Ocean Manufacturing: Standards; Analytical Ratios; Financial Statement Audit
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Given the attached case study and data, please answer the below questions:
1. The client acceptance process can be quite complex. Discuss five procedures an auditor should perform in determining whether to accept a client. Which of these five are required by auditing standards and identify the applicable standards?
2. Using Ocean's financial information, calculate relevant preliminary analytical ratios to obtain a better understanding of the prospective client and to determine how Ocean is doing financially. Compare Ocean's ratios to the industry ratios provided. Identify any major differences.
3. What non-financial matters should be considered before accepting Ocean as a client? How important are these issues to the client acceptance decision? Why?
4 a. Ocean wants Barnes and Fischer to aid in developing and improving their IT system. What are the advantages and disadvantages of having the same audit firm provide both auditing and consulting services? Given current rules on professional independence in the Joint Code of Professional Conduct, will Barnes and Fischer be able to help Ocean with their IT system and still provide a financial statement audit?
4 b. As indicated in the case, one of the partners in another office has invested in a venture capital fund that owns shares of Ocean common stock. Would this situation constitute a violation of independence according to the Joint Code of Professional Conduct? Why or why not?
5 a. Prepare a memo to the partner making a recommendation as to whether Barnes and Fischer should or should not accept Ocean Manufacturing, Inc as an audit client. Carefully justify your position in light of the information in the case. Include consideration of reasons both for and against acceptance and be sure to address both financial and non-financial issues to justify your recommendation. (
5 b. Prepare a separate memo to the partner briefly listing and discussing the five or six most important factors or risk areas that will likely affect how the audit is conducted if the Ocean engagement is accepted. Be sure to indicate specific ways in which the audit firm should tailor its approach based on the factors you identify.
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1. The client acceptance process can be quite complex. Discuss five procedures an auditor should perform in determining whether to accept a client. Which of these five are required by auditing standards and identify the applicable standards?
1. Obtain an understanding of the client's business and operations. Consideration should be given to reading available financial information regarding the prospective client such as annual reports, registration statements, Forms 10-K, other reports to regulatory agencies and income tax returns.
2. Inquire as to the general reputation of high ranking employees, influential directors and shareholders, as well as the entity itself. Carefully consider any matters that may negatively reflect on management's integrity, ability and attitude. Such inquiries may be directed to the prospective client's bankers, legal counsel, underwriters, and others in the business community. Background checks obtained by investigative firms may also be useful.
3. Consider management's response to observations about or suggestions for improvements in internal controls made by the predecessor auditor and/or the internal auditor.
4. Consider the composition and autonomy of the Board of Directors and the Audit Committee, including the number of independent outside directors.
5. Communicate with the predecessor auditor in accordance with the provisions of Statement on Auditing Standards (SAS) No. 84 [AU315]. Inquiries should be directed to the integrity of management and the reasons for the change in auditor. The following situations should be carefully considered in assessing whether to accept a client:
o There has been a disagreement with the previous auditor over accounting principles or practices; financial statement disclosures; auditing scope; or the Form 8-K discloses a reportable event as defined in Securities and Exchange Commission Regulation S-K.
o The previous auditor resigned or declined to stand for re-election or there is no clear reason for the cessation of the client relationship.
o Access to the predecessor auditor's working papers has been denied.
o Other CPA firms have declined to serve the prospective client.
There appears to be evidence of "opinion shopping."
2.
Return on Equity (ROE=Net profit after tax /Total Shareholders' Equity * 100) 2521/35469 x100 = 7.11%
Return on Assets (ROA=Net profit after tax / Total Assets * 100)2521/66820 x 100 = 3.77 Unfavorable
Assets to Equity (Total Assets / Total Shareholders' Equity) 66821/35469 = 1.88 favorable
Accounts Receivable Turnover (Sales / Account receivable) 104026/7936 = 13.10 favorable
Average Collection Period (Account receivable / Sales * 365) 7936104026 x 365 = 27.84 favorable
Inventory Turnover (Cost of sales / Inventory) 69177/10487 = 6.6 Unfavorable
Days in Inventory (Inventory / Cost of sales * 365) 10487/69177 x365= 44.3 Favorable
Debt Ratio (Total Liabilities / Total Assets)31352/66821 = 0.47 Not available (industry figures)
Debt to Equity (Total Liabilities / Total Shareholders' Equity) 31353/35469 = 0.88 Favorable
Times Interest Earned (Profit before interest and tax / Interest expense) 6242/1474 = 4.23 Favorable
Current Ratio (Current assets / Current liabilities)27064/14118 =1.92 favorable
Profit Margin (Net Profit before interest and tax / Sales * 100) 6242/104026 x100 = 6.00 Unfavorable
The comparison needs to be done for the audited accounts and since the audited accounts are available for 2001 and 2000 but the industry figures are available only for 2001 and 2002 we have to select the year 2001 for comparison.
The accounts show that the company is healthy and the ratios are mainly favorable except that the company is not properly leveraged and this is leading to a loss of opportunities and a lower profit margin and lower return on equity.
There are no grounds of objection ...
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