Fraud Risks And The Impact On Financial Statements: A Case Of DIPL Ltd

Ratio Analysis and Evaluation for DIPL Ltd

1. The financial and nonfinancial decision can be taken with the aid of analytical procedure. An Analytical procedure is of paramount importance to the auditor and the management at large. In this scenario, the analytical process is conducted for DIPL Ltd that will shed light on the performance and depict a correct view. Further, this process is of immense help while tracing any defects in the financial statements and prevents any fraudulent activities. The analytical procedure can be performed depending upon the nature of the business and the results that are required (Ghandar & Tsahuridu, 2013). As per the case of DIPL Ltd, the two major analytical processes undertaken are:

Firstly, the information that is contained in the financial report is compared with the past figures (three years) to project a trend and to trace any differences that are present. Moreover, such a comparison can be done with that of the industry standards and the patterns can be observed. The trend of the business can be noted with the aid of the comparison. Moreover, any deviations can be easily traced and the reason can be fetched. From the financial statements, it can be observed that the company made a stupendous increment in sales that augurs well for the company (Cappelleto, 2010). The figures indicate a strong momentum for the company, however, if compared with the stock figure there is a big difference because the stock figures have inflated even considering the fact that the sales have increased.  It is a matter of concern because the sales and the stock figure have increased simultaneously (Nicolaescu, 2013). Therefore, the auditor needs to consider this difference and trace the exact reason for the same.

Secondly, the process of ratio analysis can be used to know about the trend and is one of the major tools for the purpose of evaluation. There are different ratios that can be computed to find the pattern of movements.  For DIPL Ltd, the ratio is computed for a period of three years ranging from 2013 to 2015. Going through the process of analyzing the ratio computation must contain profitability, liquidity and solvency ratio that will boast regarding the performance and the trend. The profitability ratios stress on the profits earned by the company through net profit and gross profit margin (Porter & Norton, 2014). Secondly, the liquidity ratio indicates whether the company is in a position to discharge all the obligations. Thirdly, the solvency ratio indicates whether the company has a higher proportion of debt or equity.

IT System Launch and Incorrect Allocation of Transactions

Going by the ratio computation above, the profitability ratio signifies that DIPL Ltd has performed effectively. However, the gross profit ratio has declined in all the three years and this can be cited due to a strong increment in the cost of sales. On the other hand, the company has seen an increase in the net profit ratio that is due to a strong command on the expenses (Shah, 2013).  Hence, the blend of gross profit and net profit indicates that the company has maintained a consistent level.

Current ratio and the quick ratio has been used to shed light on the liquidity of DIPL Ltd.  The current ratio of the company is more than 1 meaning for every current liability, the company has 1 current asset. Hence, the computation reveals that the company has more of current assets in respect to current liability that boasts of the strong liquidity. On the other hand, the quick ratio is computed ignoring the stock and hence, is a better indicator of the liquidity. It is near to the standard ratio of 1:1 therefore, the liquidity position is strong and the company can meet the obligations.

As per the ratio computed above, that is the debt ratio and the equity ratio, it can be commented that the company’s debt increase in all the three years and is above.50 in 2015 that is an alert for the management. Higher debt will erode the company’s profitability. Secondly, the equity ratio has dropped considerably and a lower equity ratio strikes that the company will have more debt financing servicing costs.

The above facts will have a strong impact on the profits and fluctuations can be witnessed. Therefore, the auditor must ascertain the validity of the ratios and ensure that such ratios are derived from the genuine figures.

2. When it comes to the point of inherent risk, there are hardly any remedial actions because the inherent risk is present in the nature of the business.  It does not rely on any act of omission or faults. In the case of DIPL Ltd, the two major inherent risk are as follows:

In DIPL Ltd, a new IT system was launched that was completely automated and contained the features to record everything on its own. As per the IT manager, it was said that the new system was floated without any previous research.  Before any project, it is essential that a pilot testing needs to be done so that the observations can be made. Before the initial launch or when the testing was done on a preliminary basis, it was noticed that many transactions that were appearing at the end of the year were not allocated correctly (Subramanyam & Wild, 2014). This means the transaction of one period will be reflected in another hence, will lead to significant differences.  In short, the profit figures will be impacted.  It is a case of material misstatement and moreover, the officials in the organization are aware of the fault in the software and hence can use it for gaining an additional advantage (Niemi & Sundgren, 2012). Hence, such a faulty practice will lead to practice that is unethical and will erase the company’s goodwill.

Appointment of CEO with Financial Interest

When it comes to the appointment process, the management must ensure that the appointment of CEO must be an independent person who does not have a financial interest in the company. However, in the case of DIPL Ltd, it was observed that the CEO was appointed that has a financial interest. The provision stands that the CEO will have 10 percent share in the profit if the growth of the company surges 10 per cent and more. The inherent risk stands in the way that is the CEO will try to drive the business so that he attains the desired share in the profit. However, if the company fails to attain the desired growth then there is a chance that the CEO will indulge in misstating the records so that profits can be enhanced (Bhasin, 2008). This even impacts the internal audit and manipulations chances are very prominent.

The above two condition seriously pose a big threat to the financial report.  The IT system was launched before any testing and the transactions were allocated incorrectly that is bound to create problems in the profit figures. Secondly, the appointment of a CEO having a material interest is altogether against the ethical standards and the appointment is sure to create problems in the financial statements.

3. Going by the prevalent situation in DIPL Ltd, two fraud risks can be observed in the following scenario:

When the new system was implemented, the company failed to have a clear cut planning that leads to a big difference. Many entries that form a part of the last year failed to appear in the new accounting system.  This incident can be due to the practices of accountants and management who needed a way to tamper the records.  It is clearly visible that the cash balance of the company has had a strong fall (Cappelleto, 2010). No reason for the fall in the cash scenario has been provided and neither any reasons are visible that projects the new system was altogether used for fraudulent activities.

It was noted that the sales of the company reached a strong peak in the year 2015 however, in consideration to that the level of inventories too rose strongly indicating a big issue.  The level of inventory must showcase a fall because the sales increased, however, an opposite situation was observed. The rise in the level of inventory depicts the deficiency in the practice (Elder et. al, 2010). This can be an act of management whereby the level of inventory has been purposely increased to tamper the accounts.

Fraud Risk Factors and Impact on Audit Quality

3a. Fraudulent practice always impacts the conduct of the audit because the auditor needs to provide a true and fair view. If the statements contain a wrong figure or figures that are manipulated the auditor will end up giving a different view that might lead to the wrong judgment.  The fraudulent practices mentioned above will have a strong impact on the financial statements and will deteriorate the audit quality too. It might happen that the amount that was falsified was huge and that will impact the overall figure (Messier & Emby, 2005). Moreover, the auditor will need some time to get acquainted with the new system and hence, this will consume time. The entries will be required to be checked and since the transaction was recorded for the wrong period will create doubts (Arens et. al, 2013). The auditor will provide a judgment when the relevant evidence are present. In the case of big differences and absence of relevant material, the auditor will present a qualified opinion and that will lead to questions on the management. Such a report is doubted by the outside parties.  Further, the auditor needs to have a detailed research on the inventory level, the sales receipts, etc.  Valuation of inventories will affect the audit quality and hence, it is the duty of the auditor to conduct a detailed analysis to trace the variations otherwise the auditor will end up giving an unqualified opinion (Wood, 2011). Therefore, the auditor must apply reasonable skills and cross check the data to provide an unqualified opinion.

References

Arens, A. A,  Best, P. J, Shailer, G. E. P & Loebbecke, J. K, 2013, Assurance Services and Ethics in Australia, 9th ed,  Australia: Pearson.

Bhasin, M. L 2008, ‘Corporate Governance and Role of the Forensic Accountant’, The Chartered Secretary Journal, vol. 38, no. 10, pp. 1361-1368.

Cappelleto, G. 2010, Challenges Facing Accounting Education in Australia, AFAANZ,

Elder, J. R, Beasley S. M.& Arens A. A 2010,  Auditing and Assurance Services, Person

 Ghandar, A & Tsahuridu, E 2013, The Auditing Handbook 2013, Australia: Pearson.

Messier, W & Emby, C 2005, Auditing & Assurance Services: A systematic approach, McGraw-Hill.

Nicolaescu, E., 2013, ‘ Understanding Risk Factors for Weaknesses in Internal Controls over Financial Reporting’,  Psychosociological Issues in Human Resource Management, vol. 1, no. 3, pp.38-44.

Niemi, L & Sundgren, S 2012, ‘Are modified audit opinions related to the availability of credit? Evidence from Finnish SMEs’,  European Accounting Review, vol. 21, no. 4, pp. 767-796.

Porter, G & Norton, C 2014, Financial Accounting: The Impact on Decision Maker, Texas: Cengage Learning

Shah, P 2013, Financial Accounting, London: Oxford University Press

Subramanyam, K & Wild, J 2014, Financial Statement Analysis, McGraw Hill

Wood, D A 2011, ‘The Effect of Using the Internal Audit Function as a Management Training Ground on the External Auditor's Reliance Decision,’ The Accounting Review, vol. 86. No. 6