HI6026 Audit Assurance and Compliance

Published : 17-Sep,2021 | Views : 10

Question:

Case Study

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).

As part of your planning process, you are considering whether you will need to use the services of an expert in the audit of Double Ink Printers Ltd (DIPL).Based on the background information contained in the case, explain whether it will be necessary to use the work of an expert in the audit of DIPL.

You are at the planning stage of the audit of Double Ink Printers Ltd (DIPL) for the year ended 30 June 2017 and have been asked by the audit manager to assists determine the materiality levels.

Required:
(a) Referring to the background information contained in the case, identify five factors that would influence your determination of the preliminary figure for overall materiality for the 2017 audit of DIPL.
(b) Explain why the factors identified in (a) above are relevant to your calculation of the preliminary figure for overall materiality.
(c) Describe how the factors identified in (a) above will influence your preliminary figure for overall materiality in the audit planning process.

Answer:

The guiding principle for using the work of expert in the auditing of financial statements of an organization is done in accordance with International Auditing and Assurance Standard Board. It is required by auditors to consider some pre requisites before carrying out audit work and analyzing the existence of material misstatement. The audit planning and information usage should be incorporated and it act as evidence. Specialist or expert is employed by organization for providing advisory advices and substantive test performances for evaluating material financial statements assertions (Alzeban & Sawan, 2015). It can be depicted from case study of DIPL that it is certainly possible for auditors to encounter some subjective and complex matters that are potentially material to their financial statements. An auditor might be required to use the work of specialist or hire expert in the following events, however, it is not limited:

Determination of physical characteristics relating to
In event, an organization is required to perform the valuation of some high technology equipment or materials, plant and equipment, inventories for special purpose in real course of business. It might also involve real estate, complex financial statements, environmental contingencies, restricted securities and work of arts (Ebimobowei & Peter, 2013).
Analysis of complex and unusual issues related to tax compliance.
Interpretation of agreements or regulations that involves determination of potential significance of contracts or legal documents and any other technical requirements.
Determination of amount relating to assets such as inventories using specialized methods and techniques.
Valuation of environmental liabilities and costs associated with cleaning up of sites.

Sufficient and appropriate evidence is required in the process of auditing by experts in the field other than auditing. An organization is required to make the assessment about requirement of expert or specialist service. Furthermore, firm or organization hiring service of expert is required to determine whether experts are capable, competent and has the objectives of carrying out audit. Auditors might require expert’s service because in order to analyze and gain an in depth understanding about environment of entity and identifying the existence and risks associated with material misstatement (Gay & Simnett, 2015).

Issues faced by DIPL	Decision regarding expert requirement in audit of DIPL.
Depreciation of fixed assets	DIPL has employed straight-line method o calculate the depreciation on fixed assets. Employment of this cost has been done for allocation of cost over useful life of assets. Measuring asset impairment by incorporating depreciation might require service of experts while conducting audit (Reding et al., 2013).
Valuation of raw materials inventories	It is reported in the case study that using average cost to value inventories was not appropriate, as average cost was much below the current cost of paper. As per analysis, it is considered necessary to allow for inventory obsolescence so that estimated decline in value of covered. However, board resolves inventory allowance by writing back and using another method. Concerning this, service of expert is required for valuing inventory using approximate value.

The application of materiality is done in evaluation of effect of identified material misstatement on audit of financial statements of organization. Material determination is a matter of professional judgement and it is influenced by perception of auditors about financial information presented by organization. The preliminary materiality figures of financial information of DIPL are influenced by several factors. It has been analyzed while making assessment of given case in respect to functionalities. The fair representation of material aspects of financial information is considerably impacted either separately or aggregately by presence of material misstatement in financial assertions (Messier et al., 2014). While performing and planning audit of any organization, auditors perform the application on concept of materiality. The factors influencing determination of preliminary figures for overall materiality of financial information of DIPL are listed below:

a) Factors influencing preliminary figures determination of DIPL	b) Reasons attributable to factors relevance in calculation of preliminary figures for overall materiality	c) How the identified factors influence preliminary figures in process of audit planning for overall materiality
Risk of fraud influencing materiality- Risks pertaining to fraud seem to have negative impact on overall materiality of financial statement assertions. As depicted from case study that, implementation of new accounting system is due to extreme pressures from board. However, the responsibility of installation, proper reconciliation and testing of system was placed on staffs. Fraud risks rests due to absence of insufficient staffs in the handling on new accounting system (Graham, 2015).	The calculation of preliminary figures of DIP is considerably impacted by prevalence of risk of occurrence of fraud. As evident from case study that there is not, enough staff members to perform reconciliation and testing of new system. In such situation, it is certainly possible that collection and processing of data while preparation of financial reports of DIPL might not be accurate and free from errors. There might be errors in valuation and classification of several items while application of particular accounting policies.	Information technology manager was not satisfied with the implementation procedures of new information system. Installation of new accounting system was pressurized on staffs and it was depicted in preliminary testing that the allocation of some transactions was not done in correct period. This would have material impact of financial information and thereby affecting planning process of audit.
Materiality impacted by accounting practices of DIPL- Accounting policies of DIPL was not appropriate in carrying out measurement and recognition of several items of financial statement. It has been ascertained by carrying out case study analysis that using average cost for valuation of inventories is not proper. This is so because the cost of raw materials inventory has considerable increased their current cost.	Pervasiveness of inherent risk is one of the factors that have influencing effect. There is no objectivity and integrity in administration of DIPL that has the likelihood of making produced results material. Due to improper measures used for valuation, it is certainly possible that employees will get involved in fraudulent activities.	The procedures and measures adopted by DIPL in evaluating their raw materials for inventories were not appropriate. Impractical and unsuitable assumptions in the valuation process have influenced the overall functional process of carrying out audit and accounting (Duncan & Whittington, 2014). This specific factor relating to improper accounting and unreasonable accounting policies will probably impact the overall confirmation given by DIPL as preliminary figures are considerably impacted.
New process of registration of accounts- The procedures of maintaining several accounts such as cash receipt are perceived to have a considerable impact on financial statement materiality (Louwers et al., 2015). Some payments are received by DIPL by cheques and by electronic fund transfer. Majority of expenditures that are borne by corporation are transacted through electronic payment. Preparation and reconciliation of accounts is required to be prepared by accountants periodically and more frequently. In terms of generation of revenue by re publishing, marketing and printing, it is certainly possible that materiality of financial statements would be influenced.	Process of accounting of DIPL is one of the significant factors affecting materiality of financial statement used by DIPL. Recording and measuring raw materials inventories of corporation are not appropriate.	Electronic system of making transactions significantly influences the overall process of recording and maintaining details. There is a possibility that there will be down fall of business resulting from insufficient and improper recording of data (Ricchiute, 2014). It would severely affect the financial statement preparation due to materiality prevalence resulting from various issues identified in relation to DIPL business.
Complicated selection procedures of Chief executive officer- The procedure involved in new Chief executive officer appointment is complicated and lengthy as ascertained from analysis. Procedures of appointing CEO carries a certain amount of risks as indicated by commencement of various activities and transition process involved in selection of CEO. The improper appointment of CEO and abrupt leaving of workers	The lengthy and complicated procedures of appointing CEO of corporation would have a significant and noticeable impact financial information transparency. This would make it difficult for decision maker in upper level of management to deal with certain business transactions effectively and efficiently. Ultimately, the materiality of financial statement of corporation would be adversely impacted.	Materiality of financial information would be significantly impacted by the convoluted process of hiring and selecting CEO in running business of DIPL. Therefore, the appointment of procedures of hiring CEO for corporation should be transparent and filtered.
Various environmental facets impacting materiality- It has been ascertained while evaluating the case study that the preparation of financial statement does not incorporate recording of some transactions because of human errors or deliberately on part of employees in an attempt to conduct fraud with business of corporation (Gwiazda et al., 2017). Considering this, there were inconsistencies in planning of activities related to marketing and selling activities.	Complex procedures of appointing CEO have the possibilities of affecting the financial information transparency that would have an undesirable impact on audit planning and process (Coetze et al., 2015). This particular factor would have considerable influence on materiality because ambiguity of decision maker.	The identification of macro and micro environmental factors as analyzed from the case study depicts that appropriate DIPL. Overall planning of audit did not employ method of financial accounting is considerably impacted by information presented in financial statements and thereby leading to materiality.

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