Potential Audit Risk Areas in Adios Ltds Financial Statements - Assignment Example

This can be a potential material risk for an auditor, as this can affect the financial position of a company as considered by the potential investors.

Increased Debts and Borrowings
The company’s financial statements show a considerable increase in the long-term borrowings of the company, which has given rise to the interest expense paid by the company and consequently a negative impact on profit.

Decreased Operating and Net Profit
The company’s profit and loss account show a decrease in both operating and net profit as compared to the previous year, even though the company’s annual sales are shown to have increased. There are many factors reported in the profit and loss account that have affected the company’s profit. The most prominent of them is the increasing cost of sales and interest expenses.



REQUIRED (b)

MAIN TRENDS IN THE COMPANY’S FINANCIAL POSITION AND PERFORMANCE
The major trends and tendencies in the company’s financial position and performance for the current year as indicated by Adios Ltd’s financial statements can be assessed with the help of the following factors:
Increased Assets
The company’s balance sheet shows that the company has enhanced its investment in tangible assets by 84% whereas the investment in intangible assets of the company has been reduced by 80%. But overall as compared to the previous year, the company’s investment in total assets has increased.
Working Capital
Working capital is the capital, which remains with the company after accounting for all the current liabilities of the company out of its current assets. This capital is required by every company to meet its short-term obligations or liabilities without any hassles, whenever a need arises. Working capital can be obtained by subtracting a company’s current liabilities from its current assets. Adios Ltd’s total current liabilities are about 25% of its total current assets, which shows a good working capital position for the company.

Increased Long-term Borrowings
The company’s financial statements indicate that the company’s long-term debts and borrowing have increased to a great extent. As compared to the previous year, the company’s long-term debts have increased by about 7 times. Consequently, the company’s interest expense has also been 6 times more than that of the previous year.

Increased Sales
According to Adios Ltd’s profit and loss account, the company’s total sales increased by 11.46% as compared to the previous year. Simultaneously, the company’s cost of sales has also increased by 55%, which has resulted in a decline in the company’s gross profit margin. Adios Ltd’s gross profit margin was about 55% in the year 2004, which decreased to 23% in 2005 despite an increase in the company’s sales.
Decreased Profit
The company’s profit margin for the year 2005 has declined by 30% as compared to that of the year 2004. The company has shown many factors responsible for this in the financial statements. The most prominent of which is the increasing cost of sales and increased interest expense resulting from an increasing trend in the company’s long-term debts and borrowings.


INFORMATION IMPORTANT TO BE ASKED BY AN AUDITOR
An auditor needs to obtain the following information from the company’s management in order to gain a better insight into the company’s financial position and performance:

Classes of Transactions and Account Balances
The auditor needs to access the classes of all the financial transactions that occurred in the company during the financial year. He should also obtain the company account balances and the bank statements from the management of the company in order to verify the accounts presented. This should include the information on occurrence, completeness, and accuracy of the transactions. In other words, he should ask for the information that could verify that the transactions in the accounts actually occurred, no transaction has been concealed or kept secret, and finally whether these transactions have been recorded in correct currency amounts.

Audit Evidence

The auditor should ask the management for evidence regarding the information put forth by the company’s information system. This will depend on the different audit procedures used by the auditor. If the auditor considers comparing budget data with the actual figures, then he should access the necessary information to ensure the correctness of budget data.

Acknowledgment of Internal Control Efficiency

It is important for the auditor to stipulate the evidence for the efficiency of the company’s internal control operation. He should also perform different tests to authenticate the company’s internal control procedures. He needs to ensure that the internal audit has been carried out with the obligatory completeness and accuracy. The internal control measures and methods should be fully presented so as to be helpful for the auditor to conduct the audit more efficiently and conveniently put forth a justified view of the company’s financial records.