AC2104 Seminar 5

Feedback on team activity in Sem 4

- Remember to explain reasons for need for testing
- Tracing must be followed up with using which exact documents and how it should be done

Seminar 4 Revision
- Audit procedures (by objective & type)
- Financial Statement assertions
- Sufficiency (quantity) & Appropriateness (quality relevance and reliability (source, nature and
circumstance)) of Audit Evidence

(Clicker qn) As one step in testing sales transactions, an auditor traces a random sample of sales
journal entries to debits in the AR subsidiary ledger. This test provides evidence as to whether:
a) recorded sale represents a bona fide transaction
- meant for vouching
b) all sales have been recorded in the sales journal
- AR sub ledger has individual customer accounts therefore does not support completeness
c) all debit entries in the AR sub ledger are properly supported by sales journal entries
- starting point is AR sub ledger and therefore is vouching and not tracing
d) recorded sales have been properly posted to customer accounts

Analytical Procedures Evaluations of financial information by study of plausible relationships among

financial and non-financial data.
- Comparison across financial information
- Relationships = ratios

Stage 1: Preliminary analytical procedures

- For risk assessment
- Use aggregate data to see possibility of high risk misstatement
Stage 2: Substantive analytical procedures
- To detect material (monetary) misstatement
- To assess reasonableness of assertions (depreciation and useful life)
- Use information to form expectation to see alignment to clients assertions/numbers instead of
detailed testing of individual accounts
Stage 3: Final analytical procedures
- Do ratios and fluctuations make sense
- Make overall conclusion

1) Evaluative procedures
Trend analysis look at fluctuations across time
Ratio analysis across time or to a benchmark

2) Predictive procedures (reasonableness analysis)

Development of model to form expectations between accounting period
- Warranty provision is an expectation formed by management based on past rate of return and cost
- E.g. regression

(Seminar Qn 1)
Calculate percentages on SFP and SPLOCI and check if it matches description
- Total sales should not be able to increase by 31.9% due to destruction of factory early in the
financial year and therefore production rates will be affected
- Possibility in recognising consignment as sales
- Increased competition from low cost companies
- Therefore, occurrence of sales and existence of AR are assertion concerns

- GP Margin = GP/Total sales

- Considerably high despite outlook

- Overheads increase by 10.29% despite decrease in production due to factory destruction

- Fixed overhead may not increase but variable increases due to sales
- Must clarify the proportion of fixed and variable overheads in 2015
- Completeness for expenses assertion questionable

- Interest Expense higher by 12.5% but loan has decreased and OD has decreased
- Completeness of loans assertion (may be understatement)
- Due to factory destruction, if factory used as collateral, bank might have new terms for interest

- PPE decrease minimal at 5.73%

- Existence of fixed asset assertion (overstatement chance)
- No depreciation information P/L shows no write-off due to destruction
- Completeness of write-off of PPE is a concern

- Inventories increased by 40% despite sales increase

- (increase inventories only affected by consignment if youre holding other peoples goods)
- Increase despite production and warehouse storage affected
- Existence assertion (overstatement)
- Fast-paced industry means demand for product is short-lived and hence inventory could become
obsolete fast. Therefore valuation is a concern.

- Bank overdrafts and bank loan drastic decrease despite no confidence in obtaining funds for new
factory

- Patents increase despite not obtaining as much patents

- Amortisation of patents is not recognised in P/L
- Impairment cost (expiry) not recognised
- Issue with valuation of patents
- Introduction of product into market without patent could mean copying competitors products and
hence legal issues contingent liability aspects

- Trade receivables increase

- Calculate AR Turnover or number of days outstanding (77.5 days CY, 86 days PY) despite credit
terms of 30 days
- DSO = (AR/Total Credit Sales) x 365
- Valuation of receivables an issue

- Not strong cash balance = liquidity problems

- Trade payables increase due to increase in inventories

- Ability of company to pay up an issue due to lack of cash (hence ability to survive is a going
concern)
- 78 Days to settle payables

- Completeness of disclosure with regards to dividends

 - Beginning RE + Profit after tax = 7000 but only 5375 recognised as retained earnings therefore
company might have declared dividends

Analytical Procedures as Substantive Procedures

Usefulness:
- Test of details of transactions/balance used if high risk of material misstatement
- Greater degree of disaggregation, greater precision of expectation (split lines for sales reports)
- Predictability of relationships (non-predictable is R&D) = greater precision
- Can make use of non-financial information, availability affects precision

(Seminar Qn 2)
- $ 315,843 is general bonus
- Assess reasonableness: Recorded is 300,000; as percentage, there is 5.3% variation and hence
bonus is reasonable/unreasonable
- Some stick to universal standard of 5% benchmark for provision reasonableness
- Can inquire with management about reason for variation above 5%

*Look at fig 5.7 in textbook for procedure