Teletubbies Company: Financial Auditing - Essay Example

In the accounting profession, the way to verify if the information provided by the accounting department to internal or external users is correct is by performing an audit. Auditing can be described as the examination and statements of accounts and of other documents connected with accounts by other persons who have had no part in the preparation of the financial reports (Yahoo, 2006). Financial auditing can be performed on the entire financial system of an enterprise or on specific areas of the system. The third piece of data given is that the long-term receivables in the books belong to an R&D company owned by one of the directors.

The auditor would start this audit by inspecting the balance sheet, income statement, annual report, code of ethics, and physical warehouse of Teletubbies. The balance sheet requires special attention. These financial statements have the data to calculate the debt to equity ratio. The auditor needs to inspect that the company is complying with the 2:1 requirement. After verifying the metric the auditor should go back a few years and compare the current debt to equity ratio level to the last three years' results to find any tendency in the metric that might place the contract at risk in the near future. The company recently changed its inventory obsolescence provision to 10%. The auditor has to immediately verify if this change was notified to the shareholders in the financial statements in the form of a note to the financial statements. This change represents a new discrepancy in the way the accounting methods thus it must be notified for purposes of following the accounting principle of consistency. The desired to cut the provision down to 5% requires certain numerical and physical auditing procedures. The long-term receivable information is a worrisome sign since lending money to a company that is owned by a company director represents a conflict of interest. Due to this ethical irregularity, the auditor should inspect the company’s code of ethics manual.

The financial controller wants to reduce inventory obsolescence provision from 10% to 5%. In accounting, there is a principle called conservatism that would be violated if this change was implemented after the recent 20% to 10% provision reduction. If the financial controller pushed the issue the auditor could perform some auditing procedures to see the validity of the claim. The auditor would calculate the inventory turnover ratio to see the movement of the inventory thought out the year. This metric would be calculated in further previous periods to find tendencies in the data by breaking down the financial periods in trimesters. They also would also perform a physical inventory count to verify the information in the books is aligned with the physical inventory count. The auditor could also perform a hypothesis test to verify the validity of the 5% obsolesces claim based on a confidence level of 99%. Even if all the proof is there for the validity of the claim the auditor's recommendation should be to hold off on the provision reduction until a later accounting period due to the conservatism principle.