Financial Statement Accounts - Assignment Example

Title: CASE STUDY ASSIGNMENT-AUDIT PLANNING-CLOUD 9 PTY-LTD Name: Tutor: Institution: Date of Submission: Question 1 Reporting materiality= 12/9 × $184679 × 5% = $ 12,311.93 Planning materiality = ½ of reporting materiality =1/2 × $12,311.93 = $ 6,155.97 Justification for the basis used for the calculation There are two steps of calculating materiality. The first step is to determine reporting materiality. A misstatement in excess of this amount would result in the financial statements being materially misstated. Reporting materiality is normally calculated as 5% of net income from continuing operations. If the company has a tax minimization objective, then it is computed as 1% of revenues. The second step is to determine planning materiality or tolerable error. Planning materiality is normally calculated as ½ of reporting materiality. Financial statement accounts greater than planning materialities are considered significant because they might contain a material misstatement. Most of the audit work is concentrated on significant accounts. Accounts less than planning materialities are considered insignificant. Planning materiality is set at ½ of reporting materiality to reflect the possibility of both overstatements and understatements. If most of the audit work is made after year end, planning materiality is based on the client’s preliminary financial statements. However, because most audits involve significant interim work, these calculations are initially made based on pro-forma statements. The pro-forma statements consist of actual year-to-date results plus projections for the remainder of the year. To compute the reporting materiality, the nine months operating income was therefore adjusted by multiplying the value by 12/9 to reflect the actual results. Question 2 (a) Measures of financial strength The ratios showing financial strengths include commonly used liquidity ratios, and they help a company evaluate its ability to pay its short-term obligations. This includes; Current ratio = current assets / current liabilities From the balance sheet total current assets in 31st December, 2010 and 31st December 2009 are, 23, 459, 329 and 27, 046, 502, respectively. The total current liabilities are; 17, 050, 818 and 22, 427, 671, respectively. Therefore, the current ratios are; For 2010, the current ratio = 23, 459, 329/ 17, 050, 818 = 1.37585 For 2009, the current ratio = 27, 046, 502/22, 427, 671 = 1.2059 The other ratio is quick ratio. This is considered because in most cases inventory is difficult to convert into cash. The quick ratio emphasizes assets that easy to convert into cash; Quick ratio = (current assets – inventory)/ current liabilities In 2010, the inventory is 6, 263, 242 and in 2009 it was 6, 796, 990. Therefore quick ratio for 2010 is (23, 459, 329 -6, 263, 242) / 17, 050, 818 = 1.0085 For 2009 is (27, 046, 502 - 6, 796, 990) / 22, 427, 671= 0.9029 Note: The higher the ratio, the better is the company. Ratios greater than 2:1 for the current ratio or 1:1 for the quick ratio is good and safe, whereas those less than 2:1 or 1:1 is a sign of a company’s inability to meet its obligations. From the analysis, the company was in a better position to meet its obligations as for the year that ended at 31st December, 2010, than for that which ended on 31st December, 2009. To analyze strength also debt to equity and debt to assets ratios are computed. These are also called leverage ratios and they measure the portion of a firm’s asset provided by the owner versus that provided by others. Debt equity = total debt / owner’s equity For the 2010, the total debt was total liabilities – payables = 10, 386, 849 and owner’s equity = 5 789 186 For the 2009, the total debt was total liabilities – payables = 11, 257, 203 and owner’s equity = 5 063 032 Therefore, the debt equity for 2010 was1.7942 For 2009, the debt equity was 2.2234 Note: This ratio helps the firm to know what to buy and what not to buy. Question 2 (b) Common-Size Statement Cloud 9 Pty Ltd 30-Sep-11 31-Dec-10 Current Assets $ $ Cash assets 245,965 1,753,765 Trade receivables 10,552,109 19,701,064 Inventory 5,924,136 6,263,242 Financial assets 4,469,759 4,075,205 Prepayments of other assets 1,112,028 666,054 Total current Assets 22,303,997 23,459,329 Non-current Assets property plant & equipments 1,449,330 852,965 Deferred tax assets 346,949 277,559 Total Non-current assets 1,796,279 1,130,524 Total assets 24,100,276 24,589,853 Current liabilities Payables 10,323,185 8,413,818 Interest bearing liabilities 9,127,218 8,240,091 Current tax liabilities 159,866 207,893 Provisions 247,746 189,015 Total current liabilities 19,858,015 17,050,818 Non-current liabilities Deferred tax liabilities 198,647 170,284 Interest bearing liabilities 1,500,000 Provisions 153,912 79,566 Total non-current liabilities 352,559 1,749,850 Total liabilities 20,210,574 18,800,667 Equity Issued capital 5,448,026 5,448,026 Reserves 247,638 259,498 Accumulated losses -1,805,962 600,658 Total Equity 3,889,702 5,789,186 Total liabilities and Equity 24,100,276 24,589,853 Comments: The amount of cash receivables flowing through the accounts in both periods is significantly high and is an indication of the progress of the business. It is important to note that cash is vital to the survival of the business and inability to pay debts arises due to shortage of cash and this can render a firm insolvent. Therefore, cash has a greater materiality. It has also been noted that there is a high volume of transactions which contributes to a significant level of inherent risk. There are also some levels of misstatements in the accounts especially when one looks at the balance sheet. Question 2 (c) The following places should have special emphasis and they include transactions that produced audit risk at some stage in the sample testing phase, reviews on all documentation, as well as approval of the financial transactions and authorization. And also review of the company’s segregation of duties and company management’s disclosures in financial statements. The preliminary judgment about materiality is the upper limit amount the auditor considers the statements could be misstated and still could not impinge on the decisions of reasonable users. It is determined early in audit. There are two reasons for allowing the sum of tolerable misstatements to exceed overall materiality. First and foremost, it is unlikely that all accounts will be misstated by the complete amount of tolerable misstatement. Secondly, a few accounts are likely to be overstated while others are likely to be minimalist or understated, adding up to net misstatement that is likely to be less than overall materiality. Memorandum Subject: Potential problems areas To Suzie Pickering senior auditor From Auditor The following are potential problem sources.  Flow of transactions related to the relevant assertions, including how these transactions are authorized, initiated, recorded and processed;  Misstatement as result of fraud  Controls or Checks which the management has put into operation to address these potential misstatements  Controls that management has put into operations over the avoidance or timely detection of unauthorized disposition of the company's assets, acquisition or use. The following accounts and related assertions would require particular attention and for each line in the financial statements, management makes five assertions as illustrated below. Completeness Existence or Occurrence Rights and Obligations Presentation and Disclosure. Valuation or Allocation References Metcalf, R. W. (1976). Principles of Accounting. Philadelpia: W B Saunders. Myers, J. N. (1969). Financial Statement Analysis. Englewood Cliffs: Prentice Hall. Read More