What responsibility does an auditor have to detect material misstatements

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Xerox Corporation is one of the global brand companies, which is selling and manufacturing different ranges of colour printers and photocopies, as well as providing related consulting services and supplies to their customers. Major competitor of Xerox Corporation is Hewlett Packard Company (HP), which provides similar product lines and business strategic as Xerox Corporation. The different between Xerox Corporation and HP is that HP provides products such as computer, scanners, digital cameras, calculators, PDAs and other. However, Xerox is just focusing on digital production printing

(b) Using the financial information, perform some basic ratio analyses for the two companies. However does the two companies financial performance compare?

Short-term Liquidity Ratio:

 

Xerox Corporation

Hewlett Packard Company

 

1997

1998

1999

2000

1997

1998

1999

2000

Current Ratio

1.4

1.466

1.508

2.083

1.867

1.559

1.511

1.53

Quick Ratio

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1.037

1.082

1.125

1.776

1.264

1.163

1.172

1.155

Xerox Corporation had an increasing trend in liquidity ratio which may improve the ability to make profit during 2000. The data indicated that Xerox Corporation had a much higher ability for paying short-term liability and collected cash from credit customers than Hewlett Packard.

Profitability Measures

 

Xerox Corporation

Hewlett Packard Company

 

1997

1998

1999

2000

1997

1998

1999

2000

Profit Margin

0.08

0.02

0.074

-0.021

0.088

0.075

0.082

0.076

ROE

0.291

0.081

0.29

-0.106

0.193

0.17

0.19

0.26

ROA

0.052

0.013

0.049

-0.013

0.107

0.093

0.099

0.108

Profit margin

Both Xerox Corporation and Hewlett Packard Company experienced an obvious decrease in terms of net sales which brings major profit to business. However, Hewlett Packard had more power to keep higher earning per dollars of sales than Xerox Corporation.

Return of Equity (ROE)

The trend of Xerox Corporation while negative has not ensured the figure has dropped to an unsatisfactory level. It does show, however, that the return to shareholder is less in 2000 than that in 1997. Xerox Corporation's ROE was lower than Hewlett Packard Company's ROE which indicated that the former has collected much more money than the later from shareholder.

Return of Assets (ROA)

There had been dramatic increase and decreases in the ability of both Xerox Corporation and Hewlett Packard Company. The ratio of Hewlett Packard Company indicated that its assets could be used more efficiently to earn profit, and its shareholders could earn more from their investment.

Financial Leverage Ratio:

 

Xerox Corporation

Hewlett Packard Company

 

1997

1998

1999

2000

1997

1998

1999

2000

D/E Ratio

3.74

4.278

4.027

5.752

0.088

0.075

0.082

0.076

Debt Ratio

0.767

0.79

0.78

0.829

0.193

0.17

0.19

0.26

Debt/Equity Ratio

Xerox Corporation has been aggressive in financing its growth with debt during 1997-2000. This could result in fluctuating earnings as a result of the additional interest expense. However, Hewlett Packard Company had got a stable trend in financial leverage ratio, which may indicate that the company has a stronger financial interest in the business than Xerox Corporation.

Debt Ratio

There is a rising debt ratio of both of the companies during 1997-2000. However, Xerox Corporation still had a higher debt ratio of 0.829 in 2000, which illustrates that Xerox Corporation is more likely confront tension on paying interest and their long-term debt. In addition, because debt ratio increased more quickly in Hewlett Packard Company then it decreased in Xerox Corporation, it is possible that Hewlett Packard Company have a higher business's obligations in the future.

Capital Turnover Ratios:

 

Xerox Corporation

Hewlett Packard Company

 

1997

1998

1999

2000

1997

1998

1999

2000

Assets Liquidity

0.388

0.416

0.416

0.441

0.66

0.584

0.613

0.683

Sales to Assets

0.654

0.648

0.667

0.628

1.117

1.243

1.2

1.437

Net Worth Sales

0.356

0.324

0.33

0.273

0.456

0.429

0.432

0.291

There is a growth in assets liquidity and sales to assets ratios in both companies. And this means both companies use its stockholders' equity to generate revenue better from 1997 to 2000. Merely, less in assets liquidity ratio, Xerox Corporation does not necessarily indicate it had worse performance than Hewlett Packard Company.

Question 2

(a) What responsibility does an auditor have to detect material misstatements due to errors and fraud?

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Auditors spend a great portion of their time planning and performing auditing to detect the unintentional mistakes made by management and employees in financial reports. (Arens,Best, Shailer,Fiedler,Elder and Beasley. 2010). Auditors detect errors because of such things as mistakes in calculation, omissions, misunderstanding and misapplication of accounting standards, and incorrect summarisations and descriptions.

The auditing standards recognise that it is more difficult to detect fraud and errors because management, or the employees perpetrating the fraud, attempt to conceal the fraud. (Arens,Best, Shailer,Fiedler,Elder and Beasley. 2010) one important thing to assess fraud is to keep in mind fraud has two characteristics: the pressure and incentive to get a desired financial gain, and the perceived opportunity to commit the fraud.

(b) What two main categories of fraud affect financial reporting?

Fraudulent financial reporting

This is an intentional misstatement or omission of amounts with the intention to deceive users. The fraud involves management's deliberate actions to meet earning objectives and shifting revenue and expenses to reduce fluctuations. Companies often overstate profit and assets or omit liabilities and expenses or they deliberately understate profit in an attempt to reduce profit taxes.

Misappropriation of assets

This is theft of an entity's assets involving employees and others internal to the organisation. The misappropriation of assets is generally perpetrated at lower level of the organisation hierarchy. Sometimes, top management in involved in the theft because of its greater authority and control over organisation assets.

(c) What types of factors should auditors consider when assessing the likelihood of material misstatements due to fraud?

Incentives/pressure, opportunities and attitudes are three conditions of fraud (Arens,Best, Shailer,Fiedler,Elder and Beasley. 2010). In assessing the fraud risks, auditors should sceptically consider the following:

Information the auditors obtained through communication about their knowledge of the company and its industry.

Inquires of management about their view of the risk of fraud and about existing programs and controls to address specific fraud risks.

Specific risk factors, such as incentives or pressures to perpetrate fraud, opportunity to carry out fraud or attitudes used to justify a fraudulent action.

Analytical procedures results obtained during planning

Information gained from other procedures as well as corporate governance and other control factors.

(d) Which factors existed during the 1997 though 2000 audits of Xerox that created an environment conducive for fraud?

Xerox's action to accelerate the lease revenue recognition. For example, it allocates a bigger portion of the lease payment to the equipment instead of service or financing activity or periodically change the assumptions used to calculate the return on equity.

Xerox elects to recognize the revenue from lease price immediately instead of recognizing the revenue over the life of the leases.

Xerox write-up the residual value of some leased equipments.

Xerox switched from sales-type lease agreements to rental contracts, and there is no disclosure of the change.

Xerox established an acquisition reserve for unknown business risks and recorded unrelated expenses to the reserve accounting.

The interest income recognition had been implemented since 1997, but had not been done for the previous years.