Auditing And Assurance: Risk Factors For Weaknesses Essay

Question:

Discuss about the Case Study for Auditing and Assurance of Risk Factors for Weaknesses.

Answer:

1: When the auditors carries and plan the audit, there needs to be great focus on the ratios such as inventories and the accounts receivables.

The industry benchmark for the current ratio is 1.8. The current ratio of the Nirvana produce Pty ltd for the year 2015 is 1.89. In fact the current ratio has increased and it is above the industry benchmark. The current ratio is in line with the industry average and therefore, there is no need on the part of auditors to focus on the liabilities and assets. It is indicative of the fact that the company had sufficient liquid assets to meet its current liabilities. But in the current year that is 2016, the current ratio has fallen to 1 which is below the industry benchmark. The reason attributed to this is that the sales invoices are due for long period of time and there are also outstanding payments on accounts of sales (Asare et al., 2012).

If the accounts receivable is higher than expected then it indicate the possibility of doubtful debts and it may result in the risk of the account receivable overstatement. The industry benchmark for days in receivables is 7 days. The debtor turnover ratio has decreased for the previous year that is in the year 2015, the business was able recollect the amount due from within eight days and now in the current year it has increased to twelve days and this can be attributable to the problem of collection. This increase in the account receivable days results in the risk of revenue that is not appropriately recognized or there might be the risk of fictitious sales generated. For investigating this particular ratio, the auditors would compare the sales to the budget and would look for income statement of the company (Czerney et al., 2014).

If there is any difference between the industry benchmark for the inventory turnover ratio and the ratio of the company, then there arises the need on the part of the auditor to investigate the cause of difference. If the inventory turnover ratio has increased then it is indicative of the fact that the company does not have sufficient inventory. The auditor finds that this may be due to the valuation of the inventor above the net realizable value or the company is giving heavy discount to sell off the stocks. The inventory turnover ratio for the NP has remained constant over the two years and is as per the industry benchmark. This indicates that the company is able to sell of its inventory at a regular pace and it does not have any slow moving inventory.

The debt to equity ratio for the company has remained constant over the pace of two years but it is above the benchmark set by the industry which stands at .20. The debt to equity ratio is constant at .50 but there is a difference between the actual value and the benchmark. The standard set the lower dependence in the debt and company needs to finance itself through the equity. Here, the NP Pty Ltd is relying on the debt as well as on the equity in equal proportion. This indicates that the company is not able to generate sufficient profits to retain its use in the business so that its reliance on the debt decreases.

The analysis of the ratios conducted above might suffers from weakness and would not be able to put complete reliance on it in assessing the business risks. The timing of the cash flow is not considered in the analysis of current ratio. There might be the case that the company has to pay off its short term obligations within few days but the company is facing long collection days of receivables or the inventory has not been cleared off (Deumes et al., 2012).

The days in the account receivables or say the debtor turnover ratio is useful only when the majority of sales are made in the credit. In order to improve this ratio, the business needs to tighten the credit policies. The analyses of ratios are done using the historical results and it is not necessary that the same results are applicable in the future operation of the business. The disparity in the valuation done at the current cost and the historical cost is might depict unusual results. The performance of the company can be indicated over the years using the past financial results. The analysis depicted by the ratio may mislead the auditors if it is not combined with the economic circumstances of the business and the management of the company. Therefore, the auditor needs to consider the future vision of the company, its product and the competitors (DeFond & Zhang, 2014).

The auditor place heavy reliance on the financial statement published by the company and most of the information for the analysis purpose is obtained from the same. The information obtained from the ratio analysis is constrained by the quality and quantity of the data which has been published in the financial reports of the company. The analysis using the ratios is inherited by the defects and shortcomings. The companies have tendency to publish the statement of profit and loss and this is done at the” net profit before tax” (Healy et al., 2012). Therefore the valuable information about the sales figures, expenditure of operations and the cost of sales are denied by the company to the auditors. The investment potential concerning the future cannot be evaluated using the ratio analysis and it only guides about the future investment potential. The umber depicted by the ratio only reflects the input data quality and the logic behind the construction of ratios. Therefore, the number generated from the ratios cannot be regarded to be deterministic (Darmadi, 2016).

2: The strength and weakness in the internal control system of Nirvana Produce Pty ltd can be discussed below:

Strength of the internal control system:

The software installed is accessed through the numerous numbered networks and the module can be accessed only through the passwords and has level of authorizations.

The buying slips are attached to the boxes to be purchased by the buyer and such buying slips are used by the debtor clerk to generate invoices.

The duties of entering, receiving, picking the orders are segregated

The sales invoices payment is made by the electronic funds transfer and the electronic fund transfer payment is matched by the debtor clerk and who chases up the payments that are outstanding (Hermanson et al., 2012).

The invoices are generated using the completed buying slips

The outstanding payment is chased by the debtor clerk and the payment of the funds is matched by the invoice

The cash purchase float is maintained and reconciled daily by the bookkeeper

The bank account is reconciled monthly by the bookkeeper

The payment to the creditors is approved and maintained and the creditor ledger is maintained by the bookkeeper.

The payment is entered in the accounting software and is made through the online banking system.

The invoices are stamped and then the initial of the bookkeeper and the payment date is entered in the invoice.

The pay roll is completed on the basis of the normal working hours and is completed by the bookkeepers.

Weakness of the internal control system:

There is no proper authorization and the requisitions for the good and services can be raised by any other departments

The accounting software used by the NP does not have the facility to generate the details of the payment made to the creditors and the file cannot be uploaded into the bank account of NP.

The company has only two sales clerks to handle the sales order

The company has a significant number of short payments to be made on the invoices

Purchase orders are not easily accounted for and the reason is that purchase is often made in the cash and the details of the same are made on the slip of paper. In the event of losing or misplacing the slips, it would not be possible to keep the track of record of the purchasing expense.

The company has made a number of duplicate payments to the creditors and this was clearly depicted by the having a brief review of the credit ledger accounts. However, the issue was being resolved.

The moment the requisition is received the goods and services are received by the purchasing departments and this is done by the departments without making a check on the best deal available (Kumar & Sharma, 2015).

The sales order which is received by the sales clerks via the email or the telephone comes with the possibility of the fictitious orders and this is due to the fact that the sales orders are accepted without the documentary evidence.

The sales clerk might be exposed to the misappropriation of the goods that extra goods picked by the customers. This is because the clerk does not count the goods which have been picked physically (Balsam et al., 2014).

Financial report assertions that may not be met for the internal control weakness:

Control activity

Explanation

Key assertions

Sales orders, allowances and returns needs to be authorized

All the sales related order and the allowances should be authorized by the person having the appropriate level of authority in the company.

Sales occurrences

The duties regarding the handling, packing, buying and generating of invoice and cash receipt or the payment receive online needs to be segregated (Gordon & Wilford, 2012)

If the duties concerning the different functions are segregated then this would avoid or make the theft in the business difficult.

Cash completeness

Reconciliation of the bank accounts should be done by employee other the bookkeeper

The detection of fraud and the error would get easier if the reconciliation of cash records is getting prompt attention.

Completeness of cash records

Receiving the sales order on a written basis

The sales order received by the sales clear via phone might be a fictitious order and the written form would prevent any occurrence of fraud (Liu & Lai, 2012)

Occurrence and sales existence

Credit sales need to receive approval from the appropriate authority

The approval should be required for making the credit sales to avoid the bad debt

Occurrence of bad debt expense and valuation of accounts receivables

Risk identification and steps taken to reduce the audit risks:

Internal control weakness

The accounts balance at risks

Assertions at risk

Justification

Sales order does not have any sequence check completion

Sales account

completeness

In order to ensure that the sales orders are complete, the sequence of the sales order should be accounted for.

Purchase is not accounted for

Purchase account

completeness

The purchase is not recorded in the accounts and this is due to the not availability of the purchase details. Therefore, the purchase details has to be accounted for.

The sales order are received orally

Accounts receivable

Sales account

Existence

occurrence

Customer orders are not generated using the external documentary and there is no such evidence of the same. Therefore there is a chance of generating the fictitious assets

Inability to generate the payment details made to the creditors

Purchase account

occurrence

The details of the payment made to the creditors are not generated and without the control the payment made would not be accounted for.

The NP Pty Ltd being a small business where the accounting procedures are performed by only few persons. In this company there are two sales clerks and the bookkeeper handing the accounting transactions. They have custodial as well as operating responsibilities and hence there is limitation on the segregation of duties. Under these circumstances where the organization is lacking the supervisory controls the auditors are exposed to several other risks. The auditors have to provide with the necessary evidence to support his opinion by performing the substantive procedures and the audit work involved in preparing the financial statements of the company.

3:

Control

CAAT

Sales clerk cannot override the goods sold

The test transactions order or the dummy has to be created and attempt is made to override the unit price of the sales made

The passwords of the various models has to be changed within the short time interval say, 2months

The profile of the random users from the spreadsheet should be selected and the security control is tested and attempt should be made to access the system sing the passwords which had been initially allocated.

The unit price of purchase is generated automatically and the bookkeeper cannot override it

The auditor would process a dummy data and the per unit price of the purchase is overridden.

Computer based audited technique helps the auditors in assisting the collections of the evidence on audit form the computerized system. The accounting system of the business and its records would enable the auditors using the CAAT to check the source locations rather than relying on the print outs which are believed to be the copy of the records. The setting up of the CAAT would enable to obtain the audit evidence. This CAAT also enable to compare to the traditional testing and the overall confidence of the audit would be increased sing this CAAT (B. Curtis et al., 2014). The various CAAT which could be used by the auditors are

Audit software-

The computer files of the client can be interrogated by the auditors using this software for the investigation purpose. This would provide the opportunity to scrutinize the data of the NP Company. The program logic involved in the software performs most of the functions of the auditors. This would include the comparison of files, selecting samples, reporting of the exceptional items and summarization, stratification and analysis of the data of the concerned entity.

This may include the enquiry program and it is integral to the accounting system of the client. The system is providing for the reporting of the routine on the monthly basis of the employee and the leavers. This system is used by the auditors when the salaries and wages of the employees are audited in the financial statements of the clients. The reported vale of the creditors could be verified by the auditors by using the facility of reporting trade payable long outstanding balances (Yadav & Yadav, 2013).

Another suitable CAAT to be used is the Test data

This involves processing the computer system of the clients by submitting of the data to the software. The operation of the control system of the application is tested sing the software is the principal objective. This would need the arrangement of the dummy data to be processed containing may error conditions. This would ensure that the particular problem can be identified by using the client’s application control. The main advantage of data test is that it can be used during the normal production run of the business. Therefore, the unauthorized sales can be easily recognize in the NP Ltd and this particular CAAT would be considered suitable (Sims, 2012).

The effectiveness of the audit program is done by using the audit test data. The computer system of the client is processed through the dummy transactions and in order to evaluate the efficiency of the control system, the expected results of the auditors are compared with the results of processing. This can be explained with the help of an example say if the two dummy transactions relating to the bank is processed and the transactions that is processed within the parameters is accepted by the system. Now, if the expected results is not produced in the dummy transactions, then the auditors needs to consider the substantive procedures in the area where the reviewing is taking place (Chen et al., 2014).

The working paper documentation in the use of GAAT are the objectives of CAAT, details of the test to be performed, audit findings and conclusions and staffing to be used in the process.

Risks

Assertion at risks

IT application control

CAAT

The payments made to the creditors has a risk of being calculated incorrectly

Accuracy

The monthly payments made to the employees and any outstanding amount is to be paid is calculated automatically by the HRMIS

This is done by creating a dummy data that is in this case creating a dummy employee and proceeds to see that the system is able to automatically calculate the payments to be done.

Possibility of existence of the fictitious sales made

Occurrence

CIS would look into the process of transactions which needs to be examined

Test data is performed by using the master file of the client and attempt to override the transactions done

Goods and services requisitioned by any other departments

Occurrence

This might lead to the unauthorized access of the data and in this regard ITF is used to enable the requisition of the services and goods to the allocated departments

Test data is performed and it is run through the production system

Possibility of existing of fictitious employees

Occurrence

The segregation between the person who initiate and process the Pay run and those who create the employees and this is done suing the HRMIS

The performance of the function has to be segregated and this is identified by accessing the mechanism.

The computer should separate the lists by sorting the user accounts is sorted by the functions

The list needs to be merged so as to identify the users present in both the lists

Auditing in the environment of the internal control system would require the auditor to assess the several risk associate with the auditing (CERTIFIED, 2013). The test data and the audit software are the two CATT that would be used in the auditing of the Nirvana produce Pty Ltd.

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