Ratio Analysis, Fraud Risk Assessment, and Audit Implications for DIPL Ltd

Ratio Analysis, Fraud Risk Assessment, and Audit Implications for DIPL Ltd

Ratio Analysis and Assessment for DIPL Ltd

1. Financial and non-financial decisions may be made with the assistance of analytical procedures. An analytical method is crucial for both the auditor and management overall. This analysis is performed for DIPL Ltd to illuminate its performance and provide an accurate representation. This approach is very beneficial for identifying errors in financial statements and deterring fraudulent activity. The analytical approach may be executed based on the business's characteristics and the desired outcomes (Ghandar & Tsahuridu, 2013). In the instance of DIPL Ltd, the two primary analytical procedures conducted are:

The financial report's data is compared with numbers from the prior three years to identify trends and discrepancies. Furthermore, a comparison may be made with industry norms, allowing for the observation of trends. The business trend may be seen via comparison. Furthermore, any discrepancies may be readily identified and the underlying cause can be determined. The financial results indicate that the firm had a significant increase in sales, which bodes well for its future (Cappelleto, 2010). The data demonstrate robust momentum for the firm; yet, a significant disparity exists when compared to the stock statistics, which have become inflated despite the growth in sales.  The simultaneous growth in sales and stock figures is a reason for worry (Nicolaescu, 2013). Consequently, the auditor must evaluate this discrepancy and ascertain its precise cause.

Secondly, ratio analysis serves to identify trends and is a major instrument for assessment. Various ratios may be calculated to identify the movement patterns.  The ratio for DIPL Ltd is calculated during a three-year period from 2013 to 2015. The analysis of ratio computations must include profitability, liquidity, and solvency ratios to reflect performance and trends. The profitability ratios emphasize the profits generated by the firm via net profit and gross profit margin (Porter & Norton, 2014). Secondly, the liquidity ratio assesses the company's ability to fulfill all commitments. Thirdly, the solvency ratio reveals the company's relative percentage of debt to equity.

IT System Launch and Incorrect Allocation of Transactions

The aforementioned ratio analysis indicates that DIPL Ltd has shown excellent performance in terms of profitability. Nevertheless, the gross profit ratio has decreased during the three years, attributable to a significant rise in the cost of sales. Conversely, the organization has seen an augmentation in the net profit ratio attributable to effective expenditure management (Shah, 2013).  Thus, the combination of gross profit and net profit signifies that the firm has maintained a stable level.

The current ratio and quick ratio have been used to elucidate the liquidity of DIPL Ltd.  The company's current ratio exceeds 1, indicating that for each current obligation, there is one current asset. Consequently, the analysis indicates that the corporation has a greater amount of current assets relative to current liabilities, which underscores its robust liquidity. Conversely, the quick ratio is calculated excluding inventory, so serving as a more accurate measure of liquidity. The liquidity situation is robust, as it approaches the statutory ratio of 1:1, enabling the firm to fulfill its commitments.

According to the calculated debt and equity ratios, it can be seen that the company's debt has risen throughout the three years, exceeding 0.50 in 2015, which serves as a warning for management. Increased debt will diminish the company's profitability. Secondly, the equity ratio has significantly declined, indicating that the firm would incur higher expenses associated with debt financing.

The aforementioned facts will significantly influence profitability, and swings may be seen. Consequently, the auditor must verify the accuracy of the ratios and confirm that they are based on authentic numbers.

2. Regarding inherent risk, there are few corrective measures available, since this risk is intrinsic to the structure of the firm.  It does not depend on any acts of omission or errors. In the instance of DIPL Ltd, the two principal inherent risks are as follows:

DIPL Ltd implemented a fully automated IT system equipped with autonomous recording capabilities. The IT manager said that the new system was implemented without prior investigation.  Prior to any project, it is important to do pilot testing to facilitate observations. Prior to the original launch or during early testing, it was observed that several year-end transactions were inaccurately allocated (Subramanyam & Wild, 2014). This indicates that the transaction from one time will be manifested in another, resulting in substantial discrepancies.  The profit numbers will be affected.  This is a major misstatement, and moreover, the organization's executives are aware of the software's defect, allowing them to use it for extra benefit (Niemi & Sundgren, 2012). Consequently, such a flawed process will result in unethical conduct and diminish the company's reputation.

Appointment of Chief Executive Officer with Financial Stake

The management must guarantee that the CEO selection process involves an impartial individual without any financial interest in the organization. In the instance of DIPL Ltd, it was noted that the CEO hired had a financial stake. The stipulation states that the CEO will get a 10 percent share of the profits if the company's growth exceeds 10 percent. The intrinsic risk lies in the CEO's pursuit of maximizing the company's profit share. Should the firm fail to achieve the anticipated growth, there exists a possibility that the CEO may engage in the misrepresentation of records to inflate earnings (Bhasin, 2008). This also affects the internal audit, and the likelihood of manipulations is significant.

The aforementioned conditions significantly threaten the financial report.  The IT system was implemented prior to any testing, resulting in the misallocation of transactions, which is likely to cause discrepancies in the profit numbers. Secondly, the selection of a CEO with a significant conflict of interest contravenes ethical norms and is likely to result in complications within the financial statements.

3. Based on the current circumstances at DIPL Ltd, two fraud risks may be identified in the following scenario:

Upon the implementation of the new system, the firm lacked a definite plan, resulting in significant discrepancies. Numerous entries from the previous year did not manifest in the new accounting system.  This occurrence may result from the actions of accountants and management who sought to manipulate the records.  The company's cash balance has significantly declined (Cappelleto, 2010). No explanation has been given for the decline in the cash situation, nor are there any indications suggesting that the new method was entirely used for fraudulent purposes.

The company's sales peaked significantly in 2015; nevertheless, this was accompanied by a substantial increase in inventory levels, signaling a major concern.  The inventory level should have decreased due to higher sales; yet, the contrary was found. The increase in inventory levels indicates a shortcoming in the approach (Elder et al., 2010). This may be a management action in which inventory levels have been intentionally augmented to manipulate the accounting.

Factors Contributing to Fraud Risk and Their Effect on Audit Quality

3a. Fraudulent practices always affect the audit process, since the auditor must provide an accurate and impartial assessment. If the statements include erroneous statistics or altered data, the auditor may provide a misleading perspective that might result in incorrect judgments.  The aforementioned fraudulent actions will significantly affect the financial statements and compromise the quality of the audit. The faked quantity may be substantial, potentially affecting the total result (Messier & Emby, 2005). Furthermore, the auditor will need time to familiarize themselves with the new system, therefore consuming additional time. The entries must be verified, since the transaction was recorded for an incorrect timeframe, which would raise uncertainties (Arens et al., 2013). The auditor will provide a judgment when the relevant material is available. In instances of significant discrepancies and lack of pertinent information, the auditor will provide a qualified opinion, which will prompt inquiries about management. The external parties question the validity of such a report.  Additionally, the auditor must do a comprehensive analysis of the inventory levels, sales receipts, and related data.  The valuation of inventory influences audit quality; thus, it is the auditor's responsibility to do a thorough examination to identify discrepancies, or else the auditor may provide an unqualified opinion (Wood, 2011). Consequently, the auditor must use due diligence and verify the facts to provide an unqualified judgment.

References

Arens, A. A,  Best, P. J, Shailer, G. E. P & Loebbecke, J. K, 2013, Assurance Services and Ethics in Australia, 9th ed,  Australia: Pearson.

Bhasin, M. L 2008, ‘Corporate Governance and Role of the Forensic Accountant’, The Chartered Secretary Journal, vol. 38, no. 10, pp. 1361-1368.

Cappelleto, G. 2010, Challenges Facing Accounting Education in Australia, AFAANZ,

Elder, J. R, Beasley S. M.& Arens A. A 2010,  Auditing and Assurance Services, Person

 Ghandar, A & Tsahuridu, E 2013, The Auditing Handbook 2013, Australia: Pearson.

Messier, W & Emby, C 2005, Auditing & Assurance Services: A systematic approach, McGraw-Hill.

Nicolaescu, E., 2013, ‘ Understanding Risk Factors for Weaknesses in Internal Controls over Financial Reporting’,  Psychosociological Issues in Human Resource Management, vol. 1, no. 3, pp.38-44.

Niemi, L & Sundgren, S 2012, ‘Are modified audit opinions related to the availability of credit? Evidence from Finnish SMEs’,  European Accounting Review, vol. 21, no. 4, pp. 767-796.

Porter, G & Norton, C 2014, Financial Accounting: The Impact on Decision Maker, Texas: Cengage Learning

Shah, P 2013, Financial Accounting, London: Oxford University Press

Subramanyam, K & Wild, J 2014, Financial Statement Analysis, McGraw Hill

Wood, D A 2011, ‘The Effect of Using the Internal Audit Function as a Management Training Ground on the External Auditor's Reliance Decision,’ The Accounting Review, vol. 86. No. 6