Materiality Amount and its Impact on Audit Budget

The report is prepared with the intent of assisting the planning stage of small audit client from the viewpoint of an audit firm. The audit firm would be carrying out the audit work of Amarnath Enterprises by using its preliminary trial balance. The first part would emphasise on ascertaining whether the materiality amount of $15,500 is suitable along with the impact of materiality assessment on audit budget. The next segment would conduct an analytical review of the items in the income statement from trial balance by utilising trend analysis. After this, three items from the income statement at risk would be detected based on which audit processes would be recommended for each account. Finally, the report would focus on fraud risk and the suitability of suggestion provided from the end of the audit partner.   

As commented by Aobdia, Lin and Petacchi (2015), materiality could be explained as the threshold beyond which missing or wrong information in the financial statements would affect the decision-making procedures of the users. It is necessary for the auditors to modify three audit risk components while making preliminary material evaluation. The components are described as follows:

• The users of the financial statements such as investors, suppliers, shareholders, employees, creditors, regulators, customers and others
• The size of the financial statement elements such as current assets, total revenues, current liabilities, net profit and total assets
• The trends of the organisation in relation to revenues, cash flows and earnings (Bowlin, Hobson and Piercey 2015)

In order to ascertain the average amount of materiality for a small company such as Amarnath Enterprises, the materiality amount should be applied between 5% and 10% of sales revenue. In this case, the materiality amount is assumed as 7.36% of the total sales revenue of the organisation in 2017. In this regard, Cannon and Bedard (2016) cited that if the amount of materiality does not include a significant proportion of net income, the loss would be considered as immaterial. The reason is that the average financial statement users would not be worried with the loss, which could be 0.1% of the net income of the organisation.

However, it is noteworthy to mention that due to the small size of Amarnath Enterprises, there is high probability that majority of the random expenses might not be recorded in separate accounts. This could be validated by the fact that credit amount of $148,906 could not be tracked in 2017, due to which it has been recorded as suspense account. For example, if an assumption is made that the omitted expenses of the organisation amount to $15,500, it could be material to the financial condition and appropriate justification of the expenses is necessary. Hence, the material amount of $15,500 could be considered as accurate by the auditor.

Analytical Review of Income Statement

Since the debit side and the credit side of the trial balance of Amarnath Enterprises do not match with the each other in both 2016 and 2017, suspense account is used for matching the balances of both sides.

Accounts	Names of accounts	Risk of misstatement	Audit risk	Relevant assertions
1	Sales	For Amarnath Enterprises, increase in sales revenue could be observed over the period. In case, revenue recognition criteria are not followed effectively by the organisation or the allowances are overstated, material misstatement risk might take place (Chambers and Odar 2015).	Certain deficiencies might be inherent in Amarnath Enterprises, since it is a small company. The reason is that a single person might be associated with billing customers, obtaining money from the customers, undertaking deposits, recording ledger payments and reconciliation of the associated bank account (Edwards and Chandler 2014). As a result, the auditor might experience an increase in control risk.	The pertinent assertions, in this case, include accuracy and completeness. The reason is that there is high probability that there might be omission of certain transactions by the book-keeper. In opposition, the revenues might be shown deliberately higher in order to represent better financial performance of the organisation.
2	Service fees	Amarnath Enterprises offers other services on various technical aspects. This might constitute of new guidelines for auditing or tax regulations (Ettredge, Xu and Yi 2014).	In this situation, there is high probability for manipulation, which might be due to the largest threats to advisory services and their credibility. As a result, the audit risk might be increased.	The other advisory services contain more independence risk for the audit organisation. Along with this, the audit organisation would not carry out its obligations in the form of an external auditor correctly. Hence, the significant assertions at risk comprise of valuation, completeness and accuracy.
3	Depreciation	If any asset sale is not recorded appropriately, there is increased chance of asset misappropriation. Along with this, if the capitalisation of expensed costs is not conducted properly, material misstatement is bound to take place.	The most significant audit risks are associated with accurate valuation of property, plant and equipment along with depreciation and disposal of the stated asset. In addition, when the accounts department could not find evidence of stock take and chance of theft, the audit risk might increase.	The main assertions at risk for depreciation take into account valuation, existence, rights and completeness.
4	Miscellaneous	The accountants have omitted certain transactions, which could have been recorded as miscellaneous expenses. This might result in material misstatement risk.	In this case, certain transactions might have been omitted deliberately, which might reduce the overall expenses and this might lead to audit risk.	The significations assertions at risk include existence, valuation and completeness.

Accounts	Names of accounts	Management assertions	Audit procedures	Explanation of the audit procedures
1	Sales	The sales revenue is to be incorporated in the assertion of completeness under transaction classes.	Transaction testing	In order to verify the sales figure accuracy, it is necessary for the auditor to review all transactions associated with sales ledger approximate to the financial statement date in order to ensure that Amarnath Enterprises has considered sales before the date (Glover, Taylor and Wu 2016).
2	Service fees	In this case, classification is identified as the management assertion for verifying whether correct posting of transactions is made at the accurate accounts (Griffiths 2016).	Re-calculation	This process takes into account conducting the work made from the end of the client so that the difference could be analysed between the auditor’s work and that of the organisation
3	Depreciation	For depreciation, the management assertions include rights, valuation, completeness, disclosure, existence and presentation.	Observation and inquiry	When any asset is observed, it is crucial for the auditor to determine the existence of the audit. Moreover, it needs to be checked whether contrast could be made between the condition and the remaining useful life depending on the schedule of depreciation.
4	Miscellaneous	The management assertions for miscellaneous expenses include existence, valuation and completeness.	Inquiry and re-calculation	The auditor is required to check whether the omitted transactions form part of the miscellaneous expenses.

In order to discuss the fraud risk, it is necessary to provide an overview of scepticism. Scepticism could be explained as an attitude that takes into account a questioning mind of any individual (Johnson 2016). This signifies likely misstatements due to errors or frauds along with considerable evaluation of audit evidence. The financial reports often contain material misstatements that take place due to frauds or errors Lenz, R. and Hahn, U., 2015). The latter is deemed to be intentional so that personal benefits could be obtained. On the contrary, fraud risk involves the conditions or events signifying incentive or pressure in order to commit fraud.  In accordance with the above analysis, the main accounts at risk in case of Amarnath Enterprises constitute of sales revenue, service fees and depreciation. The maximum chance of fraudulent activities is possible with these accounts, since increase in revenue would denote better financial performance of the organisation (Louwers et al. 2015).

Conversely, the service fees for other advisory service would assist in improving the brand image of Amarnath Enterprises, which might not be appropriate. Lastly, if lower depreciation is charged for property, plant and equipment, the fair value of the asset might show increased value, which would be misleading for the investors. It is noteworthy to mention that the auditors are not expected to show doubts on past experience of honesty and integrity associated with the employees responsible for company governance (Power and Gendron 2015). However, the auditors are required to act accordingly towards scepticism in considering the risks related to material misstatements to detect variations in events.

Conclusion:

The above discussion makes it apparent that the auditor has deemed an appropriate materiality amount of $15,000 for Amarnath Enterprises, since it has a significant amount of credit balance missing in its unadjusted trial balance. Due to such missing information, suspense account is used for tallying the debit side and credit side of the trial balance. The four accounts in the income statement at risk include sales revenue, service fees, miscellaneous expenses and depreciation, as they are subject to risks associated with audit and material misstatements. Hence, various pertinent assertions as well as management assertions are considered in the context of the organisation. Finally, it has been evaluated that the three identified accounts contain fraud risk. Although the employees are deemed to be diligent and honest, it is necessary for the auditor to take into account professional scepticism.

References:

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