HI6026 Audit Assurance and Compliance

Published : 09-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:

An efficient assessor in the auditing field is necessary to acquire ample as well as appropriate audit evidence. The assessor has basic requirement in utilizing service of specialist. The auditors are required to obtain proper understanding in the field to analyze adequacy of audit work and ascertain nature, function, purpose and scope of the evaluator in the auditing process. Moreover, the assessor is required to evaluate whether the expert has the potential and obligatory competence for evaluation (Louwers et al. 2015). The objectivity analysis for external account involves the exploration of interest that might create threat to the objectivity of specialist.

In this present case on DIPL, it has been identified that inventory and payment for inventory obsolescence has existed from previous period in order to cover the predicted reduction. In addition, depreciation on the fixed assets of DIPL is itemized by using straight line method. Therefore, for enumerating depreciation and impairment, specialist service is essential for the audit work in DIPL.

Problems encountered by DIPL firm	Necessity of expert whilst undertaking process of auditing
Inventory obsolescence	It has been stated by () that subsistence of allowance for inventory obsolescence hugely for estimated decrease in value occurs owing to storage weakness. Additionally, analysis of case on functions of DIPL highlights that occurrence of inventory obsolescence subsists for principal inventory. Assessment of report also highlights that inventory outlays are basically undertaken at currency of nation. Furthermore, board reveals that stipulation for inventory obsolescence has needed to be written back. Therefore, the DIPL firm has requirement for expert service for evaluation of obsolescence value.
Depreciation of fixed assets	The process of application of straight line method was mainly for the basic purpose of cost allowance over accounted definite assets (William, Glover, and Prawitt 2016). Therefore, the DIPL company can use professional service for estimating specific asset impairment combined with depreciation during auditing process.
For averting problem related to proper monitoring of auditing work	Efficient assessor can aid in averting problems related to monitoring audit- · Estimation of the services associated to oil reserves · Approximation of environmental liabilities along with clean up cost of the location · Assessment of distinctive tax or else complicated compliance concerns · Approximation of intricate financial instruments, plant and equipment, property, artistic work, antiques, assets and liabilities that is considered under business, enumerated assets impairment that includes intangible assets. Actual estimation of firm’s liabilities associated to insurance agreements besides the benefit plans of staff members.

Identification of five varied factors that affect preliminary

Materiality signifies specific features that can be considered to be vital for good presentation of financial statements according to relevant standards. Assessment of the functions of DIPL entity can help in identification of the factors, which can exert affect on initial materiality figures. The misstatements particularly are vital enough to put forth effect on presentation on material features. In addition, this misstatement can arise either from unintentional errors or from fraudulent actions. Specifically, in this context, errors relates to varied unintentional misstatements otherwise elimination of different amounts as well as disclosures in firm DIPL’s financial pronouncements.

The recognition of five varied factors combined with its impact on the procedure of ascertainment of initial figures on materiality process on auditing, which is presented in the table given below-

Indentified factors	Importance of the recognized factors	Portrayal of the acknowledged factors
Fraud risk affecting materiality of financial statement Fraud risk has been considered to be vital facet that can affect materiality of financial information. The findings of the study reflect that there subsists extreme pressure from the board of DIPL organization. However, the IT section of DIPL organization handled to set up new accounting arrangement. Moreover, this process also exposed DIPL firm to varied risk in relation to fraudulent acts.	Knechel and Salterio (2016) states that, mistakes usually arise during collection and processing data. Estimation of irrational accounting also exists from misapprehension of various sections of evidences. Furthermore, deception actions in relation to falsified activities are also considered as the main cause of misstatement of financial statement (Weiss and Solomon 2016). The auditor’s comprehension might magnify as well as improve the business regarding the risk of material misstatement. Furthermore, fraudulent activities owing to huge pressure on staffs and implementation of accounting systems have the ability in shaping monetary information.	The operation manager in the IT department was not satisfied with the arrangement of the organization’s machines. Furthermore, huge pressure was mainly on DIPL staffs for reconciling as well as investigating creative system in proper way. Nonetheless, the test disclosed the reality that less number of company’s transactions, which were carried out during closing time was not allotted in proper way.
Accounting strategies affecting materiality of the financial information Valuation process of raw material that applies average cost method was not suitable. Proper estimation of case on this firm discloses that process of inventory estimation of raw material specifically at average cost was unsuitable as the current paper cost improved from the application of average cost method.	Accounting measures implemented by the DIPL company’s administration for evaluation of the raw goods has been one of the basic factors that influence materiality. This is mainly because of the reality that accounting method helps in evaluation of raw materials, which in turn might facilitates users for comprehending fitting condition of various accounting items (Duncan and Whittington 2014). Moreover, DIPL administration mainly lacks integrity as well as objectivity. Additionally, mistakes while execution of accounting principle related to categorization, revelations and quantity. In addition, misinterpretation of pecuniary declarations of this company exerts risk.	Process of inventory valuation of raw materials at average cost was not proper. Additionally, inapt valuation mechanisms exert impacts on substantive accounting system procedure. This in turn impacts on assessor substantiation along with auditing policy decision.
Various environmental factors affecting materiality There are various business deals , which are not regarded while making financial assertions. This elimination can be carried out either intentionally or by some mistake. As a result, this might lead to irregularity in effective planning procedure. Moreover, DIPL failed in achieving targeted profit level in comparison to sales figure. Based on this estimation, it is asserted that this entity failed in investigating macro as well as micro objectives.	Incapability in integrating environmental facets by DIPL administration can affect materiality of statement. This in turn affects financial outcome as well as audit’s opinion.	Incapability of DIPL administration for considering micro as well as macro factors and elimination of economic transaction highlights the way to bend in financial announcement (Arens, Elder and Mark 2012). Moreover, the information users fail in attaining fair statement view, which in turn have effect on planning audit, assessing the impact of misstatement.
Procedure of CEO appointment influencing materiality The process of CEO appointment in DIPL might be considered to be complicated. Basically, transition procedure of CEO and the actions taken by Mr Jackson engages huge risk as this process was not according to directives. Moreover, inappropriate CEO appointment and late initiation of actions expose to various types of risk. This in turn impacts on materiality of DIPL’s audit process.	Intricacy of selection course and CEO engagement in DIPL puts huge impact on intelligibility. Thus, this obscures the vision of judgement maker. Hence, it is one of the vital factor that affects materiality.	The procedure of selection of CEO in DIPL firm can be deemed to be highly complicated. Hence, officials are essentially required for systematic process of engagement.
Factors related to novel recording account system Materiality is influenced by cash receipt record maintenance by accountants. Outlays are usually undertaken through electronic payment system. The method of maintaining receipt copy of firm after undertaking batch reconciliation can e usually done by accountant. This reconciliation statement made by DIPL accountant is required to be reviewed during specific time period. Apart from this, revenue that DIPL attains through e-book marketing impacts on materiality.	The vital factors that put forth affect on materiality is mainly accounting process that should be used by DIPL for estimating as well as registering accounting items.	Outlays that are undertaken through electronic payment system exert impact on maintenance process of receipt and arrangement of reconciliation statement. The DIPL management might fail in comprehending business transaction.

References

Arens, A.A., Elder, R.J. and Mark, B., 2012. Auditing and assurance services: an integrated approach. Boston: Prentice Hall.

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.

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.

Weiss, M. and Solomon, M.G., 2015. Auditing IT infrastructures for compliance. Jones & Bartlett Publishers.

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

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