Question

Preliminary analytical procedures are performed as part of the planning process to assist the auditor in gaining an understanding of the entity and its environment (ASA 315 ‘Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment’). Required: From the three rows of data shown below for Georgie Manufacturing Pty Ltd: (a) what conclusions would you draw from the ratio analysis (i.e. interpret any movement in the ratio and discuss the audit risks that could be present); and (b) what areas would you then emphasise in conducting the audit in relation to the risks identified in your conclusions. Millicent Manufacturing Pty Ltd 2016 2015 2014 2013 Industry 2016 1. Inventory Turnover 3.40 3.21 4.66 5.64 4.88 2. Current Ratio 1.65 1.69 2.08 2.31 2.00 3. Days Sales in Receivables 99 86 90 62 60 Question 1 Part B continued a) Inventory Turnover Conclusions: _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ Audit Emphasis: _____________________________________________________________________ _____________________________________________________________________ b) Current Ratio Conclusions: _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ Audit Emphasis: _____________________________________________________________________ _____________________________________________________________________ c) Days Sales in Receivables Conclusions: _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ Audit Emphasis: _____________________________________________________________________ _____________________________________________________________________ (2 marks

Answer 1

1. Inventory turnover ratios

Inventory turnover ratio vary significantly among industries. A high ratio indicates fast moving and a low ratio, on the other hand, indicates slow moving or obsolete inventories in stock. A low ratio may be the result of maintaining excessive inventories needlessly. Maintaining excessive inventories unnecessarily indicates poor inventory management because it involves tiding up funds that could have been used in other business operations.

As the inventory turnover ratio is increasing, it indicates that the company is appropriate in maintaining inventory and have a good inventory position.

Audit emphasis

The company needs to pay more attention to the forecasting techniques. If you can forecast the demands of the customer correctly, you need to stock only those items. This will reduce your inventory levels, which in turn will increase the inventory turnover ratio.

Can improve the sales

Better inventory price

1. Current Ratio

Current ratio measures the monetary volume of current assets in relation to current liability.

Higher the ratio means higher the amount of current assets available to meet short term obligations and thus higher the liquidity of the entity. However, high current ratio might be the result of excessive inventory (or obsolete inventory that should be written down) and receivables that might require provision for doubtful debts.

Lower current ratio may be indicative of the fact that entity will be dependent on external source of finance or utilizing cash flows from its operating activities directly. In both cases entity’s operating cash flows are getting affected. If entity relies on outside finance then profits will be burdened by interest cost (finance cost). If operating cash flows are applied to pay liabilities then again entity is effectively short on cash asset to pay dividends.

As the company’s current ratio is increasing and becoming very nearer to idle ratio of 2:1., we say the company’s liquidity position is in a viable position.

1. Days sales in Receivables

The days’ sales in accounts receivables ratio means average number of days it takes to collect an account receivable. Since the accounts receivable turnover ratio used in the days' sales in accounts receivable was based on the credit sales during a one-year time period, and the average accounts receivable balances during that one-year period, the 36 days calculated above is an average. It is possible that within the accounts receivable there are some accounts which are 120 days or more past due. This information might be hidden by the average, because the average included some accounts that paid early. Therefore, it is best to review an aging of accounts receivable by customer to understand the detail behind the days' sales in accounts receivable ratio.

Days sales in accounts receivables is decreasing and ultimately now reached to 60 days which indicates that the company is in a good position.