Graduate Auditing Theory and Practice - Assignment Example

Running Head: Graduate Auditing Theory and Practice University Name: For the purpose of giving the shareholder a fair view regarding the performance of the Firm, different analysis techniques can be employed. For the purpose of comparison I have employed ratio analysis technique as a principle method in analysing the company’s performance. Ratios expressed in this comparison have either been expressed as a percentage or as a quotient. In this way they are aimed at examining in detail the overall picture portrayed by the final statements to ensure that the equity shareholders i.e. the suppliers of the basic risk capital gets the information they need in terms of investment returns. The same analysis would also be of a similar importance to the internal management as well as the company creditors. Horizontal Analysis Turnover For the year ended 31st Dec 2004 the turnover was ₤10,490. This shows an increase using the turnover rate of ₤14,485 for the year ended 30.09.05. The difference is ₤3995. To Complete the Total asset turnover for the financial year for the year ended 31.12.04 Total asset turnover = 10,490 = Sales 26,616 Total assets = 0.394 For the year ended 30.09.05 Total assets turnover = 14,485 41,710 = 0.347 Using the trend analysis to interpret the two ratios, the year ended 31.02.04 shows a better performance compared with the notion outcome of the year ended 30.09.05 To conclude the profitability ratio by using the total asset turnover ratio of the Krypton ltd Company may not be final. I would still expect to do some companies with other firms’ dealing with similar commodities that is inter-firm companion. This entails companion of this ratio for a number of different firms the same industry. Such attempt would facility comparative study of financial position and performance of the firms in the industry. In using this comparison, the most important fact to be taken care of in the variations of the accounting system changes in the policies and procedures of the firm. The targets of the krypton ltd co. must also be taken into consideration. For the purpose of getting a fair and true view of the profitability of this company basing on the turnover ratio it is important to compare with the standard set. The best example of such standard is the 1:1 ratio which is to be considered a good ratio for analyzing acid –test ratio. Acid test ratio relates liquid assets that are (current asset less stock) to current liabilities. i.e. Acid test ratio = Current Assent less stock Current liabilities. (This ratio of 1:1 is usually ideal and satisfactory) Cost of Sales This is the cost incurred in order to deliver the art of order achieved. It shows how efficiently the firm is employing the available resources. (Edgar, 1989) For the year-ended 31.12.04 the cost of sales is ₤ 5,710. There is an increase in the cost of sales as shown in the P&L A/C for the year ended 30.09.05. Using this information for the year ended 31st.12 year 2004, is more profitable due to the less costs incurred. However to get picture of the performance, rate of turnover ratio is needed to be completed. Rate of stock turnover = Cost of sales Average stock Average stock is the average of opening stock and closing stocks. For the two years the opening stock is not available, but for comparison purpose let’s assumes the opening stock amounts to $100. For the year ended 31.12.04.Implying that – Rate of stock turnover = 5,710 = Cost of Sales 366+100 Closing stock+openingstock 2 2 = 5710 233 = 24.506 For the year ended 30.09.05 Rate of stock turnover = 6290 = 6290 = 9.26 579+100 679 Rate of stock turnover is an activity ratio which measures the efficiency of a firm in employing available resources . for this reason there is need to compute the degree of effectiveness of asset utilization in the business activities. Using the two figures computed in the two final years, it seems there is a decline in the efficiency or a fall in demand for this company’s products. This is based on the fact that the rate of stock turnover decreased from 24.506 in the year ended 31.12.04 to 9.26 for the year ended 30.09.05 Gross profit The gross profit in the year ended 30.09.05 is higher compared with the previous financial year. Without considering the expenses to be achieved this shows a great increase in the amt of gross profit. The gross profit ratio, as a revenue ratio is used to indicate the margin of sales price compared to factory cost. For the year ended 31.12.04 Gross profit ratio = 4780 = Gross profit 10,490 Sales = 0.4556 For the year ended 30.09.05 Gross profit ratio = 8195 = 0.556 14,485 The year ended 30.09.05 has a higher margin activity more profitability. Distribution Cost The distribution cost is higher for the year ended 30.09.05 than for the year ended 31.12.04. This dramatically reduces the higher gross profit obtained in the earlier year. Excluding the administration expenses incurred thereafter, the gross profit would be higher, assuming the difference of ₤152 in the distribution expenses would be less. Opening Profit Due to the higher gross profit incurred in the year ended 30.09.05 the opening profit gives a higher figure with a difference of 1024. /to compute the krypton PLC profit that is available for distribution, there is need to get the post – tax profit figure (profit available for distribution) For the year ended 31.12.04, Profit Margin = 1661+100 = profit and taxation before interest 10,490 Sales = 0.158+100% = 15.8% For the year ended 31.09.05 Profit margin = 1445 = 0.099x100% = 9.9% 14,485 Implies that the profit available for distribution for the year ended 31.12.04 is higher that the one available for the company investment for the year ended 31.09.05 with a difference of 5.9% Profit before Taxation Due to drastically less met interest incurred for the financial year ended 31.12.04, the profit before taxation is higher as compared with the net profit for the year 30.09.05. Profit after Taxation The profit after taxation for the year ended 30.09.05 is higher as compared to the profit after taxation for the year ended 31.12.04. Return on investment ratio (ROI) which may also be referred to as the returns on owner’s equity ratio can be computed to gauge the profitability of the two financial years. For the year ended 31.12.04, ROI = 981 x100 = profit after tax 1065 Total share capital =92.1% For the ended 30.09.05 ROI= 995 x100 1065 =93.43% Using the above ratios the return on owner’s equity seems to be higher for the financial ended 30.09.05 Dividends The dividend paid up for the year ended 31.12.04 is higher than the dividend paid up for the year ended 30.09.05 with a difference of 100₤. To determine the actual dividend that could be paid out of current profit and also the proportion of undistributed profit for the two years, there is need to compute the dividend cover ratio. (Mahadeo, 2000) For the year ended 31.12.04 Dividend cover = 981 = Net profit after taxation 630 Total ordinary dividend =1.557 For the year ended 30.09.05 Dividend cover = 995 530 = 1.8777 Comparing the above two ratios, the dividend cover for the year ended 30.09.05 is higher than the one of the financial year ending 30.12.04. This indicates that the ordinally share holders of the Krypton PLC have a higher confidence of getting adequate returns on their shareholdings on this particular year as compared to the year ending 31.12.04 Profits Retained For the true financial years, as shown in the profit and loss account the year ending 30.09.05 was more profitable since the profit retained that year is 465₤ which is higher that the retained profit from the previous financial year ending 31.12.04 with a difference of 114₤ Ratio analysis is an important tool of financial statement analysis. In this circumstances Krypton Ltd CO. would therefore benefit in the following ways using the ratios computed as shown 1) They are the simplest ways of guiding the management in formulating their future financial planning and policies. 2) It would throw to the management a light on the efficiency of the business organization. 3) By comparing the firm’s figures with similar firms and possibly with industry – wise data, it would be make the company to have a sound financial condition. 4) Using the variations in the distribution cost of Krypton and putting into consideration the Net profit thereafter this analysis would ensure effective cost control of the company. The most disastrous outcome of a firm is to be declared insolvent. Using the ratios as analyzed above, this concern would be able to measure its solvency besides its profitability. As far as the ratio analysis is used, few limitations concerning this technique must be put into consideration. The variances are shown by different ratios as computed for this particular company may be as a result of some of the following factors. i) Since there are no standards with which to compare, they fail to throw light on the efficiency of this company. ii) They may fail to indicate immediately where and when the mistake occurred. iii) Due to seasonal factors, these variations may have resulted iv) Inter-firm comparison may not be so much effective due to the fact that ratios vary enormously between different firms v) The given set of accounts cannot fully be relied upon to show a complete picture of this company’s activities as far as we rely on these ratios. Audit Report 1 Stock accounts of the company The stock for the year ending 30.09.05 is 579₤, which is higher than the stock as at the year ending 31.12.04. This is an area where I would engage a technical valuer to get the actual stock without relying on the report from the management. Audit implications According to Ray (2000) there are some frauds likely to be found in the stock account of the Krypton’s plc. This may include: - Since the krypton plc supplies bottled gas and appliances, which may be great in number there may incorrect additions in stock sheet There may be incorrect valuation of stock in trade that is the stock was valued at selling price Over valuation of stock by not providing for damaged, slow moving or obsolete stock Inclusion of the stock (bottled gas) sold to customers and already recorded in the sales book but has not yet been delivered to customers. Inclusion of such stock in stock sheets but the invoices relating to them has not been recorded in the purchases book. Taxation The tax reduced from ₤540 in the year 31.12.04 to ₤450 in the year ending 30.09.05 this reduction would be my concern in the audit process, the fraud may involve tax avoidance, thus in the verification of taxation my concern would be: - To check the internal control system in particular tax computation and recording, this should be done by different people. To obtain a schedule of tax liability and search through the schedule to asses its reasonableness. To request a tax paid receipts for the two years from income tax department and trace the entries therein with those in the tax schedule in (ii) above To recomputed tax liability for the two years. To ensure the tax liability as properly recorded. (Norman, 1998) Dividends This is another area where I would still be interested in. The fraud may involve payment of fewer dividends by the directors to the shareholders with an aim of misappropriating some of the shareholders returns. As an audit manager I would verify whether- There was press publication regarding the announcements of dividends which I would compare with the records in the company, There is any relationship between dividends received against the number of shares held by the company. Dividend warrants have been deposited with a bank for collection, Krypton plc Should allow me to write to bank and obtain a certificate to this effect. Distribution Costs Comparing the distribution cost of the two financial years, there is a drastic increase for the year ending 30.09.05. There may be a possible fraud within the distribution department in form of dummy costs in term o0f fuel consumption and other related expenses. (Reginald, 2003) My interest would to verify whether: - Fuel consumption in the process of distribution is related with the distance covered in the process bearing in mind any allowable extra expenses. The allowances agreed apron by the management of the company and the distribution department for this purpose has been keenly upheld. Proof of this in terms of receipts would be required as a basis of determining the credibility of these costs. Cash This is an area where possibilities of fraud is high unavailable cash may be shown in the balance sheet of the Krypton plc. Thus as an audit manager I would not hesitate to: - Visit Krypton plc at the balance sheet date and count cash at hand and compare this with cashbook entries Count the cash in the presence of cashiers responsible, if there were any shortage, I would request a certificate of shortage from the cashier concerned this will have to be mentioned in the management letter. Company’s Debtors Since the krypton plc has sold its debts to another financial institution, the fraud here may involve underestimating of the bills receivable by the management with a aim of diverting some of the amounts recoverable to their own accounts. (William, 1999) As an audit manager my steps would be – (i) Review the internal control system regarding the company’s bills receivable management. (ii) Check bills dishonoured, because such may have been paid and fictitious entries made to show that such a bill was dishonoured in order to conceal a fraud of misappropriation. Reference Douglas, R. (2000): Auditing Concepts and Methods. New York, McGraw-Hill Edgar, N. (1989): Essentials of Public Administration, Michigan, Staples press Hans, B. (1995): Reflections on Auditing Theory, London, Phillip Wallage. Lawrence, R. (1998): Auditing; A Practical Manual for Auditors, New York, Ayer Publishers Mahadeo, P. (2000): Public Administration in Theory and Practice, Bombay, Kitab Mahal. National Conference of Professors of Educational Administration (2001): Theory And Practice Of School Finance, Rand, McNally Norman, D. (1998): Tax Administration in Theory and Practice, Michigan, Praeger publishers. Ray, W. (2000): Principles of Auditing, London, Irwin Reginald, A. (2003): The Railroad Travelling Auditors Work and Methods, Theory and Practice, Davenport, H.S Crocker Co. Robert, H. (1998): Auditing Theory and Practice, New York, the Ronald Press Company William, B. (1999): The Personnel Function In Educational Administration, New York, Macmillan. Read More