Effective Audit Planning And Materiality Determination For Financial Reports Essay.

There are three sections to this assignment. Each section is worth 10 marks. Each section includes a component for communication skills. Communication with clients is an imperative necessity for auditors and excellent writing skills are expected from professional accountants, therefore please write your answers carefully and clearly. You will lose marks for poor presentation, spelling mistakes or grammatical errors. 

• 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. 

Steps for determining materiality

While the auditor carries on the audit procedure the main objective is to express the opinion regarding whether the financial reports are presented in all the material aspects, as per the applicable framework for financial reporting. This is separate decision and separate responsibility that is made by the company while preparing the financial reports (Christensen, Glover & Wolfe, 2014). In auditing context, the term materiality is the threshold limit above which the incorrect or missing information related to financial statement is deemed to have impact on the user’s decision making aspect. Sometimes it is construed in terms of the total impact on the profits reported or changes in percentage for some specific items included in financial statement (Moroney & Trotman, 2016). Steps involved in determining the materiality are as follows –

• Identifying external as well as internal shareholders
• Conducting initial outreach for the shareholders
• Identifying and prioritizing what needs to be measured
• Designing the materiality survey
• Launching the survey and starting with insight collection
• Evaluating the insights
• Putting the insights into action (Legoria, Melendrez & Reynolds, 2013).

At the stage of planning the auditor is required to analyse the materiality with regard to the financial statements. Calculation of the materiality involves both qualitative as well as quantitative methodologies. Once the materiality involved in financial reports are identified and assessed by the auditor, performance materiality that is the tolerable misstatement with regard to financial statements are set (Eilifsen & Messier, 2014). However, the planning materiality must be higher than the performance materiality. The quantitative factors used for computing the materiality planning are –

• 2% of sales revenue
• 1% of total assets
• 2% of shareholders equity
• 5% of net profit

Therefore, for Perpetual Limited the planning materiality amount will be as follows –

• 2% of sales revenue = $ 520,881 * 2% = $ 10,417.62 thousand
• 1% of total assets = $ 11,71,545 * 1% = $ 11,715.45 thousand
• 2% of shareholders equity = $ 634,381 * 2% = $ 12,687.62 thousand
• 5% of net profit = $ 137,238 * 5% = $ 6,861.90 thousand (Perpetual.com.au, 2018).

While calculating the materiality planning the auditor may choose to take highest amount from the above. However, the auditor must understand qualitative factors related to materiality involved in the financial statements before concluding the planning materiality size. Therefore, in the given case of Perpetual Limited materiality can be planned at the amount of $ 11,000 thousand. However, an amount ranging from 50% to 75% of materiality planning is considered as the performance materiality or tolerable misstatement for Perpetual Limited (Johnstone, Gramling & Rittenberg, 2013). It is based on the determination of lower level of significant items involved in the financial reports like cash and cash equivalents, receivables and payables.

Cash and cash equivalents – Perpetual Limited’s cash and cash equivalents included the short-term deposits that represent rolling for 30 days to 90 days term deposits. The company mainly holds the cash and cash equivalents for supporting the regulatory requirement of capital that was amounted to $ 151.2 million. However, there are no specific rules regarding the amount and by nature cash is regarded as material item. Cash is considered as material item as it forms integral part in user’s view for the company (Ruhnke & Schmidt, 2014). It is recognized from the annual report of the company for the year closed on 30^th June 2017 that the cash and cash equivalent of the company has been increased from $ 278,230 to $ 323,487 over the past year. The auditor shall analyse all the receipts and payment related vouchers and records. The auditor shall further verify the authorisation on payments to satisfy him that no material misstatement or error has been taken place (Perpetual.com.au, 2018).

Audit procedures for verifying cash and cash equivalents, receivables, payables, contingencies, and provisions

Receivables – It is recognized from the annual report of the company for the year closed on 30^th June 2017 that the trade receivables of the company has been increased from $ 86,611 to $ 90,046 over the past year. As receivable is always exposed to risk of bad debt and misstatement the auditor shall verify all the data related to receivables. It shall carry out the debtor ageing analysis for verifying the payments due for more than the allowed credit period (Kanapickien? & Grundien?, 2015).  In case of any suspicious transaction the auditor can confirm the balance from third party also.

Payables – It is recognized from the annual report of the company for the year closed on 30^th June 2017 that the payables of the company has been increased from $ 38,523 to $ 51,850 over the past year. Payables are considered as material as it plays important role in analysing the company’s liquidity position.

Contingencies – under the ordinary business course, the contingent liabilities are disclosed by the company with regard to potential claims and existing claims. The company is not sure regarding the material impact of the contingencies on the financial position or operation of the company for the year closed on 30^th June 2017. When it is not possible to project the amount in terms of materiality the auditor must project the chances of the contingencies to take place. However, while projecting the likelihood of occurrence of the event the auditor must use his professional experience and judgement. Contingent liability shall be disclosed in the notes associated with the financial report if it is found that the liability is not probable but reasonably possible or the liability is probable but the amount cannot be estimated. However, if the occurrence or probability is remote, the contingent liability shall not be disclosed or recorded.

Provisions – the company recognizes provisions under the financial statements while it has present constructive or legal obligation owing to the past event and which can be reliably measured. Further, it shall be probable that the economic benefit outflow is required for settling down the obligations. Judgements are exercised by the management for estimating the amount of provisions. There is a chance that outcome in the future year will differ from the amounts provided s provision in the current year. Hence, the amount will have to be adjusted for the carrying amount of the liability. While auditing the provisions the auditor shall verify is with regard to contingencies and liabilities. The auditor shall further assure that the provided amount is adequate and all the provisions are recorded through debiting profit and loss account. Moreover, the auditor shall assure that all provisions are properly utilized for intended purpose. All provisions shall be disclosed properly in financial reports. Moreover, if the auditor is in the view that the created provisions are not adequate or in excess, the management shall be advised for providing exact amount.

Analysis of key financial ratios for evaluating the company's financial performance

Profitability ratios – it is used by the investors and analysts for evaluating and measuring the company’s ability to create income with regard to revenue, operating expenses, assets and shareholder’s equity under particular period of time.  It shows how the company utilizes the assets for creating return and value for the shareholders. It can be found from the ratio computation table of Perpetual Limited over the periods from 2014 to 2017 that the net profit margin of the company was in improving trend and reached to 26.35% from 19.14%. It indicates that the company’s profitability has been improved over the past years (Delen, Kuzey & Uyar, 2013). Return on assets that indicate the profit percentage earned by the company as compared to overall resources. Looking into the company’s return on assets it can be identified that the ROA of the entity was in improving trend and reached to 11.71% from 7.44%. It indicates that the company’s profitability has been improved over the past years.

Key assertion involved with the profitability ratio is accuracy that is the amount of transaction has been recorded in full without any error. Required audit procedure for removing this assertion is to check all the vouchers and receipts associated with the receipts and payments and the amount shall be matched with books of accounts.

Liquidity ratio – it is used for measuring the ability of the entity to pay off the short term liabilities when it will become due. It has direct impact on the credit rating and credibility of the entity.  Current ratio as well as the quick ratio of the company states whether the current assets of the company are adequate to meet its short-term obligation. From the ratio computation table of Perpetual Limited over the periods from 2014 to 2017 it is identified that the current ratio of the company was in improving trend and reached to 1.78 from 1.64. However, the quick ratio of the company is reduced from 1.62 to 1.30.

Key assertion involved with the liquidity ratio is completeness that is the amount of assets and liabilities has been recorded in full without any error. Required audit procedure for removing this assertion is to check all the transaction associated with the liabilities and assets and the amount shall be matched with the reported amounts in balance sheet.

Stability ratio – the stability ratios are used to investigate the level of support provided to the entity through debt and whether the equity and debt are balanced. Debt equity ratio of the company states the proportion of liabilities as compared to the equity under the capital structure (Pervan & Kuvek, 2013). On the other hand, debt to asset ratio states the percentage of debt used by the company purchase its assets. Both the stability ratios of the company are stating that both the ratios are in improving trend and the debt and equities of the company are balanced.

Key assertion involved with the stability ratio is valuation that is the amount of assets and liabilities has been recorded at proper valuations. Required audit procedure for removing this assertion is to check all the borrowing related documents and shall be matched with the amount recorded in balance sheet. Further, the asset amount shall be verified with the asset register (Lessambo, 2018).

Looking into the statement of cash flows released by the company for the year ended 30^th June 2017 it is found that operating cash flows provided majority of the cash inflows. On the contrary, cash used for financing led to majority of the cash outflows (Bhandari & Iyer, 2013).

Further, it is observed that proceeds from investment sale amounted to $ 40,925,000 was primary receipts of cash for the company. On the contrary, payment towards dividend amounted to $ 121,094,000 was primary payments of cash for the company (Chang et al., 2014).

Non-cash financing expenses was the payment of dividend amounted to $ 121,094,000.

On the basis of the company’s financial performance over last 4 years that is from 2014 to 2017 it can be stated that the entity’s profitability ratio improved over the past years. Further, the stability ratio is indicating that the debt and equity of the company are balanced (Mock & Fukukawa, 2015). However, to improve the quick ratio is shall pay off the short term liabilities. Therefore, no major risk regarding going concern is observed in case of Perpetual Limited.

From the audit report of the company included in the annual report for the year closed on 30^th June 2017 it is observed that the auditor of the company that is KPMG expressed unqualified opinion. Further, they stated that the financial report has been prepared as per the requirement of Corporations Regulations 2001 and (AAS) Australian Accounting Standards (Pucheta?Martínez & García?Meca, 2014). However, any additional section has not been included regarding any audit issue.

Reference 

Bhandari, S. B., & Iyer, R. (2013). Predicting business failure using cash flow statement based measures. Managerial Finance, 39(7), 667-676.

Bowlin, K. O., Hobson, J. L., & Piercey, M. D. (2015). The effects of auditor rotation, professional skepticism, and interactions with managers on audit quality. The Accounting Review, 90(4), 1363-1393.

Chang, X., Dasgupta, S., Wong, G., & Yao, J. (2014). Cash-flow sensitivities and the allocation of internal cash flow. The Review of Financial Studies, 27(12), 3628-3657.

Christensen, B. E., Glover, S. M., & Wolfe, C. J. (2014). Do critical audit matter paragraphs in the audit report change nonprofessional investors' decision to invest?. Auditing: A Journal of Practice & Theory, 33(4), 71-93.

Delen, D., Kuzey, C., & Uyar, A. (2013). Measuring firm performance using financial ratios: A decision tree approach. Expert Systems with Applications, 40(10), 3970-3983.

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

Johnstone, K., Gramling, A., & Rittenberg, L. E. (2013). Auditing: a risk-based approach to conducting a quality audit. Cengage learning.

Kanapickien?, R., & Grundien?, Ž. (2015). The model of fraud detection in financial statements by means of financial ratios. Procedia-Social and Behavioral Sciences, 213, 321-327.

Legoria, J., Melendrez, K. D., & Reynolds, J. K. (2013). Qualitative audit materiality and earnings management. Review of Accounting Studies, 18(2), 414-442.

Lessambo, F. I. (2018). Audit Risks: Identification and Procedures. In Auditing, Assurance Services, and Forensics(pp. 183-202). Palgrave Macmillan, Cham.

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.

Moroney, R., & Trotman, K. T. (2016). Differences in Auditors' Materiality Assessments When Auditing Financial Statements and Sustainability Reports. Contemporary Accounting Research, 33(2), 551-575.

Perpetual.com.au. (2018). Investments, superannuation, retirement, & advice | Perpetual. [online] Retrieved 2 September 2018, from https://www.perpetual.com.au/

Pervan, I., & Kuvek, T. (2013). The relative importance of financial ratios and nonfinancial variables in predicting of insolvency. Croatian Operational research review, 4(1), 187-197.

Pucheta?Martínez, M. C., & García?Meca, E. (2014). Institutional investors on boards and audit committees and their effects on financial reporting quality. Corporate Governance: An International Review, 22(4), 347-363.

Ruhnke, K., & Schmidt, M. (2014). Misstatements in financial statements: The relationship between inherent and control risk factors and audit adjustments. Auditing: A Journal of Practice & Theory, 33(4), 247-269.