Industry Average vs EasyFit Pty Limited‘s Financial Ratios
As per the case which is provided in the question, EasyFit Pty Limited is engaged in the business of shoe manufacture and the target market of the business lies between 18 to 24 years of age. The auditor of the business has to consider analytical procedures in order to identify any risks which might be associated with the business. The ratios which are considered are provided below along with risks implications for the same if any:
- Current Ratio: This represent the liquidity position of the business and is considered to be an important estimate to judge the overall liquidity position of the business. The current ratio represents the capacity of a business to meet its current obligations. As per the estimates of the business, there has been a fall in the current ratio of the business from 2016 estimates and it is even lower than industry average which is shown to be 2.84 for 2017. The current ratio is ideal but the same is still lower in comparison to industry average which suggest that the business should improve the same or it can pose a liquidity risk for the business in future.
- Receivable Turnover Ratio: This ratio forms a part of efficiency ratios of a business and represents the ability of the company to realize funds from debtors which the debtors owe to the company (Jans, Alles and Vasarhelyi 2014). The receivable turnover ratio of the business is shown to be 6.3 for 2017 and the same has slightly fallen from 7 which was in 2016. The estimate of the business is better than industry average which is a favorable sign. The estimate also signifies that the business has an efficient debtor’s policy. The overall risk in this respect is quite low as per the auditor.
- Inventory Turnover Ratio: This also forms part of efficiency ratio of a business and shows the ability of a company to clear its inventory stocks and realize the same into liquid cash. The inventory turnover ratio of the business is also shown to be favorable in comparison to industry average and the estimate for 2017 is shown to be 5. There has been a fall in the inventory turnover ratio from previous year estimate which was 5.5 and the auditor needs to investigate the same in order to avoid risk which is related to manipulations (Titera 2013). The auditor can verify the inventory stocks by applying verification of stocks and also physical take of stock.
- Return on Total Asset: This represents the capacity of a business to generate revenues for the business with the use of the assets which the business possesses. This is considered to be one of the financial indicators for overall success of a business. The return on asset of the business for the current year is shown to be 13% and the same was 11% in 2016. The estimates are much higher than industry averages. The auditor needs to confirm these which can be done by analysis of financial statements in order to avoid misrepresentation of facts in financial statements. As per the estimates which is shown, the business is performing extremely well and worth investing in for the potential investors.
- Net profit Margin: The net profit margin of a business shows the profit earning capacity of a business. The net profit margin is considered to be an important estimate for the business and the same for EasyFit Pty Limited is shown to been same for both the years which is 0.04 while the industry average is shown to be 0.6. The net profit margin of a business is considered by the investors and is affected by any misstatement, manipulations or omission in the financial statement and therefore the auditor needs to ensure that the estimate is revealing the true information.
- Gross Profit Margin: The ratio also reveals profitability of a business and also the efficiency of the operational structure of the business (Yoon, Hoogduin and Zhang 2015). The estimate for the business is shown to have increased slightly but the estimate for 2017 is still lower than the industry average which is shown. The auditor needs to apply audit procedure in this area so as to confirm the results shows are free from any manipulations.
As per the case, the company had purchased a land and building in 2004 when the same was valued to be 2 million for land and building. Land and building was revalued in 2010 and the accumulated depreciation of the business was considered to be $ 2,00,000. The land and building was then valued by an independent valuer who valued land at 2.9 million and building at 2.1 million respectively. The auditor needs to consider the provisions of ASA 620 which is related to the use of work of an expert for ascertaining whether to rely upon the valuation done by the valuer or not. As per the provision of ASA 620, an auditor can use the work of an expert if the work is related to a different filed which is other than accounting and auditing and the auditor is of the opinion that the item is material enough or may contain misstatement or misrepresentation (Auasb.gov.au. 2018). The auditor however needs to ensure that the expert is competent and free from the influence of the company so that an independent opinion of the expert can be obtained. The standard also states that before relying on the work of the expert, the auditor needs to obtain an understanding of the valuation process which is conducted by the expert in order to ensure that the work done by the expert is accurate and fair (Sanderson 2014).
The auditor needs to verify the balances of machinery which is recorded in a non-current asset register in a computerized system. The auditor first needs to test the internal control of the business and also check the integrity and accuracy of the computerized software which is used by the business. If the auditor is not satisfied with the recordings in the non-current asset register of the business, the auditor can conduct an independent valuation of the asset so as to ensure whether the asset actually exist and whether the asset value is accurately recorded in the financial statements of the business (Knechel and Salterio 2016). In order to conduct a valuation of the asset and ensure that the same is showing a true and fair view in the financial statement, the auditor can use the services of an expert as per the provisions of ASA 620 (Shantapriyan et al. 2014). Moreover, the auditor can also search for corroborative audit evidences which can suggest existence of machinery and its valuation which can be done through site inspection, analyzing past year’s audited statements. Thus, following the above procedures, the auditor can establish whether the machinery values are shown exist and are complete or not.
Current Ratio
As per the case, the business has note receivable which is of a significant amount and consist of both principle amount and accrued interest. The individual who is suppose to pay for the note receivable has filed a suit for bankruptcy for which the business will be receiving little or no money at all. The business has not reduced the note receivable in the financial statement. The auditor will be issuing a qualified audit report as the assets will be mis represented if note receivable is not reduced to realizable value and the amount of note receivable is of significant amount and hence cannot be ignored by the auditor (Tsipouridou and Spathis 2014).
As per the case which is provided, the auditor of a business is not satisfied with the information which recorded for inventory of the business and feels that the same are not reliable. The auditor is not satisfied with the year end balances for inventory of a business and therefore is undertaking a physical stock take to be assured about the closing inventory value of the business. The auditor will be issuing a qualified report if sufficient corroborative evidences does not turn up from the physical stock take (Blandón and Bosch 2013). The qualified report will clearly state that the auditor was unable to attain any sufficient audit evidence for confirming the value of inventory which is shown in the annual reports of the business and therefore issuing a qualified report for restriction which is imposed on the scope of audit due to natural circumstances.
As per the case which is shown in the question, the client is engaged in a business where the total liabilities of the business consist of superannuation liability which forms around 35% of the total liability of the business. This is a significant amount and therefore the auditor cannot ignore the item as the same is material in nature and also complex and therefore can be subjected to manipulations (Habib 2013). The auditor takes the services of an actuary who calculates the superannuation liability which is close to that which is reported by the management. In such a case, the auditor will be issuing an unqualified report which suggest that the financial statement is free from any material misstatement (Czerney, Schmidt and Thompson 2014). The minor difference between the reported figures of management and calculated figures of actuary can be ignored by the auditor judging by the complexity of the item.
As per the case which is provided in the question, the company which is being audited is in substantial doubt about the going concern principle of the business. The management of the business has not made adjustment to the financial statements regarding uncertainty which exist in the business (Ratzinger-Sakel 2013). The auditor under these circumstances will be issuing a unqualified report which will be consisting of a emphasis on matter paragraph which will be stating the uncertainties and the substantial doubt of the auditor about the going concern principle of the business.
Receivables Turnover Ratio
As per the case, one of the debtor of the client becomes insolvent from whom the business was going to receive an amount of $ 600,000. This has taken place before the financial statements were issued and therefore the auditor will be responsible for bring about amendments in the annual reports of the business (Iaasb.org. 2018). It is deemed that entire amount will not be received and therefore the same should be recorded as bad debts of the business and assets of the business needs to be readjusted. In order to get an unqualified opinion on the revised financial statements, the management of the company needs to make the necessary changes and also provide appropriate disclosures for the same.
As per the case study, a flood occurred and damaged inventory which were valued to be 2 million in 2nd July. This is within the date of the auditor’s report and therefore the auditor will be responsible for the opinion on the financial statements which is provided. The loss will significantly affect the financial statement both the assets and the profitability valuation of the business. The management of the company needs to record the loss suffered and also reduce the value of inventory which is shown in the annual report of the business. The management also needs to recognize a provision for half of the loss which the business expects to be recovered by insurance. In addition to this, appropriate disclosure are required to make the financial statement represent true and fair view again.
As per the case which is provided in the question, Outback’s exploration license is at risk of being revoked which will affect the business and also the going concern implications of the business as the main activity of the business is mining and exploration. There is an uncertainty in the situation and the auditor needs to make appropriate changes in the audit report of the business and also advise the management to create a provision for any losses which the business can expect in future and also the uncertainties the business faces (Hardies, Breesch and Branson 2016). If the management does not disclose the same, the auditor can issue modified report with an emphasis of matter paragraph included in the same.
The case states that government has imposed a regulation which will be severely affecting the revenues of the business and thereby the customers of the business will lessen greatly due to the restriction imposed by the Government. The auditor can make the management create a provision for anticipated losses but the management does not create the same, the auditor may or may not issue a qualified report as the item is not of material importance.
Reference
Auasb.gov.au. (2018). [online] Available at: https://www.auasb.gov.au/admin/file/content102/c3/ASA_620_27-10-09.pdf [Accessed 1 Aug. 2018].
Blandón, J.G. and Bosch, J.M.A., 2013. Audit firm tenure and qualified opinions: New evidence from Spain. Revista de Contabilidad, 16(2), pp.118-125.
Czerney, K., Schmidt, J.J. and Thompson, A.M., 2014. Does auditor explanatory language in unqualified audit reports indicate increased financial misstatement risk?. The Accounting Review, 89(6), pp.2115-2149.
Habib, A., 2013. A meta-analysis of the determinants of modified audit opinion decisions. Managerial Auditing Journal, 28(3), pp.184-216.
Hardies, K., Breesch, D. and Branson, J., 2016. Do (fe) male auditors impair audit quality? Evidence from going-concern opinions. European Accounting Review, 25(1), pp.7-34.
Iaasb.org. (2018). [online] Available at: https://www.iaasb.org/system/files/meetings/files/2684.pdf [Accessed 1 Aug. 2018].
Jans, M., Alles, M.G. and Vasarhelyi, M.A., 2014. A field study on the use of process mining of event logs as an analytical procedure in auditing. The Accounting Review, 89(5), pp.1751-1773.
Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Routledge.
Ratzinger-Sakel, N.V., 2013. Auditor fees and auditor independence—Evidence from going concern reporting decisions in Germany. Auditing: A Journal of Practice & Theory, 32(4), pp.129-168.
Sanderson, J., 2014. Audit issues. SMSF Guide: Current Issues and Strategies for the Self-Managed Superannuation Funds Adviser, p.377.
Shantapriyan, P., O’Donnell, K., Streeter, J. and Hicks, B., 2014. Getting it Right: Directors’ Assessment of Information.
Titera, W.R., 2013. Updating audit standard—Enabling audit data analysis. Journal of Information Systems, 27(1), pp.325-331.
Tsipouridou, M. and Spathis, C., 2014, March. Audit opinion and earnings management: Evidence from Greece. In Accounting Forum (Vol. 38, No. 1, pp. 38-54). Elsevier.
Yoon, K., Hoogduin, L. and Zhang, L., 2015. Big Data as complementary audit evidence. Accounting Horizons, 29(2), pp.431-438.
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