Audit Assignment Case Solution
After applying analytical procedures over the balance sheet of Waren Sports Supply, we conclude that the cash, accounts receivable, inventory, federal income tax payable, notes payable and retained earnings of the company increased by 12%, 6%, 4%, 2%, 8% and 13%respectively in 2017 however fixed assets, accounts payable and common stock of the company decreased by 31%, 2%, and 23% respectively in the same year.
As from the balance sheet we conclude that the company obtained debt in 2017 therefore, it is possible that to enhance the liquidity position of the company they may create fictitious customers and records their receivables.Along with this, it is also possible that they may record obsolete inventories to improve its current assets portion and other items such as prepaid expenses, marketable securities, and account receivables may also be fictitious only to improve the overall position of the current assets.
Areas with the highest risk of Material Misstatement:
From the analytical review of income statement, we conclude that the cost of goods sold is 67.78% of net revenue, however, the total operating expenses are 19.49%.There is a risk that company may record some of its cost of goods sold expense in the operating income and vice versa to improve the overall gross margin and net margin of the company. If this is the case, then it is against the accounting standards hence it will be considered as the misstatement because it does not present the fair view of the operations. If the bonuses of the management are linked with the gross or operating margins of the company, then this risk will increase by a significant level.Moreover, if we assess the breakdown of these parts on the basis of materiality, then we will conclude all particulars of the cost of goods sold and advertising expense, wages and salaries, rent, repairs and utilities, depreciation and other operating expenses from total operating expenses which are above the predefined level therefore, auditors have to obtain sufficient and appropriate audit evidences about these accounts.
According to ISA 240,responsibilities of the auditor relating to fraud in an audit revenue is considered as one of the most sensitive account balances.There are higher chances of fraud in this account balance therefore, the auditor has to assess this account with skeptical mind and has to obtain sufficient and appropriate audit evidence about the revenue of the Waren Sport Supply.
However, from the analytical review of the balance sheet, we conclude that the cash balance of the company increased by approximately 12% in 2017. In a sport company increase in cash by 12% will be considered as significant increase. Moreover,due to this increase the risk that the company may be used as a vehicle to convert black money into white money (money laundering)has increased therefore,the risk of material misstatement due to fraud is high in this account balance.Moreover, the reported balances of receivables, inventories, and marketable securities are above the materiality threshold. From these accounts,marketable securities are one of the items, therefore, the risk of material misstatements are high in this account.
Along with this, the fixed assets of the company decreased by approximately 27%.The decrease may be due to the impairment if this is the case, then the impairment should be recorded separately at the face of the income statement of the company but income statement of the company does not represent any such item, therefore, the risk of material misstatement due to error is high in respect of this.
Furthermore, from the balance sheet of the company we can see that the company obtained loan finance in the current year, therefore, it is possible that to obtain this finance company may provide misstatement about numerous account balances of its financial statement, therefore, this increases the overall risk of material misstatement in the financial statement of the company.
The above areas will increase the overall audit risk of the company, therefore, the auditor has to perform more procedures and has to obtain more audit evidence in relation to all these areas to reach an appropriate conclusion.
Audit strategy sets the overall timing, direction, and scope of the audit. After assessing the inherent, control and deduction risk an auditor can estimate the overall audit risk. After this assessment auditor will design the nature, timing, and extent of audit procedures that can be used in reducing audit risk to the acceptable level.
Audit risk is defined as the risk that an inappropriate opinion on the financial statements has been drawn by the auditor. Audit risk is resulted by combining three factors inherent risk, control risk and detection risk.
Inherent risk is defined as the risk of material misstatement which is due to the nature of the product, account or thing i.e. gold is considered as a risky commodity because the risk of theft is high in this commodity. Hence we can conclude that the inherent risks are natural risks which can only be reduced by installing effective controls………………
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