MAA 303 Financial Auditing Assessment

MAA 303 Financial Auditing Assessment

An introduction on ‘Financial Auditing’

A financial auditing refers to an equitable inspection and the calculation of the financial statements of an organization. A financial auditing can be done both internally (using the employees of the organization) and externally (hiring an outsider concern).

Financial auditing are considered as an accounting process of a business trade. An autonomous body is assigned to inspect the financial statements covering all the transactions of a business. Presenting an exact accounts of the financial transactions of a business organization is the ultimate objective of an auditing of this form. This exercise is practiced for ensuring a fair financial transactions of an organization and the justification and the authentication of the accounts which were disclosed in public and to the shareholders (Leung, 2011).

Applying professional and ethical judgment in auditing

Adopting an arrogance of professional disbelief, a professional judgment can be applied with an addition of being clear and impartial while inspecting the evidences of auditing. Without being doubtful widely one should possess an open and reasonably interrogative mind while practicing a professional disbelief without being assuming the honesty or the dishonesty of the management. It is important to keep the outside presence of fraud in mind while inspecting the audit. if the evidences of auditing is found to be inadequate, this things will lead to raise the interrogations in mind and instigates to inspect that the evidences are just incomplete or it is manipulated.

Follow the four guidelines when applying professional judgment:
  • It is undeniable that the fraud exists in every audit.
  • Whileinterrogating the management, if any notions are developed, fraud can still have its existence no matter how honest or ethical the management seems to be (Managerial Auditing Journal, 2006).
  • The evidences gathered, should always be rechecked with a mind-set of the presence of fraudulency.

Make sure to follow up with any less-than persuasive evidence by asking more questions and examining more records if need be.

Ratio analysis of MBL(as per given data) :                                                                        Industry Averages
201420132012201420132012
Current ratio(1,2,3)2.051.861.3422.012.12
Quick ratio(4,5,6)1.411.32.901.011.151.11
Debt-to-equity ratio(7,8)1.851.121.43.64.6.49
Times interest earned(9,10)1.3710.074.2734.55
Average collection period(days)(11,12)442823323130
Average payment period(days)(13,14)896964302222
Days to sale inventory(15,16)12710251484540
Gross profit margin(17)20.32%29.57%21.47%252327
Net profit margin(18).538.914.5556.58
Refer to the note no.(1,2,3….4…)
  • Total Current assets=cash+ inventories+ pre payments+ trade receivable
  • Total Current liabilities=trade payable+ provision
  • Current ratio=current assets/current liabilities
  • Quick assets=current assets-stock-prepaid expenses
  • Quick liabilities=current liabilities-bank overdraft
  • Quick ratio=quick assets/quick liabilities
  • Share holder’s equity= equity share capital+ retained earnings
  • Debt-to-equity ratio=total external liabilities/shareholder’s equity
  • Profit before interest and tax= profit before tax+ interest expense
  • Times interest earned=profit before interest and tax/interest expense
  • Average collection period={365/(credit sales /avg. debtors)}
  • Average debtors={(opening+closing)/2}
  • Average payment period={365/(cost of goods sold/avg. creditors)}
  • Average creditors={(opening+closing)/2}
  • Days to sale inventory ratio={365(cost of goods sold/average inventory)}
  • Average inventory={(opening stock+closing stock)/2}
  • Gross profit ratio= {(gross profit/ sales)*100}
Net profit ratio= {(net profit/sales)*100}

Audit risk

an audit risk is said to be an unacceptable report prepared by an auditor failing to identify the manipulation of the transactions or the frauds present in that account. The inherent risk (IR). Control risk (CR), and detection risk(DR) are involved in the risk factors which can be calculated as:

AR=IR*CR*DR

The risks which are involved with the types and the nature of the respective business nor financial transactions are considered as the inherent risks (IR). For instance, the cash transaction may have higher IR than transaction involving settlement by checks (Ohta, n.d.).

The CR is the risk which can be occurred by manipulating the financial transactions or creating an error in the books of accounts without being identified or corrected by the internal control systems of the organization. Exampled as, a risk control appraisal may be higher in an organization where thejob separations are not well defined.

The probability or the possibility of getting the manipulations, misstatements and the frauds unidentified or undetected is said to be a detection risk. This risks are occurred either due to the errors in sampling or the human factors while the control risks are occurred due to the incapability of the internal control systems.

Over all audit strategy

Given the lack of effective internal controls and the high risk of material misstatement, substantive procedures should be focus of the audit. Given the time constraint, the combined approach will be preferred where possible. If the analysis of the IT system determines that it is working properly and the effective controls are in place, then a combined approach can be used with regards to these values.

Sales/cash

  • There is the audit evidence that they recognize all unnamedrevenue. For this we need to issue the qualified opinion and ask vl to correct the same. The organization recognizing sales when the customers redeem the gif card is questionable.
  • Vl recognized unearned revenue from the sale of gift cards AS THE REVENUE IN THE CURRENT PERIODS .
  • We need to determine whether there are further cases of aggressive/ early income recognition.
  • We need to consider the sales returns and allowances account. (Is it a major risk?)
  • We need to ensure that the significant discount given to the corporate customer is recorded. If it is unrecorded, sales account may be overstated (Mayor, 2010).

Assertions

Sales (occurrence, cut-off, detailed tie in)

Existence for sales and completeness and classifications and assertions are for the sales return and allowances account. Cut off is also an assertion.

Materiality: materiality is a concept or convention within auditing, and securities regulation relating to the importance/ significance of an amount, transaction or discrepancy. The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared. In all material respects, with conformity with an identified financial reporting framework such as generally accepted accounting principal (GAAP).the assessment of what is material is a matter of professional judgment (Houghton et al., 2010).

Part B

The purpose of financial auditing is to assess the financial transactional statements of a business and provide an accurate account of a company’s business transactions. Being a financial auditor I applied professional and ethical judgment while conducting the audit process of MBL. My approach was unbiased and to provide a true and fair view of the financial transactions relating to the business. While analyzing the financial ratios of MBL I compared the same with the industrial averages and comparing the same with the industrial averages that the solvency position of the company has improved in the year 2014 as c compared to the two preceding years and the current ratio of the company 2014 is 2.5 while the industrial average ratio is 2.2. The ratios of MBL provided that the company had adequate quick assets in the year 2014. As the industry average was 1.01 and the quick ratio of the company in 2014 was 1.4 while the same for the last two preceding years was below the industry averages (Houghton et al., 2010). The debt to equity ratio of the company revealed that the company has employed more debts in its capital structure than equity in all the three years but the highest amount of debt employed by the company was in the year 2014 as the industry average was 0.64 and the debt to equity ratio of the company was 1.85. The time interest earned ratio of the company indicated that the ability of the organization to pay off its debts was highest in the year 2013 and it was lowest in the year 2014, though the ratio in the year 2012 was below the industry average. It was found that the company is paying out of his earnings to cover its debts in the year of 2013 as the time interest earned ratio (10.07) was far above the industry average (4.5). But the ability of the company to cover its debts failed in the next year where the time interest earned ratio (1.37) went below the industry average which is 3. The average collection period of the company was highest in the year 2014 (44 days) as compared to the preceding two years. This means that the company’s liquidity position was under stake as the industry average for 2014 was 32 days. By looking at the average payment period, it can be said that the company has been able to keep its cash assets blocked for the longest period in 2014(89 days) as compared to 2013 (69 days) and in 2012 (64 days). The inventory turnover was lowest in the year 2014 (127 days) while it was highest in the year 2012 (51 days). The gross profit of the company was found highest in 2013 (29.57%) and was lowest in the year 2014 (20.32%) while the net profit of the company was highest in 2013(8.91%). the net profit of the company also going to the lowest level in the year 2014 counting 0.53%.

I did not find any material misstatements and there was no audit risk arisen. The company is required to decrease the level of debt in its capital structure while increasing its ability to cover its debt obligations. The company is also required to reduce the credit period provided to its debtors and also increase the inventory turnover rate. The company is also required to check its costs and increase the level of revenue earned with an objective to increase its gross profit and net profit margins (Houghton et al., 2010).

References

  • Houghton, K., Jubb, C., Kend, M. and Ng, J. (2010). The Future of audit. Acton, A.C.T.: ANU E Press.
  • Leung, D. (2011). Inside accounting. Burlington, Vt.: Gower.
  • Managerial Auditing Journal. (2006). Managerial Auditing Journal, 21(2).
  • Mayor, S. (2010). Stroke strategy in England is improving acute care, shows audit. BMJ, 340(feb03 3), pp.c687-c687.
  • Ohta, Y. (n.d.). A Comparative Game Analysis on Limited Auditor Liability, Audit Quality, Audit Risk and Audit Fees. SSRN Journal.