Identifying Special Circumstances And Unusual Risks - Free Essay Example

Financial reports should meet the information needs of various users. These users could be shareholders, investors, security analysts, managers, employees, lenders, suppliers, customers and government regulatory agencies. However, if auditors fail to identify users who will actually be relying on the report and if, for example, the company fails in its operation, then the assigned auditors will be held liable for their negligent actions and must pay damages to the plaintiff. In the case of R.B Patel Group Ltd, the foreseeable parties from our perspectives are: The companys bankers; Australian New Zealand Banking (ANZ) and Westpac Banking Corporation, Shareholders of the company, Fiji Independent Commission Against Corruption (FICAC), Fiji Inland Revenue and Customs Authority (FIRCA), South Pacific Stock Exchange (SPSE), Directors of the company, Staff and Management of the company, Solicitors of the company (Sherani Company), Lenders and payables of the company. When asked with the management if there is any other party under the privity of contract then they have said that there is none. Assessing a prospective clients legal and financial stability Since R.B Patel is a new client, we need to assess this clients legal and financial stability. Risky clients whether legally or financially is rejected by auditors because since auditors are known as having deep pockets, those clients can turn the blame to them and thus, will want compensation from them (auditors)[2]. R. B Patels assessment in terms of their legal stability According to their annual reports of R.B Patel for the year ended 30 June 2009, Fiji Independent Commission Against Corruption (FICAC), has taken some documents of the company under a search warrant. Thus the company is under investigation by FICAC and the reason for that is unknown and also the company has not commented further on that issue. R. B Patels assessment in terms of their financial stability Auditors should also check to see how well the prospective client is in terms of financially[3]. We check the companys contingent liabilities and also did analytical procedures to check the clients solvency and liquidity status. Profitability ratios were not used to check if the company is making some progress or not because prior to their financial year, 30th June 2009, they had a 12-month financial period, but last year, as stated above, 30th June 2009, they had a 15-month financial period. So the quality of comparability is absent and will not provide reliable information if we try to compare profitability ratios from last year to the year prior to last year. We used the following methods and evaluated the results and then came to the conclusion. According to R.B Patels annual report for the financial year, 30th June 2009, we noticed that the company has a contingent liability[4]of $900,003. This is a material amount and can really affect the company if it turns out to be actual liability. Thus there is a risk attached to the companys financial stability. Quick ratio[5] This ratio is calculated using the formula: = Cash + A/c receivable + current asset investments Current liabilities Mapping the formula with R.B Patels financial data for the year ended 30 June 2009, we get: = $2, 518, 326 $16, 445, 442 = 0.15 The quick asset ratio, as calculated above gives 0.15. This means that for every $ 1 of current liability, the firm has or can pay 15cents on demand. A ratio of 2:1 is regarded as comfortable or 1:1 is also good (Edwards 2004)[6]. In this case, R.B Patels quick ratio is very less than 1, which shows that this company has not got a good financial stability as far as short-term obligation is concerned. Current ratio[7] This ratio is calculated using the formula: = Total current assets Total current liabilities Mapping the formula with R.B Patels financial data for the year ended 30 June 2009, we get: = $12, 828, 967 $16, 445, 442 = 0.78 The result shows that the company has a current ratio of 0.78. A current ratio of 2:1 is generally considered of having good short-term financial strength and if the company has a ratio less than 1, then the company will have problems meeting its short-term obligations (InvestorWords, [no date])[8]. Applying the concept to R.B Patels current ratio, it can be concluded that its current ratio is less than 1 and so, this company might have problems in meeting its short-term obligation; a clue of financial instability. Working Capital The calculation of working capital is used to find out how much current assets remains to fuel the businesses in meeting its goals and objectives after it pays off all the current liabilities. The formula is: = Total current assets Total current liabilities Mapping the formula with R.B Patels financial data for the year ended 30 June 2009, we get: = $12, 828, 967 $16, 445, 442 = ($3, 616, 475) So after doing the calculation we get a negative working capital. This means that the company will not have sufficient current assets after paying off all its current liabilities. Therefore taking up the responsibility of auditing this company is risky as this cpmpany is prone to liquidation because of financial instability as far as working capital is concerned. Debt to equity[9] This ratio is calculated using the formula: = Total liabilities Shareholders equity Mapping the formula with R.B Patels financial data for the year ended 30 June 2009, we get: = $28, 021, 403 $16, 931, 481 = 1.65 The result shows that the debt to equity ratio is 1.65, which is like 165% (1.65 x 100%). According to Leung et al (2009, pg 259)[10], he states that this ratio is used to measure how much debt is used to finance its assets and thus, used to run the business. In addition, he also states that this ratio should not exceed 100% because in such cases creditors will have more at stake than owners will. So looking at the ratio, we can say that R.B Patel is using most of the liabilities to finance its assets and assist in its on-going operation. It has a ratio of 165%, far more than 100%. As a rule of thumb by Leung et al (2005), creditors can claim the businesses assets before the shareholders can. All in all, R.B Patel is not financially stable as far as debt to equity is concerned. After doing the analytical procedures to check R.B Patels solvency status, it was found that every ratio signaled for risk that the company might not be able to pay its very short-term (on-demand) and short-term (within the financial year) obligations. In addition, creditors have more stake with the assets of the business than the shareholders have. According to the companys annual report, the chairman stated that the future of the company seems to be very challenging due to: Increase in wage rate; Cost such as transportation, refrigeration and security services to increase.'(R.B Patel Financial Report, Financial Year: 30th June 2009, Subheading: Future Outlook, page 3)[11]. This implies that the company will be in serious financial instability as analytical procedures and information from the chairman proves it. Evaluating the entitys auditability As was seen from the companys annual report for the year 30 June 3009, the previous auditor, G.Lal + Company, stated that the company keeps a proper records of the accounts and that the company has no problem of our compliance of the audit according to International Standards of Auditing[12]. In addition, the company is happy to comply that the financial statement to be prepared in accordance with Companies Act 1983 and International Financial Reporting Standards (IFRS). So the company accepts the standards that we would like to comply with and also maintains a proper book of accounts. The companys internal control is okay and there is no disagreement with the management in regards to the overall plans of doing the audit of the company and they have assured that there will be no interference that can affect our conduct of the audit.