Case Study Analysis: Auditing
Case Study Analysis: Auditing
Question 1: Analytical Review
Analytical procedures have a nature and purpose in gaining the necessary financial information of a firm through the process of comparison. Based on the financial records and periods provided by the organization, the auditing procedures can be successfully executed. Through comparing the valuable information indicated in the financial records of the firm, the budgets and forecasts expenses or revenue are anticipated. Usually, the auditors are capable in preparing the pre-determined estimation of various assets, more likely to its depreciable values. The information being emphasized in planning the audit and the entire procedure is done by comparing the firm’s ratio of sales to trade debtors with industry averages, and/pr with the ratios related to other comparable firm’s within the same business environment.
During the analytical procedures, the consideration between the elements of financial information and their relationship takes place. More likely, the auditor considered the analytical review on the availability and relevance of the provided financial information. It is noted that there are range of various methods that are useful and appropriate in performing the auditing procedures. From the simple comparison of financial data up to the use of statistical techniques to provide quality analyses, the auditor is free to conduct the procedure according to what is needed. Moreover, the analytical procedures are effectively applied on the financial statements and other financial information of the firm with a matter of professional bearing (AFL, 1995).
Ratio of Analysis: Activity Ratio
Ratios and trends are procedures for the financial analysis in which there is an involvement of the relevant fluctuations and relationships of the financial information. The ratio analysis is simply described within the relationships between two or more variables. It is easy to compute but indeed being criticized because of the grounds for a reliable interpretation. In this case, an auditor should choose the appropriate elements to execute proper assessment in the performance of the firm (Koskivaara, 2007). There are a number of financial ratios that can be used in the analytical procedures. Namely, there are four types: short-term liquidity, activity, profitability, and coverage ratios. In the analytical review, the activity ratios and computation are emphasized. Activity ratios are used to effectively determine the firm’s assets are managed. It is also useful for the auditors for the purpose of determining the accounts that might contain any errors or misstatements.
Receivables Turnover and Days Outstanding in Accounts Receivable
This type of activity ratios delivered the information on the activity with the matter of accounts receivable. The turnover of the receivables indicates the times that an account receivable may return during the specified year. Based on the provided data from Incredible Yarns Company Ltd (IYC), the first activity ratio is computed in which entirely taken from 2008 data:
Note: Approximately 60 per cent of the company’s trade receivables are overseas customers who are on 60-day credit terms; therefore the total revenue (21,937,000) is subjected to 60% (21,937,000 * .60 = 13,162,200)
There is a 60-day credit terms for the consumers in the overseas, accordingly, the firm is in the middle of bad debt problems because of the slowdown of payment due to several financial problems in most of the foreign countries.
Inventory Turnover and Days of Inventory on Hand
Inventory turnover recognizes the frequency with which the inventory is consumed within a year. If the ratio is high, it means that the firm is better in liquidating the inventory. On the other hand, the days of inventory on hand measures the inventory that is still available for sale.
Question 2: Audit Risks
Risks in Receivables and Inventory
The analytical procedures are used by auditors to assists them in audit planning as being incorporated with the overall review of the financial position of the firm. The review is given to support the auditor/s in understanding the firm’s nature of business, as well as identifying the potential and existing risks. The most important tool that the auditor can use is through the financial information, budget, and appropriate management. In a business that have a little understanding in terms of appropriate management, controlling, and monitoring action on the financial performances might affect the generated financial information and the determination of any potential and existing financial risks. In the application of appropriate analytical procedures, the essential aspects of business’s financial elements can be determined and be part of the audit investigation (AFL, 1995).
The recognition of risk is very important for the continuous and smooth flow of the financial transactions. In the assessment of the internal control, there is a great possibility for an accurate determination of the financial risks. In receivables, the identified risks are the advanced rates which vary, based on the nature of the receivables. In addition, the collectability from the customers is another priority on which depends the creditworthiness. On part of the business, risks might be identified in the concentration of the customers, such as there are only few or majority of the customers can produce the receivables. The business should monitor the delinquency status of the receivables as well as the exposure on state of dilution. There are receivables that are ineligible which may come from the government receivables, foreign receivables, affiliate transactions, and the contra-accounts because of several reasons such as the proper documentation, policies, and changes in financial trends. Meanwhile, inventory is usually lower than the receivables and there are several requirements for the evaluation of the inventory. Outstanding accounts are the only thing needed to be collected, the goods should be a finished output, sold, and paid (Freeman, 2000).
Other Risk in Audit
There are other risks that might create an impact on audit and can be identified through comparing the various clients. It is already identified that the system of the firm, monitoring procedures and the level of internal control are the most common places for risks. But there are still risks that the auditor/s should identify such as the pace of changes in the organization, the sufficiency and skills of the staff, proper documentation, nature of information being generated, timing of reports, and the people who will interface the creation of the financial reports (Bedard, Jackson, and Graham, 2003).
Question 3: Purchases Cycle
A. Additional Procedure
A business that has a good purchasing system not only means that they have a quality control but also reflects in the essence of economical procedure and efficiency. The controls that are in appropriate place assures that the materials been purchased are suited to the needs of the organization. In addition, the appropriate allocation of the resources means that the organization has place importance in delivering the quality services and production. The purchasing cycle has an objective to coordinate the inventory and securing the cash flow that made it available to make payments for the goods and services. A good purchasing system provides enough documentation of purchasing transactions to meet the objectives of appropriate monitoring and authorization in the system as well in budgets (Walters, 2002). Upon receiving the fourth copy of the purchasing order or the delivery purchase, there should be a person who will input all the received inventories in the systems inventory template for the proper documentation and all should be coordinated before the end of the day.
B. Weakness in the Purchases Cycle
Without proper coordination in the purchasing system, the organization might experience the problems such as the duplication of the orders, mistakes in orders, defective goods, and unreasonable prices (Walters, 2002). All the enterprises incorporate their controls within a practice or system to ensure that there is a complete operational effectiveness in their internal control. All the applied control are specifically chose and implemented to fight any errors, misuse of information, and fraudulent actions. There are various areas of weakness in the control such as time-consuming, costly, and yet complicated procedures just to follow the needs and requirements of the organization (ACL, 2004). Mostly, the idea of catching up with the business’s processes and regulatory changes make the control opposed to what has been assume.
C. Sample Purchase Transactions
Purchase transactions can be effective and efficient if all the purchased items are appropriate on the organizational needs. For example, the company is focus on the production and yarns, therefore, the items that need to be sufficient are the materials that are concentrated in producing their common product. In addition, if possible, the organization can also ask the supplier of the materials to give them the materials according to the time they need it. Basically, the demand of the product can help the managers to determine if there is a need for additional production. In this case the proper communication should be emphasized. However, in terms of the audit participation, the managers are required to monitor or do initial inventory every end of the day to secure or rather, identify if there were any signs of fraud or defective supplies. In addition, the procedures in operation for purchasing can be administered by placing the responsibilities and use of the various, yet related forms that are intentionally applied in the purchasing cycle. The request form, authorizing purchase, and purchase orders documents are the possible method to ensure the transaction is secured and effective.
D. Compliance of Substantive Transactions
The substantive audit procedures are based on the auditor’s judgment regarding the effectiveness and efficiency of the available procedures in reducing the risk that might involve in the creation of financial statements. The reliability of the information is the main foundation to provide the satisfactorily results. The procedure should be plausible and predictable regarding the relationship of the information for the intended comparison and evaluation. For an instance, a strong relationship between the determined selling expenses and turnover in the business can invite more sales. The degree and reliability of the information can help the auditor some up with a reliable result. The audit procedure can be done through reviewing the collectability of debtors, such as investigating the subsequent cash receipts or learning the various consumers’ profile. Through the accuracy of the results, the auditor may jump into the conclusion regarding the ability of the consumers to pay their debts. In addition, the continuous review of the auditors can help the firm’s internal control aligned to the organization’s objectives.
ACL, (2004) “ACL Continuous Controls Monitoring”, Controls Assurance for the Purchase-to-Payment Cycle, ACL Services Ltd., Accessed 15 April 2010, from http://www.acl.com/pdfs/DP_PtoP.pdf
AFL, (1995) “Analytical Procedures”, The Accountancy Foundation Limited - Financial Reporting Council, Accessed 15 April 2010, from http://www.frc.org.uk/images/uploaded/documents/APB_410.pdf
Bedard, J.C., Jackson, C., & Graham, L., (2003) “Information Systems Risk Factors, Risk Assessments, and Audit Planning Decisions”, Accessed 15 April 2010, from http://aaahq.org/audit/midyear/03midyear/papers/Systems%20Risk%20Factors%20and%20Audit%20Planning%2009-18.pdf
Freeman, T., (2000) “Accounts Receivable and Inventory Financing”, Comptroller of the Currency Administrator of National Banks, Accessed 15 April 2010, from http://www.occ.treas.gov/handbook/arif.pdf
Koskivaara, E., (2007) “Integrating Analytical Procedures into the Continuous Audit Environment”, Journal of Information Systems and Technology Management, Vol. 3, No. 3, Accessed 15 April 2010, from http://www.tecsi.fea.usp.br/revistatecsi/edicoesanteriores/v03n03-2006/v03n03-2006/v3n3a5.pdf
Walters, L., (2002) “Purchasing”, Accessed 15 April 2010, from http://www.dced.state.ak.us/dca/LOGON/pubs/LGH3-4.pdf