Materiality In Financial Statements Audit: A Case Study Of Cimic Group Limited Company Essay.

Write the Different Bases and Considerations Employed in Arriving at Materiality.

Section 1: The Level of Materiality to Be Used For the Audit

The purpose of this paper is to examine the 2017 annual report for Cimic Group Limited Company and determine the level of materiality that should be used for the group accounts for the fiscal year ending 2017. This report also represents a preliminary analytical review on the information that is provided by the company. Key balance sheet and profit and loss ratios over the period 2014 to 2017 have been addressed. In addition to this, the report gives a review of the cash flow statement of the company and discusses its primary cash receipts and cash payments during the year ending 2017.

Section 1: The Level of Materiality to Be Used For the Audit

According to the framework of IASB, material information is that whose misstatement or omission would possibly influence how financial statement users make their economic decisions based on such financial reports. Therefore, materiality refers to how significant transactions, errors and balances contained in a company’s financial statements are. This is a cutoff or threshold which determines whether or not financial information is relevant for use by users in meeting their decision making needs. Companies must therefore ensure that information presented on their financial statements is complete and relevant at all times, and is presented on a fair and true basis that represents the entity affairs. Materiality highly relates to the size of an individual company, as well as its particular circumstances (Cim, 2014).

1. What Materiality Represents In Terms of the Audit of a Set of Financial Statements

In financial statements audit, materiality represents errors or misstatements. Misstatements or errors in financial statements are often considered as misstatements that have not been recorded or corrected. In normal audits of financial statements, auditors identify and report the dollar amount of such errors and misstatements on a schedule in which normally he lists two categories of errors in financial statements. For instance, he reports amounts in financial statements which have been recorded incorrectly. These are transactions which were generally not recorded correctly since they were posted in incorrect amounts or in wrong accounts (Cim, 2014).

Additionally, the auditor must also report amounts that ought to have been recorded in financial statements but were not. The auditor is responsible for calculating to an exact dollar amount the misstatements that have been unrecorded or uncorrected in financial statements. For errors that are based on an estimated adjustment, they are considered to result from weaknesses or deficiencies in internal controls. The auditor must therefore consider reviewing each item against the determined level of materiality with a view to determining whether or not to make adjustments to financial statements (Media, 2012).

1. Different Bases and Considerations Employed in Arriving at Materiality

Factors Considered in Determining the Level of Materiality

In determination of materiality levels, the auditor must consider a number of factors. For instance, the level of materiality should be in relation to intended uses and purposes of the financial statements audit. The auditor must clearly understand the financial information which is considered important and valuable for use by decision makers. For instance, in regard to solvency or regulatory issues, the level of materiality is highly related to industry benchmarks in solvency ratios (CIM Group et al., 2015). Additionally, for purposes of appraisal, the level of materiality is specifically related to net income or net worth of a company, or its earnings per share (EPS). For general purposes relating to financial statements, the level of materiality is associated with both the net surplus or the net capital and the net income (Cimic Group Ltd, 2017).

The level of materiality also varies in accordance with other features or characteristics of the company, such as its size, access to capital, the stage of organizational life cycle, its net retention and type of business conducted (whether commercial lines, personal lines or single line versus multi-line). The financial strength of the company is also considered since it influences the materiality level. It is generally postulated that as an organization approaches a given threshold for materiality, the materiality standard for work in relation to that threshold becomes increasingly rigorous (CIM Group et al., 2015).

1. The Rationale behind Your Choice of a Certain Level of Materiality

Determination of dollar amounts that are considered material to financial statement users is a matter of professional judgement. A certain percentage is often applied by the auditor to a chosen benchmark as a preliminary step in determination of the level of materiality adopted by financial statements in entirety. These benchmarks may either be firm oriented or industry oriented. For instance, the benchmarks could be based on items such as gross profit and total revenues (Cimic Group Ltd, 2017).

However, in determining the level of materiality in unrecorded and uncorrected misstatements in financial statements, the auditor uses several methods based on various rationales. For instance, the 5% rule is very key in determining the materiality level in financial statement misstatements, and the value of misstated dollar amounts is derived in consideration to this percentage limit of materiality. This limit is acceptable since any unrecorded and/or uncorrected misstatements that approach this percentage are considered material misstatements in the financial statements of the company. There is therefore a need to take appropriate audit tests and measures for ascertaining whether or not the actual misstatements happened. In the audit of Cimic Group Limited Company, the maximum limit of acceptable level of materiality is therefore 5%. Any misstatement that exceeds this value is thus considered material in the financial statements of Cimic Group Limited Company (Liu, 2015).

1. Review the Various Draft Notes and Disclosures

Section 2: A Preliminary Analytical Review on the Information Provided

Upon reviewing the various draft notes and disclosures accompanying the draft annual report of CIM Company, there are several notes and disclosures that were found to be significant in the audit. For instance, according to the notes on recognition of revenue, the company recognizes revenue using the percentage complete method where stage of completion is determined with reference to the total costs that have been incurred and calculated as a percentage of the total estimated costs for every contract (Aicpa, 2017). This note is very significant in the audit of Cimic Group Limited Company since where the result of the project can be estimated reliably, the revenue and expense of the contract are recognized as earned and incurred in the profit and loss statement of the company. However, if the results cannot be measured reliably, the profits are then deferred and the variance between the amount of consideration received and the expenses incurred is carried forward to the next operating periods as either payables or receivables of the contract (Verschoor, 2008).  In regard to this disclosure, the auditor must perform audit procedures to ascertain whether the results of the various projects or contracts of the firm during the year ending 2017 were estimated reliably. This can be achieved by examining the various expenses and profits incurred and realized from each contract, and then establishing whether they are in accordance with the budgeted amounts for the same (Key, Riddle & Institute of Internal Auditors, 2012). 

Additionally, the company discloses in its notes to financial statements that the finance costs are recognized as expenses in the period in which they were incurred, with an exception to cases where the amounts are included in the respective costs of qualifying assets. The rate of capitalization used in determining the amount of finance costs to be capitalized is the weighted average interest rate that is applied to the borrowings of the company during the financial year. This is significant to the audit since the auditor needs to ascertain if such costs were accurately recognized as expenses in the year ending 2017. In doing this, the auditor must consider reviewing the each qualifying asset to determine whether the finance costs have been included in the cost of the assets or not (Jubb, 2010).

Section 2: A Preliminary Analytical Review on the Information Provided

1. Key Balance Sheet and Profit & Loss Ratios

Based on the results obtained above and the nature of Cimic Group Limited Company’s business and its markets, there are apparent trends and changes its key ratios. For instance, the gross margin of the company increased from 6.99% to 7.46% during the year 2016 and 2017 respectively. The net profit margin also increased by 0.05% in the years 2016 and 2017. Additionally, there was an increase of 1.73% in Return on Assets (ROA) during the year 2016 and 2017. Also, the current ratio and quick ratio increased by 0.12 in both 2016 and 2017 (Cimic Group Ltd, 2017).

1. Key Risk Areas for the Audit

There are various risks associated with the audit. For instance, risk of misstatement is very significant. Every stakeholder in the corporate chain of this company makes key decisions based upon the information presented on the financial statement of the company. For this purpose, material misstatements or non-disclosures in the financial statements may lead to significant audit risks that should be examined. There is also a risk that the auditor may not be able to detect fraud caused by weaknesses in the internal controls of the Cimic Group Limited Company. The auditor therefore needs to address these key risks in his audit plan (Aicpa, 2017).

1. Relevant Assertions and Audit Procedures

The auditor should make the following assertions in regard to classes of transactions as well as related disclosures for the financial year ending 2017.

1. Occurrence

He should certify that the recorded events and transactions have actually occurred and they are in pertinence to the company. This can be done by examining and inspecting the original books of accounts such as purchase vouchers (Hayes, Gortemaker & Wallage, 2014).

1. Completeness

The auditor must ensure that the all events and transactions that took place in the year ending 2017 have been recorded in the financial reports. He can achieve this by critically examining the financial records against the original documents (Cim, 2014).

• Accuracy

Additionally, accuracy of the amounts entered in the account books need to be ascertained by the auditor. He can do this by critically examining the account books to verify that the transactional amounts have been recorded appropriately and necessary disclosures made (Fiedler & Fiedler, 2010).

Upon reviewing the cash flow statement of Cimic Group Limited Company in the year ended 2017, it has been established that the majority of the company’s cash inflows were generated by the cash flows from operating activities, which totaled to $14,090. The company generated net cash flows amounting to $1,362.40 from its operating activities in the year ending 2017. The company’s largest cash outflows were also reported from its operating activities, which totaled to $12,754 (12,566.5+106.2+80.8). During the year ending 2017, Cimic Group Limited Company recognized primary cash receipts of $15,798. The company also reported primary cash payments amounting to $15,472 (Arens, Elder & Beasley, 2016).

According to the cash flow statement of Cimic Group Limited Company, the entity has several non-cash financial and investing activities. For instance, the firm receives significant amounts from sale of its property, plant and equipment amounting to $118. The company also makes payments in relation to these items totaling to $424. Additionally, the company makes a payment of $29.3 for acquisition of non-controlling interests (Nobes, 2014).

According to question 2 and 4, Cimic Group Limited Company is experiencing some key risks concerning its going concern. For instance, the firm is highly dependent on cash inflows from its operating activities since its investing and financing activities reported a negative net cash flow during the year ended 2017. In addition to this, the greatest cash outflows of the company were reported from its operating activities. This means that the company may not has huge payments which may lead to significant stoppage of its operations in future should the cash outflows exceed the inflows. This highly contravenes the going concern of Cimic Group Limited Company (Arens, Elder & Beasley, 2016).

There are various audit procedures that are highly recommended for addressing this risk. For instance, the management should consider diversifying the operations of the firm in order to ensure that operating activities are not the only main sources of its cash inflows. It should also be ensured that the huge costs and expenses are cut or reduced materially. This would ensure that the company recognizes an increased amount of free cash flow that can be used for its future expansions, thus guaranteeing it’s going concern and eliminating the associated risks (Dennis, 2015).

Upon reviewing the Company’s financial for the year ended 2017, it has been established that the independent auditor issued an unqualified opinion regarding the financial statements of the company. In their opinion, the auditor certifies that the financial report of the Cimic Group Limited Company is prepared in accordance with the Corporations Act of 2001. The financial statements present a true and fair view of the financial position of the group as at 31^st December 2017 and of its financial performance for the year ended 2017 (Crain, Hopwood, Pacini, & Young, 2018).  

Conclusion

As discussed in the above sections, the financial statements of Cimic Group Limited Company have been prepared in accordance with the Generally Accepted Accounting Principles (GAAPs), and they give a true and fair view of its financial position as at 31^st December 2017 as well as its financial performance for the financial year then ended (Wells, 2014). 

References

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Cimic Group Ltd - AnnualReports.com. (2017). Retrieved from https://www.annualreports.com/Company/Cimic-Groupltd

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