Audit Planning Subject ( accounting )

RAR Company

Analytical Review of Trial Balance for Audit Planning

1.0   Audit planning

A detailed analytical review of RAR Company’s Trial balance has been done to plan audit process and identify key balance sheet and Income statement items that carry significant risk of material misstatement. In the course audit, total of five accounts shall be selected based on materiality judgement, fraud risks and qualitative risks.

1.1 Analytical review

The Trial balance of current financial period is only provided for a period of 11 months i.e. July 1, 2016 – May 1, 2016. To facilitate comparison with financial year ending 2016, the Trial balance has been restated to cover period of 12 months, making certain assumptions. The horizontal analysis of Trial balance is shown below:

1.2 Preliminary judgement of materiality

The materiality test has been carried out by following generally accepted benchmarks and range for deriving materiality as shown below.

Net Profit (PBT)	1,70,461	1,53,717
10% of Net Profit	17,046	15,372
5% of profit	8523	7686
1% of turnover	1980	1875
1/2% of turnover	990	937
Gross Assets	5,34,941	5,07,150
1% of Gross Assets	5,349	5,072
2% of Gross Assets	10,699	10,143

After considering movements of various items in Trial balance and benchmarks on profit, turnover and gross assets, the materiality value has been set at 5% of PBT which is $7700.  The accounts identified based on materiality statement made above are:

·         Sales

·         Accounts Receivables

·         Equity

Further two accounts that have been chosen that are considered to be at risk of misstatement due to qualitative reasons and fraud risk are:

·         Cash at Bank (Fraud Risk)

·         Machinery (Qualitative Risk)

2.0   First account selected

Sales

2.1 Rationale for selection

Sales of RAR Company have increased by 6% or $11000, from FY 2016 to 2017 and thus fall within the range of materiality value determined in the materiality statement.

2.2 Assertion and Explanation

Assertion Identified - Accuracy

Sales have increased by 6% but cost of Sales show a slide of 4% which is unusual therefore it is important to assure that fictitious entries have not been made to inflate sales.

2.3 Recommended audit procedure

Identified category of audit procedure – Substantive procedure

Identified audit procedure – Test of Controls and documentation

The control procedures for recording complete flow of sales including accounting entries need to be done by tracing Purchase order, invoicing, stock issue entries, related vouchers and receivables. The process must be leak proof in terms of duplication and backdated entries. The procedure for backdated entries should be stringent and used sparingly only for genuine cases after following line of approval.

(Gray. et al. 2015. Zuca. n.d).

3.0   Second account selected

Accounts Receivables

3.1 Rationale for Selection

Accounts Receivables have shown an increase of 7% which is $ 8977 and thus pose the risk of material misstatement.

3.2 Assertion and Explanation

Assertion Identified – Accuracy

Misstatement of Accounts Receivables can be used for improving the financial performance shown by balance sheet. The provision for bad debts and its adequacy must be estimated. Further there is a trend in case of RAR Company where Cost of Sales has gone down whereas Sales have increased which has an impact on Accounts Receivables. Also the increase in sales in terms of value and percentage is similar which is unusual. Therefore both the accounts should be carefully studied.

3.3 Recommended Audit Procedure

Identified category of audit procedure – Substantive procedure

Identified audit procedure – Testing flow of Transaction and Controls

Identify major customers and obtain balance confirmation from them to establish the accuracy of balances. Further examine the ageing report to identify long pending dues that might be disputed and may require provision for bad debts. Perform a cut-off test to ensure that only sales pertaining to current financial year have been recorded in the financial statements. Examine purchase orders and invoices randomly to ascertain the credit terms and their compliance. In case there is a departure from the agreed credit terms, check approvals and communication regarding the same.

(Gray et al. 2015)

4.0 Third Account Selected

Equity

4.1 Rationale for Selection

Equity balance of RAR Company has shown a decrease from $ 139808 to $127451 which is a slide of 9%. This change falls within the range of materiality value arrived and thus requires investigation.

4.2 Assertion and explanation

Identified assertion – Occurrence

Equity includes share capital plus retained earnings. RAR Company has been registering profit yet there is a decrease in its share capital. Possible causes of this fall could be payment of cash dividends, purchase of treasury stocks or misstatement. There is a need to establish the occurrence of event that has led to this decrease.

4.3 Recommended audit procedure

Identified category of audit procedure – Internal Control Procedure

Identified audit procedure – Testing accuracy of transactions and details of Balance

Determine the cause behind decrease in equity and then trace the transactions that have been posted to effect this decrease. A dividend payout or purchase of treasury stock needs board’s approval. Check the minutes of board meetings held and resolutions passed and signed to establish proper authorisation for the same.

(Puncel, 2008)

5.0   Fourth Account Selected

Cash at Bank

5.1 Rationale for Selection

The change in cash balance from 2016 to 2017 is just $814 which is much below the materiality level determined. However, by nature cash carries an inherent risk of fraud. It is easy to misstate cash balances and divert it if proper procedures and controls are not in place.

5.2 Assertion and explanation

Assertion Identified – Completeness

It is important to establish that all transactions related to cash at bank have been recorded and none of the cash receipts have been omitted or suppressed.

5.3 Recommended audit procedure

Identified category of audit procedure – Substantive Procedure

Identified audit procedure – Test of balances and internal Control

The first step is to obtain balance confirmation from the bank and reconcile the balances. If there are any receipts or transfers that have occurred towards the year end, then ensure that the same have been recorded subsequently. Verify the procedure related to cash handling, approval and posting process to identify potential loopholes and leakages.

(Ramamoorti et al. 2017)

6.0   Fifth Account Selected

Machinery

6.1 Rationale for Selection

There is an increase in balance of Machinery by $ 7000. Fixed asset accounts tend to show a healthy asset position while giving tax benefits. It is pertinent to establish the cause behind this increase and its correct recording in the books as it carries not only material but also qualitative risk in terms of internal control and incorrect treatment of purchase/lease.

6.2 Assertion and explanation

Assertion Identified – Existence

The aim of audit procedure shall be to test the assertion of existence of Machinery and increase in its value during the financial year.

6.3 Recommended audit procedure

Identified category of audit procedure – Substantive Procedure

Identified audit procedure – Check of documentation, transactions and physical examination

Check the fixed asset register and Machinery account to ascertain the reason behind increase. Examine the invoice for owner’s name, address, amount paid and date of invoice. If the machine is leased then check the lease deed and ensure that treatment of lease in books is as per the associated accounting standard. One must pay attention to internal procedure of authorisation for purchase of machinery. The aforementioned steps shall establish the correct treatment of transaction in the books in terms of classification, cut off and amount. Check depreciation computed thereon as it has bearing on the net value of asset block. Finally examine the machinery bought to establish that the machinery exists and it is in good state.

(Gray et al. 2015)

References

Zuca, S. (n.d). ‘Audit Procedures- Receivables and Sales’, Pg 184, 186, provided by Romanian-American University in its journal Romanian Economic and Business Review 2013.

Puncel, L. (2008). ‘Audit Procedures 2008’, Pg 19.05, 19.04, Published by CCH,2007.

Ramamoorti,S. et al. (2017). ‘The proof of Cash Should be King Among Forensic Auditing Techniques’, Pg 828,830, Published in Journal of Forensic & Investigative Accounting, Volume 9, July-December 2017.

Gray, L & Manson. S, 2015. ‘The Audit process: Principles, Practice and Cases’, Pg. 455, 223, 233. Published by Cengage Learning EMEA, 2007.