of misstatement is below the materiality level, and then it is the auditor who forms an opinion where the financial statement of an organization presents true as well as fair view. On the contrary, if the misstatement is higher than the materiality level, then it is understood that the auditor will be performing further audit procedures for revealing the truth as well as fairness of the financial statement in the most appropriate way (Eilifsen et al. 2013).

Statement of Significant Financial Ratios

a) In this question, it is required to explain the concept of analytical procedures. Analytical procedures are one of the processes that help in evaluating the financial information of any business organization based on the financial as well as non-financial data (Campbell 2015). This help in gaining insights about the financial position of any company as well as risk associated with the business that actually enhances the computation of ratio analysis (William Jr, Glover and Prawitt 2016).

Table: Calculation of Ratios

(Source: Created by Author)

The above table indicates statement of financial ratios for the given year 2010 to 2011. These ratios are generated from the annual report of company for given years as it helps in gaining proper insights of the company financial strength for a period of time. There are three popular types of ratios that are essential for any company to calculate such as liquidity ratios, profitability ratios and solvency ratios (Bierstaker 2012). Liquidity ratio is one of the ratios that help in measuring the ability of any business firm whether they can pay the current liabilities by using their assets. Types of liquidity ratio include current ratio and quick ratio. Current ratio is one of the liquidity ratios that help in measuring the ability of any business firm whether they can meet short-term obligations within a stipulated time (William Jr, Glover and Prawitt 2016). The above table reveals that fact that current ratio and liquidity ratio is increasing within the span of two years. Increased in the liquidity ratio clearly explains that the company to repay their short-term liabilities have been increased over the specified time (Boynton and Johnson 2016).

The above table shows the solvency ratio that measures the ability of business firm to sustain their operations by comparing the level of debt with the equity (William Jr, Glover and Prawitt 2016). There are two important solvency ratios that business organization needs to know namely debt equity ratio and times interest ratio. These two ratios are calculating for gaining insights upon the solvency position of any business organization. In this, debt ratio is one of the solvency ratios that compares total debt and equity of business organization (Elder, Beasley and Arens 2012). The above calculation shows that debt ratio of the company has increased and this reveals the fact that company is using more debt in their capital structure. It is important to consider the fact that reasonable debt in the capital structure actually helps in increasing the level of profitability of the company in a way through reducing the cost of capital. Hence, it is noted that use of very high debt in the capital structure increases the level of risk. The other solvency ratio, the times interest earned ratio help in measuring the ability of the business firm for paying the liability of interest payment in an effective way (Elder, Beasley and Arens 2012). The above table indicates the fact that in the year 2010, the company has the ability for making the payment of interest within the time. In the year 2011, it was noted that the company had incurred loss so they were not able to make sufficient profit in that given year and there was adjustment with the payment of interest (Arens, Elder and Mark 2012).

Ratio Analysis and Business Management

Profitability ratio help in determining the profitability position of any business organization (Arens, Elder and Beasley 2015). There are two popular types of profitability ratios that are used by business organization namely net profit and return on equity. In this, net profit ratio is one of the profitability ratios that measure the profit where the company had earned per dollar of sales (Elder, Beasley and Arens 2012). The above table shows the calculation where in the year 2010, the company has positive net profit ratio but in the year 2011, they had incurred a loss. As far as return on equity is concerned, it helps in measuring the ability of the business firm for earning profit from the invested amount by the shareholders (Arens et al. 2016). There has been decline in the return on equity from the year 2010 to 2011.

Ratio analysis is one of the important financial tools that help in measuring the liquidity, profitability and solvency position of any business organization. Business Corporation uses this tool for getting their financial results and gaining insights on how to manage their current assets and pay the current liabilities on time. It is advisable for company for managing their stock or inventory so that there is no shortage or excess of stock as it will help in smooth functioning of business enterprise (Elder, Beasley and Arens 2012). Companies should be able to issue more equity shares in their business and be able to pay the dividend on time.

b)

Table: Common Size Balance sheet

(Source: Created by Author)

The above table illustrates the common size balance sheet for a given company. In other words, the common size statement helps in analyzing every item that are used in the balance sheet statement and measured in terms of percentages. This is an important tool that helps in comparing the balance sheet figures (William Jr, Glover and Prawitt 2016). The above table shows that total noncurrent assets decreased by 2% from the year 2010 to 2011. In case of current liabilities, there has been decrease in the current liabilities from the year 2010 to 2011. Even the proportion of non-current liabilities had been decreased in the 2010 than 2011.

c) To,

Suzie Pickering,

Senior Auditor,

Subject: Potential problem areas and other major concern that need proper attention

Respected Sir,

I would like to show my concern and highlight on some of the facts as mentioned in the memorandum. It is regarding the material misstatement present in the financial statement where certain facts are highlighted at the time of evaluating the financial statement of business organization. At the time of evaluating the financial statement, it was noted that revenue of the company has increased for a specified time. Hence, this can be portrayed as one of the positive development for that company. The overall profit of the company is declining irrespective of increase in revenue for a particular time span. The reason behind decline in the profit for the company is significant increase in the borrowing cost as well as other expenses in relation to the ordinary activities by 42% and 23%. It is thereby necessary for the auditor for giving special emphasis upon the area of expenses. It is the responsibility of the auditor for applying the appropriate analytical procedures for determination of reason of given significant increase in the expenses such as advertisement, sales, promotion and insurance.

In case of preliminary materiality, it is determined that the auditor actually follows and evaluates the material misstated figures as presented in the financial statement. Auditor should be following the misstated figures that are above the materiality level and give special emphasis upon analyzing the reason for increase in the expenditure.

Thanking You,

Reference List

Arens, A.A., Best, P., Shailer, G., Fiedler, B., Elder, R.J. and Beasley, M., 2016. Auditing and assurance services in Australia: an integrated approach. Pearson Education Australia.

Arens, A.A., Elder, R.J. and Beasley, M.S., 2015. Auditing and assurance services: An integrated approach. Prentice Hall.

Arens, A.A., Elder, R.J. and Mark, B., 2012. Auditing and assurance services: an integrated approach. Boston: Prentice Hall.

Bierstaker, J.L., 2012. Auditing and Assurance Services. Issues in Accounting Education, 17(3), pp.341-344.

Boynton, W.C. and Johnson, R.N., 2016. Modern auditing: Assurance services and the integrity of financial reporting. Wiley.

Campbell, D.R., 2015. Auditing and Assurance Services. Issues in Accounting Education, 16(1), pp.157-157.

Eilifsen, A., Messier, W.F., Glover, S.M. and Prawitt, D.F., 2013. Auditing and assurance services. McGraw-Hill.

Elder, R.J., Beasley, M.S. and Arens, A.A., 2012. Auditing and Assurance services. Pearson Higher Ed.

Garner, D.E., 2014. Auditing & Assurance Services. Issues in Accounting Education, 13(3), p.768.

Gay, G.E. and Simnett, R., 2015. Auditing and assurance services in Australia. Sydney: Mcgraw-hill.

Louwers, T. J., Ramsay, R. J., Sinason, D. H., Strawser, J. R., and Thibodeau, J. C. 2013. Auditing and assurance services. New York, NY: McGraw-Hill/Irwin.

Ricchiute, D.N., 2015. Auditing and assurance services. South Western Educational Publishing.

Whittington, R. and Pany, K., 2016. Principles of auditing and other assurance services. Irwin/McGraw-Hill.

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