Being the appointed audit report manager of Multiproducts Plc, for the forthcoming year which ends on the 31st of March 2011, I will conduct a report which aims to gain an understanding of the enterprise and its environment, showing how I will obtain the information. Secondly looking at the concept of Materiality and explaining how this concept helps to identify certain areas which will require specific audit attention. Having identified material risk areas I will analyse, in more detail, three activity related areas using values from the financial statements given, explaining why this material area is significant to the audit assessment. Pen ultimately i will cover inherent risks that will affect Multiproducts Plc and why I believe they are a inherent risk.
The Enterprise and its Environment
Understanding the enterprise and the environment is very important for identifying and assessing audit misstatement within the enterprise and its environment. risk. For this I will be guided using ISA 315 which deals with identifying and assessing the risk of material
The nature of the entity
I need to consider business operations; this includes geographical dispersion and industrial segmentation, which relates to where Multiproducts Plc operating activities are spread and in to which segments. In this case the operations are spread through the United Kingdom, Eastern Europe and Western Europe. We know already that the core market is currently in the UK and we have further information from the case study, but having a healthy scepticism is important so investigations in to this information is necessary. If more details are required we should talk to and make enquiries of management within Multiproducts Plc. To gain a feel for the operation sectors, such as marketing and manufacturing, we should set up visits to observe and inspect these operations in the flesh. Whilst on the visit I would be looking to see whether they are doing what they say, in terms of product ranges and staff activities.
Considering Multiproducts Plc's aim to invest in both large and small scale acquisitions to strengthen its market position it is important to understand the investment side of Multiproducts Plc. This understanding will allow me to analyse risks which may be incurred with these acquisitions. I would gather this information through meetings with the finance managers who are in charge of the investments to gain a thorough understanding of the potential acquisition and the financial information which comes hand in hand. I would then externally investigate these acquisitions insuring that all the information previously gained is accurate.
Relevant Industry, Regulatory and Other External Factors
To gain an overview of the market segment which Multiproducts Plc operates it is necessary to examine its competition; this includes demand, capacity and price competition. This information can be gathered through the analysis of competitor's financial accounts. Once the accounts have been acquired analysis of the financial information will be undertaken, this analysis could include return on capital employed, inventory holding period and turnover analysis.
Being in the Domestic and Personal Care Products industry may give rise to risks of material misstatement because of the nature of contracts which Multiproducts Plc hold. These contracts can stem over a long period of time, creating vast estimates and forecasts which could create material misstatements. Therefore understanding the contracts within the industry will help reduce the risk of material misstatement. One way this risk can be processed is through risk assessment procedures. These controls may already be implemented, but as the audit they must be checked.
Multiproducts Plc's Objectives and Strategies
One of the strategies which Multiproducts Plc implements is to broaden their product ranges by introducing and developing new products, this creates product liability as not all products will do as well as predicted. I would investigate this by setting a meeting with the marketing and research divisions to gain information on expected product performance, actual product performance and competition performance.
Internal Control Systems
The heavy use of I.T software with Multiproducts Plc to improve performance and satisfy customer needs creates high risk as not all customers are users of the I.T SAP management and accounting information systems. I would need to research this internal control thoroughly and look for risks of I.T failure and ensure that this eventuality had been accounted for appropriately. I would gain knowledge or this system through primarily speaking to the I.T department in order to gain a thorough understanding of the system and make a judgement on whether more investigation was required. I may also call upon previous historical data that will show previous malfunctions which shows me the level of provisions needed to give a fair reflection.
It is important to understand the accounting policies Multiproducts Plc adopt so that we understand how they have prepared the financial statements and to what policy the data is applied. It is also important to take note of any changes that have recently been made to the accounting policy as it is vital to see whether they have been fulfilled correctly. The last thing that I need to consider is whether the accounting policies are in my professional opinion appropriate for the business, if not what I would change it to giving grounds why.
The Materiality Concept
Materiality is used throughout the whole audit to reduce audit risk down to a low level, it is the concept which enables the final financial statements to be looked upon as free from material misstatements whether the misstatements are through error or fraud. ISA 320 explains this concept with this definition, 'misstatements, including omissions, are considered to be material if they individually or in the aggregate could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements.' (ISA 320 point 2 1st bullet point). This point brings in another aspect which is how to determine how significant a misstatement is, this is down purely to professional judgement, sometimes with a bench mark percentage set, to how much effect the auditor feels the misstatement will have on the decisions of a user of the information. Materiality concept aids the identification of significant accounts areas because it is the basis which gives the financial report credibility that says the accounts are free from material misstatement, therefore pointing towards areas specifically that shareholders and potential investors would use. An example of these areas are, trade receivables and trade payables, inventories, equity and asset/liability valuations including levels of depreciation and provisions.
Material Activity Areas
Cost of Sales
Material activity areas are driven by the nature of the business. Multiproducts Plc is a manufacturing business that produces domestic and personal care products and hence meaning that cost of sales is a key activity area. When calculated the materiality level of cost of sales to sales revenue, the materiality level is 65%, this is calculated by dividing cost of sales by sales turnover multiplied by one hundred. This 65% is greater than the recommended 0.05-1% shown in slides risk and materiality, this means that within Multiproducts Plc the cost of sales is a material area. This doesn't mean under any circumstances that there is a misstatement but does mean that specific audit attention is required. This level of 65% has risen from 64%, this is not a significant rise but in the case study it pays reference to the rise in oil prices affecting the cost of sales. This has been combated by implementing factory efficiency and cost saving measures, as the auditor it is important to be aware of these implementations because they are recent and may take awhile to become accustom to.
Trade and Other Receivables
Trade and other receivables we already know are material to Multiproducts Plc due to the nature of their contracts which stem across a vast amount of time, but now more because of the number of deliveries made which amounts to nearly 105 million cases each year. When calculated in terms of total assets the material level comes to 37% which is greater than the recommended materiality level of 0.05-1% showing that trade and other receivables is a material area. This is important for the audit assignment because there will be a high amount of data transfer through the I.T systems, where errors could occur due to the input of data and hence i will have to be aware of this possibility.
Admin costs are a material activity as there materiality level comes to 23% of revenue; this is higher than the recommended level of 0.05-1% showing that it is a material area of activity for Multiproducts Plc. This is a surprising level only when compared to the materiality level of selling and distribution costs which is the predeceased inherent risk due to the nature of Multiproducts
Plc, which amounts to 6% of revenue. With Multiproducts Plc delivering to 950 destinations at 105 million deliveries per year, rings alarm bells because Multiproducts Plc produces and distributes its own products which i would have thought meant that the selling and distribution costs would be of a higher material value that the administrative costs.
Integrity of the Management
This is a very sensitive inherent risk in every form of business management, it relates to the values and honesty of each and every individual involved. The chances of one of the managers solely being dishonest and acting without the goals of Multiporducts at foremost are very slim due to internal controls. If a case of this was in operation the chances are more than one manager would be involved. The inherent risk is amplified in a company with the size of Multiproducts Plc, who have an average number of employees at 2700, 500 of which are management; therefore we must look at the benefits the managerial staff will gain. This inherent risk cannot be avoided but can be reduced with the aid of internal controls. Having said this Multiproducts Plc board has just recently put in place procedures which identify, asses and manage external and internal risks. This will help to prevent any corrupt behaviour and in turn reduce risk. The manager's word should never be taken at face value I will always investigate and gain evidence to reinforce the discussions I have with the management.
I will have to be aware of management experience because of the new acquisitions which Multiproducts Plc aim to make. These acquisitions will mean, in the short term, that new management will be brought in from the acquired company and therefore may not be experienced in the way Multiproducts Plc is run and the processes in which it operates. This means I will have to be aware of error and misstatement from the new management due to not previously working in the company and a company of this size. This does not mean that all the management currently working for Multiproducts Plc will have experience so i have to be aware of this also.
Managers generally have many pressures placed upon them, whether this be ensuring uniformity or meeting their targets. All this is made harder when considering the market current conditions. In the case study it tells us managerial reactions to these external affects. A tough economical climate has meant that Multiproducts Plc has had to close one of their factories and restructure of European operations. This is a huge inherent risk as it is one which can only be reduced in costly ways explained above
Nature of the Business
Multiproducts Plc operates in three areas, United Kingdom, Eastern Europe and Western Europe. I believe this to be an inherent risk because of the downsides which come from the various divisions.
One of the down sides has to be the language barriers which will arise due to operating in different areas, language barriers can cause confusion over requirements and therefore creating error. This can be overcome by having employees who are capable of speaking a multitude of languages. This inturn can cause more problems because demand of these employees will increase hence creating power for the individuals which will give way to higher risks.
Another inherent risk will be the location of Multiproducts Plc's factories being based in the United Kingdom. This creates risk of expenses being misstated due to the constantly changing environment the logistical routes take. Therefore delivering the products to all over Europe will become a problem.
Changes within the industry can be an inherent risk that cannot be avoided due to market changes. An example of this is the rise in oil prices that has meant the implementation of efficiency and cost saving matters. This affects the cost of sales because it will increase the cost of purchasing oil used in the production stages. This oil fluctuation will also affect the price of delivering products to customer through petrol/diesel prices.
Analysis of Discussion
In conclusion this report has shown the importance of understanding the enterprise and environment, explaining certain areas that are important and how to gain this information. Having explained the concept of materiality I have then gone in to three significant areas which this concept pointed me towards, analysing the financial data in each area. Lastly I have addressed five inherent risks I think is appropriate to Multiproducts Plc.