As part of your planning process, you are considering whether you will need to use the services of an expert in the audit of Double Ink Printers Ltd (DIPL).
Based on the background information contained in the case, explain whether it will be necessary to use the work of an expert in the audit of DIPL.
You are at the planning stage of the audit of Double Ink Printers Ltd (DIPL) for the year ended 30 June 2017 and have been asked by the audit manager to assists determine the materiality levels.
(a) Referring to the background information contained in the case, identify five factors that would influence your determination of the preliminary figure for overall materiality for the 2017 audit of DIPL.
(b) Explain why the factors identified in (a) above are relevant to your calculation of the preliminary for overall materiality.
(c) Describe how the factors identified in (a) above will influence your preliminary for overall materiality in the audit planning process
The Need for Audit Expertise in DIPL
1. In the business organizations, certain issues may arrive that can only be solved by the viewpoints and expertise of the audit experts. For this purpose, companies can find the necessary guidelines in International Auditing and Assurance Standard Board (IAASB). It is essential for the audit expects to use the obtained financial information about the auditing entity as audit evidences while developing the audit plan. In this situation, three major aspects are competency, objectivity and capability that all the audit experts are required to possess for smooth conduct of the audit operations (Ferguson, Pinnuck and Skinner 2016). The following discussion indicates some specific circumstances or situations that demand the work of an audit expert:
- At the time of conducting the audit operations, it is required to have sufficed audit evidences. Thus, for the collection of appropriate audit evidences, it is required to obtain the service of an audit expert.
- At the time of the assessment of matters related to taxation and compliance issues, it is required for the companies to have the service of an audit expert.
- It is the duty of the financial managers of the firms to do the true and fair valuation of various substances like machines, plant and other fixed assets. It is also under the regulation to make the valuation of the Thus, for the valuation of the assets and liabilities, it is required to have the service of an audit expert.
- At the time of the assessment of the liabilities related to insurance contract and employee benefits, it is required to have the expertise of an audit expert.
As per the earlier discuss, at the time of doing all these audit operations, the auditors must have sufficient knowledge in the fled of auditing along with three major characteristics; and they are capability, competency and subjectivity (Carson, Redmayne and Liao 2014).
The following indicates about the required areas requiring the audit expert viewpoint in DIPL:
Required Revision for Audit
Inventory and purchase of Inventory Obsolescence
The thorough analysis of the provided information about DIPL provides the indication of prevalent of inventory from the last year. It has been done with the motive to cover the projected reduction in the value of the inventory along with to cover up the shortage in the total amount of the inventory. Thus, for DIPL, there is a requirement of having the work of an audit expert in order to achieve the objective of reckoning the exact value of inventor for the current financial year (Houghton and Campbell 2013).
Depreciation of fixed assets
According to the provided information about DIPL in the case study, the company uses straight-line method in order to charge depreciation for their assets. In this context, it is also necessary for the company to obtain the exact value of asset impairment for that particular financial year. Thus, it implies the necessity for DIPL to acquire the service of an audit expert for the depreciation calculation and to get the correct value of asset impairment (Barrett 2012).
2. The provided information about DIPL indicates that five major factors are affecting the materiality of financial statements. They are discussed in the following table along with their influence in the materiality of the company.
Fraud Risk: In case of the business operations of DIPL, the risk of fraud can affect the company’s overall materiality. The existence of huge pressure is evident on the employees of DIPL coming from the board of directors around the new accounting system implementation. This extreme pressure exposes the business operation of the company to numerous business risks related to materiality. Thus, this total aspect can negatively influence the materiality of the financial statements of DIPL (Reyad 2013).
The accountants make financial errors at the time of the collection and process the financial information to prepare the financial statements. These errors are major contributors of irrational accounting assumptions from the misrepresentation of various financial factors. In addition, the accountant also make errors at the time of the application of accounting policies related to the valuation, classification and justification of different accounting substances. Due to these, the users of financial information get wrong information about the company. In these situations, the viewpoint of an audit expert eases the situation for the company as they help in the solution of these major organizational issues.
The situation of DIPL is a clear indicator that there is not any coordination and matching between the administrative work of the IT department and the installation of the new system. Due to this, the employees of the company had to suffer due to the immense pressure on them. All of these aspects have negative impact on the overall materiality of the company (Goos, Dole and Geiger 2012).
Accounting Policies: The adoption of average cost method for valuating raw materials by DIPL is evident from the provided case information and accounting rules denies the effectiveness of this method in the company. The adoption of average cost method contributes towards the undervaluation of the present cost of papers. The undervaluation of inventory affects the overall accounting processes of DIPL along with the inventory valuation. Considering the ineffectiveness of average cost method, the viewpoints of audit experts can be advised for DIPL (Kend, Houghton & Jubb 2014).
The wrong valuation of the raw material of the company can lead to inherent risks for DIPL that can negatively influence the overall materiality of financial statements. In this process, the lack of integrity and honesty of the management team of DIPL is evident. All these factors can affect the financial position of the company that can lead to material misstatement (Schmidt, Wood & Grabski 2016).
Inappropriate valuation of inventory in DIPL indicates towards the adoption of inconsistent accounting assumptions for the valuation of raw materials and inappropriate accounting assumptions may affect the whole accounting process of the company. As there is a positive relation between the accounting system and materiality, inappropriate accounting system can affect the overall materiality of the company. For all of these reasons, there is a need for the work of an audit expert.
Environmental Factors: After the analysis of the financial statements of DIPL, it can be found that some of the major financial transactions are missing by the management of the company either by mistake or deliberately. However, the business operations of DIPL can be affected in wither of the cases. The case study states that this particular aspect has affected the sales and marketing process of the company (Mendoza, Wielhouwer & Kirchle 2017). The management of DIPL cannot able to analyze the effects of environmental factors on the company and it affects various operations of the company. These aspects lead to ineffective as well as inconsistent accounting planning.
Earlier discussion shows that there is a chance of fraud activities around the installation of new accounting system due to the immense pressure on the employee from the boar board of DIPL. Thus, this aspect can also create impact on the accounting process of DIPL that can lead to the material misstatement of DIPL.
DIPL has not been able to adopt correct financial accounting system for them. Two evidences of this are the failure of considering the environmental factors and the omit of accounting transactions. For this reason, the users of DIPL get misleading financial information about the financial position of the company. Thus, they will not be able to judge the true and fair financial situation of the company. Materiality of DIPL and the company’s audit operations are hurt due to these reasons (Anderlini, Gerardi & Lagunoff 2016).
Appointment of CEO: The provided information about DIPL in the case indicates towards the fact that the company did not follow the requisite schemes at the time of appointing and transiting the CEOs. Moreover, the date was not followed in this case as the process was done after the set date. These aspects can raise business risks for the employees of DIPL (Mercuri & Neumann 2016). Thus, it is evident that the overall materiality of DIPL will be hurt as a result of all these reasons.
The case study of DIPL shows that the process of selecting the CEO is a lengthy process that has major negative effect on the transparency of the company. For this reason, the materiality of DIPL can be hurt due to these reasons.
It can be noticed that the inappropriate process of the selection of CEO has negative effects on the business operations of DIPL as the workforce of the company has to face major business risks. Hence, all these factors can contribute to the development of material misstatement for DIPL (Earley 2015).
Recording Cash receipts and Expenses: As per the provided case study of DIPL, it can be observed that the company uses to record the majority portion of their expense with the help of electronic system so that they can be easily downloaded with the assistance of mails and can be easily reconciled. However, this aspect can lead to material misstatement due to lack of consistency. In the presence of consistency, they can be easily conducted o frequent basis. This particular aspect is helpful in the reconcile process at the end of the month. Apart from this, the derivation of sales by DIPL from the e-book marketing, republishing and others can affect the materiality of the company (Perjuci, Ismajli & Hoti 2012).
As per the case study of DIPL, the company’s process to record their raw materials is an inappropriate process that can have significant effect on the overall materiality of the company. Apart from this, the inability of the management of DIPL to integrate environmental factors with business operation is another major contributor of material mistaken of the company.
The recording of cash receipts by DIPL with the help of electronic means is a major contributor of material misstatement of the company. This particular aspect can directly become the reason of the downfall of the accounting system of DIPL. All these aspects together influence the materiality of the company (Cangemi, Michael & Marks, Norman 2012).
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Schmidt, P.J., Wood, J.T. & Grabski, S.V., 2016. Business in the cloud: research questions on governance, audit, and assurance. Journal of Information Systems, 30(3), pp.173–189.
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