Auditing Case Study: Barnes and Fischer, LLP
The client acceptance decision has been carefully considered by gaining an understanding of Ocean Manufacturing business and industry. The nature of Ocean Manufacturing business and industry affects business risk and the risk of material misstatements in their financial statements.
During this investigative process we gained a better understanding of the business operations and processes, management and governance, objectives and strategies, and overall performance. This knowledge gained allows us to assess the risk that the client may fail to achieve its objectives.
Analytical procedures are required in the planning phase to assist in determining the nature, extent, and timing of audit procedures. Since Barnes and Fischer auditors are not familiar with the small appliance industry it was imperative for us to compare Ocean Manufacturing data to similar medium-sized companies Nothing the industry. During the compilation of this information we gained an understanding of the internal controls in place, with a large emphasis on the accounting system they recently converted to.
Finally, we developed an overall audit plan and program, which allows us to determine the resources required for the engagement.
Part of our analytical procedures to better understand Ocean Manufacturing we lactated several financial ratios and compared the results to similar companies Nothing the small appliance industry. The following ratios were calculated: [pick] The return on assets (ROAR) ratio provides a standard for evaluating how efficiently management employs the average dollar invested in the firm’s assets. Ocean Manufacturing ROAR is significantly lower than the industry standard indicating Inefficient use of business assets.
The ROAR ratio for Ocean Manufacturing has increased from 2007 to 2008. Although marginal, it is notable since the industry as a Manhole saw a decline in ROAR during this period. Nee debt to equity ratio indicates what proportion to equity and debt the company is using to finance its assets.
A high debt equity ratio generally means the company has been aggressive in financing its growth with debt. This does not appear to be the case with Ocean Manufacturing as their debt to equity ratio is significantly lower than those within the industry.
The current ratio gives an idea of the company’s ability to pay back its short-term liabilities with its short-term assets. The higher the current ratio, the more capable the company is of paying its obligations. The current ratio can also give a sense of he efficiency of a company’s operating cycle or its ability to turn product into cash.
Ocean Manufacturing appears to be handling their short-term liabilities efficiently, as their current ratio is higher than those within the industry. The ratio of profitability measures how much out of every dollar a company actually keeps in earnings.
A higher profit margin indicates a more profitable company that has better control over its costs compared to competitors. This does not appear to be the case with Ocean Manufacturing. Their profit margin is substantially lower than their competitors. Times interest earned is used to measure a company’s ability to meet its debt obligation.
Ensuring interest payments to debt holders and preventing bankruptcy depends mainly on a company’s ability to sustain earnings. Ocean Manufacturing has a high ratio, indicating they may be paying down too much debt with earnings that could be used otherwise.
Based on the information analyzed it appears Ocean Manufacturing is not effectively using their business assets, since their ROAR is significantly lower those Nothing the industry. Ocean Manufacturing does not appear to be managing the costs associated with conducting business, therefore affecting the profit margin. The low profit margin raises concerns of their ability to reach the goal of making an initial public offering.
Ocean Manufacturing would yield greater returns by investing its earnings into other projects and borrowing at a lower cost of capital than what they are currently paying to meet debt obligations.
As the successor auditor of Ocean Manufacturing we carry the burden of initiating communication with the predecessor auditor, which is required by auditing standards. Frank Stevens, Ocean Manufacturing vice-president of finance, was Initially hesitant of Barnes & Fischer contacting the predecessor auditor. Mr.. Stevens indicated that the predecessor auditor and Ocean Manufacturing management had disagreed on minor accounting issues during the prior year’s audit, and it was in Mr.
Stevens opinion that the predecessor auditor did not have an understanding of Ocean Manufacturing business and industry environment. During a meeting with the predecessor auditor he indicated the problems his firm had with Ocean Manufacturing related to the complexities and problems with the new IT system and management’s tendency to aggressively reflect year-end accruals and revenue in order to meet creditor’s requirements . The auditor indicated TN the dissolution to the relationship was a mutual agreement between both parties.
The issues between the predecessor auditor and Ocean Manufacturing, although they do not relate to the financial information we have preliminarily reviewed, are concerns for Barnes & Fischer.
Based on conversations with the predecessor auditor there appeared to be a difficulties from the beginning, which negatively affected communication between the predecessor auditor and management of Ocean Manufacturing. If Barnes & Fischer does decide to issue an engagement letter expectations will need to be set prior to accepting Ocean Manufacturing as a new audit client.
In addition to the dissolution of the previous auditing relationship, additional concerns arose regarding management. In October 2008, the company experienced significant management turnover. Jessica Wood, vice-president of operations, has 12 [ears of experience within the industry.
Although Ms. Wood seems to have the knowledge and ability to oversee operations, there have been no improvements to he in-process inventories which do not appear to be organized. Theodore Jones, the newly appointed controller, has little relevant experience.
Problems still exist in inventory tracking and cost accumulation, receivables billing and aging, payroll tax deductions, payable, and balance sheet classifications. The transition to the new IT system has not gone well and management is frustrated with the situation because problems continue with the internal budget reports, inventory status reports, and as result several shipment deadlines have been missed.
Due to the inaccuracy of the Information put out by the new IT system, the misstatement of financial reporting could potentially be quite material.
The financial reports produced by Ocean Manufacturing appear to be consistent with previous years; however there is still the possibility of misstatement. In addition to auditing the financial statements of Ocean Manufacturing, they have requested Barnes & Fischer aid in developing and improving its IT system. The advantages to assisting with this process are great to Barnes & Fischer, as we will be sure the information entered into the system is being accurately classified and managed appropriately within the system.
Therefore, we can be certain as long as the information inputted into the system is accurate and consistent with business activity, we will receive the correct output in the financial statements. Providing a non-audit service in addition to an auditing service could potentially impair our Independence.
Since Ocean Manufacturing is not currently a public held company Nee do not fall under the PEPCO and SEC rules. However, in the future when Ocean Manufacturing does make an PIP, we will fall under PEPCO and SEC rules.
Therefore, earners & Fischer must assess Ocean Manufacturing willingness and ability to perform all management functions related to the engagement and this must be well documented. The understanding should include a description of the IT services we are providing and management’s responsibilities in regards to these services. As part to Barnes & Fisher’s quality control program we review disclosures to personal stock provided by our employees.
During this review, we found that a partner of the Salt Lake City office owns shares in a venture capital fund which in urn holds a private equity investment in Ocean Manufacturing common stock.