Fabulous Phone Company Ratio Analysis
1. Based on the information gien on the Fabulous Phone Company, the ratio analysis for the past 3 years, following are the conclusions drawn:
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What the ratio means |
Conclusions to draw |
Potential risks to be investigated |
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Current Ratio is the measure of the current assets to current liabilities in the company. It is the measure of the working capital being held by the company. It shows how the company would be able to pay back its liabilities on time out of the current assets being held in the books. |
The company has had a stable current ratio ranging from 3.85 to 3.40 which is well above the industry trend of 2 and shows that the company is proficient enough to meet it liabilities in time. This should that the company has a good liquidity position. (Boccia & Leonardi, 2016) |
The only risk here is that the current ratio has eroded a bit over the past year which is indicative of the fact that current assets have either been sold or liquidated to meet the current liabilities. Also, it shows that the company may be carrying unnecessary current assets like cash and stock and thus blocking the funds. |
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Acid test or liqiuid ratio is one of the another liquidity ratio which shows that the how much of readily liquidable assets is being carried in the books to meet the current liabilities. This includes those assets which can be liquidated immediately. Stock and prepaid expenses needs to be ignored. |
The liquid ratio has come down drastically from 1.30 to 0.98 over the last year which shows that the company has lost some of the readily cash convertible asset in the last year. Though the industry trend is 1, still the company should infuse more cash to keep the position status quo. |
The risk which is foreseen here is the erosion of cash convertible assets or cash itself which may land the company into adversities if the trend continues. Thus it needs to infuse funds in the form of cash in the working capital. |
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Inventory Turnover ratio is the measure of how many times the inventory is rolled over or being converted to final sales in a given accounting year. It shows the churn or the no. of cycles of conversion of inventory to sales. |
This again has dropped from 5.10 to 4.20 which shows that the inventory conversion rate to sales has dropped. This might be because the sales might have decreased or the inefficiencies or internal control might have weakened. |
The risk which is being seen here is that the sales needs to checked properly for the reasons why ist has dropped or why the inventory churn out ratio has decreased, whether there is any inefficiency in the system or internal control is weak. (Capaldi, et al., 2017) |
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Receivables turnover ratio is the measure of how many times the debtors is being converted to cash in the period of 365 days. The greater it is, the better it is for the company. |
This has increased from 3.50 to 4 over the last 2 years which shows that the company has tightened the collection procedure and the movement of debtors to cash has increased |
The auditor needs to check what could be the reasons for this increase, like if the company is offering discounts to customers for paying upfront or if the company has revised its credit policy or any other issue. |
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Days to sell inventory is one of the most important ratios which shows how much time or how may days does the company takes to convert the inventory to sales or how much days does the inventory is being kept in the godown. (Das, 2017) |
The inventory to sales days has increased from 98 to 130 which is negative trend and which shows that the company has been stagnant and not been able to convert the inventory into sales quickly. This is indicative of the fact of blocking of the funds in the form of inventory. |
The major risk here is the blocking of the funds in inventory and that’s why the current ratio is high, the EOQ needs to be maintained and the management needs to answer why it has such a long inventory conversion period. |
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Gross Profit margin is the measure of the gross profit being earned on the sales made by the company. It is sales less cost of goods sold. This shows the direct margin being made by the company. |
The company’s gross margin has dropped marginally from 44% to 41% which can be temporary. Moreover, it is earning as per the industry trend. Moreover, the factors can be analysed for the stability and why the company hasn’t been able to increase it. |
The risk foreseen here with the gross margin is why the same has been constant over the years. Is the company not growing or if it is growing, the company’s costs have been proportionately same with the company’s increase in sales. (Jefferson, 2017) |
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Profit margin is the measure of the net profit being earned by the company on the sales made. This is the actual margin after all the direct and indirect expenses, depreciation and interest cost. (Li, et al., 2017) |
The company’s net profit percentage has increased from 8% to 10% despite a decrease in gross profit which shows that the company has been able to cutoff on its indirect costs and is thus able to increase the distributable profit. |
The risk here is that whether the company is earning as per the industry trends, whether the company has repaid any of its loans or whether any of the indirect costs have been missed out to be recorded in the books or whether the profist have been overstated dues to some reasons. |
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Return on Shareholder’s Equity or ROI is the measure of the distributable profit or the return which the company is earning on the amount of investment being made by the shareholders. This is the rate of return being earned by the investors. |
This has decreased from 6% to 4% over the past 2 years which shows that the company has not been able to meet shareholder’s expectations on the profit front. This has decreased by 33% which shows that the expected return of the investors might not be met. |
The risk here is why the company has not been able to meet as per the industry expectations, whether the internal control is weak or the industry itself is performing low, whether there are any other dependencies. |
2. Here we would be discussing the various issues which Christine Careful, the senior auditor might have come across during her audit engagements:
i. Here the concept of related party is being touched upon as the finance controller of the client or the company being subject to audit is the related party (uncle) of one of the auditors which will not only impact the independence of the auditor but will have a serious impact of the reporting and other critical and crucial requirement and information which may be kept hidden from the stakeholders in the wake of related parties being involved. This is agsinst the laws set in the Professional Ethics where the related party cannot do the audit of the client. The solution to it can be the change in the audit team who is going to audit the client’s financial statements. (Section 100.12 – Familiarity Threat) (Fay & Negangard, 2017)
ii. In the given case, one of the team member of the audit team is holding shares of the client Great Gadgets company. One the audit is accepted, the firm should check on the audit engagements and whether there are any ethical conflicts or threats which will have an impact on the objectivity and independence of the auditor. Here, in case the auditor is holding the shares of the client, he should turn down the engagements as it may impact the reporting and safeguards may be used by the auditor in order to reduce the impact on the share prices of the company so much so that the material information may be kept hidden. (Section 340.2 – Financial Interest)(Lin, et al., 2017)
iii. Sam Savvy being the team member of the audit team is aware of the confidential information regarding the client Wonderful weekends company and other recent developments but the same should not be leaked at any cost or even the same should not be misused for personal motive or profit/gains. Here, the confidentiality of the client information is being overridden and thus, Christine should forbid Sam from doing so or stop Sam from doing any audit assignment as here the General Ethical Principles of auditing is being violated. (Section 140 – Confidentiality)
iv. Here in this case one of the other auditors David Double is entering into business besides being in Auditing profession and shares the information with Christine. As per the General Ethical Principles, an auditor cannot engage in multiple profession i.e., business and practice the same time. This is a professional miscondusct. The ethical dilemma her for Christine is to forbid him from doing so. She should either convince him from entering as a owner of Suzy Strippers Night Club or she should report it to the concerned Accounting body of the state. (Section 220 – Conflict of interest) (Félix, 2017)
v. As per the Ethical Principles and code of conduct for the auditors, they should not accept any offerings or gift or any other material possession or other considerations except the contracted audit fees. This not only impacts the independence but safeguards the interest of both the parties and as a result, the auditor may get influenced to release the audit report which does not gives the true fair view. This is the ethical dilemma in the question. To encounter this, she should not accept to have lunch free of cost or she should pay for the same. (Section 260 – Gifts and hospitality) (Goldmann, 2016)
Various Ethical Dilemmas Faced by Auditors
vi. In the given case, the auditor is holding a loan from the bank i.r. the auditor is one of the customer of the bank. The ethical dilemma being faced here is that this transaction falls under th related party transaction as Steady Steve may try to play with the postion of his loan due to the bank and may even report the wrong figures on account of it to get the benefit. To encounter with this situation, either the firm should turn down the audit engagement with the client or Christine should change the team member doing the audit as this would negate the independence. (Section 200.5 – Self Review threats)
vii. In the given case, Freddy Fast is the accountant and Christine is the auditor of Good Gear Ltd. The preparation of the financial statements of the entity is the responsibility of the management and director of the company and the auditor just needs to check the same so as to give the reasonable assurance about the same to the stakeholders and to express an opinion on gthe true and fair view but here the CEO is asking the auditor herself to prepare the left over financial statements. This will not only impact independence of the auditor but the entire objective of the audit itself is being defied and lost. Thus, here Christine to turn down the enagegement or ask the CEO to get the financial statements from the other accountants of the company. (Section 200.13 – Engagement Specific safeguards) (Heminway, 2017)
viii. Here, Penny Poor, the senior accountant is the client who is going overseas and asking the auditor to take his place once the audit is over. The ethical dilemma which will arise here is the independence while doing the audit as then Christine would forego all the material misstatements, if any or any other critical issues in the wake of she being the senior accountant of the company in the near future. To avoid this, she should turn down the offer or she should quit from being the auditor of the client. (Section 200.4 – Self interest threats)
3. a) There are a lot of advantages that are associated with an external audit. External auditors are third party professionals who give an unbiased opinion on the overall financial statement of the company. It helps the management in understanding the errors in their system and rectifying the same. It helps in providing the true snapshot of the position of the company and thus can be very helpful for the investors in taking important decisions regarding the company. (Kodua & Mensah, 2017)It helps in identification of the weakness in the control methods that are employed the management and helps them in rectifying the same. It is not mandatory for all the companies to get their accounts audited beyond a certain limit, but it is an indispensable part of the overall auditing scenario that exists. It is very helpful for all the stakeholders who are related to the company in some way or other. Thus external auditing helps in understanding the effectiveness of the overall functions of the company.
Advantages of External Financial Audits
b) Under the Auditing Standards and Corporations law, the external auditors are appointed by the companies to judge the overall efficiency of the accounts of the company and to check whether the management of the company has incorporated effective internal control methods. Internal controls are very important as it helps in stabilizing the operations of the company. It helps in management of all the departments of the company and to make sure that the system is free from errors. If there are any loopholes in the internal control methods than the management of the company will suffer. Hence external auditors are appointed to judge the effectiveness of the same. (Meroño-Cerdán, et al., 2017)They can apply various audit procedures like substantive and assertive that will help I judging the overall validity of these systems. It should do a thorough check and in cases they find any errors then they should ask the management of the company to make the necessary corrections. It helps in understanding the overall approach of the management and also helps in understanding the loyalty of the employees and helps in avoiding all kinds of malpractices in the business. (Bloxham, E 2015)
c) Under the Auditing Standards and Corporations law, if the external auditor of the company comes across any such methods that are detrimental to the health of the company, or in cases they find that the internal management is not up to the mark. The control processes applied by the management of the company are not fruitful than the company must take the necessary steps that will help them in getting over the same.(Minnis & Sutherland, 2016)The auditor must inform the management about the same, and ask the management to make the necessary changes. And in case the auditor is seeing that the management is not doing their work properly, than the management should be held liable. The auditor can issue a modified audit report stating the same. It is the responsibility of the auditor to comment on the effectiveness of the system and provide a true and fair view of the overall business practices. (kabir, et al., 2017)
References
Bloxham, E 2015, ‘Should companies eliminate audits?’, Fortune Magazine, viewed 2 Aug, 2017, https://fortune.com/2015/06/18/company-audits/
Boccia, F. & Leonardi, R., 2016. The Challenge of the Digital Economy. Markets, Taxation and Appropriate Economic Models, pp. 1-16.
Capaldi, N., Idowu, S. & Schmidpeter, R., 2017. Dimensional Corporate Governance. CSR, Sustainability, Ethics & Governance, pp. 175-187.
Das, P., 2017. Financing Pattern and Utilization of Fixed Assets – A Study. Asian Journal of Social Science Studies, 2(2), pp. 10-17.
Fay, R. & Negangard, E., 2017. Manual journal entry testing : Data analytics and the risk of fraud. Journal of Accounting Education, Volume 38, pp. 37-49.
Félix, M., 2017. A study on the expected impact of IFRS 17 on the transparency of financial statements of insurance companies. Master Thesis pp. 1-69.
Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business. Financial Environment and Business Development, Volume 4, pp. 103-112.
Heminway, J., 2017. Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and Organic Documents. SSRN, pp. 1-35.
Jefferson, M., 2017. Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland. Technological Forecasting and Social Change, pp. 353-354.
kabir, H., Rahman, A. & Su, L., 2017. The Association between Goodwill Impairment Loss and Goodwill Impairment Test-Related Disclosures in Australia. 8th Conference on Financial Markets and Corporate Governance (FMCG) 2017, pp. 1-32.
Kodua, P. & Mensah, P., 2017. The Role of Corporate Social Responsibility in Influencing Brand Loyalty: Evidence from the Ghanaian Telecommunication Industry. Marketing at the Confluence between Entertainment and Analytics, pp. 77-90.
Lin, S., Riccardi, W. & Wang, C., 2017. Relative Effects of IFRS Adoption and IFRS Convergence on Financial Statement Comparability. SSRN, pp. 16-40.
Li, S., Sougiannis, T. & Wang, I., 2017. Mandatory IFRS Adoption and the Usefulness of Accounting Information in Predicting Future Earnings and Cash Flows. SSRN , pp. 1-47.
Meroño-Cerdán, A., Lopez-Nicolas, C. & Molina-Castillo, F., 2017. Risk aversion, innovation and performance in family firms. Economics of Innovation and new technology, pp. 1-15.
Minnis, M. & Sutherland, A., 2016. Financial Statements as Monitoring Mechanisms: Evidence from Small Commercial Loans. Journal of Accounting research, 55(1), pp. 197-233.
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