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Determine the level of materiality to be used for the audit of the group accounts for the year ending in 2017. Your answer should include a discussion of the nature of materiality, and a description of what materiality represents in terms of the audit of a set of financial statements, and should discuss the different bases and considerations employed in arriving at materiality.
Explain the rationale behind your choice of a certain level of materiality. Provide a quantitative estimate of materiality for your company.

Review the various draft notes and disclosures accompanying the draft annual report. Highlight those that may have significance to the audit, eg. Contingencies, and outline the audit procedures that you will need to perform.

The partner has requested you to prepare a preliminary analytical review on the information provided by your company. The partner suggests that as a minimum you address key balance sheet and profit and loss ratios over the period 2014 to 2017.

Based on these results and the nature of your company’s business and its markets, outline the apparent trends and changes in these ratios, the key risk areas for the audit and the matters that will have to be addressed in the audit plan. Give examples of relevant assertions and at least one audit procedure for each assertion.

Review the statement of cash flows. Which category of cash flows provided the majority of cash inflows? Which category had the greatest outflows?

Identify the primary cash receipts and cash payments during the year.
What were the main non-cash financial and investing activities?
Using the results of questions 2 and 4, evaluate the going concern risk of this company.
What audit procedures would you recommend to address this risk.

Review the audit report of the 2017 financial report. What type of opinion was expressed?

Are there any additional sections or paragraphs indicating any audit issues? If any, describe the nature of these issues in detail. 

Concept of Materiality and Qualitative Aspects

Audit materiality is amongst the most important concepts for auditors. Misstatements are considered material if they influence the decision making of the users based on the financial statements. Materiality encompasses qualitative and quantitative aspects of auditing. While dealing with materiality in the aspects of quantity, the points to be considered are setting up of the preliminary judgment of materiality which is done at the planning stage of audit (ICAEW, 2017).

In this context, there are certain phrases in relation to materiality such as misstatements including omissions which can impact the decision making of the users of financial statements. It is also based on the judgment which is based upon the surrounding circumstances comprising of size and nature if misstatements (CFI Education Inc, 2015).  .So, in this article, the concept of materiality would be discussed in the context of Genworth Mortgage Insurance Australia Limited.

The draft annual report and its financial statements would also be analyzed along with the various ratios over the period of 2014-2017. The key risk areas will be assessed and audit procedures would be advised to mitigate those risks.

The auditors set the materiality regarding the financial statements at the stage of planning. The primary purpose is to use it to identify the performance of materiality and clarifying the thresholds for accumulating misstatements. The concept of materiality pertains to misstatements and omissions which are considered to be material if they individually or collectively affect the decision making of the stakeholders on the basis of financial statements. It comprises of qualitative and quantitative aspects.

As per ASA 320 Materiality in Planning and Performing an Audit, the quantitative considerations consider the aspects such as setting preliminary judgment for materiality.It is done at the planning stage of audit and the performance materiality is considered .i.e. materiality on a line item basis for example inventory and accounts receivable.  The materiality should be estimated in a cycle or a particular account(AASB Standard, 2013).

As per AASB 1031, the qualitative considerations pertain to the non-disclosers made by the company such as contingent liability and transactions of a related party. There are various methods which the group auditors use to determine the level of component materiality comprising of setting up the limit of aggregate of component materiality which is relative to the group materiality. Their limits would increase proportionately to the increase in the number of components. Factors influencing the level of component materiality comprise the fact that component materiality is lower than the group materiality.

Quantitative Considerations for Materiality

In    Genworth Mortgage Insurance Australia Limited, the general rule of considering materiality is 5-10% of normalizing net income and 0.5-2% of the total assets. In this case, the materiality margin in Gross Written Premium (GWP) should be up to  5-10 %. 10% of GWP A$ 381.91 Million in the year 2016 is A$ 38.191 Million.   The maximum GWP in the year 2017 should be A$ 343.719 Million. In this case, the GWP in the year 2017 is A$368.963 Million.

The total assets in 2016 are A$ 3835.552 Million. The materiality margin, in this case, should be 2% of the total assets which should be A$ 76.711 Million. The total assets should be A$ 3758.841 Million. In the given case, the total amount is A$ 3765.885 Million which is greater than the given amount.

The operating lease commitments of the company were A$10.135 Million in 2016 whereas it was A$22.317 Million in the year 2017. The group leases the property and equipment as per the operating leases in which the lessor retains all the benefits and risks arising out of the ownership of leased items which expire from one to five years.

Upon their renewal, the terms are renewed and the payments of the lease comprise of base amount along with an incremental contingent rental. The contingent rentals are based upon the fluctuations in the Consumer Price Index.  The auditing procedures to address the contingencies and risk assessment are:

  1. Control the environment
  2. Assessment of risk
  3. Information system
  4. Control the activities
  5. Monitoring controls

The auditors are required to assess the issues of governance and whether the company has created and maintained a culture of honesty and ethical behavior. Secondly, auditors are required to evaluate the risk assessment procedures of the entity by identifying its business risks and estimating the relevance of those risks.

The next step would be to obtain the understanding of the information systems and accounting records. The auditors are required to understand how the company communicates its role in financial reporting with the regulatory authorities. They are also required to obtain the understanding of the control activities which are relevant to evaluate the risks of material misstatements and to formulate procedures to mitigate the risks. Lastly, the auditors should analyze the monitoring activities used to control over the financial reporting ( Budescu, Peecher & Solomon,2012).

As per Genworth (2017) the company is the leading provider of Lenders Mortgage Insurance (LMI) in Australia. LMI has been a crucial part of the residential mortgage lending market in Australia since Housing Loan Insurance Corporation was founded in 1965 by the Australian Government.

Analysis of Materiality in Genworth Mortgage Insurance Australia Limited

The vision of Genworth is to provide consumer-focused capital and risk management solutions in the residential mortgage markets.  In the year 2017, its Gross Written Premium was A$369Million.  Its Market Capitalization was $1.5 Billion and the investment portfolio was $3.4 Billion (Genworth, 2017).

The key ratios to be analyzed are financial leverage ratios, Current ratio, Quick ratios, Return on equity and Net Profit Margin.

Financial Leverage of the company

Year

Particulars

2014

7.46

2015

8.30

2016

8.28

2017

7.85

As the ratio is fluctuating from 7.46 in the year 2014 to 7.85 in the year 2017 which means that the assets are mainly financed through debt than equity (Genworth Financial, Inc.,2015).

Return on Equity of the company

Year

Particulars(in %)

2014

-8.49

2015

-4.43

2016

-2.18

2017

6.27

Return on Equity measures the profitability of the company in relation to book value of shareholder’s equity, so it measures how well the company utilizes its investments to generate the growth of its earnings. Since a 15-20% is considered good, so  the company is not able to generate income from the available equity.

Net Profit Margin of the company

Year

Particulars

2014

-13.01

2015

-7.19

2016

-3.31

2017

9.85

This ratio indicates that how much profits are generated by sales of each Australia Dollar. So, it has been observed that the net profit margins are reported as negative and in the year 2017, a positive net profit margin has been reported. It represents the unhealthy financial position of the company (Genworth Financial, Inc., 2016).

The current ratio of the company

Year

Particulars

2014

0.24

2015

0.49

2016

0.72

2017

0.41

The current ratio of the company indicates the ability of the company to pay its short and long-term obligations. A ratio below 1indicates that the liabilities of the company are greater and it would be unable to pay its obligations when they become due. The current ratio of the company for all the years is below 1, so the capability of the company to repay its liabilities is doubted.

The key risk areas to be addressed to be addressed in the audit plan are an assessment of audit areas which are affected by economic factors, analyzing the recurring audit deficiencies. They should increase the transparency through new disclosers and focus on the independence of auditors (Hall, 2015).  

The relevant assertions are used by the auditors in the analysis of financial statements for assessing their accuracy. These assertions are existence, completeness, rights and obligations, accuracy and valuation and presentation and disclosure.  

The assertion of existence is the declaration that the liabilities, assets and the balance of shareholder’s equity actually existed at the end of the accounting period. The accounting procedure to address this assertion is conducting interim and final audit tests. During the interim audit, the internal control system is documented and assessed. It would determine the mix of tests of controls and substantive tests which will target transactions conducted so far.  

Key Ratios and Financial Position

The assertion of completeness pertains to the inclusion of every item in the statement of the given period. The auditors would check the entries in the relevant ledgers to make sure that none of them is missed. The supporting documents shall also be assessed to ensure the occurrence of the transaction (Knechel & Salterio, 2016).

The assertion of right and obligations pertain to controlling of rights by the entity to the assets and that the liabilities are the obligations of the company. In the case of property, the deeds of the title should be verified. The current assets should be checked regarding the purchase of invoices and to confirm the cost (Kaplan Financial Limited, 2012).

The assertion of accuracy and valuation is associated with the actual amount at which the liabilities, assets and equity interest are valued and recorded. The cost of assets should be matched with the purchase invoices and the rates of depreciation should be verified.

The assertion of presentation is associated with disclosures of assets and liabilities are done in a presentable manner which is easy to understand. The relevant accounting procedure is disclosing the checklist to ensure that the financial statements are presented as per the accounting standards and legislation (AASB Standard, 2015). 

It can be analyzed from the cash flow statement of the company that the maximum cash inflow is received from investing activities. It amounts to A$ 120.206 Million in the year 2017. The maximum cash outflow is from financing activities amounting to A$ 193.505 Million in the year 2017.

The primary cash receipts are from the proceeds received from the sale of investments amounts to A$ 1398.475 Million and premium received amounting to A$368.963 Million in 2017.

The major cash outflow activities are payment for investments amounting to A$1276.963 Million and cash payments in the course of operations amounting to A$192.267 Million.  

The cash flow from investing activities are payments done for plant, equipment and intangibles amounting to A$13.06  Million and payment for investments amounting to A$1276.963 Million. The amount received from the sale of investments is A$1398.475 Million.

The non-cash financing activity is the expenditure incurred on the development of software expenditure amounting to A$25.263 Million and purchase of goodwill amounting to A$9123 Million (Genworth, 2017).

The company is exposed to liquidity, market and credit risk along with low financial leverage, net profit margin, return on equity and current ratios. Liquidity risk is the risk of insufficient funds  to meet the obligations of the holders of policy and creditors. The company is also prone to the  market risks . It is the risk of loss arising from fluctuations of the market price of the assets  which would result in an adverse impact on the market value of the assets (Van  et al., 2014).

Key Risk Areas and Relevant Assertions

It is of three types viz- currency risk, cash flow and fair value interest rate risk and equity price risk. Currency risk is the risk of loss arising due to unfavorable movements in the exchange rates in the market. Interest rate risk arises due to the fluctuating rate of interest. Equity price risk pertains to fluctuation in the fair value of a financial asset because of changes in the market rate (Cullinan, Earley & Roush, 2012).

The company is exposed to credit risk because of low current ratio as there is a risk of default by the borrowers and transactional counterparties and loss of value of assets due to decline in the credit quality.

As per Siqani  & Sekiraca (2016) for addressing the credit risk, the process of risk management and internal control should be verified and tested regularly. The auditors should recommend that the company should adopt and implement appropriate risk management and operate the credit granting process and maintaining credit administration, monitoring and measurement process.

The risk measurement system should measure all the important market risks of the assets, liabilities and off-balance sheet items. The auditors should adopt net income simulation, economic valuation model, street test and repricing gap report ( Mock & Fukukawa,2015).  

The liquidity risk should be managed by the internal auditors by verification the forecast cash flows. Internal auditors must assess whether liquidity targets for cash balances have been defined. Compliance has been monitored with regard to defined limits and they should report the instances of non-compliance to the audit committee (International Professional Practices Framework, 2017).

The key audit matters addressed were the valuation of gross outstanding claims liability and net earned a premium and unearned premium liability. The valuation of gross outstanding claims is a complex matter of valuation methods. The outstanding liability of claims reflects the analysis for future expected outcomes which are influenced by several factors including the macroeconomic ones. The role of the auditors is to evaluate the underlying documents regarding the methods and assess the changes in the values as compared to the previous year.

The net earned a premium and unearned premium liability are the key audit matters as methods of actuarial science are used to model the earnings curve and relevant judgment is applied to assess the adopted assumptions. So, as a result, the senior level actuarial specialists have been involved to judge the authenticity of the adopted assumptions and the contingency of adopted pattern of risk emergence have been assessed.

Conclusion:

Hence to conclude, it can be said that materiality is crucial for auditors as they are accountable for providing an opinion  of the financial statements are prepared in all the material respects and according to the financial reporting framework . So the focus of auditing   is to recognize the risks of material misstatements and formulating the procedures to quantify them.

References: 

AASB Standard (2013). Materiality . Retrieved August 30th, 2018 from    https://www.aasb.gov.au/admin/file/content105/c9/AASB1031_12-13.pdf 

AASB Standard (2015). Auditing Standard ASA 320 Materiality in Planning and Performing an Audit. Retrieved August 30th, 2018 from     https://www.legislation.gov.au/Details/F2016C00029 

Budescu, D. V., Peecher, M. E. & Solomon, I. (2012). The joint influence of the extent and nature of audit evidence, materiality thresholds, and misstatement type on achieved audit risk. Auditing: A Journal of Practice & Theory, 31(2), 19-41.

CFI Education Inc(2015) . Audit Materiality. Retrieved August 30th, 2018 from    https://corporatefinanceinstitute.com/resources/knowledge/accounting/audit-materiality/ 

Cullinan, C. P., Earley, C. E. & Roush, P. B. (2012). Multiple auditing standards and standard setting: Implications for practice and education. Current Issues in Auditing, 7(1), C1-C10.

Genworth (2017) .2017 Annual Report. Retrieved August 30th, 2018 from https://www.annualreports.com/HostedData/AnnualReports/PDF/ASX_GMA_2017.pdf 

Genworth Financial, Inc.(2015). 2015 Annual Report. Retrieved August 30th, 2018 from https://s2.q4cdn.com/240635966/files/doc_downloads/2016/Genworth-Financial-2015-Annual-Report-(Bookmarked)-[FINAL].pdf 

Genworth Financial, Inc.(2016). 2016 Annual Report. Retrieved August 30th, 2018 from https://s2.q4cdn.com/240635966/files/doc_financials/2016/annual/GENWORTH-2016-ANNUAL-REPORT-[FINAL](Bookmarked).pdf 

Hall, J. A. (2015). Information technology auditing. USA:  Cengage Learning. 1-565.

ICAEW (2017).  Materiality in the audit of financial statements. Retrieved August 30th, 2018 from    https://www.icaew.com/-/media/corporate/files/technical/iaa/materiality-in-the-audit-of-financial-statements.ashx 

International Professional Practices Framework (2017). Auditing Liquidity Risk. Retrieved August 30th, 2018 from https://www.iia.nl/SiteFiles/PG-Auditing-Liquidity-Risk-An-Overview.pdf 

Kaplan Financial Limited(2012). Materiality . Retrieved August 30th, 2018 from https://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/Materiality.aspx 

Knechel, W. R. & Salterio, S. E. (2016). Auditing: Assurance and risk. NY: Routledge. 1-20.

Mock, T. J. & Fukukawa, H. (2015). Auditors' risk assessments: The effects of elicitation approach and assertion framing. Behavioral Research in Accounting, 28(2), 75-84.

Siqani , S.H. & Sekiraca , E.(2016). The Impact of the Internal Audit in Reducing Credit Risk in Commercial Banks in Kosovo. European Scientific Journal,12(4),268-280.

Van Buuren, J., Koch, C., van Nieuw Amerongen, N. & Wright, A. M. (2014). The use of business risk audit perspectives by non-Big 4 audit firms. Auditing: A Journal of Practice & Theory, 33(3), 105-128.

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