Termination Risk And Multiple Exercises: A Discussion

DIPL-Ratio analysis

Discuss about the Termination Risk and Multiple Exercises.

This assignment represents how an auditor digs in to the financial statements of the company to extract crucial information regarding the operational efficiency of the company and also the possible anomalies that are taking place in to the activities of the company(Christensen et al.,2012). In this assignment an audit report has been prepared to identify the accounting accuracy with respect to the major items of the financial statements in order understand the financial health of the company and also to identify the areas where possible fraud can happen.

Table-1: DIPL-Ratio analysis

• The current ratio of the company has increased from 1.4 to 1.5 during the period 2013-2015.But the current ratio of the company is still below the benchmark ratio of the global printing industry.
• The gross profit margin ratio of the company has declined from 18% to 15% during the period 2013-2015.This indicates that the gross profit generation capacity out of the sales revenue earned is declining over period for the business. This indicates that the cost of goods sold by the company is increasing over time
• The operating profit margin ratio of the business has declined from 20% in 2013 to 19% in 2015.This indicates a deteoriation in the operational efficiency of the company. However the ratio of the business is still better with respect to the bench mark ratio of the global printing industry (15.63%).
• The Return on Asset Ratio has declined from 38 %( 2013) to 32 %( 2015); this describes that the income generation capacity out of the total asset has declined steadily for the company over years(Costello, 2011)
• The debt-equity ratio and the debt-asset ratio of the company describes that up to 2014 DIPL was a solely equity based company. In 2015 the company has acquired huge amount of interest bearing loan probably due to reduced capacity of generating profit &income from assets in possession and sales revenue earned by the company(McCue and Nayar, 2009).
• The interest coverage ratio describes that it has reduced drastically from 40.94(2013) to 4.8(2015) as the company borrowed huge amount of loan in 2015.This indicates the weak strength of the current operating income of the company for servicing the interest bearing liabilities of the company.

• The holding of liquid asset of the company should be enhanced and new investments will be done in such a way so that the business is left with sufficient liquid assets that can be readily converted in to cash for repaying the shorter liabilities that are to be paid within one year from 30^th June,2015
• The business should work on enhancing the operational efficiency of the company as well as the work force before going in to any new venture.
• Any new investment decisions should be taken while considering the fact that business has bear the burden of a loan of 7.5 million for which they have to maintain a strong current ratio of 1.5
• The company should strengthen their debt collection mechanism so that the provision of doubtful debt can be reduced to a great extent and the revenue earning mechanism of the company can be enhanced substantially.
• In order to bring transparency inventory should be valued on FIFO basis as it is revealed in the auditors note that there is much volatility in the current method of inventory valuation.
• To avoid any kind of fraudulent activity and to ensure compliance with the applicable accounting standard revenue earned from sale of E-book will be recognized as per the stage of completion

DIPL is generally involved in printing of books, magazines and advertising materials that are ordered by the clients who are mainly from the publishing, educational and advertising industries. Once the order is placed and confirmed by the client, then the accounts department of DIPL check the credit record of the client and if there is no problem then the business has to deliver the job within the predefined time limit given by the client. The time with in which the publishing job has to be completed often appears to be quiet short and any failure in delivering the job on time or a delivery of an erroneous job will be considered as a breach of trust or fraud on behalf of the ordering client for which DIPL may lose the business reputation or may end up paying heavy financial penalty(Bushman and Williams, 2012). Thus there appears a high risk of failure if DIPL accepts a publishing order without making the proper calculation regarding whether the available resources are sufficient for completing the ordered job in time or not.

The impact of this risk is that if an order is cancelled then the business will not only lose their reputation but there is a huge scope of material misstatement. Because when a certain amount of resources are sanctioned for an order, on cancellation of the order those partially unutilized resources may wrongfully will not be accounted with respect to the inventory and this will lead to erroneous  valuation of inventory as well as mis-statement of asset in the balance sheet.

More over if the cancellation of order is not recorded properly then there lies a possibility that the cancelled order may worn fully be included under credit sales which may inflate the revenue earning of the company

Key Findings

Valuation of raw materials inventories at an average cost is another risk factor inherent to the nature of operation of DIPL.DIPL is involved in a business where it is essential that predefined jobs are to be completed with a in the limited time. Therefore in order to maintain an undisturbed production process it is essential that the business should keep up-to-date their required stock of inventories and should also keep a tap on the required cost of purchasing the inventories that accounts the maximum share of the total expense made by the business. But if the inventories are valued at average cost when the  actual cost of inventories are much below the average cost then such valuation will lead to wrong estimation regarding the expenditure that has actually been incurred for acquiring the inventories(Leung and Sircar, 2009). Thus miscalculation of inventory acquiring cost is a huge risk in itself as it can lead the business to operate out of budget at any point of time especially when huge orders are placed to the business.

The impact of this risk is that there is a possibility of erroneous recording of expenditure amount under the head of “inventory purchase” in the profit and loss statement and possible error may also take place in case of recording the amount with respect to the “cost of goods sold” in the balance sheet. Thus this risk may lead to the above mentioned material misstatements in the financial statements as well as financial reports.

The above table-2, describes that there is a substantial difference between the numerical values that has been stated in the financial statements & the statements made by the auditor after making the financial audits(Jans et al.,2010).

In 2013 the balance sheet of the business reported the amount of “accounts receivable” by 165000 units less compared to what stated by the auditor. In 2014 the balance sheet reported the amounts of accounts receivable by an amount which is higher than the respective statement of the auditor by an amount of 38, 67,000.Again in 2015 the balance sheet accounts statement with respect to the accounts receivable is lesser by an amount of 2, 40,000 with respect to what has been stated by the auditor. Thus it can be seen that in each year from 2013-2015 there is an anomaly with respect to the amount that has been reported against the head accounts receivable as per balance sheet and as per the audited amount as presented by the auditor. Therefore it should be suspected that DIPL is susceptible to the fraudulent accounting as risk identified by the differences in the report of balance sheet and the report of the auditor with respect to “Accounts receivable”.

Inherent Risk Factors

Again discrepancy can be observed with respect to the amount reported against “inventory” in the balance sheet and the amount reported by the auditor. In 2013 the balance sheet amount of “inventory” is less by an amount of 1, 06,312 compared to what stated by the auditor, in 2014 the balance sheet amount of inventors is less by an amount of 125876 compared to that of auditor. However in 2015 both the reported amounts with respect to the auditor as well as balance sheet match for inventory(Norman et al.,2010).

Therefore it should be suspected that DIPL is susceptible to the fraudulent accounting risk as identified by the differences in the report of balance sheet and the report of the auditor with respect to “Accounts receivable” and inventory. The above inspection reveals a crucial fact that the accounting discrepancy or inaccurate accounting has taken place almost each year under consideration [2013-2014] with respect to the two most important items of the balance sheet namely “Accounts receivable” and “inventory”. When an accounting error with respect a particular item is repeated each year then it should be considered as an act of deliberate error or fraud and therefore it can be said that DIPL is exposed to accounting fraud risk and the management of the business should take some preventive measures for protecting the company from such risk.

Another major misstatement can be observed in the balance sheet with respect to the description of the capital structure i the year 2015.As per the finance information of the business in 2015 DIPL take an interest bearing loan of 7.5million from BDO Finance Ltd but still the balance sheet of the company represented the entire asset of the company in the form of equity. This can be considered as deliberate act of omission or fraud which has been done to show that IDPL is a financially healthy company and can efficiently run without taking any interest bearing loan(Brazel et al.,2009). This risk has been identified while ratio analysis has been done and both values of debt-equity ratio and debt-asset ratio appear to be same [0.61] for the year 2015.Thus it can be seen that DIPL is exposed to fraud risk of misrepresentation of capital structure which is often done to attract the investors by concealing the real financial condition of the business.

Identification of these possible fraud risk factors will make the audit process more detailed and stringent. As presence of any fraud will do long term harm to the business.Thus now it is recommended that a further deep audit should be conducted for identifying the other operational malfunctions that may have taken place in the business and thus hampering the financial performance of the business(Soh et al.,2011).

Fraud Risk Factors

Conclusion:

The above assignment describes a deeper analysis of the financial statements as made by the auditor can catch every progress or deteoriation in the financial health of the company as described above. The ratio analysis reveals that the declining gross profit as well as operating profit generating efficiency of the business out of the sales revenue earned when the company is moving from 2013 to 2015(Hodgdon et al., 2009).The ratio analysis also reveals that the business is exposed to the risk of misrepresentation of capital structure in terms of the financial statements so that investors consider this company as an attracting one for investment. In the context of the above revelation it can be recommended that rigorous corporate governance should be practiced by DIPL for protecting the business from the risk of the identified frauds and the same time new strategies will be formed for enhancing the operational efficiency of the company.

Reference:

Brazel, J.F., Jones, K.L. and Zimbelman, M.F., 2009. Using nonfinancial measures to assess fraud risk. Journal of Accounting Research, 47(5), pp.1135-1166.

Bushman, R.M. and Williams, C.D., 2012. Accounting discretion, loan loss provisioning, and discipline of banks’ risk-taking. Journal of Accounting and Economics, 54(1), pp.1-18.

Christensen, B.E., Glover, S.M. and Wood, D.A., 2012. Extreme estimation uncertainty in fair value estimates: Implications for audit assurance. Auditing: A Journal of Practice & Theory, 31(1), pp.127-146.

Costello, A.M., 2011. The impact of financial reporting quality on debt contracting: Evidence from internal control weakness reports. Journal of Accounting Research, 49(1), pp.97-136.

Gleeson, E. (2017). Seven Key Printing Industry Ratios. [online] www.piaa.org. Available at: https://www.piaa.org.au/verve/_resources/The_Seven_Key_Printing_Industry_Ratios_(Benchmarking)_from_2014.pdf [Accessed 24 Aug. 2017].

Higgins, R.C., 2012. Analysis for financial management. McGraw-Hill/Irwin.

Hodgdon, C., Tondkar, R.H., Adhikari, A. and Harless, D.W., 2009. Compliance with International Financial Reporting Standards and auditor choice: New evidence on the importance of the statutory audit. The International Journal of Accounting, 44(1), pp.33-55.

Jans, M., Lybaert, N. and Vanhoof, K., 2010. Internal fraud risk reduction: Results of a data mining case study. International Journal of Accounting Information Systems, 11(1), pp.17-41.

Leung, T. and Sircar, R., 2009. Accounting for risk aversion, vesting, job termination risk and multiple exercises in valuation of employee stock options. Mathematical Finance, 19(1), pp.99-128.

McCue, M.J. and Nayar, P., 2009. A Financial Ratio Analysis of For?Profit and Non?Profit Rural Referral Centers. The Journal of Rural Health, 25(3), pp.314-319.

Norman, C.S., Rose, A.M. and Rose, J.M., 2010. Internal audit reporting lines, fraud risk decomposition, and assessments of fraud risk. Accounting, Organizations and Society, 35(5), pp.546-557.

Soh, D.S. and Martinov-Bennie, N., 2011. The internal audit function: Perceptions of internal audit roles, effectiveness and evaluation. Managerial Auditing Journal, 26(7), pp.605-622.

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