Audit Report Preparation: Materiality And Analytical Review

Discussion and Analysis

In the given case, an audit is to be conducted for one of the small client named Chartreuse Enterprises and hence the audit partner of the company has requested the audit assistant to prepare an audit plan for the same based on the trial balance of the client given below. The Trail balance is to be studied and the significant audit accounts which need immediate attention and checking needs to be highlighted. In the report below, the materiality to be taken for the audit of the client has been revisited and calculated (Goldmann, 2016). The preliminary analytical review of the company has been done and trend analysis has been done to find out the risk of material misstatement and a brief justification has been provided as to why these accounts are eligible for audit testing. The audit procedure that would be required in each of the above cases to find out audit evidences has also been mentioned. Finally, the fraud risk analysis of the client has been done based on the analytical review.

The trail balance of the client, Chartreuse Enterprises has been shown below:

Chartreuse Enterprises
Trial Balance
Particulars Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper		Jul 1, 2016 – Apr 30, 2017		Jul 1, 2015 – June 30, 2016
	Debit	Credit		Debit	Credit
Cash at Bank		85,000			80,000
Accounts receivable		118,340			111,000
Inventory		187,500			174,000
Machinery		71,000			65,000
Accumulated Depreciation			30,959			24,375
Motor Vehicles		66,000			66,000
Accumulated Depreciation			27,308			21,000
Furniture		7,400			7,400
Accumulated Depreciation			2,820			2,220
Bank Loan			230,000			230,000
Sales			157,500			187,450
Cost of sales		57,917			63,595
Consultancy fees			49,375			57,000
Interest income			40			50
Bank charges		290			350
Depreciation		13,492			15,863
Interest expense		9,583			11,500
Printing		210			250
Repairs and Maintenance		1,200			5,050
Wages		40,000			53,000
Superannuation		2,967			4,770
Total		660,898	498,002		657,778	522,095

Materiality is something, which is very important and critical from the auditor’s perspective. Some information, misstatement, error or omission is said to be material in individual or in aggregation if the same has the capability or the ability to change the economic decision of the user(Belton, 2017). It serves a very important purpose in the audit as it helps in classifying what is material and what is not, thereby helping the auditor in focusing in critical and significant areas only. In the case of the given company, the preliminary materiality level has been set at $15000, which is very high considering the financials of the company (Islam & Islam, 2011). The IASB as well as the accounting board and firms have prescribed and set many norms for the determination of the materiality limits, which has been explained below with the example. The materiality limits can be in the range of 0.5-1% of gross revenue, 1-2% of the total assets or the gross profit, 5-10% of the net profit, 2-5% of the shareholder’s return, etc. The materiality level as per the below working should be in the range of $787.5 to $157 as if any other limit is being chosen, lot of material accounts would be missed out in the process and from the ambit of the audit (Werner, 2017). Considering the given materiality limit, the accounts, which would not be ignored, is the interest expenses, superannuation account, repairs and maintenance, depreciation, etc.

(in $)
Chartreuse Enterprises
Quantitative estimate of materiality
Criterion	Base	Amount	Materiality level/range
0.5% to 1% of gross revenue	Gross Revenue	157,500.00	787.5 to 1575
1% to 2% of the total assets	Total Assets	474,152.93	4741.53 to 9483.06
1% to 2% of the gross profit	Gross Profit	59,583.33	595.83 to 1191.67
2% – 5% of the shareholders’ equity	Equity	NA	NA
5% to 10% of the net profit	Net profit	81,256.67	406.28 to 812.57

Materiality

The analytical review has been done in the form of the trend analysis and the preparation of the common size balance sheet for the years 2017 and 2016. Each of the line items of the profit and loss account has been represented as a percentage of the sales(Trieu, 2017).

Chartreuse Enterprises
Income Statement
Particulars	2,017	% of sales	2,016	% of sales
Sales	157,500	76.1%	187,450	76.7%
Consultancy fees	49,375	23.9%	57,000	23.3%
Interest income	40	0.0%	50	0.0%
Total Revenue	206,915	100.0%	244,500	100.0%
Less: Expenses
Cost of sales	57,917	28.0%	63,595	26.0%
Bank charges	290	0.1%	350	0.1%
Depreciation	13,492	6.5%	15,863	6.5%
Interest expense	9,583	4.6%	11,500	4.7%
Printing	210	0.1%	250	0.1%
Repairs and Maintenance	1,200	0.6%	5,050	2.1%
Wages	40,000	19.3%	53,000	21.7%
Superannuation	2,967	1.4%	4,770	2.0%
Total Expenses	125,658	60.7%	154,378	63.1%
Net Profit	81,257	39.3%	90,122	36.9%

Chartreuse Enterprises
Income Statement
Particulars	2,017	2,016	Variance
Sales	157,500	187,450	–         29,950
Consultancy fees	49,375	57,000	–           7,625
Interest income	40	50	–                 10
Total Revenue	206,915	244,500	–         37,585
Less: Expenses
Cost of sales	57,917	63,595	–           5,678
Bank charges	290	350	–                 60
Depreciation	13,492	15,863	–           2,372
Interest expense	9,583	11,500	–           1,917
Printing	210	250	–                 40
Repairs and Maintenance	1,200	5,050	–           3,850
Wages	40,000	53,000	–         13,000
Superannuation	2,967	4,770	–           1,803
Total Expenses	125,658	154,378	–         28,720
Net Profit	81,257	90,122	–           8,865
Net Profit %	0	0	0

As per the trend analysis above, we can see a number of accounts which are at risk in the given trail balance and there is a risk of material misstatement in a few of them and thus they need significant audit attention.

Sl. No.	Account Name	Audit Assertion and risk
1.	Sales	The overall revenue has declined by 15.37% and the direct sales has declined by 15.98%. The net profit has also been on the lower side as compared to the last year by 9.84% and it needs to be checked if it is due to the fall in prices or fall in quantity or it is due to the some other external reasons. In terms of the common size statement, the sales percentage has been more or less same (Saeidi, 2012).
2.	Depreciation expenses	It can be seen that the percentage of depreciation expenses has remained 6.5% of revenue in each of the years. Furthermore, it has declined by almost 15% as compared to the last year. Being a fixed expense, it should not have gone down so estimations and judgement of the management in this regard, the useful lives, etc. needs to be checked. It also needs to be seen if the company or management has made any major acquisition or disposal of the assets (Jefferson, 2017).
3	Wages	Wages being a direct expenses, was expected to decrease in the proportion of the sales whereas in the given case, the same has fallen by around 24.53% and in case, the expense is measured as a percentage of the overall sales for the year, it is seen that it was 21.7% of sales in 2016 and dropped to 19.3% in 2017. It needs to be checked if the number of labour resources have been cut or the wages have been declined (Sithole, et al., 2017).

 The audit assertions for each of the given accounts has been explained in detail in the above question. Now the audit procedures to be employed for checking each of these accounts are shown below:

Sales: Here pareto analysis can be employed to do the audit of sales, vouching of the invoices should be done, besides the prices and the quantity sold for both the years needs to be checked(Knechel & Salterio, 2016). The top contributing part number or the products can be considered for the audit purposes and it needs to be checked if the revenue recognition policy and standards have been adhered to.

Depreciation: Careful scrutiny needs to be done by the audit team in this regard. It needs to be checked if the acquisitions or disposals have been done during the year and is there a change in the method of depreciation or the rate of depreciation(Raiborn, et al., 2016). The auditor should also check if the proper accounting standard has been used for accounting of the depreciation expenses and if the management has conducted physical verification of assets during the year.

Wages: Since wages is direct expenses, it should have fallen in proportion of the sales but it has fallen more in proportion of the sales and therefore it needs to be checked if the number of labourers has been reduced or the wage per hour has been reduced(Bizfluent, 2017). It also needs to be checked if the Minimum Wages Act has been adhered too and if the company is giving adequate security to its labourers.

Conclusion & Recommendation 

1. In the given case, the audit partner of the firm has suggested that the fraud risk checking is not to be conducted for the given client Chartreuse Enterprises as the company is a very professional and authentic one and can be trusted(Dichev, 2017). This instance is against the principle of professional scepticism, as per which even if the client has maintained all the work ethics and has prepared and presented the annual accounts in the best possible manner, even then he should be checked and audited thoroughly with respect to the audit. Furthermore, from the preliminary audit analytical procedures, it can be seen that there are many areas in which audit can be conducted and which a deviation from the normal course of business are. There has been a sharp decline in the sales, cost of sales and also the profitability and hence the entity should be checked for fraud risk factors. Some of the heads under which fraud analysis can be done are as follows:
2. The superannuation expenses has decreased by more than 37% as compared to the last year and therefore it is expected that a large number of employees would have left the company, the same needs to be checked from employee register.
3. There is a sharp decline in the repairs and maintenance expenditure and it needs to be seen if accounting has been done correctly and all the present year expenses has been booked and not shifted to future years(Choy, 2018).

• Finally, there is also a significant decline in the interest expense by 16.67% as compared to the last year, which shows that either the company is using less debt or it has made repayment of the debt in the current year(Linden & Freeman, 2017).

These are few of the major fraud risk factors, which needs to be examined and audited.

References 

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

Bizfluent, 2017. Advantages & Disadvantages of Internal Control. [Online]
Available at: https://bizfluent.com/info-8064250-advantages-disadvantages-internal-control.html
[Accessed 13 September 2018].

Choy, Y. K., 2018. Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis. Ecological Economics, p. 145.

Dichev, I., 2017. On the conceptual foundations of financial reporting. Accounting and Business Research, 47(6), pp. 617-632.

Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business. Financial Environment and Business Development, 4(3), pp. 103-112.

Islam, M. A. & Islam, M. A., 2011. Environmental incidents in a developing country and corporate environmental disclosures: A study of a multinational gas company. Society and Business Review, 6(3), pp. 229-248.

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

Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.

Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), pp. 353-379.

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

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

Sithole, S., Chandler, P., Abeysekera, I. & Paas, F., 2017. Benefits of guided self-management of attention on learning accounting. Journal of Educational Psychology, 109(2), p. 220.

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

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