HI6026 Audit, Assurance and Compliance

Published : 20-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:

Application of analytical procedures to the financial report information of Double Ink Printers Limited

In this particular question, ratio analysis had been calculated for the company named as Double Ink Printers Limited where analytical review had been applied by generating information from annual reports of company (William, Glover and Prawitt 2016).

Profitability analysis

Profitability Ratio
Gross Profit	6004500	6079500	6604500
Net sales	34212000	37699500	43459500
Gross Profit	17.55085935	16.1262086	15.1969075
Net Income	2359190	2291362	2972183
Net Sales	34212000	37699500	43459500
Net Profit	6.895796796	6.0779639	6.83897192
Net Income	2359190	2291362	2972183
Total Assets	12930000	15903900	26147991
Return on assets	18.24586234	14.4075478	11.3667738
Net Income	2359190	2291362	2972183
Shareholder Equity	9150000	10783650	12250491
Return on Equity	25.78349727	21.2484827	24.2617459

From the annual report of Double Ink Printers Limited, profitability ratio is calculated for the company for three consecutive years (2013, 2014 and 2015). Calculating profitability ratio for a company help in predicting the profitability position of any business organization

As far as gross profit ratio is concerned, it has declined over the three consecutive years. In the year 2013, the gross profit of DIPL was 17.55%, 16.12% in the year 2014. There was further decrease in gross profit at 15.19% for the year 2015 (Simnett, Carson and Vanstraelen 2016).
As far as net profit is concerned, it had declined from 2013 to 2015 and further increased in the year 2015. In the year 2013, net profit of DIPL was 6.89% and 6.07% in the year 2014. There was further increase in net profit at 6.83% in the year 2015.
As far as return on assets is concerned, there was constant decrease from the year 2013 to 2015. In the year 2013, return on assets of DIPL was 18.24 and 14.40 for the year 2014. There was further decrease in return on assets at 11.36% (Sierra?García, Zorio?Grima and García?Benau 2015).
As far as return on equity is concerned, there was decrease in return on equity from 2013 to 2014 and then further increase for the year 2015. In the year 2013, return on equity for DIPL arrives at 25.78% and 21.24% in the year 2014. There was further decrease in return on equity at 24.26% in the year 2015.

Liquidity Analysis

Liquidity Ratio
Current assets	5385938	7509150	9600929
Current Liabilities	3780000	5120250	6397500
Current Ratio	1.424851	1.466559	1.500731
Current assets	5385938	7509150	9600929
Inventory	2256188	2671362	4180500
(Current assets-inventory)	3129750	4837788	5420429
Current liabilities	3780000	5120250	6397500
Quick ratio	0.827976	0.944834	0.847273

From the annual report of Double Ink Printers Limited, liquidity ratio is calculated for the company for three consecutive years (2013, 2014 and 2015). Calculating liquidity ratio for a company help in predicting the liquidity position of any business organization

As far as current ratio is concerned, there was constant increase in the current ratio over the three consecutive years. In the year 2013, current ratio for DIPL arrives at 1.42 and 1.46 in the year 2014 ( and Idowu 2015). There was further increase in current ratio at 1.50 in the year 2015.
As far as quick ratio is concerned, there was increase in quick ratio from 2013 to 2014 and then further decrease for the year 2015. In the year 2013, quick ratio for DIPL arrives at 0.82 and 0.94 in the year 2014. There was further decrease in quick ratio at 0.84 in the year 2015.

Efficiency Analysis

Efficiency Ratio
Cost of goods sold	28207500	31620000	36855000
Average inventory	2256188	2671362	4180500
Inventory Turnover ratio	12.50228261	11.8366586	8.815931109
Net credit sales	34212000	37699500	43459500
Average accounts receivable	2482500	4320000	5073309
Debtors Turnover Ratio	13.78126888	8.72673611	8.566302585

From the annual report of Double Ink Printers Limited, efficiency ratio is calculated for the company for three consecutive years (2013, 2014 and 2015). Calculating efficiency ratio for a company help in predicting the efficiency position of any business organization

As far as inventory turnover ratio is concerned, there was decrease in inventory turnover ratio over the three consecutive years. In the year 2013, inventory turnover ratio for DIPL arrives at 12.50 and 11.83 in the year 2014. There was further decrease in inventory turnover ratio at 8.81 in the year 2015.
As far as debtor’s turnover ratio is concerned, there was decrease in debtor’s turnover ratio over the three consecutive years. In the year 2013, debtor’s turnover ratio for DIPL arrives at 13.78 and 8.72 in the year 2014. There was further decrease in debtor’s turnover ratio at 8.56 in the year 2015.

Solvency Analysis

Solvency Ratio
Total Liabilities	3780000	5120250	13897500
Total Equity	9150000	10783650	12250491
Debt to Equity Ratio	0.413115	0.474816	1.134444326

From the annual report of Double Ink Printers Limited, solvency ratio is calculated for the company for three consecutive years (2013, 2014 and 2015). Calculating solvency ratio for a company help in predicting the solvency position of any business organization

As far as debt to equity ratio is concerned, there was constant increase in the debt to equity ratio over the three consecutive years. In the year 2013, debt to equity ratio for DIPL arrives at 0.41 and 0.47 in the year 2014. There was further increase in debt to equity ratio at 1.13 in the year 2015.

Impact of analytical review on audit planning for the year ending 30^th of June 2015

In this particular question, different risk had been identified from the analytical review and evaluating the financial reports of DIPL that links with the impact on the audit planning.

On analysis, it is noted that the profitability of DIPL had not improved in the year 2015. There had been decline in the profits of DIPL that lead to issue of going concern ability for business organization. Therefore, detailed analysis need to make for DIPL where the company should plan for exploring the future prospects (Louwers et al. 2015).
On analysis, it is noted that the current ratio of DIPL has improved in the year 2015. By this, it is understood that there is proper writing back of allowance for any loss present for stock or inventory. Hence, in-depth analysis needs to perform on inventory allowance for checking over the validity of actions (Lenz and Hahn 2015).
On analysis, it is noted there is increased financial risk present at DIPL. In this case, the disclosures are related to risk that need to be analyzed after checking the fact whether information for the same had been properly declared in the reports.
On analysis, it is noted that there is decline in the efficiency of management at debt to equity ratio where the company failed to manage the current assets and should make an effort for identifying the possible reason to do so (Knechel and Salterio 2016).

Identification of inherent risk factors that arise from the nature of business operations of Double Ink Printers Limited

Double Ink Printers Limited
Risk	Material misstatement in the financial statement
Financial risk It is one of the risks that arise from the inability of any business when they cannot pay off their long-term liabilities on time (Al-Akra, Abdel-Qader and Billah 2016).	On analysis, it is noted that DIPL makes an attempt to manipulate in their financial records so that the company can maintain current ratio and debt to equity ratio as agreed by the lending company (Junior, Best and Cotter 2014). DIPL need to inflate their current assets through increased values of receivables or stock to maintain the current assets. On the other hand, DIPL inflate the value of equity through increased value of retained earnings to maintain debt to equity ratio.
Information technological risk It is one of the risks that arise when a company adopts information technology. To that, any deficiency in the information technology control had adverse impact on the business organization (Arens et al. 2016).	On analysis, it is noted that DIPL failed to maintain balance between new accounting system and existing software system. Due to that, there was problem relating to improper allocation of transactions for specific period of time. In addition, the accounting concept of periodicity was not followed and that adversely results to inaccurate presentation of profitability and financial position of DIPL (Eilifsen et al. 2013).

Key risk factors related to misstatement in financial reporting

Risk Factors	Material misstatement in the financial reporting
Debt covenants	On analysis, it is noted that debt covenants is one of the risk factor that DIPL faced for given period of time (Carey 2015). To that, there was huge pressure on the Finance Department of DIPL as they find it difficult to meet the different debt covenants. Furthermore, a loan of 7.5 million was taken from BDO Finance Limited by DIPL in the year 2015 based on two components. In that case, if DIPL fails to meet these two conditions, then the loan will be taken back that negatively affect the operations of the company. Therefore, there is a possibility that current assets might have inflated so that the ideal current ratio can be maintained (Crockett and Ali 2015). It is noted that there are some manipulation present in the retained earnings as the debt ratio should be less than 1.
Nature of control environment	On analysis, it is noted that nature of control environment is one of the risk factor that was faced by DIPL for specified time period. Nature of control environment lead to existence of fraudulent practices in financial reporting that exists due to poor defined job description of poor segregation of work. In addition, there is a possibility that stock can be manipulated through portraying less stock at the time of arrival of cash. Hence, there is improper system used at the time of documentation that helps in preventing fraudulent activities (Cohen and Simnett 2014).

Effect of risk factors on conduct of audit

Effect of debt covenants on audit plan- DIPL need to balance their current assets and current liabilities after checking whether there is any inflation present in current assets or deflation in current liabilities (Christopher 2015). Therefore, the balance of equity need to be analyzed through careful verification of retained earnings.
Effect of control environment on audit plan- DIPL need to check the balance of stock or inventory. The quantity of orders placed for the purchase of stock need to match with the quantity received and there should be no manipulation present and conducted by any accounts payable clerks (Carson, Redmayne and Liao 2014).

Reference List

Al-Akra, M., Abdel-Qader, W. and Billah, M., 2016. Internal auditing in the Middle East and North Africa: A literature review. Journal of International Accounting, Auditing and Taxation, 26, pp.13-27.

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

Carey, P.J., 2015. External accountants’ business advice and SME performance. Pacific Accounting Review, 27(2), pp.166-188.

Carson, E., Redmayne, N.B. and Liao, L., 2014. Audit market structure and competition in Australia. Australian Accounting Review, 24(4), pp.298-312.

Christopher, J., 2015. Internal audit: Does it enhance governance in the Australian public university sector?. Educational Management Administration & Leadership, 43(6), pp.954-971.

Cohen, J.R. and Simnett, R., 2014. CSR and assurance services: A research agenda. Auditing: A Journal of Practice & Theory, 34(1), pp.59-74.

Crockett, M. and Ali, M.J., 2015. Auditor independence and accounting conservatism: Evidence from Australia following the corporate law economic reform program. International Journal of Accounting & Information Management, 23(1), pp.80-104.

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

Junior, R.M., Best, P.J. and Cotter, J., 2014. Sustainability reporting and assurance: A historical analysis on a world-wide phenomenon. Journal of Business Ethics, 120(1), pp.1-11.

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

Lenz, R. and Hahn, U., 2015. A synthesis of empirical internal audit effectiveness literature pointing to new research opportunities. Managerial Auditing Journal, 30(1), pp.5-33.

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

Rahim, M.M. and Idowu, S.O. eds., 2015. Social Audit Regulation: Development, Challenges and Opportunities. Springer.

Sierra?García, L., Zorio?Grima, A. and García?Benau, M.A., 2015. Stakeholder engagement, corporate social responsibility and integrated reporting: an exploratory study. Corporate Social Responsibility and Environmental Management, 22(5), pp.286-304.

Simnett, R., Carson, E. and Vanstraelen, A., 2016. International Archival Auditing and Assurance Research: Trends, Methodological Issues, and Opportunities. Auditing: A Journal of Practice & Theory, 35(3), pp.1-32.

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

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