Influence of Audit Risk and Materiality Guidelines on Auditors Planning Materiality Assessment

Planning materiality is the maximum amount of statements that could be misstated by way of any unknown fraud and errors as believed by auditors that would not have any impact on the financial or investment decisions made by the users of financial statements. It is required to quantify the materiality levels as per the clarified accounting standards and such estimates helps in guiding the decision making of auditors.

For the computation of planning materiality or the tolerable level of misstatements at any given level of financial statements, a general range of percentage is used based on the moderate level of risk. Planning materiality is computed at the higher level if the level of risk is extremely low. On other hand, the planning materiality level is calculated at lower level when the level of financial statement risk is high. It is the professional judgement of auditors that determines the illustrations of the percentage factors that results from the assessed level of financial statement risk. The lower limit relating to any significant items in the financial statements is determined by the performance materiality that depends upon the low or high risk respectively (Amiram et al. 2017). Therefore, it can be concluded that planning materiality plays a very significant role in their audit decision making and accordingly representing a true and fair view of the financial statements.

The given case study is about the company Cloud 9 Pty Limited that is a retailer and manufacturer of the customized basket ball shoes. Company operates in number of countries which is indicative of the facts that it has large scale business. An auditor of Cloud 9 is interested in knowing the planning materiality for determining the estimated amount of misstatements in the financial statements so that they can develop the audit strategy (Audsabumrungrat et al. 2015). For planning the audit, auditor relies on the projected yearend balance that is of approximate value for computing the planning materiality. The several bases that can be used by the auditors to compute the materiality of the Cloud 9 includes turnover which is at 0.5%, profit before tax at 5%, total assets at 0.5%, gross profit at 2% and equity at 1%. For calculating the materiality base, auditor takes into account profit before tax. However, if the entity reports loss in any financial year, profit before tax cannot be used as the basis of calculating planning materiality.

Table 1:

The Effect of Materiality Disclosures on Investors Decision Making

(Source: created by author)

It can be seen from the table that total assets value form the basis of computation of planning materiality. Items of total assets impact the estimates of planning materiality and they make the material misstatement susceptible. Assets are considered important factor as they have function at international level and forms the significant source of earning (Baldauf et al. 2015).

The financial position and the business risk of Cloud 9 are evaluated by using the analytical procedures that requires calculation of various ratios. Calculation of ratios helps in critically analysing the risks associated with the overall financial position (Eilifsen et al. 2017). The efficiency, solvency, liquidity and profitability position of Cloud 9 is analysed by the computation of several ratios.

The efficiency of company in generating return to its investors is measured with the help of profitability ratio. It can be seen from the table above that the gross profit margin declined in year 2016 by 1.04%. The reason attributable to the declining revenue is reduction in sales volume. On other hand, the net profit margin has increased significantly in year 2016 by 1.36 and this increase is due to the falling cost. It is the responsibility of auditors to identify any errors and omission that is the cause of any misstatement and how the revenue is impacted (Christensen et al. 2018).

The ability of company to effectively manage its assets and liabilities so that it is capable of generating income or cash overtime is measured by the efficiency ratios. There has been decline in inventory turnover ratio in year 2016 from 4.511 to 3.965 in year 2015 indicating that the inventories are not efficiently managed. For receivables turnover ratio, there has been decline from 3.816 in 2015 to 3.027 in 2016 that the collection process and credit policy is not effective. It is therefore required by Cloud 9 to work on their credit policies and collection process.

From the above table, current ratio initially increased to 2.565 and decreased subsequently to 1.45. This is indicative of the fact that in current year, current assets is not sufficient to meet the short term liabilities and there is a dearth of cash in the business. Now, looking at the figure of the quick ratio depicts that ratio has increased by 0.688 in year 2015 and further it decreased to 0.728 in year 2017. It is suggested by the figures that the liquidity position of company in the current year is not favourable.

Examining the Effect of Audit Materiality and Sensitivity Analysis Disclosures on Investors

The figures suggest that the total amount of debt in the company has reduced and there has been reduction in the financial leverage in the current year.

The team members of audit are required to describe the procedure of audit in respect to account balances, specific classes of transaction and disclosures. In the current time period, Cloud 9 has witnessed a decline in the sales volume and this call for the audit to conduct an examination of the revenue figure. For analysing, whether the sales figure has been overstated or not, auditors should carry out the process of vouching. The financial position could also be impacted by the sceptical movement of the figure of debtors and stock that has been piled up (Messier and Schmidt 2017).

The report is prepared to analyse certain disclosures regarding compensation paid to the executives of three companies listed on the Australian stock exchange. These three companies include Agrimin limited, Aeris limited and Alara resources limited.

The information on the remuneration paid to the executives is shown below:

Remuneration of key management personnel of Agrimin Company:

(Source: Agrimin.com.au 2019)

The executives of Agrimin Company are paid by way of cash bonus that is measured against the KPI and is approved by directors. Executives are paid by way of defined contribution plan, share based payment transactions and short term benefits. Directors are responsible for approving the STI and LTI that is payable to chief executive officer (Agrimin.com.au 2019).

Remuneration of key management personnel of Aeri Company:

(Source: Aerisresources.com.au 2019)

The above table represents the remuneration payable to the executives of Aeri resources limited. It is the responsibility of the remuneration committee to determine the remuneration elements relating to STI and equity that is based on the performance of company and personal performance of employees. A fixed remuneration of senior executive comprised of basic salary, superannuation, salary continuance insurance, base salary, leased motor vehicle and coverage for incapacity and death (Aerisresources.com.au 2019). It is the responsibility of the board to conduct annual review of fixed remuneration.

Remuneration of key management personnel of Alara resources:

(Source: Alararesources.com 2019)

The key management personnel of the company are paid fixed amount of salary along with the superannuation contribution. No retirement benefits are provided to the employees other than entitlement to unused long and annual service leave. The executives of Alara resources limited are paid in terms of short term benefits and long term benefits. Short term benefits include fees, salaries, allowances, cash bonus, non cash bonus and others. In addition to this, there is post employment benefits comprising of superannuation an end of service or termination and equity based payments (Alararesources.com 2019). The highest payment is made to the key management personnel of Aeri Resources Company with the short term benefits totalling to $ 2932552.

Calculation of Planning Materiality and Its Significance in Audit Decision Making

The above section depicts the analysis of the remuneration payment made to the executives of three ASX listed companies. Total amount of remuneration paid to the executives of the company is directly related to the performance of the business. However, all the executives of the companies are entitled to the payment of fixed amount of remuneration in addition to other benefits such as bonus and equity instruments and exercising performance rights (Lakis and Masiulevi?ius 2017). Moreover, there is remuneration that is linked to the performance of executives. The remuneration framework of companies embodies some of the principles such as structuring the remuneration that is competitive and reflects the accountabilities and duties of executives.

Conclusion:

The aim of the companies listed on ASX tends to reward their management personnel with a mix and level of remuneration that commensurate with the responsibilities and position. This is done to ensure that executives are provided competitive remuneration that aligns with the standard of market. From the observation of the data relating to remuneration in the annual report of the companies, it can be seen that data have been segregated properly which enable the users to understand the type of payments that is received by executives.  However, the companies can take some efforts to make a detailed explanation of the compensation data and more elaborated presentation.

References list:

Aerisresources.com.au. (2019). Annual Reports. [online] Available at: https://www.aerisresources.com.au/investor-centre/annual-reports.html [Accessed 2 Feb. 2019].

Agrimin.com.au. (2019). Agrimin Limited. [online] Available at: https://agrimin.com.au/ [Accessed 2 Feb. 2019].

Alararesources.com. (2019). Alara Resources Limited. [online] Available at: https://www.alararesources.com/IRM/content/default.aspx [Accessed 2 Feb. 2019].

Amiram, D., Chircop, J., Landsman, W.R. and Peasnell, K.V., 2017. Mandatorily disclosed materiality thresholds, their determinants, and their association with earnings multiples.

Audsabumrungrat, J., Pornupatham, S. and Tan, H.T., 2015. Joint Impact of Materiality Guidance and Justification Requirement on Auditors’ Planning Materiality. Behavioral Research in Accounting, 28(2), pp.17-27.

Baldauf, J., Steller, M. and Steckel, R., 2015. The Influence of Audit Risk and Materiality Guidelines on Auditors’ Planning Materiality Assessment. Accounting and Finance Research, 4(4), p.97.

Christensen, B.E., Eilifsen, A., Glover, S.M. and Messier, W.F., 2018. The Effect of Materiality Disclosures on Investors’ Decision Making.

Eilifsen, A., Hamilton, E.L. and Messier Jr, W.F., 2017. The Importance of Quantifying Uncertainty: Examining the Effect of Audit Materiality and Sensitivity Analysis Disclosures on Investors’ Judgments and Decisions.

Lakis, V. and Masiulevi?ius, A., 2017. ACCEPTABLE AUDIT MATERIALITY FOR USERS OF FINANCIAL STATEMENTS. Journal of Management, 2(31).

Messier Jr, W.F. and Schmidt, M., 2017. Offsetting Misstatements: The Effect of Misstatement Distribution, Quantitative Materiality, and Client Pressure on Auditors’ Judgments. The Accounting Review, 93(4), pp.335-357.