Question

Question 1.9 Change in payable days = 10 days Increase in trade payable = 35%

Question 1.10 Change in current ratio = 2 Decrease in quick ratio = 2

Looking at the relationship between ratios in 1.9 and 1.10, What are the audit risk/problems that may be present?

Answer 1

Let’s consider each ratio in detail and interpret the problems associated with their values:

1. Change in payable = 10 days

The accounts payable days formula measures the number of days that a company takes to pay its suppliers. If the number of days increases from one period to the next, this indicates that the company is paying its suppliers more slowly, and may be an indicator of worsening financial condition.

2. Increase in trade payables = 35%

If trade payable increases over a prior period, that means the company is buying more goods or services on credit, rather than paying cash. This increases the current liabilities of the company.

3. Change in current ratio= 2

The current ratio is an indication of a firm's liquidity. If the company's current ratio is too high it may indicate that the company is not efficiently using its current assets or its short-term financing facilities.

4. Decrease in quick ratio= 2

The quick ratio indicates a company's capacity to pay its current liabilities without needing to sell its inventory or get additional financing. The higher the ratio result, the better a company's liquidity and financial health; the lower the ratio, the more likely the company will struggle with paying debts. Since, the quick ratio is decreased by 2, we can say that company will struggle with paying it’s debts.

Here, current ratio (CA/CL) is more, indicating that company is not using its current assets or its short-term financing facilities. But the quick ratio (CA-inventory/CL) is less. and also, there was a 35% increase in trade payables. So we can say that there was more inventory for the period.

Therefore, we can say that there was inherent risk and control risk in auditing. Control risk or internal control risk is the risk that current internal control could not detect or fail to protect significant error or misstatement in the financial statements.

Basically, management is required to set up and assess the effectiveness and efficiency of internal control over financial reporting to make sure that financial statements are free from material misstatements.