The Audit Process: Carpet Right plc - Case Study Example

Carpet rightplc. (Audit and Assurance)   Carpet rightplc. (Audit and Assurance) The risk based approach is an auditing method that was developed to be applied entirely in audit work in an effort to be used efficiently and effectively focusing on the timing, nature and extent of audit procedures in areas within an organization that have a high potential of material misstatements in the annual report. Three steps are involved in the risk based approach of auditing. The first step that the auditor will take into account when auditing carpet right plc. Is understanding the environment of the company including the internal control system. The external auditor’s judgment at this level will be very important which reduces the likelihood that the auditor will miss some necessary information in the company. Other essential things that the external auditor need to understand include; competitors, the structure of the company, the nature of the firm, industry in which it operates in, internal control system and financial reporting processes that are key to the company. This information could be derived from enquiry from relevant authorities, performing analytical procedures, important financial and non-financial information, and inspection and through observation of processes within the organization and documentation. The second step the auditor will take into account in carpet right plc. Is identifying and assessing potential risks that are in the company. This includes risk that affect individual transactions, disclosures, account balances and overall annual report. The auditor’s professional skills and judgment will be relevant on assessing how the potential risks have an impact on the measurement, accuracy, occurrence, completeness. Presentation and disclosure in the annual report of the company. The potential risk within the company will also determine how the auditor designs the audit program. The risk within a company is either significant or normal. Where significant is likely to occur while normal has a possibility of occurring. The third level will involve responding to the potential risk in the company. This requires the auditor to acquire substantial amount of evidence in the company. The auditor will be required to relate any risk identified on its impact in the financial report of the company, the individual transactions, disclosure and account balances. In concluding his report, the auditor will be required to provide a report whether he obtained all the information necessary deemed for the audit and whether the risk contains material misstatement in the company. Financial ratio analysis to show the company was undergoing going concern problems year 2011 2012 2013 Gearing ratios       debt-to-equity ratio 1.90 1.23 1.19 equity ratio (equity / assets) 21% 26% 25% Debt ratio (total debt / total assets). 39% 31% 30% The gearing ratio, is used to demonstrate the degree to which the firms uses debt to finance the company versus equity or owners funds. The higher the ratio, the more likely that Carpet right plc. Is likely to be risky in its operations. From the table, the company’s debt level has decreased over the three years and hence the firm can be said to be safe in financing its operations. The equity ratio shows how much the shareholders would receive in the event of liquidation. The table shows a decrease in 2012 from the worse financial results that were experienced in the year. The debt ratio is used to show how much amount of debt has been utilized in the purchase of assets. The higher the ratio, the higher the financial risk, from Carpet right data, the firm has been able to put its debt levels at an average rate hence not exposed to financial risk (Porter, et al., 2008). year 2011 2012 2013 coverage ratios       interest coverage ratio 2.53 4.00 2.00 debt service coverage ratio 0.09 0.21 0.04 Coverage ratios, are used to measure the ability of the company to meet its financial obligations when they fall due. The higher the ratio, shows that a company is efficient in meeting its financial obligations, from the data, year 2012 was the only efficient year over the three year period in settling debt, year 2013 shows worse results which puts doubt the going concern aspect of the firm. year 2011 2012 2013 Liquidity Measurement Ratios       Current Ratio 0.619565 0.601002 0.565368 Quick Ratio 0.319099 0.281302 0.239827 The liquidity ratios of Carpet right plc. Shown above, indicates how well the company is able to meet its short term financial obligations when they fall due. The effective rate in current ratio is 2:1 which shows that the company has been experiencing problems in meeting its shorterm financial obligations. The quick ratio which shows how well current assets can be quickly converted into cash is not doing well for the firm in the three year period. The effective ratio is 1:1 indicating a signal in the firms going concern aspect. year 2011 2012 2013 efficiency ratios       fixed asset turnover 2.000822 2.297758 2.370984 total asset turnover 1.506654 1.700938 1.771583 The above two efficiency ratios of the company shows how well the company is using its fixed assets and total assets in generating revenue. The higher the ratio, the more efficient the firm is but from the results in the table, fixed assets on average have not been utilized well in generating revenue, but on total assets, only in year 2013 that the total assets were utilized efficiently used in generating revenue to the company. This raises a concern in the future if the firm is going to maintain its efficient use of assets to generate sales. year 2011 2012 2013 profitability ratios       net profit margin 0.94% 2.33% -1.44% operating profit margin 2.24% 3.82% 0.74% return on equity 7% 16% -10% The profitability of Carpet right plc. Have decreased over the three year period. Only in year 2012 where the results seemed pleasing but in 2013 the company made huge losses. The operating profit was low to 0.74% indicating an increase of operating costs in the company while net profit margin resulted to increased finance costs and income taxes during the year. The amount attributable to shareholders went as low as -10% which indicates a great danger to the company, as shareholders might withdraw their investment, raising concern in the going concern aspect of the firm. Report on whether the company will continue operations in the foreseeable future. From the statement of financial position, the company has been able to reduce the amount of debt in the company over the three year period. This is a great sign that the company will not be exposed in financial risks in the future. The amount of interest payment has also decreased in the three year period from reduction in debt financing meaning that in the near future the company may be expecting high net income due to reduction of finance costs. The resignation of former CEO, Mr. Sharpland may have been seen as a big blow to the company but the father figure and founder of the company Lord Harris represent a very heavy component in the management of the company. His input and wide experience shows that the company will restructure in various levels and become a success in the future. Harris in his statement describes that 2013 was a difficult year for the company based on the market conditions, but things might go well in the future and the company transform from recession to recovery. From the Audit committee’s report, they indicate that the company had consistency in the use of accounting policies within the firm, the use of accounting standards and the methods that were used in accounting for significant transactions. The particular items that the audit committee concentrated on during the financial year were on impairment of goodwill, freehold properties, and stores due to the volatile economic conditions experienced by the company in the market segments. Compliance with external auditor is also a great sign that the company has no any intention to hide any material information and thus the 2013 financial results present a true and fair view and the company will continue its operations in the future (Messier, et al., 2010). The ISA/700 provides the standards and guidance on the form and content of the external auditor’s report that is issued from the work performed by an independent auditor on a company’s financial statements. The main objectives of the auditor include forming an independent opinion on annual reports based on an evaluation of the conclusions derived from the audit evidence obtained during the course of his audit work. Two, express opinion drawn through a well-written statement that also describes the basis of his opinion (Financial Reporting Council, 2013). The ISA/705 describes the process that an external auditor would take to modify audit report in expressing a normal opinion where the financial statements are misstated. An audit report is said to be modified if expressed in three ways including; disclaimer, qualified and adverse opinion.  An adverse opinion is when the auditor gives an opinion that the financial statements are not giving a true and fair view. Disclaimer opinion is when the auditor didn’t get sufficient evidence in his audit work while a qualified opinion, is when the auditor concludes that except for certain aspects, the financial statements provide a true and fair view (Financial Reporting Council, 2013). The ISA/706 involves an independent auditor adding more information in the audit report to draw attention to the users of the statements. Matters paragraph is important information that would be useful in decision making of the users of the statements. Any other matters that are important but not disclosed in the financial statements are the responsibility of the external auditor (Financial Reporting Council, 2013). From the three standards, the external auditor would express a qualified opinion that he obtained all the information deemed necessary for audit work and that the financial statements of Carpet right plc. Give a true and fair view to the users of the financial statements. However, based on the evidence collected it is good to note that the company has not been performing well due to the volatile economic conditions that has seen the revenues of the company’s go down. In that I express an independent opinion based on my evidence that the company could be undergoing financial problems and the company may not be able to continue its operations in the foreseeable future if the economic conditions persist. Bibliography Financial Reporting Council, 2013. publications. [Online] Available at: https://www.frc.org.uk/Our-Work/Publications/Audit-and-Assurance-Team/ISA-700-%28UK-and-Ireland%29-700-%28Revised%29.aspx [Accessed 30 March 2014]. Gray, I. & Manson, S., 2008. The audit process: principles, practice and cases. London: Thomson. Messier, W. F., Glover, S. M. & Prawitt, D. F., 2010. Auditing & assurance services: a systematic approach. New York: McGraw-Hill/Irwin. Millichamp, A. H. & Taylor, J. R., 2008. Auditing. London: South-Western/Cengage. Porter, B., Simon, J. & Hatherly, D. J., 2008. Principles of external auditing. Chichester, West Sussex, England: John Wiley. Read More