HI6026 Audit, Assurance and Compliance

You are a senior manager with Stewart and Kathy and you have been approached to undertake the audit of Double Ink Printers Ltd (DIPL). For the year ended 2015, taking over from the small audit firm of Jay and Associates. DIPL print books, magazines and advertising materials for the publishing, educational and advertising industries on a print-on-demand basis. Printing on demand means that publishers can print the exact quantities ordered by retail outlets, rather than estimating in advance how many books are required and often printing too few or too many. The average printing turnaround time for DIPL is two business days for small orders and five to ten business days for large orders. In addition, five years ago, DIPL further expanded its earnings base by having publisher’s titles available as searchable ‘ebooks’ that could be downloaded directly by readers from DIPL’s website.

Purchase and Inventory
DIPL purchases 50% of its inventory requirements of paper, ink and binding materials from Australian sources and 50% from Asian countries. When inventory received at DIPL’s warehouse (whether it is purchased from Australia or Asia), the accounts payable clerk, Bill Jimmy, records the arrival of the inventory and also its value and quantity in the accounts payable system. Inventory is paid for the relevant currency of the country from which it is purchased. Raw materials have been valued at average cost and an allowance for inventory obsolescence has existed in previous years to cover the estimated decline in value from the effects of storage hazards. Work in progress is immaterial due to the quick turn- around time of printing jobs. Any work in progress is assessed at the cost of raw materials and labour and
proportion of manufacturing overheads based on normal capacity. At year end, the warehouse is closed from 28 to 30 June for stocktake, so sales must be invoiced in the system by close of business on 27 June. The stock must have been sent to the customer (that is, it must either be on track, ship or plane on its way to the customer, or it must already have arrived at the customer; it must no longer be in DIPL’s warehouse). 

‘Print on Demand’ revenue and receivables
Each time a publisher wants to add a book to DIPL’s ‘digital library’ (a server storing all of the publisher’s books in a digital format, ready to print), it emails the book to DIPL in PDF format. The digital library is backed up at the close of business every day, with the backup tapes kept off site. Once the book is stored in the digital library, the publishers can order copies to be printed as required.

When the publishers confirm the order, the accounting system automatically retrieves details of the publisher’s credit record and stops any orders from publishers that have exceeded their credit terms and limits. A printout of the transactions history of the publishers is generated and must be signed by both Helena keng, the head of publishing, and Jane Roger, the head of accounts at DIPL, before the order can continue, after the transaction history has been signed and dated, accounts receivable staff file it.If there are no credit problems with the order, it is processed and printed by casual staff in the relevant warehouse, who then load the books onto pallets for shipping. When printing is
finished, the sales clerk, Brown Pall, prepares an invoice and dispatch docket and forwards them to the accounts receivable department. The accounts receivable clerk Gay Chan, checks the prices and arithmetic accuracy of the invoices and signs the invoice as evidence of her check. Gay records the sales both the accounts receivables subsidiary ledger and the general ledger and books are shipped to the publisher’s nominated destination (or the publisher will
arrange pick up at the warehouse if has its own distributors). The client accepts liability for the goods when they are received in accordance with the purchase order, and signs the dispatch docket as proof of delivery.

‘E-book’ Revenue
The proceeds from each e-book sale are paid to the publisher’s net of a 5% commission.Proceeds are sent to publishers automatically upon download (the commission is withheld by DIPL). Revenue from the commission is recognised when is withheld from payment to the publishers.DIPL also charge publishers an annual “storage fee” payable 12 months in advance, for keeping the e-book on DIPL’s website. Publishers are invoiced on the date the first download of a title occurs. As new books are downloaded on an ongoing basis, the storage fee isinvoiced at different times of the year. Revenue from storage fees has been recognised in the month the fees are invoiced, notwithstanding the fact that the fees are charged 12 months in advance.

In September 2014, DIPL acquired Nuclear Publishing Ltd (NPL). The main rationale behind the lay in the value of the copyright NPL held over a large range of specialised medical textbooks. Although the potential print run for the textbook was not large, each textbook had a high profit margin and had been used in universities across the world for many years. DIPL acquired the business operation of NPL (not the shares), paying net assets (including the right
to the copyright). However, in June 2015 an article was published in a medical journal about a new theory that could result in NPL’s medical textbooks becoming obsolete. If the new theory is valid, the textbooks are unlikely to be reprinted or used as textbooks at universitiesin the future, effectively making them unviable as e-books.

Cash Receipts
Some Payments from accounts receivables are received by cheque through the mail, and the cashier, Judy Bones, record these in an inwards remittance register when the mail is opened. She then banks the cheques and forwards the payment advices to Gay Chan for posting ton the accounts receivable ledger. Most payments, however, are received by electronic funds transfer (EFT). Each day, Judy downloaded the previous day’s receipts from online banking and provides a copy to Gary for posting. Judy then reconciles the total of the batch postings to accounts receivable to the amount banked for the day. The assistant accountant, Boby Roger, prepares a bank reconciliation at the end of each month.

 

Fixed Assets
Since DIPL’s incorporation, depreciation on assets has been calculated using the straight-line method to allocate their cost over their estimated useful lives, as follows:
• Printing presses up to 20 years
• Other production equipment up to 15 years
• Other equipment up to 10 years

Finance
During 2015, DIPL has entered into a 7.5 million loan from BDO Finance Ltd (BDO Finance).The loan has debt covenant’s requiring DIPL to maintain a current ratio of at least 1.5 and a debt to equity ratio of less than 1. Failure to maintain these key financial ratios under the specified benchmarks would result in BDO Finance having the right to recall the loan.

Appointment of New CEO and internal Audit
William Jackson was appointed the new chief executive officer (CEO) of DIPL in January 2015.William has extensive experience in the printing business. The previous CEO, Rebecca Styles, who is now semi- retired, will remain on the board as a non-executive director. A component of William’s remuneration package is a performance bonus based DIPL achieving an annual growth of 10% in total revenue and 10% in net profit after tax. Based on William’s recommendation, the board also established a new internal audit department headed up by Cody Baines, an ex-audit manager with a Big Four audit firm and two other recently qualified chartered accountants. Cody reports directly to the board.

New IT System
During 2015, DIPL decided to invest in a new IT system that would fully computerised and integrate all the current accounting processes across the organisation, including integration into the general ledger system.Under extreme pressure from the board, the IT department at DIPL managed to get the new accounting system installed in June, although IT manager, Andy Rogers, complained several times about how the installation was handled. Andy claimed that excess pressure had been placed on staff to get the system installed and that there was simply not enough staff to do the proper reconciliation’s and testing before the new system went live prior to year-end. Andy preliminary testing showed that some transactions conducted around year-end were not being allocated to the correct period. The problem appeared to be the interface between the new accounting system and one of the existing software systems. A software ‘patch’ had to be written to fix the problem. 

Board year-end reporting discussions
As a board meeting held in June 2015, issues relating to the forthcoming year end were discussed. William stated that he believed that the valuation of raw materials inventories at average cost was no longer appropriate as the current cost of paper was substantially above the average cost. Further, he argued that the allowance for obsolescence of inventory to cover the estimated decline in value from the effects of storage hazards was necessary, as such a loss was unlikely. William also stated that based on his experience in the printing industry he believed that DIPL’s printing presses had a potential maximum life of 30 years, although he noted that another leading entity in the printing industry adopted the policy of depreciating its printing presses over a 20-year period on a straight-line basis, similar to what DIPL had done in the past. After much discussion, the board resolved that the allowance for obsolescence of inventory be written back and that raw materials be valued based on a firstin, first-out (FIFO) basis. In addition,following a review of the e-book facilities by internal audit, Cody recommended that in a report to the board that DIPL change the method it used to account for its revenue from e-book publication to ensure compliance with the applicable accounting standard. The board agreed that the revenue from e-book would be recognised in accordance with the stage of completion of each transaction (i.e. percentage of completion method).

 

Required

 

As an auditor, you are conducting your preliminary analytical procedures based on the background information for DIPL contained in the case. Apply analytical procedures to the financial report information of DIPL for the last three years. Explain how your results influence your planning decisions for the audit for the year ending
30 June 2015.

You are conducting your risk assessment of DIPL, as part of the planning for your audit for the year ended 30 June. Identify two inherent risk factors that arise from the nature of DIPL’s business operations. Explain why it is a risk and how it may affect the risk of material misstatement in the financial report.

As part of your audit of DIPL for the year ended 30 June 2015, you are considering the risk that fraud may have occurred (a) Based on the background information for DIPL contained in the case, identify and explain two key fraud risk factors relating to misstatements arising from fraudulent financial reporting to which DIPL may be susceptible. (b) Explain how the risk factors identified in (a) above would affect the conduct of the (a) audit.

Application of the analytic procedures to DIPL’s financial report information:

The most important nature of the economic report of the DIPL has been useful in development of the plan of audit. The time of undertaking the audit follows the planning process of auditing. Overall the assessor maintains the audit costs up to a level or a stage which is more or less reasonable. It has been found that this helps the maintenance of the audit cost as well helps in the misunderstanding related to the clients. DIPL’s economic statement is related to the dissemination from the firm’s financial declaration.

Approach in an analytic sense for the common size is dependent upon the financial statement as well as the common point of references. Further it has been found out that this is helpful in the comparison of the economic statements that are related to different corporations. Related to this the assessors can deem the several items that have been discussed in the financial report. An example can be cited as, the registering procedure of the items like the net assets as well as the liabilities associated with the owner’s in the company’s report. It is of a financial nature. It also helps to understand the deviation from the usual process of reporting (Hayes, Wallage and Gortemaker 2014).

Furthermore, it is found that the analysis of ratios can be considered as a suitable analytic technique used for the audit plan assessment as well as the declarations of an economic nature.

Procedural analysis of results influencing the audit planning decisions:

The most significant result of the decision regarding to the planning has been deemed important for the result analysis. The results of the analysis have been found to be influenced by the financial statements. The ratio outcomes of the DIPL can be seen in terms of the following figures: 1.42 in 2013, 1.46 in 2014 and 1.5 in 2015. Based on the profit margin, the profitability ratio has been calculated, that can be found as 0.068 in 2013, 0.60 in 2014 and 0.06 in 2015. This specific factor is beneficial in informing about the net income condition that the firm has attained in comparison to the DIPL’s net sales. More so it can be said that it is helpful in analysing whether the authorities require to curtail the budget costs and apply them in case of the firm. The three year ratio comparisons as well as analysis assist in enlightening the firm’s relative position in terms of the three particular periods. Further analysis of the factors leading to the disagreeable and unsuitable conditions of the corporations is also conducted (Louwers et al. 2015).

The financial report is given as:

The outcomes of the planning decisions related to audit planning is influenced primarily through the outcomes of analytical method to disseminate information from the financial reports.

Determination of the risk factors inherent, arising from the nature of DIPL’s Business operations:

The vital factor has been found to be based on the auditing that comprises of the related incidents in connection to the material misstatements as well as the economic declarations related to a specific nature. It can be stated however, that forms of the systematic as also the unsystematic risks has been found to further show the process in which the corporations take financial misstatements into consideration. Regardless of this, the allied risks can be seen to be based on the financial as well as the non-financial factors which are quite possible (Knechel and Salterio 2016). These factors can help in warding off a particular corporation for showing a genuine and fair viewpoint of those financial decisions which are pertinent in nature. The identifiable risks can be connected further with the several risk associations depending on the omission of the risks connected to various errors, that is not probable for a specific bookkeeper. With regard to the core of the diverse mistakes committed, the specific nature of bookkeeping possesses certain inherent risks that are found to occur from the way of the operations.

Depending on the available considerations which have been mentioned in the report, it can be clearly and surely stated that several transactions are available related to the accountants which are not usually seen with the DIPL corporation. The direct lead which is sequential with regard to the inconsistencies, specifically associated with the accountants or otherwise. This is not usually seen in case of the DIPL Corporation (Nalewaik and Mills 2016). The direct as well as chronological lead are specifically related to the ineffective planning of the activities regarding the sales. Additionally it can be said that the pecuniary declarations have been found to expose the fact that the corporation has failed to achieve the pre-determined profit level from the sales-based revenue. Particularly the failures due to the management have been recognised in terms of the particular requirements which have been recognised with resulting adjustments of the functionalities.

Separately from the workers, the overall risk has been escalated by the DIPL Corporation. The lack of proficiency and know-how of the employees, there has been increasing rise of the inherent risks (Beasley 2015). This is due to the fact that the staff members in many cases do not have the requisite competency. The non-proficient nature of the workforce can help increase the risk to stop the committing of mistakes. The exclusion or the removal of the errors as well as the cases in which misstatement have been stated are purely on the basis of the economic announcements (Arens et al. 2016).

The facts that are noteworthy in relation to the existing risks can be divided into several categories. This is done on the basis of segments exclusively formed for the environmental issues as also the external facets, misstatements of materialistic nature in the earlier time periods as well as the exercises which are falsified. Based on the given scenario’s evaluation it has been found that the DIPL has been capable of reflection on the risks which are noteworthy and need to be removed in the procedure of CEO succession (Barton and Bruder 2014). Overall it can be said that the Chief Executive Officer is obviously a different candidate in comparison to the others. Some of the risks can be considered to have an involvement with the procedural quality for the selection as well as the handling process (Hayes, Wallage and Gortemaker 2014). There are numerous risks which are associated with the process and its initiation without following the strategy, as also the derisory involvement of the CEO and the candidate departure (Duncan and Whittington 2014).

Based on the case analysis, it can be additionally revealed that the different types of implementations for innovative IT processes have caused specific problems. DIPL did not process enough staff members to handle the implementation and the reconciliation procedure before the new arrangement before the end of the year (DeFond and Zhang 2014). The procedure of primary testing initially, has shown that appropriate amount of time was not given to the transactions. This led to various incidents of materialistic misstatements. Other inherent risks of omission in specific financial declarations were also found (Eilifsen et al. 2013).

Additionally the cash receipts as also the recording were seen to be performed by the expertise of the finance professionals (Waldron 2016). The risks were not handled appropriately at first. The total members of the staff were required to abide by the correct sequence of Receivable Accounts as also the request of Accounts Receivable ledger for its perfect maintenance (Knechel and Salterio 2016). Additionally, there was also the requirement of the bank reconciliation appropriately. The register of e-book generated revenues as well as textbook reprinting have chances of leading to different nature of complexities involved in the particular procedure.

Also it can be said that the process of evaluation of the raw material inventory was not appropriate as the existing paper cost was notably higher than the average paper cost.

The way in which risk can affect the material misstatement in the financial report:

The nature of risk identification is connected to the material misstatements.

Excessive pressure on the management as well as the employees:

The excessive burden on the members of the staff affects the bookkeeping. There have been certain qualities for example the propensity to encounter concerns regarding the flow of cash, low level of liquidity along with the operating outcomes (Cannon and Bedard 2016).DIPL lacks the integrity and requisites. It is hence expected that they will be prepared for their loss of reputation.In many cases the material misstatements cause financial declarations.

Nature of business entity:

The rising growth procedure of the DIPL corporation have been thought of in connection to the competitive scenario. There is a possibility of these factors affecting the overall nature of the risk connected to the business as well as the planning structure of the audit.

Identification as well as the explanation of two major risk factors connected to the misstatements arising from the fraudulent financial reporting:

Popularly known explanations of the fraud risks connected to the material misstatements are listed below:

References:

Arens, A.A., Elder, R.J., Beasley, M.S. and Hogan, C.E., 2016. Auditing and assurance services. Pearson.

Barton, H. and Bruder, N., 2014. A guide to local environmental auditing. Routledge.

Beasley, M.S., 2015. Auditing cases: An interactive learning approach. Prentice Hall.

Cannon, N. and Bedard, J.C., 2016. Auditing challenging fair value measurements: Evidence from the field. The Accounting Review.

DeFond, M. and Zhang, J., 2014. A review of archival auditing research. Journal of Accounting and Economics, 58(2), pp.275-326.

Duncan, B. and Whittington, M., 2014, September. Compliance with standards, assurance and audit: Does this equal security?. In Proceedings of the 7th International Conference on Security of Information and Networks (p. 77). ACM.

Eilifsen, A., Messier, W.F., Glover, S.M. and Prawitt, D.F., 2013. Auditing and assurance services. McGraw-Hill.

Hayes, R., Wallage, P. and Gortemaker, H., 2014. Principles of auditing: an introduction to international standards on auditing. Pearson Higher Ed.

Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Taylor & Francis.

Louwers, T.J., Ramsay, R.J., Sinason, D.H., Strawser, J.R. and Thibodeau, J.C., 2015. Auditing & assurance services. McGraw-Hill Education.

Nalewaik, A. and Mills, A., 2016. Project Performance Review: Capturing the Value of Audit, Oversight, and Compliance for Project Success. CRC Press.

Waldron, M. (2016). The Future of Audit. CFA Institute Magazine, 27(3), 55-55.

William Jr, M., Glover, S. and Prawitt, D., 2016. Auditing and assurance services: A systematic approach. McGraw-Hill Education.