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Discuss About The Audit Expectations Gap And Corporate Fraud.

Analysis and Discussion

The audit plan for the client Trunkey Creek Wines is to be prepared for the year ended 30th June 2018. TCW is one of the significant clients of MYH for long. The principle activities in which the client deals in is growing grapes for the wine production, production and distribution of different types of wines, beef cattle production on the surplus lands and investment of the surplus funds. The insufficient rainfall has rendered few of the lands to be unsuitable for grape wine production, which is now being used for beef cattle production. However, due to average increase of 2% in the temperature, the sparkling wine production is being affected and the company is looking to purchase some lands in the cooler climates. The Wagyu beef, which is being produced by the company, is being sold and marketed through Wagyu Selling Group (WSG) in which TWC has significant shareholding (Alexander, 2016).

Several ratios of the company for the last 3 years have been computed and also the internal control being maintained in the company in the areas of purchase, procurement, booking of the orders in the system, invoice verification, payment to creditors, delivery of service, invoicing, booking the liability and payment to creditors have been discussed in the case study.

The ratio analysis, the potential audit risk and the audit steps that are needed to be undertaken to reduce the risk are shown below in the workings:

Account

Analysis

Audit Risk

Audit steps to reduce risks

Accounts Receivable

In the receivables scenario, we  can see that the receivables days has almost been constant in the wine business but the same is on the upper side as the industry trend is near 30 days whereas the company in hand is operating at the receivable days average of around  50 days, which his quite high. ON the other hand, the receivable days in case of beef business has been increasing drastically over the last 3 years and has almost doubled from 24 days in 2016 to 57 days in 2017.

Since the state of receivable days is increasing in such a fashion, it indicates the audit risk as well as the business risk on the collection from the debtors as to whether to not the receivables has been correctly recorded in the books or not and why the company has is not being able to collect from debtors. Furthermore, the auditors also need to check if there is a requirement of providing for bad and doubtful debts based on this (Choy, 2018).

Some of the audit steps which can be conducted to check the health of the debtors in the books are reconciling the sales and the debtors ledger, the follow up procedures with the debtors, the monthly and quarterly outstanding balances report with the debtors, balances confirmation from debtors, whether the debtors have been correctly and completely recorded in books, how the valuation is being done and what the disclosures in this respect.

Current Investment

In terms of investment made by company, if the returns on equity is being analysed, we can see that the same has decreased drastically from 17.5% in 2017 to 10.80% in 2018. Furthermore the gross margin has declined to 24.5% from 30% last year as well as the net profit ratio is also showing a downward trend and is at 14.38% in 2018 as against 20.27% in the last year (Dichev, 2017).

The decrease in return poses a major risk on the investment being made by the stakeholders and if the company is meeting the minimum levels of expectations. This shows the risk that either the costs are increasing tremendously or the company is not being able to generate revenue at good margins.

Since the ratios show that there is a deterioration in the efficiency of operations, it is necessary to check the major costs incurred, the management decisions, the pricing of goods and why all of a sudden, the profitability has been so low. It needs to be checked if the costs are being properly monitored and approved by management or if they pertain to the current period or future periods.

Property Assets

In terms of return on the property assets, we can see that the return on beef production assets was negative in previous years whereas the same has been 1.67% in current year. On the other hand, the return on grape wine production assets has decreased from 16.2% in 2016 to 12.2% in 2018.

The decrease in the return on assets is an indication that the property is not reaping the expected benefits and there are several factors which are hindering the growth of the returns. The risk here is that the business continuity and going concern needs to be checked and also if there are any risks on the company (Jefferson, 2017).

This risk can be checked by checking the returns and what the major reasons for the decrease in returns from the land, is it because of natural reason, or market pressure or internal policies. It can also be due to decrease in demand, low productivity or accounting policy such as that of charging depreciation, etc.

Marketing Expenses

For this head, the ratio of marketing expenses as a percentage of total SG&A expenses has been calculated and found to be increasing continuously since last 3 years and is at 23.67%.

The major risk is what are the marketing expense heads which are increasing, whether it is approved and whether the accounting is done correctly in the books, is it really required and if yes, then why the positive impact in not seen in terms of sales, productivity, profitability and growth, why all of them are falling down.

This risk can be checked in terms of quantum of marketing expenses that has been increased over the year and what the new heads under which the expenses are being incurred, is it approved by the management and if yes, on what basis. It also needs to be checked if the bookings have been done for current period only or also for the future periods as well.

In case the other ratios of the company are being analysed, we can foresee the below mentioned business risks that TWC faces:

Current Ratio and Quick Ratio: The current ratio shows the measure to which or the capability of the company to pay the short-term liabilities on time. It shows if the company would be able to pay off its current liabilities on time or it would default. For TCW, the current ratio has been increasing and is currently standing at 2.80 times, which is way above the ideal standard of two times. It shows that the company would be able to pay off its creditors in time. Similarly, the quick ratio is 1.18 times which much above the ideal trend of one is. This shows that the company possess enough short-term liquid assets to meet the short-term liabilities. However, it also poses the risks at the same time like if the current assets are not being misutilisd and if the company is not carrying too much cash in its books and missing the opportunity cost of interest(Chron, 2017).


Debt to equity ratio: The debt equity ratio shows the proportion of debt capital and the own capital in the total capital of the company. The debt comes at low cost whereas the equity comes at a higher cost so more the proportion of debt in the capital, lower the weighted average cost of capital. The ideal industry standard is 2:1, whereas for the given company TCW, the same is 0.54 and has been in the decreasing trend since the last 2 years. In a way, it is good that the company is not having enough debt capital but it needs to be seen if it is meeting the target margin and the expectation of the shareholders in terms of returns or else the debt capital should be raised to lower the cost of capital.

Times Interest earned: This is an important measure of company’s ability to repay the debt principle and the interest component in time. More the ratio, better it is for the company as it shows the credibility of the company in paying off its debt on time without faltering. For the given company, it has decreasing and it currently 6.67 times, which is a cause of concern. It depends upon company to company and should be nearly 10-12 times and so it needs to be seen why the profitability is decreasing(Saeidi, 2012).

Days in inventory – Wine: The inventory days shows what is the time for which the inventory is in stock since the time it has been manufactured. The lower the inventory days, the better it is for the company. Though it has been decreasing from 460 days in 2016 to 367 days in 2018, but still the number of days for which the inventory is in hand is way too high considering the industry trend and steps needs to be taken to reduce the same so that the inventory does not become obsolete(Raiborn, Butler, & Martin, 2016).


There are many internal controls in the system, which are effective and help the company in alleviating many types of risks to the company’s operation. The test of control for each of these identified potentially effective controls have also been mentioned below. The test of control is the audit procedure to check the effectiveness of the client’s control measures to detect and prevent the material misstatements in the financials. Depending on their effectiveness, eth auditor may choose to rely on the same.

Effective control

Risk alleviated

Test of control

Effective management of the passwords of the IT system in the company. Post the implementation of the new IT system and resolution of all the teething issues, this is being managed and monitored by management accountant (Bizfluent, 2017).

The IT system holds a number of finance configurations and also a lot of data. If the configurations are being altered unauthorised then it may bring upon the change in functionality and can adversely affect the financial accounting and results altogether. So this risk is alleviated. Furthermore, strict password control exists over access to programs, only the access to database is being enabled, so this also alleviates the risk that anybody and everybody cannot pass financial entries in the books.

Here the test of control ca be in the form of checking the authorization of the people working in finance team and other people as well. Also, it can be checked if the entries have come from other IDs as well. Certain, big ticket line items can be checked if the same has been approved and whether there are relevant supporting for the same.

The 2nd internal control is approval mechanism for the orders value limit. If the ordering amount is between $ 10000-30000, it needs to be approved by management accountant and if the value is beyond $30000, it is to be approved by company’s CEO.

And if it is beyond $50000, it is to be approved by the Board.

This ensures that none of the section managers, be it grape, wine or beef production managers do not order supplied greater than $10000 in one go. The value limits ensured that no wrong use of authority is being taken and 4 eye principle is being followed. Furthermore, it also avoids the unnecessary blockage of the funds (Belton, 2017).

The order booking can be checked in the computer ordering system as it is directly linked to the approved suppliers. A test of control can be conducted as to if there are necessary approvals in hand.

The process for receipt of the goods and invoice verification with the electronic copy received from the supplier and punching of the invoices in the payment register is a comprehensive control for the purchases and payment to vendors (Gooley, 2016).

This alleviates the risks that the false purchases are not recorded in the system, there is no shortage or discrepancy in the inventory when it is being received in the factory premises and that the invoice from supplier and the order received matches and then the payment is being processed. Due to this, no false invoices and no false delivery is accounted in the system.

The auditor can check whether the 4 eye principle was being ensured or not during receiving or orders and recording the invoices in the system. Also, sample checks can be conducted on the order copies and the invoices received electronically from suppliers if they are matching.

 

Besides the robust internal control process in several areas, the company also suffers from weakness in a number of areas relating to purchases and accounts payable. Some of these are mentioned below:

Weaknesses

Justification

The supplier information file is being centrally handed by the accounts clerk and any changes to the file is being approved manually by the management accountant. There is no such record maintenance in system as to how many times the changes have been done and the management accountant is the ultimate authority post which no control is maintained (Werner, 2017)

The approval procedure is manual and hence there is every chance that the management accountant holds the ultimate authority to make the changes in the supplier information file. There may be a case that a new unapproved supplier may be added to the file without any intimation and nobody in the company would be aware of the same and hence the records should be maintained in the system.

The payments file is finally being approved by the management accountant once in a week and then he only uploads the ABA file in the bank portal for the payment.

This shows that there is no segregation of duties and the company may fall into situation where the management accountant may also approve for the unauthorised and unchecked payments and upload the same in the bank portal for the payment. The company might suffer a loss on account of this. Therefore, there should be proper internal control and 4 eye principle being followed here (Heminway, 2017).

With regards to the payment of the service as well as supplier invoices, as soon as the invoice is being punched in the payments file and approved by management accountant, it is being recorded as paid in the accounting system without proper acknowledgement system or procedure. This can lead to serious reconciliation issues in the future with the creditors.

To avoid the reconciliation issues with the creditors in the future, the company should ensure that the acknowledgement is generated form the bank side and is also captured in the payments file and is also properly accounted in the accounting system. Also, the balance confirmation from the creditors and the vendors should be asked on a monthly basis (Trieu, 2017).

There is no control om when the next purchases of the wine, grape or beef should be made by the section managers. There should be a limit on the stock which when reached, only then the next order should be made (Linden & Freeman, 2017).

In case this control is not being maintained or implemented, then the section managers can send the purchase requisition for any and every quantity and it would be difficult for the company to maintain and monitor the stock levels and thus it can end up having excess stocks.

 

References

Alexander, F. (2016). The Changing Face of Accountability. The Journal of Higher Education, 71(4), 411-431.

Belton, P. (2017). Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat International ltd.

Bizfluent. (2017). Advantages & Disadvantages of Internal Control. Retrieved december 07, 2017, from https://bizfluent.com/info-8064250-advantages-disadvantages-internal-control.html

Choy, Y. K. (2018). Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis. Ecological Economics, 145. Retrieved from https://doi.org/10.1016/j.ecolecon.2017.08.005

Chron. (2017). five-common-features-internal-control-system-business. Retrieved december 07, 2017, from https://smallbusiness.chron.com/five-common-features-internal-control-system-business-430.html

Dichev, I. (2017). On the conceptual foundations of financial reporting. Accounting and Business Research, 47(6), 617-632. Retrieved from https://doi.org/10.1080/00014788.2017.1299620

Gooley, J. (2016). Principles of Australian Contract Law. Australia: Lexis Nexis.

Heminway, J. (2017). Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and Organic Documents. SSRN, 1-35.

Jefferson, M. (2017). Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland . Technological Forecasting and Social Change, 353-354.

Linden, B., & Freeman, R. (2017). Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), 353-379. Retrieved from https://doi.org/10.1017/beq.2017.1

Raiborn, C., Butler, J., & Martin, K. (2016). The internal audit function: A prerequisite for Good Governance. Journal of Corporate Accounting and Finance, 28(2), 10-21.

Saeidi, F. (2012). Audit expectations gap and corporate fraud: Empirical evidence from Iran. African Journal of Business Management, 6(23), 7031-41. Retrieved from search.proquest.com

Trieu, V. (2017). Getting value from Business Intelligence systems: A review and research agenda. Decision Support Systems, 93, 111-124.

Werner, M. (2017). Financial process mining - Accounting data structure dependent control flow inference. International Journal of Accounting Information Systems, 25, 57-80.

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