Discuss About The Financial Statements Of Accounts Prepared?
Audit is an independent examination of the financial statements and books of accounts prepared by the management by the auditors of the company to check whether the financials are showing correct and unbiased view of the state of affairs and to express their opinion thereof. Audit is generally conducted using the substantive and analytical procedures. Substantive audit procedures are of great relevance in ascertaining whether all the audit procedures an d cares and check have been applied consistently and thoroughly while preparing the books of accounts and preparation of financial summary. It generally includes vouching of incomes and expenses and verification of assets and liabilities. But when these 2 measures are not sufficient and does not gives the confidence on the arithmetical accuracy of the books of accounts then the auditor has to switch to analytical procedures which includes ratio analysis, trend analysis, variance analysis and a study of fluctuation in the numbers based on the past financial statements. For this, generally the data points include the past years financial data, the industry trend and average, the budgeted numbers and the forecasted numbers. IN case of DIPL limited, the auditors have also changed as compared to the last year, so substantive procedures would not be enough & the new auditors would have to resort to the analytical audit procedures to gain the confidence on the transparency of the accounts prepared and the verification of the opening balances of the client.
If post all this comparison, we would come to know that still the decision cannot be taken whether the books are to materially misstated, then the auditors would have to increase their scope of check and would have to apply further analytical procedures keeping into consideration the maintenance of the internal financial control in the company by the management. If the internal financial controls are adequate, less is the amount of risk, less will be the deviation of the actual from the standard and hence, less is the extent of checking reqd., however, in the other case, weak the leave of internal control maintained by DIPL, the more is the level of analytical procedures to be applied. Further, the management needs to answer all the queries raised b the new auditors in case of any clarifications. There are various ways in which the auditor can use these analytical procedures for ascertaining the credit viability of the company. The examination of the financial statements of previous year can be done, by derivation important key financial ratios that help the auditor in forming an opinion on the financial viability of the company. In addition, comparison with the set industry standards can be done accordingly, by trend analysis and making forecasts and budgeting. If the auditor finds from any deviation from the expected standards then he needs to find the reason of the same and approach the management to comment on the same. These are few basic tools of analytical analysis, that can help the auditor in making a statement (Bae 2017). In the given case study, financial information of past years from the books of account of the company is given. Data can be taken from the same to calculate important ratios, industry data is not available so it will be difficult to comment on the standing of the company, with respect to specific industry qualifications and provisions. The analytical procedures applied here would be reflected by means of the below mentioned table. All the data has been collected from the books of account of the company and an opinion on the same is given by making use of specific tools, as depicted hereunder-
There are various types of risks that are associated in audit of an organisation, that might affect the standing of the auditor and prevent them from forming an opinion on the financial statements of the company. The three types of risks are Inherent risk, control risks and ejection risks. Inherent risk is the major type of risk that occurs in situations that are not in control of the management. Control risks are the type of risk in which there is risk of lack of proper internal control o part of the management. In addition, detection risks occur when the auditor fails to notice an error that can be easily identifiable. In the given case of DIPL, there are certain inherent risks that are to be identified by the auditor. The auditor must also take measures to ensure mitigation of the risks. (Raiborn, Butler & Martin 2016)
Risk of material misstatement
The company faces an inherent risk of non routine transactions and adopting new changes in the statement. The main reason that is a risk on part of the auditor to comment on the financial viability of the company, because the IT system which the company is installing is entirely new. The IT system is a deviation from routine matters, there is no standard basis with which the auditor can compare its effectiveness. The system is installed under acute pressure from the management without any reconciliation between the pre operating activities and the results there of. These factors behind the installation of the new IT system, makes it probable to consist of certain risk that is not in the hands of the management and the auditor. Also the management has failed to ascertain effective control in maintenance of the same, thus the risk chances increases because of lack of proper internal control facilities (Sonu, Ahn & Choi 2017).
The risk of material misstatement encompasses the fact that it is possible that the management might have failed to include all material facts in the financial statements accurately. The main reason behind the same might be the presence of inherent risks and control risks in the operations that have prevented the auditor from forming a correct opinion on the financial statements. In the given case, if the company fails to properly reconcile all the operations with respect to the new IT system there is high chances that there might be misstatement in the financial statements of the company. This may be reflected in the overvaluation or the undervaluation of the system. There may be chances of default in the revenue system also because of the same.
2) The second type of inherent risk may be associated with the changes in the accounting policies and assumptions of the company by the board of directors. The main reason behind the same is that it is stated in the reports of the management that the management is considering change in the accounting policies and estimates. Proposals have been given on not using the average cost for the valuation of the inventory and new cost methods should be implied. Also the management is considering changes in the method of calculation of depreciation and reporting on the same. Only based on the experience of the board members the company is considering changing the method of depreciation and assuming the life of the asset to be 30 years, even though as per the industry specifications the life must be 20 years (DeZoort & Harrison 2016).
This will be lead to material misstatement because the management is changing the policies and maki9ng assumptions without any proper research and consideration and that may affect the financial position of the company. The auditor will have problem in ascertaining the viability of the books of account in chances of change of accounting policies and estimates. Proper disclosure is to be given by the management to make sure all the changes are properly recorded and stated.
Fraud can occur in the preparation of the financial statements and the main work of the auditor is to identify such fraud risk factors and to eliminate the same. In the books of account of DIPL and the statement presented by the company, many lead two fraud risk factors to falsification of the books of account.
Approach of the auditor
1) The major fraud risk factor is that there is no proper segregation of duties in major areas and one person is given all the responsibility. It is one of the major reasons that may lead to fraud because one person has got access to all the important areas. In case of DIPL, the clerk is given important work related to invoice preparation and its presentation and also authorises the same for payment. There is only level of check there in the form of the accounts receivable clerk who checks the mathematical accuracy of the invoices and makes the payment. In case of cash related activities, the e receipts are downloaded, verified and authorised by a single person, and then reconciliation of the statements is also done by the same person. Thus we see that there is little or no control, because even if the person does any fraud in the account, it will be hard for the auditor and the management to identify the same. To prevent such fraud risk factors, the auditor must ask the management to ensure proper segregation of work. There must be clear check points, so that any entry, any amount passes through at least two check points, before being finalised. The auditor in case he ascertains that any fraud has occur can bring up the matter directly to the management and can ask the management to change the present position of the person at fault, so that proper observations may be drawn in lack of any manipulation from the defaulted party (Knechel & Salterio 2016).
2) The second area of fraud in case of DIPL, can be the implementation of the new It system without any proper reconciliation. It is possible that personal motives of the directors may be involved in the same. There are chances of fraud because the system was installed without proper reconciliation and checking, and also there are no proper parameters in which the auditor can compare its efficiency and verification. It may be possible that the management had certain personal gains involved in the same, and the management wanted to do it in haste so that they can avoid any discrepancies that may arise if proper reconciliation is done. (Fay & Negangard 2017)
The auditor should make sure that all the details regarding the new system are derived from the management. Proper scrutiny of the books of accounts and third party check must be done, to ensure its effectiveness and verify its credibility. The reasons of haste must be justified and the auditor must ask the management to conduct important reconciliation and provide the report as soon a possible. These are the few ways in which the auditor can mitigate the fraud factor form the books of accounts of the company. (Grenier 2017)
Bae, SH 2017, 'The Association Between Corporate Tax Avoidance And Audit Efforts: Evidence From Korea', Journal of Applied Business Research, vol 33, no. 1, pp. 153-172.
DeZoort, FT & Harrison, PD 2016, 'Understanding Auditors sense of Responsibility for detecting fraud within organization', Journal of Business Ethics, pp. 1-18.
Fay, R & Negangard, EM 2017, 'Manual journal entry testing : Data analytics and the risk of fraud', Journal of Accounting Education, vol 38, pp. 37-49.
Grenier, J 2017, 'Encouraging Professional Skepticism in the Industry Specialization Era', Journal of Business Ethics, vol 142, no. 2, pp. 241-256.
Knechel, WB & Salterio, SE 2016, Auditing:Assurance and Risk, 4th edn, Routledge, New York.
Raiborn, C, Butler, JB & Martin, K 2016, 'The internal audit function: A prerequisite for Good Governance', Journal of Corporate Accounting and Finance, vol 28, no. 2, pp. 10-21.
Sonu, CH, Ahn, H & Choi, A 2017, 'Audit fee pressure and audit risk: evidence from the financial crisis of 2008', Asia-Pacific Journal of Accounting & Economics , vol 24, no. 1-2, pp. 127-144.