Barnes and Fischer, LLP
, Senior Auditor ____________________________________________________________
Ocean Manufacturing, Inc. has requested Barnes and Fischer, LLP consideration as a new client for auditing services and IT system solutions. Ocean Manufacturing is a medium-sized manufacturer of small appliances. They hope to make an initial public offering (IPO) of its common stock within the next few years. Therefore, Ocean Manufacturing wants to hire Barnes and Fischer to issue an opinion on its December 31, 2008 financial statements.
The client acceptance decision has been carefully considered by gaining an understanding of Ocean Manufacturing’s business and industry. The nature of Ocean Manufacturing’s business and industry affects business risk and the risk of material misstatements in their financial statements. During this investigative process we gained a better understanding of the business operations and processes, management and governance, objectives and strategies, and overall performance. This knowledge gained allows us to assess the risk that the client may fail to achieve its objectives. Analytical procedures are required in the planning phase to assist in determining the nature, extent, and timing of audit procedures. Since Barnes and Fischer auditors are not familiar with the small appliance industry it was imperative for us to compare Ocean Manufacturing’s data to similar medium-sized companies within the industry. During the compilation of this information we gained an understanding of the internal controls in place, with a large emphasis on the accounting system they recently converted to. Finally, we developed an overall audit plan and program, which allows us to determine the resources required for the engagement.
Part of our analytical procedures to better understand Ocean Manufacturing we calculated several financial ratios and compared the results to similar companies within the small appliance industry. The following ratios were calculated:
The return on assets (ROA) ratio provides a standard for evaluating how efficiently management employs the average dollar invested in the firm’s assets. Ocean Manufacturing’s ROA is significantly lower than the industry standard indicating inefficient use of business assets. The ROA ratio for Ocean Manufacturing has increased from 2007 to 2008. Although marginal, it is notable since the industry as a whole saw a decline in ROA during this period.
The debt to equity ratio indicates what proportion of equity and debt the company is using to finance its assets. A high debt equity ratio generally means the company has been aggressive in financing its growth with debt. This does not appear to be the case with Ocean Manufacturing as their debt to equity ratio is significantly lower than those within the industry.
The current ratio gives an idea of the company’s ability to pay back its short-term liabilities with its short-term assets. The higher the current ratio, the more capable the company is of paying its obligations. The current ratio can also give a sense of the efficiency of a company’s operating cycle or its ability to turn product into cash. Ocean Manufacturing appears to be handling their short-term liabilities efficiently, as their current ratio is higher than those within the industry.
The ratio of profitability measures how much out of every dollar a company actually keeps in earnings. A higher profit margin indicates a more profitable company that has better control over its costs compared to competitors. This does not appear to be the case with Ocean Manufacturing. Their profit margin is substantially lower than their competitors.
Times interest earned is used to measure a company’s ability to meet its debt obligation. Ensuring interest payments to debt holders and preventing bankruptcy depends mainly on a company’s ability to sustain earnings....
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