Risk Analysis In Auditing Essay

Questions:

1.Explain how your results Influence your Planning Decisions for the Audit for the year ending 30 June 2015
2.Explain why it is a risk and how it may affect the risk of Material Misstatement in the Financial Report
3.Identify and Explain two key Fraud Risk factors relating to Misstatements arising from Fraudulent Financial reporting to which DIPL may be Susceptible.

Answers:

1.Audit of the financial statements and the books of the accounts prepared by the management is done on the annual basis by the auditors to express their opinion whether it has been prepared on the unbiased basis and it is as per the respective financial reporting framework. The primary objective of the auditor is not to find out the errors and frauds but to see if there are any such cancels of financials being influenced by any of these. Moreover, to get these done, there are several audit procedures being followed by the auditor, few of them being substantive and analytical audit procedures. Substantive audit procedures help the auditor in ascertainment of the fact that whether the books of accounts have been prepared on consistent basis and using correct practices and procedures of financial reporting. It generally includes vouching o the incomes & expenses recorded in the books throughout the period & verification of the assets and liabilities recorded in the books at the end of the period. However, even after applying these procedures, the auditor is not comfortable enough and is unable to express his opinion on the financials then he has to resort to the analytical procedures, which included further in depth analysis, the scope of which depends on the internal financial control being maintained at the company. More strict the internal control being practices at the company, less is the risk, and less is the analytical checking required, and less strong the internal financial control being followed at the company. There are more chances of the financial error, exclusion and fraud and therefore the extent of checking needs to be increased so as to identify the areas of concern. Analytical audit procedures include comparison of the financials based on ratios, trend analysis with the past years, forecasted financial statements, or budgeted financial statements. It also includes comparison of the company from the other companies or the industry ratio. The study of all the above procedures is critical to the fact that the auditors determine the timing, nature and extent of their audit going forward and it helps them to understand and express an opinion thereon that whether there are any chances of material misstatement in the books of accounts. In case of DIPL, since the industry ratios are unavailable, we have just kept our discussion and analysis using the ratios and the trend for the last 3 years (Knechel & Salterio 2016).


On comparison of the ratios for the three financial years, following were the observation:

  1. Current ratio has moved to 1.42 in 2013 to 1.50 in 2015, which states that the company is maintaining a viable current ration & has the capability to meet its present obligations from its current assets.
  2. Liquid ratio has mode from 0.83 in 2013 to 0.85 in 2015, which again is best as per the industry trends where the ration should be one such that the company is able to convert its assets readily into cash to meet its immediate obligations.
  3. Debt equity ratio has increased from 0.41:1 in 2013 to 1.13:1 in 2015, which again is well within the industry limits of 2:1, which shows that the company has invested more of its own capital rather than the outside debts, but it is not enjoying the benefits of trading on equity.
  4. The net profit ratio has more or less remained constant from 6.90% in 2013 to 6.84% in 2015 indicating the profit margin is constant & there is a kind of stagnancy in the company and it is not being able to grow in terms of absolute numbers.
  5. The Return on equity, however, has gone marginally down from 25.78% in 2013 to 24.26% in 2015, which is indicative of the fact the company is struggling, big time to increase the growth in terms of equity(Werner 2017).

From the above observations, it is clear that even though the company has struggled to grow to increase the profit percentage but more or less, it has been able to maintain the profits. It is also certain critical liquidity ratios and debt management ratios are well within the limit and hence it enjoys the cushion of trading on equity in the future (Fay & Negangard 2017).

2.In case of auditing procedure, the auditor often faces various types of risk associated with his work. The three major types of risk are inherent risk, control risk and detection risk. Inherent risk is something, which happens because it is not in the hands of control of the management or the auditor. Control risk occurs if the management is not efficient enough in ensuring that proper control is maintained that will help in eliminating all kinds of risk in the system. Detection risk occurs if the auditor fails to detect some common errors in the system, which can be easily identified and analysed. In the given case of DIPL, the company is having certain inherent risk in its system and the same is explained below.

Inherent risk

Reasons

Risk of material misstatement

The major risk that the auditor faces is that the company is indulging in non routine transactions and that may not be properly reconciled (Knechel & Salterio 2016)

The main reason behind this risk is that the company is installing anew It system, of which the company doesn’t have any proper pre installing reconciliation or analysis. This is divergence form the routine nature of work and that makes the work of the auditor difficult, as there is no proper bench mark with which the auditor can verify the effectiveness of the new system. The auditor may not be able to form an opinion on the accounts and that may be reason of inherent risk in the company. There are also chances of high control risk because there is no proper internal control ascertained by the management for the new IT system.

There is a risk of material misstatement because of the same, as there may be chances that the management has not included all the details accurately about the new system which might lead to discrepancies. Because of the presence of these risk elements the auditor may not be able to form an opinion on the given aspect of the company. This is one of the main areas where the management must ensure that effective control is maintained so that the risk of material misstatement is reduced and the auditor is able to form an opinion that showcases the true state of affairs of the company.

The second type of risk is associated with the change in the accounting policies and methods and making major assumptions without any proper research just based on mere experience and facts (DeZoort & Harrison 2016).

This is one of the major types of risk that is inherited in the company’s books of account, because the company is considering changes in the basic accounting assumptions and policies. The CEO wants to change the method of valuation of the inventories and also wants to makes changes in the method of calculation of the depreciation. He is considering calculating depreciation by considering the life of asset to be 30 years, even though in normal industry scenario, the life of the asset is considered 20 years. There is no proper research behind the same and the management is indulging in it just based on mere experience and no proper facts (Jones 2017).

There is a risk of material misstatement because the management is changing its accounting policies, so the auditor will have issue in reconciliation. There are high chances of some material errors because of the same. Also since the management is adopting new methods without any proper research, that may also be a reason for the risk associated with it (Grenier 2017).

3.Fraud occurs when the management or the employees indulge in certain activities for their own person benefits and that is wrong and detrimental for the health of the organisation. In addition, leads to falsification of the books of account of the company. In the given case of DIPL, there are certain cases where there might be a probability of fraud. The same is stated below, and how the auditor can work to mitigate the same-

Fraud Risk

Risk Factor Identified

Approach of the auditor

One of the major areas where fraud can occur is that there is no proper segregation of duties in the company. One person is responsible for management of major work areas with no proper control established to ensure that there is no cheating and no falsification of the accounts of the company (Raiborn, Butler & Martin 2016).

In the case of DIPL, the clerk is given the major duty of managing the account receivable, preparation of the voucher, authoring the payment and passing the bill. The account receivable clerk only checks the accuracy and passes the bill further. In case of receipts also one person is given the responsibility o downloading the e receipts, checking the same, authorising the payment and also reconciling the books of account (Raiborn, Butler & Martin 2016).

There is a risk of fraud involved in the same, because a single person is doing the major work and hence there is no level of checks involved, to check the authenticity of the work. The person who has unrestricted access can falsify the accounts, and it won’t be possible for the management to easily identify the same. Thus that is one major area where fraud might exist. The auditor should ask the management to ensure proper segregation of duties. It should make sure that proper verification of the accounts is done and the third party check must also be done.

The other area of fraud is in the installation of the new IT system, which was done in a lot of haste by the company. There are high chances that some personal motives of the management was involved in the same as there was no proper reconciliation was done by the management in respect of the same (Bae 2017).

The major risk factor associated with the same is that the management is indulging in such activity without any proper research and justification... There are high chances that there is some fraud risk factor involved in the same (Sonu, Ahn & Choi 2017).

The auditor can mitigate the same by asking the management to produce proper reasons of haste in the installation of the system. Also the auditor can get expert opinion on the new system and its effectiveness. The auditor can also reconcile the accounts to find if there are any discrepancies in the same.

References

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.

Jones, P 2017, Statistical Sampling and Risk Analysis in Auditing, Routledge, NEW YORK.

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.

Werner, M 2017, 'Financial process mining - Accounting data structure dependent control flow inference', International Journal of Accounting Information Systems, vol 25, pp. 57-8

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