Issue 1: Materiality Assessment

A report has been prepared on the audit planning of one of the small entities for which the audit partner has asked the audit senior to come out with the issues relating to the critical accounts, the audit steps required, etc. The Trial balance of the company has been given, the same has been assessed, and the profit and loss account, the comparative analysis for the two given years 2016 and 2017 and the common size income statement has been prepared for the client. With the help of preliminary analytical review, some of the critical accounts have been identified which would need immediate attention and thus the audit risk and the necessary audit procedure to get sufficient and appropriate audit evidences has been suggested (Bae, 2017). Finally, towards the end the fraud risk analysis has been done for the given client to check if there was fraud in entity or not.

The trial balance of the company “Axolotl Enterprises” was already given in the question and the difference between the debit and the credit side can be taken to be the suspense account (Trieu, 2017). The same has not been considered in any of the analytical procedures since the nature of the suspense account is not known:

The materiality may be defined as something or the level, which has the ability to change the decision of the users of the financial statements. It is one of the important aspects of audit and needs to be determined as part of the audit planning by the auditors as it helps the auditors in understanding and establishing as to what should be the level till which the checking should be done, post which the amount is immaterial and can be ignored to some extent(Vieira, et al., 2017). It helps the auditor in concentrating on the critical and significant areas of audit. IN the given question, the materiality level, which has been suggested by the audit partner is $ 15000 but if the same is, being selected then many of the critical accounts would be left unchecked and unaudited. Many agencies, Big 4’s and accounting bodies over the world have prescribed certain limits to determine the materiality level, some of which are percentages of gross receipts, total assets, or fixed assets or net profit or the shareholder’s equity balance. Based on the same, the materiality level has been determined below in the table as per which the materiality level for Axolotl Enterprises should be in between $ 1425 to $ 1450 considering all the possible scenarios. With these limits, some important accounts like the other income account, Interest, superannuation and furniture account will also fall in the ambit of audit.

The common size income statement and the comparative variance analysis over the 2 years has been shown below for the given entity. This are few of the measures of analytical review and trend analysis of the company.

1. In the given section, the critical accounts in the income statement has been identified which would need inspection, analysis and audit. Some of these are mentioned below:

1. Based on the audit assertions and the audit risks highlighted above, the steps to be taken by the auditors while approaching these accounts are as follows:
2. Sales: The sales as percentage of total receipts increasing from 69% to 80% in 2017 despite a decrease of 24% in absolute terms is one of the critical audit points. To check the same, the auditor should be doing the vouching of the invoices and should reconcile the same from sales ledger or register. At the same time, it should also be checked if the revenue recognition policies have been adhered to(Carlin, 2010).
3. Cost of Sales: The sharp decline in the cost of sales over last year makes it another critical account. Besides vouching of the invoices, the prices of the raw materials should be compared with the market comparable and the accounting needs to be checked if the present costs have not been shifted to future years. The estimates and judgements in this regards needs to be verified with the management(DeZoort & Harrison, 2016).
4. Depreciation: The depreciation as a percentage of the sales has increased from 5.8% to 11.5% over the last year and it is not justified, as the gross block of the assets has remained same. Therefore, the management policy with respect to valuation of the assets, the method and rate of depreciation being used, the useful life assessment and other assumptions needs to be verified(Knechel & Salterio, 2016).

Conclusion & Recommendation

1. The fraud risk analysis is one of the integral parts of the audit and the same needs to be considered and done while auditing a client as the auditor’s opinion on financial statements is considered as reasonable assurance for decision making by investors and other stakeholders. In the given case, the audit partner has suggested that the fraud risk analysis need not be done for given client as he is trustworthy(Linden & Freeman, 2017).

However, this suggestion or contention of the audit partner cannot be accepted considering the professional ethics and the professional scepticism, which needs to be applied while doing audit as per APES 110. Every client should be checked for fraud and in the given case; there are several accounts, which falls under the ambit of fraud:

1. Depreciation account for reasons already explained above
2. Cost of sales account considering the monumental decrease of 40% in costs.
3. The fall in the other income from $25000 to $ 700 over the year indicating the possibility that a section of the business has been closed.
4. The decrease in wages by 38% despite this being a variable cost in percentage of sales.

References

Appelbaum, D., Kogan, A. & Vasarhelyi, M., 2018. Analytical procedures in external auditing: A comprehensive literature survey and framework for external audit analytics.. Journal of Accounting Literature, 40(1), pp. 83-101.

Axelsen, M., Green, P. & Ridley, G., 2017. Explaining the information systems auditor role in the public sector financial audit. International Journal of Accounting Information Systems, 24(1), pp. 15-31.

Bae, S., 2017. The Association Between Corporate Tax Avoidance And Audit Efforts: Evidence From Korea. Journal of Applied Business Research, 33(1), pp. 153-172.

Bumgarner, N. & Vasarhelyi, M., 2018. Continuous auditing—a new view.. Continuous Auditing: Theory and Application, 20(1), pp. 7-51.

Carlin, T. a. F. N., 2010. Resisting compliance with IFRS goodwill accounting and reporting disclosures evidence from Australia. Journal of Accounting and Organizational Change, 6(2), pp. 260-280.

DeZoort, F. & Harrison, P., 2016. Understanding Auditors sense of Responsibility for detecting fraud within organization. Journal of Business Ethics, pp. 1-18.

Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.

Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), pp. 353-379.

Trieu, V., 2017. Getting value from Business Intelligence systems: A review and research agenda. Decision Support Systems, Volume 93, pp. 111-124.

Vieira, R., O’Dwyer, B. & Schneider, R., 2017. Aligning Strategy and Performance Management Systems. SAGE Journals, 30(1).