Materiality Amount and its Impact on Audit Budget

The report is prepared with the intent of assisting the planning stage of small audit client from the viewpoint of an audit firm. The audit firm would be carrying out the audit work of Amarnath Enterprises by using its preliminary trial balance. The first part would emphasise on ascertaining whether the materiality amount of $15,500 is suitable along with the impact of materiality assessment on audit budget. The next segment would conduct an analytical review of the items in the income statement from trial balance by utilising trend analysis. After this, three items from the income statement at risk would be detected based on which audit processes would be recommended for each account. Finally, the report would focus on fraud risk and the suitability of suggestion provided from the end of the audit partner.   

As commented by Aobdia, Lin and Petacchi (2015), materiality could be explained as the threshold beyond which missing or wrong information in the financial statements would affect the decision-making procedures of the users. It is necessary for the auditors to modify three audit risk components while making preliminary material evaluation. The components are described as follows:

• The users of the financial statements such as investors, suppliers, shareholders, employees, creditors, regulators, customers and others
• The size of the financial statement elements such as current assets, total revenues, current liabilities, net profit and total assets
• The trends of the organisation in relation to revenues, cash flows and earnings (Bowlin, Hobson and Piercey 2015)

In order to ascertain the average amount of materiality for a small company such as Amarnath Enterprises, the materiality amount should be applied between 5% and 10% of sales revenue. In this case, the materiality amount is assumed as 7.36% of the total sales revenue of the organisation in 2017. In this regard, Cannon and Bedard (2016) cited that if the amount of materiality does not include a significant proportion of net income, the loss would be considered as immaterial. The reason is that the average financial statement users would not be worried with the loss, which could be 0.1% of the net income of the organisation.

However, it is noteworthy to mention that due to the small size of Amarnath Enterprises, there is high probability that majority of the random expenses might not be recorded in separate accounts. This could be validated by the fact that credit amount of $148,906 could not be tracked in 2017, due to which it has been recorded as suspense account. For example, if an assumption is made that the omitted expenses of the organisation amount to $15,500, it could be material to the financial condition and appropriate justification of the expenses is necessary. Hence, the material amount of $15,500 could be considered as accurate by the auditor.

Analytical Review of Income Statement

Since the debit side and the credit side of the trial balance of Amarnath Enterprises do not match with the each other in both 2016 and 2017, suspense account is used for matching the balances of both sides.

In order to discuss the fraud risk, it is necessary to provide an overview of scepticism. Scepticism could be explained as an attitude that takes into account a questioning mind of any individual (Johnson 2016). This signifies likely misstatements due to errors or frauds along with considerable evaluation of audit evidence. The financial reports often contain material misstatements that take place due to frauds or errors Lenz, R. and Hahn, U., 2015). The latter is deemed to be intentional so that personal benefits could be obtained. On the contrary, fraud risk involves the conditions or events signifying incentive or pressure in order to commit fraud.  In accordance with the above analysis, the main accounts at risk in case of Amarnath Enterprises constitute of sales revenue, service fees and depreciation. The maximum chance of fraudulent activities is possible with these accounts, since increase in revenue would denote better financial performance of the organisation (Louwers et al. 2015).

Conversely, the service fees for other advisory service would assist in improving the brand image of Amarnath Enterprises, which might not be appropriate. Lastly, if lower depreciation is charged for property, plant and equipment, the fair value of the asset might show increased value, which would be misleading for the investors. It is noteworthy to mention that the auditors are not expected to show doubts on past experience of honesty and integrity associated with the employees responsible for company governance (Power and Gendron 2015). However, the auditors are required to act accordingly towards scepticism in considering the risks related to material misstatements to detect variations in events.

Conclusion:

The above discussion makes it apparent that the auditor has deemed an appropriate materiality amount of $15,000 for Amarnath Enterprises, since it has a significant amount of credit balance missing in its unadjusted trial balance. Due to such missing information, suspense account is used for tallying the debit side and credit side of the trial balance. The four accounts in the income statement at risk include sales revenue, service fees, miscellaneous expenses and depreciation, as they are subject to risks associated with audit and material misstatements. Hence, various pertinent assertions as well as management assertions are considered in the context of the organisation. Finally, it has been evaluated that the three identified accounts contain fraud risk. Although the employees are deemed to be diligent and honest, it is necessary for the auditor to take into account professional scepticism.

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