Describe about the Auditing and Professional Practice for Global Accounting.
Part A: Audit planning
Preliminary judgment of materiality
Audit planning refers to the process to evaluate the correctness and validate all the proceedings related to the financial statements and recording produced by a company. The key objective of the audit planning in the company is to ensure that the financial statements are reported with transparency, so as to avoid any harm to the stakeholders’ interests to the company (Public Company Accounting Oversight Board, 2016). Hence, while making a preliminary judgment, these factors will be taken into account.
At the onset, Bob’s Bikes can be observed as performing fairly well according to the financial statements produced for 2014-2015 and 2015-2016. However, a comparative observation of the two years statements reveals chances of possible misstatements, which must be addressed prudently.
Five accounts selected and rationales
The five accounts that have been considered for the purpose of audit testing from the trial balance are depreciation account, interest expense account, sales account, cost of sales account and other income accounts.
The depreciation reported for 2014-2015 is $15,590 while the increases substantially in the next fiscal year of 2015-1016 to $28,916, which is almost twice the amount, reported in the previous fiscal year. It can also be observed from the trial balance that the amounts of all the assets, which include machinery, furniture and motors vehicle, for both the accounting periods, are same. Even though having the same amount for both the years, a huge difference in the depreciation amounts can be witnessed that may be erroneous.
Accumulated Depreciation Account
The amount for the machinery for the year 2014-2015 and 2015-2016 is recorded as $ 65,000 but the accumulated depreciation for both the years has changed significantly, as the depreciation amount for the year 2014-2015 has been recorded as $24,375 whereas the amount for the year 2015-2016 of the depreciation is shown as $46,041. A similar observation can also be obtained when assessing the values reported for motor vehicles and furniture where the depreciation amount for the motor vehicles and furniture has increased by $6,500 and $750 respectively.
Interest Expense Account
The second account taken for the purpose of auditing is the interest expense account. The amount for the interest expense recorded for the year 2014-2015 shows its value as $10,750 and the amount for the year 2015-2016 can seen as $8,958. However, the loans for both the years are recorded as $215,000, which indicates that the interest for both the years also had to be same. As per the trial balance of Bob’s Bike, the disclosure of the same loan amount and different amounts for interest expense indicates a possibility of misstatement in the accounts maintained for interest expense, which needs further investigation.
Cost of Sales Account
The sales for the year 2014-2015 has been recorded as $187,450 and the sales for the year 2015-2016 has been recorded as $201,515, which shows a rise in the company’s sales revenue by $14,065. Sales growth also leads to increase in the cost of sales. In other words, as there has been increase in the sales of the Bob Bikes during the year 2015-2016, the cost of sales also needs to increase. However, as per the trial balance of the Bob Bike’s, the cost of sales has instead decreased by $10,324, which also hints towards a possible misrepresentation of facts. Hence, this account also needs to be evaluated correctly.
Other Income Account
The amount for the other income for the year 2014-2015 has been shown as $25,000 whereas the amount of other income has been recorded as $1,000, which shows a vast difference of $24,000 in just one year. It indicates that the owner of Bob’s Bike is trying to hide the true income of the company or due to erroneous reporting. Apparently, the difference in the amount of other income needs proper auditing in order to make the financial statements error free.
Part B: Sample Selection
Explanation/demonstration of sampling technique
The account selected for the purpose of sample selection is the sales account. The population for samples considered in this study included multiple options, such as the sales account, consultancy fees account, other income account an interest income account. As the sales transactions of Bob’s Bike had changed substantially, with greater value addition that other accounts, which could have been motivated by the intent to show greater profit or income of the company, it was selected as the sample for further assessment. Moreover, as a disclosure to company income, its holds considerable importance that was also a reason for its selection. Sales, in terms of bookkeeping, can be defined as revenue generated by the company by selling the products or by providing services to its customers. Income from sales is directly reported in the income statement (CTI Reviews, 2016). Sales accounting is one of the most essential tasks for any organization commencing a business. It ensures that all revenues and incomes are accounted and transferred with transparency to the company records. Sales can be of two types, i.e. cash sales and credit sales. Sales involving direct payment for the product or the services are referred as the cash sales. It includes immediate payment of cash to the seller, wherein, as soon as the customers pay the seller, the transaction is over. The amount received is subsequently shown in the sales account (Kotas &Conlan, 1997). A credit sale, on the other hand, refers to the payments made by the customers in instalments (City of Lakewood, 2016). Notably, for the selection of this particular account rather than other accounts from the ledger records, the random sampling process was used.
Benefits of selected sampling technique
The random sampling technique of random sampling presumes that all the sampling units possess equal chances to be included in the sampling frame for the study and therefore, is effective to remove biases from the sampling process (Frerichs, 2008). The ledgers taken for the auditing processes included transactions recorded as on 10th of July 2015, 14th of August 2015, 25th of September of 2015, and that of 2nd of October 2015 along with the transaction recorded on 19th of February 2016. The amount transacted on 10th of July amounted to be $8,000, for 14th August, it was recorded as $5,200 and for 25th September as $5,300. The amount of sales done at 2nd October was recorded as $6,250 and the transaction done at 19th February was recorded as $6,200.
The advantages of random sampling, in this case were identified as its ability to offer an understanding of the overall activities of the population, only transactions recorded in the company’s sales account for the fiscal year 2015-2016. Accordingly, the sampling technique would enable a prominent understanding as to whether misrepresentation was conducted when recording the sales invoices in the account (ACCA Global, 2015).
Stating precisely, systematic sampling is often regarded as the modified version of random sampling, which is also known as the ‘Nth name selection technique’. Accordingly thus, after the calculations of required size of the sample, the selections of the Nth record was conducted from the population numbers (StatPac Inc, 2014). Nonetheless, the sampling technique also involves certain disadvantages. For instance, it assumes that the population size can be practically estimated, which increases the chances of biases in the process, as it restricts equal chances for the samples to be included in the study and hence, may lead to either over or under representation of the sample. This method can be inefficient in case of heterogeneous population, as observed in this case (Arizona Board of Regent, 2016). System sampling also requires complete set of population. Improper arrangement of the population taken may result in inefficient sampling, wherein the estimation of the variance cannot be obtained by conducting single sampling of the population (Statistical Institute for Asia and the Pacific, 2015). In order to reduce the chances of biases thus, the selection criteria set for the sampling process ensured that only values above $5,000 were, which would offer a better understanding of the risk of misrepresentations in the ledger account and the records provided through the financial statements for the year 2015-2016.
Table 1: Transactions taken for random sampling method of the sales account of Bob’s Bike
Part C: Considerations in substantive testing and collecting audit evidence
The reason for adopting the random sampling technique in part B was its usefulness in making unbiased selections. Moreover, it also added to the convenience of selecting samples from the relatively large population of the sample units.
As the sales account is suspected to contain misstatements, completeness of the financial reports is more concerning (Cengage Learning, 2002).
The audit procedure that would be more appropriate in case of Bob’s Bike is tracing, as it is essential to do sampling of the sales ledger in order to specify their existence through the mechanism (ACCA, 2015).
Occurrence, often referred as the existence, can also be considered as an assertion in identifying the receivables, cash balances and sales, which are recorded and have actually occurred (ACCA, 2015).
The income account shows a significant difference in the amount of 24,000, which shows that the recorded transaction is false. Hence, more information in this regard should be sought for.
The error in the financial statement is not acceptable, as it would lead to a change in the overall income recorded by the company, which might otherwise provide the shareholders with false information regarding its financial positioning.
The objective of the test of controls is to assess if effective control is ensured. However, it does not evaluate monetary errors directly, whereas substantive testing, on the other hand, allows finding the monetary errors (Prentice Hall Business Publishing, 2008). Both these techniques can hence complement each other and mitigate the limitations.
Financial planning is one of the most essential functions of a business. It is important to understand the purpose of reporting a financial statement. The auditor should also know the approaches to be used in accordance (Government of Alberta, 2016).
Part-year trial balance statement can be sought when there is a need to adjust the amounts recorded in the financial statements by the company. An auditor may seek for an unadjusted trial balance in order to evaluate the correctness of the reports maintained and identify the suspected errors in reporting more precisely (Hall, 2015).
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