Core Auditing Standards for Practitioners

Question: Discuss about the Core Auditing Standards for Practitioners. Answer: Materiality is a crucial concept in auditing that assists the auditor in carrying the audit in an effective and efficient manner. The planning materiality in the context of auditing signifies the amount set by the auditor as a threshold above which the items in the financial statements would be considered material or significant requiring special attention of the auditor (AICPA, 2016). Further, the threshold limit could also be set for performing the audit and in that case it is known as performance materiality. Any amount of misstatement encountered during the audit, whether taken individually or in aggregate, if exceeds the set threshold, is considered significant. In order to set the materiality, the auditor is required to assess the riskiness of entity being audited (AICPA, 2016). In the current case, audit of Could 9 Pty Ltd is under consideration for which the evaluation of planning materiality has been done as follows: Description Amount Total assets 24,986,261 Planning materiality (%) 0.50% Planning materiality ($) 124,931 The planning materiality as computed above is $124,931 which means that the auditor will use this figures as the threshold for planning the audit procedures. The planning materiality has been computed based on the total assets of the entity. The total assets have been used because the other parameters such as profit before tax, turnover, and equity have been considered unfit for use. The company has incurred losses in the year 2011; therefore, profit before tax can not be taken as the basis to determine planning materiality. Further, in regards to revenues and equity, the consistency has been found missing making the use of these factors unfit for determination of planning materiality. Moreover, the amount of planning materiality as arrived at $124,931 seems to be appropriate looking at the size of balance sheet and the income statement. The most of the figures of income statement and balance sheet are greater than $124,931 which implies that the audit plan will cover testing in a great detail. The detailed testing is required looking at the risk involved in the audit of Cloud 9 Pty Ltd. The addition of new line of business and that too with weak internal control system exposes the company to risk. Further, the company has also not been able to achieve its budget targets in regards to revenue growth. The company budgeted to achieve 3% growth in revenues in the year 2011; however, the results show a decline of 17.88%. Analysis of Cloud 9s Financial Position and its Business Risks The analysis of financial performance and position of the entity before conducting the audit proceedings is necessary to analyze the business risk. In analyzing the financial performance and position of the entity, the analytical procedures play a crucial role. The ratios analysis and trend analysis by computing percentage changes are the two primary tools to performance analytical procedures (AICPA, 2016). In regards to the audit of Cloud 9 Pty Ltd, the financial ratios and percentage changes have been computed to analyze the financial performance and position of the company. The key ratios of Cloud 9 are presented in appendix-B, from which it could be observed that the profit is showing unusual fluctuations. The company had net margin of 3.07% in the year 2010, which fell severely down to -6.41% in the year 2011 showing that the company incurred heavy losses (Appendix-B). Further, the debt to equity ratio also showed unusual increase in the year 2011. It increased from 3.25 times i n the year 2010 to 5.25 times in the year 2011 showing that the companys borrowings increased significantly. Further, the Interest Times ratio decreased from 0.34 times to -1.10 times. Overall, the analysis of ratios depicts that the financial performance of the company has not been good in the year 2011. The company has accumulated losses of $1,205,304 in the year 2011. Further, the percentage change analysis also depicts some unusual fluctuations in regards to expenses. The Advertising Promotion (Print) expenses increased by 49.46% and the Advertising Promotion (TV) increased by 162.86% in the year 2011(Appendix-A). Further, there was observed a decrease of 17.88% in the total revenues as against the managements estimations of 3% increase in the year 2011. The financial performance and position of the company has been observed to be deteriorating in the year 2011, which exposes it to risk of manipulation in the financial statements. There is inherent risk that the management may manipulate the financial statements to conceal the adverse financial performance from the investors. The high rate increases in the advertisement expenditure makes it prone to the risk of fraud and misstatements. Thus, the auditor should assess the business risk as high in relation to the audit of Cloud 9 for the financial year 2011. Common-size Statement for the Balance Sheet of Cloud 9 The common size analysis has been conducted on the financial statements of the 2011 and 2010 as depicted in Appendix-C. From the results of analysis, it could be observed that cash as decreased significantly in 2011. In the year 2010, the company had cash balance which comprised 7.13% of the total assets. However, it decreased in the year 2011 to 0.98% which shows low liquidity position. Further, there has been observed to be a heavy reduction in the current liabilities in the year 2011. The current liabilities were found to be 45.87% of total assets as compared to 69.34% in the year 2010 (Appendix-C). This big margin decrease in current liabilities is the sensitive matter for auditor. Further, the interest bearing liabilities under non-current liabilities have also been showing surprising increase requiring the auditor to probe in deep. The audit of Cloud 9 for the financial year 2011 requires special attention to the following points: WS is taking up the statutory audit of Cloud 9 for the first time, thus, there is a requirement to discuss with the previous auditor on the riskiness of the entity. Further, company has started a new retail store in the year 2011 which is required to under rigorous scrutiny from internal control perspectives (Gramling, Johnstone, Rittenberg, 2012). In regards to financial statement items, the revenues are the most vulnerable because there has been observed a significant fluctuation. Company has not been able to meet the targets. Thus, revenue account needs to be tested on the completeness and accuracy assertions. The advertisement expenditure has also been identified as prone to fraud or error. There has been observed a sudden increase in advertisement expenditure in the year 2011. Thus, the advertisement expenditure account needs to be tested on the accuracy and completeness assertions. The interest bearing loan account has show increase at the high rate. Thus, the auditor is required to check that whether the loans taken by the company actually exists. Further, the interest bearing account also needs to be tested on the obligation assertion (Bagshaw Selwood, 2014). The company purchases inventory on free on board (FOB) basis. In this regards, it is essential for the auditor to verify that the right, completeness, and accuracy assertions of inventory account. References AICPA. 2016. Audit Guide: Analytical Procedures. John Wiley Sons. AICPA.2016. Audit Guide: Assessing Responding To Audit Risk In a Financial Statement Audit. John Wiley Sons. Bagshaw, K. Selwood, J. 2014. Core Auditing Standards for Practitioners. John Wiley Sons. Gramling, A.A., Johnstone, K.M., Rittenberg, L.E. 2012. Auditing. Cengage Learning.