Analyzing Double Ink Printers Ltd (DIPL)

Read the Case Study on Double Ink Printers Ltd (DIPL) and answer the following questions:

1: As an auditor, you are conducting your preliminary analytical procedures based on the background information for DIPL contained in the case. Apply analytical procedures to the financial report information of DIPL for the last three years. Explain how your results influence your planning decisions for the audit for the year ending 30 June 2015.

2: You are conducting your risk assessment of DIPL, as part of the planning for your audit for the year ended 30 June. Identify two inherent risk factors that arise from the nature of DIPL’s business operations. Explain why it is a risk and how it may affect the risk of material misstatement in the financial report.

3: As part of your audit of DIPL for the year ended 30 June 2015, you are considering the risk that fraud may have occurred (a) Based on the background information for DIPL contained in the case, identify and explain two key fraud risk factors relating to misstatements arising from fraudulent financial reporting to which DIPL may be susceptible. (b) Explain how the risk factors identified in (a) above would affect the conduct of the (a) audit. 

Preliminary Analytical Procedures by an Auditor

The mechanism of the analysis of the ratio has been implemented for the analytical review and the assessment of the financial reports and statements of DIPL for the last three years have been provided in the table below:

Profitability Ratios
Ratio	2013	2014	2015
Gross Profit Ratio	17.55%	16.13%	15.20%
Net Profit Ratio	6.90%	6.08%	6.84%
Operating Profit Ratio	19.82%	19.18%	19.12%
Return on Assets	18.25%	14.41%	11.37%
Return on Equity	25.78%	21.25%	24.26%

                                                                                         Table 1: Profitability Ratios

                                                                                     (Source: As Created By Author)

The comparative evaluation of the profitability ratios of DIPL for the last three years have disclosed that:

• The gross profit ratio of the firm has has decreased from 17.55% to 16.13% in the year 2014 and has again fallen further to 15.20% in the year 2015.
• The operating profit ratio of DIPL has fallen from 19.82% to 19.18% in the year 2014 and in the year 2015 has declined significantly to 19.12%. The probable factor for lower decreases in the year 2015 is due to the fact that the allowance for the inventory undesirability has been written back in the year 2015 and there is a rise in the storage fees of the e-book even.
• It has been observed that the net profit ratio of the firm has fallen in the year 2014 even though the ratio has enhanced in the year 2015. The main factor for the rise in the net profit ratio is due to the savings that has been noticed in tax during the year 2015 because of increased interest expenditure in the year 2015.
• The return on equity has decreased from 25.75% to 21.25% in the year 2014 and later the value has increased to 24.26% in the year 2015.

Liquidity ratios
Ratio	2013	2014	2015
Current Ratio	1.42	1.47	1.50
Quick Ratio	0.83	0.94	0.85

                                                                                          Table 2: Liquidity Ratios

                                                                                    (Source: As Created by Author)

The analysis of the liquidity ratio of DIPL has depicted that:

• The liquidity condition of the organization has enriched slightly in the year 2015 and this value has been viewed with the help of the current ratio. The current ratio in the year 2013 is 1.42 and in the year 2014 has raised to 1.47. The ratio has even increased significantly in the year 2015 to 1.50.
• By looking at the quick ratio, it can be explained that the liquid assets of the firm has not developed too much in the year 2015. The current ratio in the year 2013 was 0.83 and due to various factors, the ratio has increased to 0.94 in the year 2014. Then again the value decreased to 0.85 in the year 2015.

Efficiency ratios
Ratio	2013	2014	2015
Inventory Turnover Ratio	12.50	11.84	8.82
Debtors Turnover Ratio	13.78	8.73	8.57

                                                                                          Table 3: Efficiency Ratio

                                                                                     (Source: As Created by Author)

The efficiency evaluation of DIPL has depicted that:   

• The inventory turnover ratio of the firm has fallen at a significant level during the course of three years. In the year 2013 the ratio valued to 12.5, which fell further in the year 2014 to 11.84%. The ratio in the year 2015 declined to 8.82 and it is seen that the amount declined by a very significant margin in this year.  
• The debtor’s turnover ratio of DIPL has even fallen during the three year period. In the year 2013, the ratio has been 13.78, which got deceased to 8.73 in the year 2014 and even more in the year 2015 to 8.57.

Solvency Ratios
Ratio	2013	2014	2015
Debt Equity Ratio	0.41	0.47	1.13
Debt to Total Assets	0.29	0.32	0.53
Interest Coverage Ratio	28.96	28.39	4.68

                                                                                     Table 4: Solvency Ratios

                                                                             (Source: As Created by the Author)

The solvency analysis of the financial statements of DIPL has revealed that:

• The debt to equity ratio of the organization has risen from 0.41 to 1.13 in the year 2015. This discloses the fact that DIPL has been more dependent on the external funds in the year 2015 and therefore the degree of financial risk of the firm has increased.
• The debt to total asset ratio of the firm has been 53% in 2015, which has been higher than the values depicted in the previous years.
• The ratio of interest coverage was discovered to be around 28 times in the year 2013 and 2014. The value became 4.68 the times in the year 2015. The fall in the ratio additionally reveals that there is a rise in the level of financial risk.

There have been several risks that have been recognised by looking at the analytical review and the assessment of the financial statements along with the effects on the planning of the audit has been explained below:

• The condition of profitability of the company has not developed in the year 2025. It is seen that more fall in the profits in the coming future can increase the subject of going concern capability of the firm. The detailed evaluation of the organization requires to be planned in order to discover the future scenarios (ACCA. 2012).
• The current ratio of DIPL has increased in the year 2015. The development has been mainly due to the writing back the allowance for the inventory loss(Duncan and Whittington 2014). The explained evaluation of the inventory allowance requires to be undertaken in order to examine the validity in a precise manner.   
• The fall in the efficiency level of the management in order to handle and manage their current assets requires to be assessed and the probable reasons for the same requires to be recognised (PCAOB 2015).
• It is seen that there is a rise in the financial risk of the firm. The revelations that are related to these risks requires to be evaluated in order to examine whether the evidence for the same has been given out in the financial statements or not.

Risk Assessment of DIPL

2. The risks related to the business can be described as the probability of incapability of a firm in order to accomplish their aims and objectives. This incapability can be due to several factors that are prevalent in the environment of the business, which can be external or internal to the company (Baylis et al. 2017). The two risk factors which arises from the nature of the operations of the business of DIPL can be well described as follows:

• Financial Risk:The financial risk may be described as the incapability of the organization to reimburse their long term liabilities within the stipulated time. The risk rises with the increase in the external liabilities. The debt proportion of the organization in comparison to the equity has risen in the year 2015 during the time period of the last three years. This reveals that the degree of financial risk in the year 2015 has increased significantly. It is even seen that there is a rise in the liability of payment of the fixed interest and the loan repayment burdens within the time scheduled (Thaweejinda and Senivongse 2014). Therefore, there is an intimidation to the long term affluence condition of the organization if the company does not have the capability to make payments for the fixed interest and the principle amount in the scheduled time.

There is a probability that the firm may look to influence their financial records so that they are able to control their debt to equity ratio and the current ratio according to the agreements and contracts with the lending organization. In order to maintain their current ratio, the organization can pump up their current assets with the help of increasing receivable values, the investor or can be both (Shafii, Abidin. and Salleh 2015). In the same way in order to sustain their debt to equity ratio, the firm can inflate the equity value with the help of rising values of the retained earnings.

The implementation of the information technology creates several risks to the firm.  Any deficits within the control of information technology can have confrontational effect on the company.

In the year 2015, the organisation implemented new and innovative IT processes in order to computerise their accounting roles and then assimilate it on the general ledger system. It is observed that there has been an increasing pressure on the IT department given by the management in order to conclude the process in the year 2015 only. There exists a threat to the accounting information system security because of the probability of the unnatural and natural calamities and disasters (James 2015).

The organization could not preserve the equivalency among the new accounting process and the current software process. There was an issue with respect to the inappropriate allocation of the transactions to the period. The concept of accounting with respect to the periodicity was not followed properly (Homb et al. 2014). It could therefore lead to inappropriate profitability condition presentation and the financial condition of the organization.

The background data of DIPL as provided in the case study reveals the probability of the implementation of the deceitful practices of financial reporting by DIPL. The significant risk factors that are associated with such practices can be recognised as follows:

There is a lot of burden on the department of finance in order to meet the several debt covenants. It has been observed that a loan of 7.5 million was undertaken from BDO Finance Ltd in the year 2015 that was based on the two covenants that have been discussed below:

• A minimum current ratio of 1:5:1 is to be sustained.
• The debt to equity ratio requires to less than 1.

On the advent of the company failing to stay in line with the above discussed two requirements will lead to the withdrawing of the loan, which can have an adverse impact on the activities of the firm. There exists a probability that the current assets may have been pumped up so that the current ratio can be sustained to 1:5:1. In the same manner, there can be alterations in the retained earnings so that the debt to equity ratio can be maintained to a value below 1 (Alam 2014).

Inherent Risk Factors of DIPL's Business Operations

The availability of unrefined explanation of the job description and the poor segmentation of work is another factor of risk, which may lead to the presence of practices that are fraudulent in nature in the process of financial reporting. The entrance of the purchased inventory and its quantity and value is recorded by the same individual who is even the accounts payable clerk. There exists a probability that the inventory may be altered by revealing additional inventory during the time of arrival (Nalewaik and Mills 2016). There is an absenteeism of an effective system of the documentation, which aids to limit the fraud.

The auditors requires to construct their audit plan in a process that the degree of risk can be reduced or eliminated to most possible extent. The impact of deceitful factors of risk on the conduct of the audit can be discussed as below:

• Impact of debt covenants on the audit plan:The amount of current assets and current liabilities requires to be corroborated in a careful manner thereby to examine whether there are any current asset inflation or current liabilities deflation or not. In the same way, the equity balance requires to be examined through the cautious confirmation of the retained earnings (Lad and Dahl 2014).
• Impact of control environment on the audit plan:The balance of inventory requires to be examined. The amount of the orders that has been placed for the purchase of the inventory requires to be harmonized with the quantity that is received thereby recognising whether there are any alterations has been undertaken by the accounts payable clerk or not (Simons, Bester and Moll 2017).                                 

Reference List 

ACCA. (2012). Audit Risk. Retrieved from ACCA Website: https://www.accaglobal.com/in/en/student/exam-support-resources/fundamentals-exams-study-resources/f8/technical-articles/audit-risk0.html

Alam, I.U., 2014. Effectual compliance audit of vendors development.

Baylis, R.M., Burnap, P., Clatworthy, M.A., Gad, M.A. and Pong, C.K., 2017. Private lenders’ demand for audit. Journal of Accounting and Economics.

Duncan, B. and Whittington, M., 2014, September. Compliance with standards, assurance and audit: Does this equal security?. In Proceedings of the 7th International Conference on Security of Information and Networks (p. 77). ACM.

Homb, N.M., Sheybani, S., Derby, D. and Wood, K., 2014. Audit and feedback intervention: An examination of differences in chiropractic record-keeping compliance. Journal of Chiropractic Education, 28(2), pp.123-129.

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Nalewaik, A. and Mills, A., 2016. Project Performance Review: Capturing the Value of Audit, Oversight, and Compliance for Project Success. CRC Press.

PCAOB. (2015). The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern. Retrieved April 2017, from https://pcaobus.org/Standards/Auditing/Pages/AU341.aspx

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