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Analytical Methods in Accounting and Financial Information

Question:

Discuss about the Audit and Compliance for Income Statements.

Analytical method is considered as one of the major tools for the analysis and evaluation of different kinds of accounting and financial documents of the business organizations like balance sheet, income statements and many others. Analytical method of accounting and financial information is considered as a major valuable approach at the time to prepare the audit reports of Double Pink Printers Limited (DIPL). With the assistance of audit plan, the auditors of the companies use to set the definite path of the audit operations. In addition, with the assistance of audit plan, the auditors become able to control the audit cost so that misunderstanding with the audit parties can be minimized. The financial managers of the companies become able to spread the required accounting and financial information in the organizations with the help of analytical method of financial information. In this process, the financial managers can take the assistance of different methods of analytical approaches of the financial information. All these mechanisms of analytical methods help the financial managers of the companies in taking effective and appropriate financial decisions. In addition, the common sizing analytical approach provide great assistance to the financial managers of the companies in anatomizing the financial information from different point of views. Apart from this, at the time of preparing the financial statements of the organizations, the financial managers get great supports these analytical approaches (Healy and Palepu 2012).

In order to verify the reporting process of the different kinds of items in the financial statements, different process of analytical methods plays an integral part. For example, it can be said that the financial reporting process of shareholder’s equity is very different from the reporting process of inventories and this can be determined with the help of analytical approaches. In this regard, the process of Benchmarking is considered as an important tool as the financial managers can use it to find the variances in the financial documents (Zhu 2014). This process also helps the financial managers to determine the root cause of these variances. The auditors of the companies use the benchmarking process in the development of audit plans. Along with the process of benchmarking, vast use of Ratio Analysis can be seen as an analytical method of financial information. By using ratio analysis, the auditors become able to prepare the audit plan as they can compare the financial reports of two or more years (Healy and Palepu 2012).

Ratio Analysis in DIPL

Explanation: From the provided case study, it can be seen that analytical methods play an important part to prepare audit plans. Apart from this, it helps to spread the financial information across the business organizations. As per the earlier discussion, ratio analysis is a major tool of analytical approach. In case of DIPL, the following ratio analysis is done:

Particulars

2013

2014

2015

Current ratio

1.42

1.46

1.50

Profit margin

0.068

0.60

0.06

Solvency ratio

0.62

0.44

0.21

 Table 1: Ratio Analysis

(Source: as created by Author)

According to the above table, it is prominent that the current ratio increased from 2013 to 2014 that is from 1.42 to 1.46; and there is also rise in the current ratio from 2014 to 2015 that is from 1.46 to 1.50. Besides this, it can be seen that there is major fluctuations in the company’s performance that shows transformation of net profit from the net sales. Thus, it can be said that the analysis of profitability position of the company, the financial managers can gain knowledge about the expenditures of the organization. This process is also effective in judging the effectiveness of the company’s budget making policies and the diversification policies (Weil, Schipper and Francis 2013).

In case of DIPL, with the help of observation of the financial ratios, the financial managers and the auditors of the company gain the insight about the financial stability of the company. It is prominent from the above ratio analysis that there is decrease in solvency ratio from 2013 to 2014 that is from 0.62 to 0.44; and there is further decrease in it from 2014 to 2015 that is 0.44 to 0.21. Thus, it can be seen that the solvency position of the company is not great as the company has less current assets to cover the current liabilities of their business. Hence, the ratio analysis makes the financial managers aware about the amount of cash flows that is needed in order to meet the short as well as long-term obligations of the company. Ratio analysis makes the financial managers able to compare the financial performance of the companies for two or more years and this process is helpful in determining the financial performance of the company. From this process, the favorableness of the company’s position can be judged. In case the financial managers find that the financial position of the company is not favorable, they can develop effective financial strategies to revive the situation (Brigham and Ehrhardt 2013).

Certain risk factors can be seen in the business processes of DIPL. As per the provided situation of DIPL, the employees of the company have made several errors while recording the financial transactions of the company. Out of the observation, it can be seen that ineffective and inconsistent sales and marketing operations of the company have connection with the financial transaction errors of the company. Thus, it is clear that the management team of the company has failed to provide effectiveness and efficiency in their job operations. As an effect of this, the management team has showed is inability to foresee the effects of various macro and micro economic factors like social factors, policitical factors, economical factors and many others. Thus, based on the above discussion, it can be said that low profit, low revenue and ineffectiveness of the management of the company are responsible for the preparation of inherent risk factors in the company (Bratten et al. 2013).

Inherent Risks in DIPL

From the provided case study of DIPL, it is prominent that DIPL has an inexperienced and inefficient workforce in the organization. Apart from this, the workforce of the company massively lacks professionalism. All these factors together increase the inherent risk factor of the company. One cannot ignore the fact that the success of the businesses depends on the performance of the employees. Due to be inefficient and not having any experience, the employees of the company are bound to make mistakes in their work and this process can be largely held responsible for the development of inherent risks in the company (Knechel et al. 2012).

Explanation: As per the provided case study of DIPL, immense work pressure can be seen on the employees of the company. Due to this pressure, the employees make several mistakes in the bookkeeping process that makes the process inefficient. This issue in bookkeeping leads to various other organizational issues like cash flow issues, solvency issue, liquidity issue and profitability issue. In addition, it can be seen that there is lack of financial interpretation of the financial reports and this process creates major negative effect on the financial performance of the company. In this situation, the management of the company needs to step up and they need to develop effective strategy to solve these organizational issues. It has also been seen that the management of the company lacks integrity and honesty in their jobs. Hence, based on the above discussion, it can be seen that all the above-discussed issues contribute to the material misstatements of the financial documents (Cao, Chychyla and Stewart 2015).

Types of Risk

Explanation

Fraud Risk

As per the provided information of DIPL, the employees of the company are involved in different kinds of fraudulent activities. Thus, out of these fraudulent activities, the risk of fraud is developed. Major dissatisfaction among the employees contributes to the development of fraudulent activities among the employees. As per the provided case study, massive pressure is there on the employees for the adoption of new accounting system and this pressure comes from the end of the management of the company. In order to avoid the pressure, the employees take the way of fraudulent. The employees of the organization may take the way of fraudulent so that they can easily cope up with the reconciliation process of the new software. From the provided case study, it can also be seen that the due to the improper installation of the accounting system, various accounting transactions are recorded in the wrong way and this process increases the risk of the company (DeFond and Zhang 2014).             

Financial Reporting Risk

Apart from the above reason, another major risk in DIPL is involved with the financial reporting of the company. It is a fact that the investor have major expectations from the companies. In case the investors of the company expect major financial returns, the company takes the help of financial manipulation. In order to portray the strong financial position of the company, the management does many manipulations in the financial statements. This process increase the risk of fraud in the business organizations and the same concept is applicable for DIPL also (Arens, Elder and Mark 2012).    

Explanation: According to the provided information, it can be seen that the process of valuation of raw materials of DIPL is ineffective and inefficient as the present cost of the paper is higher than the average cost of papers. Hence, this process cannot be considered as an effective process. The mentioned risk in the implementation of new accounting software can be detected with thorough process of monitoring of the different phrases of tasks. On the other hand, in order to identify the risks in the financial reporting, the financial managers take the help of analysis and evaluation of those financial reports. These are the ways to identify the major frauds in the organization (Grant 2016).

References

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

Bratten, B., Gaynor, L.M., McDaniel, L., Montague, N.R. and Sierra, G.E., 2013. The audit of fair values and other estimates: The effects of underlying environmental, task, and auditor-specific factors. Auditing: A Journal of Practice & Theory, 32(sp1), pp.7-44.

Brigham, E.F. and Ehrhardt, M.C., 2013. Financial management: Theory & practice. Cengage Learning.

Cao, M., Chychyla, R. and Stewart, T., 2015. Big Data analytics in financial statement audits. Accounting Horizons, 29(2), pp.423-429.

DeFond, M. and Zhang, J., 2014. A review of archival auditing research. Journal of Accounting and Economics, 58(2), pp.275-326.

Grant, R.M., 2016. Contemporary strategy analysis: Text and cases edition. John Wiley & Sons.

Healy, P.M. and Palepu, K.G., 2012. Business analysis valuation: Using financial statements. Cengage Learning.

Knechel, W.R., Krishnan, G.V., Pevzner, M., Shefchik, L.B. and Velury, U.K., 2012. Audit quality: Insights from the academic literature. Auditing: A Journal of Practice & Theory, 32(sp1), pp.385-421.

Weil, R.L., Schipper, K. and Francis, J., 2013. Financial accounting: an introduction to concepts, methods and uses. Cengage Learning.

Zhu, J., 2014. Quantitative models for performance evaluation and benchmarking: data envelopment analysis with spreadsheets (Vol. 213). Springer.

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