Case Study Assignment- Audit Planning- Cloud 9 Pty Ltd (total marks 40)
W&S Partners commenced the planning phase of the Cloud 9 audit with procedures to gain an understanding of the client’s structure and its business environment. You have completed your research on the key market forces, as they relate to Cloud 9’s operations. The topics you researched included the general and industry-specific economic trends and conditions; the competitive environment; product; customer and supplier information; technological advances and the effect of the internet; and laws and regulatory requirements. The purpose of this research is to identify the inherent risks. The auditor needs to indentify which financial report assertions may be affected by these inherent risks. Identifying these risks will help determine the nature of the audit procedures to be performed.
Management implicitly or explicitly makes assertions regarding the recognition, measurement, presentation and disclosure of the various elements of a financial report. Auditors use assertions for account balances to form a basis for the assessment of risks of material misstatement. That is, assertions are used to identify the types of errors that could occur in transactions that result in the account balance. Consequently, further breaking down the account into these assertions will direct the audit effort to those areas of higher risk. The auditors broadly classifies assertions as existence or occurrence; completeness; valuation or allocation; rights and obligations; and presentation and disclosure.
An additional task during the planning phase is to consider the concept of materiality as it applies to the client. The auditor will design procedures in order to identify and correct errors or irregularities that would have a material effect on the financial report and affect the decision making of the users of the financial report. Materiality is used in determining audit procedures and sample selections, and evaluating differences from client records to audit results. It is the maximum amount of misstatement, individually or an aggregate, that can be accepted in the financial report. In selecting the base figure to be used to calculate materiality, an auditor should consider the key drivers of the business. They should ask, “what are the end users (that is, shareholders, banks etc) of the accounts going to be looking at?” For example, will shareholders be interested in profit figures that can be used to pay dividends and increase share price?
W&S Partners’ audit methodology dictates that one planning materiality (PM) amount is to be used for the financial report as a whole (that is, rather than separate PMs for the income statement and the balance sheet). Further, only one basis should be selected- a blended approach or average should not be used. The basis selected is the one determined to be the key driver of the business.
W&S Partners use the following percentages as starting points for the various bases:
Part 1- Materiality
Answer the following question based on the information presented for Cloud 9 in the appendix to this case study.
(a) Using the 30 September 2011 trial balance (appendix to this case study) calculate planning materiality and include the justification for the basis that you have used for your calculation. (10 marks).
Part 2- Analytical Procedures
Answer the following questions based on the information presented for Cloud 9 in the appendix to case study.
(a) Using analytical procedures and the information provided in the appendix, perform an analysis of Cloud 9’s financial position and its business risks. Discuss the ratios indicating a significant or an unexpected fluctuation. (10 marks).
(b) Prepare a common-size statement for the balance sheet of Cloud 9, use total assets as the basis for the balance sheet. Comment on any audit implications revealed by your statement. (10 marks).