Sealant Products Pty Ltd - Auditing - Case Study Example

Name : xxxxxx Tutor : xxxxxxx Title : xxxxxxx Institution : xxxxxxx @2009 Introduction Before accepting the engagement, the following procedure will be adhered to: First is to evaluate the management integrity so as to avoid irregularity and fraud which occurs when there is dishonest.Secondly,identification of unusual risks such claimants auditor lawsuit by knowing the intended user of this financial statements so as to adhere to legal liability.Thirdly,assessing the competence to perform so as to come up with the right staff to help in writing the audit report and doing the assement.Fourthly,assessing the independence as one of the code of conduct of standards of GAAS and also determination of ability to use due care by considering timing appointment and schedule of work field. 1. AUDIT ENGAGEMENT LETTER 28th September 2009 HIRD &CO. Ltd Dear: This particular letter is aimed at making a point of confirmation that our grasp and knowledge of the objectives and terms of engagement between us, limitation and the kind of services we are to give. We are going to conduct an audit of the balance sheet and financial statements of SEALANT PRODUCTS Ltd for the period as of thirtieth June of the year two thousands and eight, and we are also going to carry out other related operations. This letter assumes the role which a contract plays, and by this it means that the letter contains the main necessary terms that are aimed at enabling a successful role out of the engagement for the reason which it has been written. If, you undertake a thorough consultation and consideration involving the counsel if need be, you will certainly concur that the particular terms shall be a control tool to nature and govern the engagement, by so saying it is quit our humble request that we ask you to sign this letter in the space located below and then please let us get the original signed letter back, you should also keep a copy of the letter for your records. Yours truly, Michelle O’Loughlin Senior Accountant ACCEPTED AND AGREED: SEALANT PRODUCTS TPY LTD. _____________________________________ ___________ By: Date 2. Changes which are to Occur in the Organizational Plan The design, development, formulation and maintenance of the internal control systems of the company always have to do with the kind of the management of the organization. Therefore, there is need to prioritize it. The organization can have higher incidence of theft if its internal control is of low standards and not given much attention. Use of preventive and detectives’ controls in organizational management, up to date information system, improve on information and communication and ensure proper monitoring. 3. SEALANT PRODUCTS PTY LTD FINANACIAL RATIO ANALYSIS Ratio Current Quick Trade receivables turnover Days receivables Inventory turnover Days inventory Asset turnover Income to net worth Income to total net worth Income to total assets Liabilities to net worth Liabilities to total assets Times interest earned 2007 2.28 0.96 14.01 26.05 2.64 138.25 1.07 0.27 0.27 0.31 0.31s 3.07 15.31 2007 1.97 1.02 21.05 17.34 1.63 224.17 1.06 0.06 0.10 0.06 0.54 0.35 9.24 Industry Average 1.9 0.9 10.43 35.00 5.85 62.39 2.83 0.12 0.05 1.11 0.53 3.00 3.00 4. Financial Report analysis Financial Services increased more than double the company's growth rate: This Company is currently trading at 0.84 time’s sales. In the same twelve month which ended on the thirtieth of June of the year two thousands and eight, their was a five hundred and sixty six point two three recorded earning per share. Thus, the company paid 23.8% of its profits as dividends. Profitability Analysis, when compared to the year two thousands and seven the margin of the gross profit is somehow an improvement when the price of the commodities traded added up to seventy four point eight percent of the sales. As June 2008, the value of the company's inventory totaled $1,582,152. Since the cost of goods sold was $4,100,134 for the year, the company had 138 days of inventory the company turned over its inventory 2.9 times per year. When a comparison is done and taking the year 2007 and looking at the inventory there was a slight growth in the turnover by the month of June of 2007 a period when there was a lower inventory. The 37 days in inventory is much less than the 3 companies which were allocated for the comparison, the three companies consisted of between forty five to fifty eight days inventory at the end of 2007. Financial Position as of June 2008, the company's long term debt was $1520 and total liabilities (i.e., all monies owed) were$2,381,032. 0.50 is the figure of the longer period debt to Equity Company’s ratio. As of June 2008, the accounts receivable for the company were $595 901, which is equivalent to 100 days of sales. This is a higher figure with a standard period of the year ending two thousands and eight when Sealand Company had 102 days of sales in accounts receivable. 5. Business risks The risks of each segment would be significant to cause a business risks. Potential errors on the trade receivables and internal control system have a potential of giving a false report. Keeping in mind that, the company submits their financial report to the bank which has lend a loan, this might lead to a detrimental effect as far as the rapport is concerned now and in the future. This might also lead to a bad public image. Internal control of revenue cycle where the sales manger is responsible for accessing the customer without the consent of others may also encourage fraud as the manager is not directly accountable to any one. Lack of privacy of customer’s accounts, which can be accessed by anyone, makes it possible to cause fraud as some members of the management may collude to alter the accounts figures of the customers. This is apparent since the management avoided maximum interaction, thus it was not easy to prove their integrity. Tolerable Error Assessment SEALANT financial statements for 2008 will be consolidated with Hird & CO. Thus, calculate materiality and tolerable error for SEALANT CO, both general entity and consolidated entity. 6. Materiality Assessment for SEALANT CO general entity Expenses and Revenue, materiality is determined at 1% of total expenses as per 2007 actual. This is because using 2007 figures are closely related to 2008 budget figures. Choosing total expenses is because SEALANT CO. is a budget dependent entity.Thus,total budgeted expenses is considered as basis for calculating materiality as potential misstatement would occur in expenses. SEALANT CO 1% of $ 3,067,731 = $ 3, 0677.31 The balance Sheet materiality is determined at five percent for all the assets items. SEALANT 5% of 4,280,707 = $ 214,035.35 However, it is important to note that materiality may be influenced by account balances, for instance, regulatory and legal requirements. To further extend note disclosure accuracy for instance commitment notes and executive remuneration may render qualitative materiality irrelevant. SEALANT CO. It is considered appropriate that we set the % error of our materiality assessment: Revenue and Expenses,2007 had no many audit adjustment, thus assumed that it had medium control risks.Therefore,in 2008 tolerable error is set close to our materiality SEALANT: 95% of $ 3,067,731 = $ 2,914,344.45 In the Balance Sheet Items of 2007, there were errors found in fixed assets components. Therefore in 2008 our tolerable error is set lower as: SEALANT: 50% of $ 214,035.35 = $ 107,017.675 Summary of Audit Differences (SAD Errors found to be above tolerated error will be carried to the Summary of Audit Differences. the difference noted during the audit, both the material errors in judgmental and recorded amounts for instance, accrual estimates, if the client has not made the corrections, they are summarized in order to evaluate aggregate effect on financial statements materiality. Summary of Unadjusted Differences (SUD) Errors found to be less than the tolerable error, is to be carried to the Summary of Unadjusted Differences for the audit evaluation. The audit team needs to be accumulating non-material errors found during the audit and summarizing them after the field work. This is so as to verify if the total unadjusted misstatement have effect on the materiality on the financial statement. The audit The audit manager must review the SUD and make sure that the audit team accumulated and evaluated the results. The manager should consider qualitative factors when evaluating unadjusted differences. The financial statement might be affected by little amounts of qualitative factors which are misstated. Explained unadjusted differences must be included in the closing report as in the management representation letter. HIRD &CO Memorandum audit work paper CODE NAME COMMENT PLANNING PL1 Objective of examination descriptions of objectives PL2 Staffing of the engagement PL3 key relevant aggregate financial data calculations, including year data PL4 Control environment assessment internal control structure PL5 Control environment evaluation PL6 Company financing internal control structure analysis PL7 User of financial report Summary of applications PL8 rev,inv,exp,int,cap Audit materiality Summary for the audit response PL10 Likely adjustment PL11 Instructions to IT Audit Memorandum of evaluation of IT need for audit response PL12 rev,inv,exp,int,cap Likely opinion PL13 Rev,inv,exp,int,cap crS,caS,crN,caR,prL deN class testing of transaction TESTING Rev,inv,exp,int,cap Programme of audit test REPORTING RP1 report to management Client SEALANT CO Audit for year ending 2008 Examination Objectives FACTOR COMMENTS Objectives To find out the effectiveness of monitoring of company-level controls. To find out the progress of the company’s management with respect to the adherence to the action plans which were developed to tackle the deficiencies found when the 2008 assessment was carried out. To furnish the company’s management with a framework for auditing to be used when monitoring controls. Client SEALANT CO. Audit for year ending 2008 Staff engagement FACTOR COMMENTS Describe the kind of entity: Operations To find out the progress of the company’s management with respect to the adherence to the action plans which were developed to tackle the deficiencies found when the 2008 assessment was carried out. Leadership and Ownership Checks and controls the unprotected risks by initiating various strategies such as applying tests Planned or created investments Checks out and brings on board the stakeholders in every plan structure Control, budget and manage the resources Prepared by/Date Signature Reviewed by/Date Signature Client SEALANT CO. Audit for year ending 2008 Audit materiality FACTOR COMMENTS Discussion of source of data Expenses and Revenue, materiality is determined at 1% of total expenses as per 2007 actual. This is because using 2007 figures are closely related to 2008 budget figures. Choosing total expenses is because SEALANT CO. is a budget dependent entity.Thus,total budgeted expenses is considered as basis for calculating materiality as potential misstatement would occur in expenses. Operating profit base method 1657.2 ( 2007) and 59590.1 (2008) Profit base method $ Blended method 0.5% of assets ($ 4937454 ) 0.5% of revenue ($ 70,599 ) 5% of profit before tax ($ 970,878 ) 2% of gross profit after depreciation ($ 4248,863 ) 1% of equity ($ 4937454 ) 24668727 35299.5 4850043.9 934754.986 49374.54 Total 248024406.03 Average /5 49604881.21 Company’s aggregate financial data $ allocation Revenue/accounts receivable Expenditure/accounts payable Cost of sales/inventory Non-current assets (tangible) Non-current assets (intangible) Cash/deposits etc 35299.5 82002.68 79105676 1582152 7372221 TOTAL 102177351.18 $ Prepared by/Date Signature Reviewed by/Date Signature Control environment evaluation FACTOR COMMENTS Communication, integrity and ethical values - means Minimal communication between the management staff and he audit team. Integrity and ethical standards considerably compromised Commitment to competence – Minimum commitment to competency noted. Sales manager performed tasks in an upsurd way, and leaving customers’ accounts to accessible to any staff member. Participation (e.g., activities of audit committee) Minimal participation as the overall audit committee did not show maximum cooperation as expected Management’s philosophy The management philosophy of accountability, equity and transpar4ency was not adhered to Organizational structure The or5ganization has a vertical functional management structure, where devolution of powers and authority reduce as one descends down the management ladder. Human resource An active human resource but with a considerable number of redundant employees whose zeal is only money gain. Prepared by/Date Signature Reviewed by/Date Signature Risk assessment and monitoring FACTOR COMMENTS Changes in operating environment New personnel New or revamped information systems Rapid growth New technology New business models, products or activities Corporate restructurings Expanded foreign operations New accounting pronouncements) The new technology is not fully employed in the system. Therefore, there is minimum risk detection by the management. No new business models employed No signs of corporate restructuring No new accounting pronouncements No expansion to foreign operations. monitors internal control over financial reporting takes corrective action The monitoring of internal control over financial reporting was not collectively approved as some members of management board felt that our findings were not true. effectiveness of the risk assessment and monitoring The effectiveness of risk assessment carried out was thorough and effective as we were able to discover fraud in the organization’s Prepared by/Date Signature Reviewed by/Date Signature Audit risks engagement Conclusion/remedy Receivables& allowance for doubtful debts Identifies and resolves variances in data trends Study the information which is used to come up with financial reports Business Services and products offered Identifies risks of negative outcomes(including fraud) Evaluates the mitigation controls for risk prevention through correction and avoidance. Studies and controls uncontrolled risks by such as designing and applying tests) Disseminating the impact of risks which are unidentified and also recommend necessary action Contract Monitssoring Executes project start-up and planning activities objectives and reports on project progress Identification and management of the risks throughout the entire project Disseminate information regarding effectiveness of the teams and stakeholders Evaluates the documents and success lessons which were learned for future use Prepared by/Date Part B 1. Strength and Weakness in the System of Controls The Strength With regards to financial reporting, Sealant Products Pty Limited prepares the financial report each month. The management also meets each month to discuss the results and formulate plans aimed at improving those areas that are regarded as not up to the required set standards and level of performance. It also it enhances the quality of reporting, reviewing and approving reconciliations Sales and Credit sales orders are approved by the controller of credit and the sales manager; invoices are also numbered and kept by the sales manager, the sales manager also occasionally checks for mechanical errors in the prepared invoices. This is strength in the system controls and puts into practice the strategy of checking the mechanical accuracy of records which lowers the errors that might arise in the system. As far as control of computer applications and moiré so data files access is concerned the company has a well set strategies to ensure security and limit the likelihood of terrors arising. The company has well trained staff who handles cash payment and collections that mainly use the computer. The computer package used for cash payment allows creditors to be set up for credit terms, payee details, general ledger account coding and automatic cheques which are run either on due date or vendor. The supervisor has passwords to all functions of the system hence being the only person who can take or authorize any of the mentioned activities. This helps the company to limit the direct physical access to assets and records information by the employees and other individuals. SP maintaining and reviewing control accounts and trial balances effectively. A special purpose report is prepared each particular month for perusal by the management meetings. Copies are also sent to the auditors and Australian finance limited. Dannii always records non recurring journal entries while Mary Bayes approves them. After receiving approval from Mary, Dannii then posts the journal to the general ledger. Also every month Dannii prepares financial statements and forwards them to Mary. Cash receipts journals maintained by Barry and Jessica, sales journal is maintained by Li Wong and the purchases journal is maintained by Jessica Stevens. The above routine enhances the best practices which are aimed at comparing internal information & data with the external parties, comparing the results of the cash, security and inventory counts with accounting information and comparing analysis of financial management. The Weaknesses Despite the well structured and practices management procedures and standards, SP faces some risks as far as the systems of control are concerned. One of the potential weaknesses is in the sales cut off between accounting periods which might lead to occurrence of errors. This is because there is a possibility of an error arising while reconciling the general; ledger control account which is always aged on a monthly basis and in case there is an account that has outstood for more than one month, there is possibility of this account not being factored in the next month ledger because of either being forgotten or because of diversion of the payment transaction to someone else. In order to run a substantive test that would assist in possible detection of the error assuming that all the information is given you will have to employ the use of accounting database software which will help in forming and saving reports that will provide pertinent information about the vendors and customers. Each report provides different kind of filter options which is able to tailor each report to meet the detection of where the error arises from in the ledger. Another weakness that is evident in the systems of control is that the customers account ledgers and journals are not kept under key and lock, this makes it possible for any one to access them and to use them for his or her malicious interests. There is also a higher potentiality of the company having so many bad debts which can arise because of poor transactional procedures hence posing a big weakness to the company. Substantive tests that may help in possible error detection can be derived from test of details or analytical procedures. This involves testing of details that involves examining details of an account so as to draw conclusions about the reported account balance. An analytical procedure involves making conclusions focusing on amounts calculated by the auditor. First I will gather information so as to verify the completeness, accuracy or validity of account balances in the classes of transactions. This is so as to make sure there is no misstatement and that the classes of transactions are valid, materially complete and accurate. The substantive procedures include, physical examination of the inventory on the balance sheet, making validity assertion that accounting records exits.complteness assertion, by writing to suppliers to affirm that the amount owing at balance date in the accounts payable is complete. Make affirmation about collectibles of customers accounts as evidence that debtors accuracy to its valuation. In the event of class of transaction and account balance not being complete, accurate or valid, then there is evidence of substantive misstatement. The overall assessment of the internal control over inventory does not really need a performance of tests of control to be initiated but what the company needs in order to limit or even do away with the minor errors is to adopt an effective accounting data base software which will record and provide reference for all the inventory and accounting information. Audit for the year ending 2008 Substantive audit work programme Transaction class ACCONTS RECEIVEABLES & ALLOWANCE FOR DOUBTFUL DEBTS. Assertions/ Probability of material misstatements Controls to detect the misstatements prevention and how to overcome it. Level of Risk of material misstatement –high, medium or low and comment Verification and allocation Executes project start-up and planning activities Describes and carries out proper management of the budgets, schedules, finances and other resources. medium medium Completeness Management and Identification of the risks in the entire phases of the project Identification of project stakeholders in carrying out the implementation of plans Low Right and obligation Communicates effectively with project team and stakeholders Low Presentation/Disclosure Find out the progress of the company’s management with respect to the adherence to the action plans which were developed to tackle the deficiencies found out in the past. medium Prepared by/Date Signature Reviewed by/Date Signature Part 3 Memo Hird &Co Auditor General TO: Members of the Hird &Co   FROM: From Hird Auditor General   CC: Michelle O’Loughlin senior accountant Trevor cook  Date: June 30, 2008   RE: Performance Audit Work Plan for 2008   Process for developing performance audit topics To identify and prioritize potential performance audit topics, I followed general principles that topics would be: Of importance to residents and the organization; provide information to help develop annual audit plans for future years; give new ways for which the audit function gets to associate itself with the other departments and have a defined scope, making the audit work most manageable.  Time Performance Audit Details Receivables& allowance for doubtful debts Following procurement policies and procedures helps ensure receivables are spent responsibly. The performance audit would involve reviewing the number of receivable. Business Services and products offered Comparing financial performance for those activities carried forward from the previous years. Contract Monitoring Audit work would involve reviewing a number of contract files from different departments and comparing them with good practices, identifying any gaps.  The audit could identify areas for further audit work.   Other work  Preliminary review – The project was approved by our senior accountant and the management board of SEP ltd in April 2008 and involves reviewing the processes involved in carrying out our audit report. Recommendation follow-up – Hird & Co requires follow-up reporting, which provides information on management’s efforts to implement audit recommendations.  A follow-up report is to be provided before or on 31st August 2008.  I plan to provide the next follow-up report to the Hird & CO in September 2008   Purchasing Cycle Risk Analysis Strength of the System One of the outstanding strength in the system as far as the purchasing cycle is concerned is that all the finished goods are transported immediately before the company manufacturing plant closes for stocktaking. Another significant strength is that, the stock is usually included in the valuation of the perpetual inventory system. Hence freight in, taxes and any applicable discounts are capitalized into the cost of the inventory and at the end of each year a physical stock counting is done in order to verify the accuracy of the perpetual system. The stock is also placed in a fenced place where it is always locked after the business hours. To make counting of the stock easier and the stock more accessible, the client moved part of the inventory into the shipping dock, also the inventory are well organized in order to facilitate easier counting. Majority of the customer’s orders are often made and manufactured according to their required design then they are immediately transported to the customer which eases the congestions in the small company’s warehouse. The purchase of raw materials from abroad is done on a smaller percentage and the purchases are made in United States dollars and the title doesn’t pass to the company until the purchase is received. Weaknesses of the System There are very slight weakness of the purchase cycle and inventory system because the purchasing transactions are not very complex, the nature of the raw material for the company leads to a very low risk of theft. The risk of obsolescence is also at very low levels since the raw material is converted to an order immediately. For the imported raw materials the lead time in receiving the materials and the possible disruptions which might be caused by the disputes of maritime unions raises the level of risk of shortage of inventory. This risk is countered by having more local suppliers to provide more quantities than the ones imported. Process for developing performance audit topics To identify and prioritize potential performance audit topics, I followed general principles that topics would be: Of importance to residents and the organization; provide information to help develop annual audit plans for future years; give new ways for which the audit function gets to associate itself with the other departments and come up with a definitive scope, making the audit work most manageable.  Time Performance Audit Details Receivables& allowance for doubtful debts Following procurement policies and procedures helps ensure receivables are spent responsibly. The performance audit would involve reviewing the number of receivable. Business Services and products offered Comparing financial performance for those activities carried forward from the previous years. Substantive tests that may help in possible error detection can be derived from test of details or analytical procedures. This involves testing of details that involves examining details of an account so as to draw conclusions about the reported account balance. An analytical procedure involves making conclusions focusing on amounts calculated by the auditor. First I will gather information so as to verify the completeness, accuracy or validity of account balances in the classes of transactions. This is so as to make sure there is no misstatement and that the classes of transactions are valid, materially complete and accurate. The substantive procedures include, physical examination of the inventory on the balance sheet, making validity assertion that accounting records exits.complteness assertion, by writing to suppliers to affirm that the amount owing at balance date in the accounts payable is complete. Make affirmation about collectibles of customers accounts as evidence that debtors accuracy to its valuation. In the event of class of transaction and account balance not being complete, accurate or valid, then there is evidence of substantive misstatement. The top manager overall responsibility is to design and implementing effective internal control. He must have integrity and ethics and for a positive control environment. Managers assign responsibility for specific internal control policies and procedures to personnel responsible for the unit's functions Board of Directors: Effective board has the objective, capable and inquisitive. They also have knowledge of the entity's activities and environment, and commit time to fulfill board responsibilities. Auditors: measure the effectiveness of internal control through their efforts Substantive audit work program Transaction class INVENTORY BALANCES. Assertions/ Probability of material misstatements Controls to detect the misstatements Level of Risk of material misstatement –high, medium or low Valuation and allocation Existence Executes project start-up and planning activities Describe and program the schedules, resources and budgets in rolling out the objectives while giving a feedback through reports Medium Medium Completeness Describe and identify the risks in the project Describe and identifies stakeholders who are vital to the management Low Right and obligation Bring on board the stakeholders and partners in implement the needed change Low Presentation/Disclosure Use the lessons learnt in the past in binging future success to the projects Medium Prepared by/Date Signature Reviewed by/Date Signature Read More