1. In the case of DIPL Ltd, an expert opinion is very important because, for proper assessment, there are several ratios and aspects that must be taken into account. For instance, the company’s current ratio reported an upwards trend that necessitates proper evaluation so that its ability in repaying its debt obligations can be determined. Its current ratio stands at 1.5 while its quick ratio stands near to 1. Further, its net profit and gross profit ratio reported a declining trend that requires proper explanation, thereby necessitating expert opinion (Matthew, 2015).
In facilitating the audit of DIPL Ltd, the opinion of an expert can assist in displaying a better scenario by assisting in offering both financial and non-financial decision. In relation to this, various processes must be taken into account that must be guided by an expert. Based on the present situation, it is relevant for DIPL to evaluate its performance records of the previous years or forecasts made for the future (Heeler, 2009). Besides, financial information prevalent in the company’s financial statements can assist the expert in providing an enhanced viewpoint regarding its financial structure. For instance, the company’s decline in turnover can be compared with its future estimates for better evaluation and understanding.
If the turnover trend portrays a positive trend, it is a good sign for the company but the reason must be appropriately explained, as the actual reason may be attributed to returning from debtors or discount from creditors. Nonetheless, the reason for the same must be explained effectively and can be facilitated under the supervision of an expert (Gilbert et. al, 2005). Further, it must also be ascertained whether any amount is settled outside the managerial scope or not.
2. If disclosure of an item can affect the financial decision-making ability of users or impact major stakeholders like investors, employees, etc, then it is believed to be of a material nature.
a. Factors affecting the preliminary amount of total audit materiality
A penalty of $50 can be considered material in few scenarios but in some cases, petty costs of $100 may not be regarded material if management has a role in authorizing the same. It is the auditor’s duty to evaluate materiality after preliminary scrutiny of the entire business, or by observing the past year’s annual reports (Guerard, 2013).
Based on the anticipation of user’s tolerance for the misstatement, the benchmark percentage can be computed as follows:
Profit before tax
An item is regarded material if it is significant for audit purposes and it exceeds 5% of the net profit before tax (whether as an expense or income).
DIPL has witnessed an enhancement in revenues over the years and an item of income or expense that surpasses 1% of the entire revenue is therefore regarded material in nature.
Net current assets
The current ratio of DIPL being 1.5 and maintenance of a debt-equity ratio of less than one makes the same a material item in its audit process. Further, the same must be catered to throughout the year so that it can be made a preliminary necessity for audit.
Such item assists in determining materiality on a stable level because it is not volatile like other figures on the financial statements. It consists of non-current and current assets and based on the discussions, revision of the useful life of printing press has been facilitated and finalization of inventory valuation is also done on FIFO (first in first out) basis (Geoffrey et. al, 2016).
The reason why 5% is considered as the materiality level is that the overall equity and retained profits must witness an upward trend that is a major audit requirement.
b. Importance of aforesaid points in computing preliminary amounts of overall materiality
After relying on internal controls, an auditor must enhance his processes to seek misstatements and errors in financial statements. For instance, if the management has introduced dummy or false transactions to enhance their share prices, it may prove dangerous for the entire company (Elder et. al, 2010). Hence, the auditor must thoroughly check the entries and his evaluation on materiality must rely on several controls prevalent in the company.
There may be scenarios wherein revenue might be increasing but current assets and profits are declining owing to enhanced operating costs, resulting in capital and equity deterioration. Other benchmarks can be considered for decision-making if profit before tax is volatile in nature. Besides, decrease or increase in current and total assets must be effectively evaluated to ascertain long-term business growth (Elder et. al, 2010).
The significance of factors like revenue, equity, current assets, etc can be understood by the ideology that misstatements of such items can affect decisions of third parties. Moreover, in DIPL’s case, its affairs have enhanced and business has witnessed extreme variations, thereby creating immense pressure on the accountant to exercise prudence in auditing processes. If such misstatements are lesser than preliminary materiality judgement, then financial statements are believed to be truly presented and vice-versa.
c. Impact of aforesaid points in audit planning
The auditor may wish to examine every transaction but owing to lesser time, he may verify only the financial transactions but he has the power to interrogate the management’s intention if any suspicion arises amidst the auditing process. For instance, if the company attained immense liabilities against its assets, the auditor can question the management’s decision regarding the same. Moreover, verification of every transaction is not feasible and therefore, materiality levels are set up by the auditor (Northington, 2011). Such benchmark levels can impact the selection of proper transactions classes or account balances in the audit process.
In the case of DIPL, since a new accounting system has been set up, issues may have risen during the transition from old to new system. Therefore, reconciliation of closing balances in the old system with that of opening balances in the new system can form a major audit part (Roach, 2010).
Based on year-end board discussions, revenue recognition must be considered from e-book for percentage completion method in order to facilitate enhanced verification for influencing the depicted figures of revenue. Besides, complications may generate in shifting methods and utilization of net income as a major variant. Further, as year-end reporting and valuation of inventory are revised, allowance for obsolescence of inventory is regarded material for auditing (Gay & Simnet, 2015). Overall, the influence and significance of these points must not be observed individually and instead must be seen in totality.
Elder, J. R, Beasley S. M.& Arens A. A 2010, Auditing and Assurance Services, Person Education, New Jersey: USA
Gay, G & Simnet, R 2015, Auditing and Assurance Services, McGraw Hill
Geoffrey D. B, Joleen K, K. Kelli S & David A. W 2016, ‘Attracting Applicants for In-House and Outsourced Internal Audit Positions: Views from External Auditors’, Accounting Horizons, vol. 30, no. 1, pp. 143-156.
Gilbert, W, Joseph J & Terry J. E., 2005, The Use of Control Self-Assessment by Independent Auditors. The CPA Journal, vol. 3, pp. 66-92
Guerard, J. 2013, Introduction to financial forecasting in investment analysis, New York, NY: Springer, pp. 78-81
Heeler, D 2009, Audit Principles, Risk Assessment & Effective Reporting. Pearson Press
Matthew S. E 2015, ‘ Does Internal Audit Function Quality Deter Management Misconduct?’, The Accounting Review, vol. 90, no. 2, pp. 495-527
Northington, S 2011, Finance, New York, NY: Ferguson's, pp. 52-55
Roach, L 2010, Auditor Liability: Liability Limitation Agreements, Pearson.