Reference no: EM13503832

Question

Case Scenario

You are currently planning the audit of RC Pty Ltd. You have calculated the following ratios in order to assist you in identifying potential audit risk areas:

Ratio	Unaudited 30/6/X4	Audited 30/6/X3	Industry average
Cost of goods sold/sales (%)	73.27	79.34	69.24
Operating expenses/sales (%)	12.96	16.25	14.81
Selling and Administrative expenses/sales (%)	4.00	4.51	4.90
Interest expense/sales (%)	3.31	3.44	5.23
Total cost/sales (%)	92.99	97.40	93.25
Profit/sales (%)	4.47	3.91	5.15
Inventory turnover (times per year)	1.44	1.95	2.15
Accounts receivable turnover (days)	80.00	95.00	75.00
Current assets/current liabilities	1.37	1.20	1.45
Receivables/current liabilities	0.25	0.25	0.40
Profit/capital (% per year)	13.89	15.81	18.19
Times dividend earned	1.60	2.00	1.80

 

In addition you have the following information:

• RC Pty Ltd is a large proprietary company involved in property development and residential construction in the Parramatta region. It experienced losses a few years ago but in recent years has improved its performance and returned to profitability.
• Current year operating profit has increased by nearly 50% while sales have fallen slightly from last year's levels.
• Eight months ago, RC Pty Ltd became involved in a consortium building a large residential project on the out skirts of Parramatta. The project is expected to take 7 years to finish, with completed dwellings being sold in stages 'off-the-plan'. Off-the-plan sales have become increasingly popular with consumers as only a small deposit is required to secure the property, with the balance not payable until completion (often up to 12 months later)
• In order to finance participation in the residential project, RC Pty Ltd doubled its bank loan.
• Industry average data was obtained from the Australian Bureau of Statistics, and is calculated using figures from all listed property development companies in Australia.

Your assistant has reviewed the data and made the following notes:

1. Cost of goods/sales, operating expenses/sales, and selling and admin expenses /sales have all fallen, indicating an improvement in management efficiency. In addition, these ratios are all lower than industry averages, indicating RC Pty Ltd has good cost control measures in place.
2. The inventory turnover ratio has fallen, indicating that inventory is held for less time than prior years. This should lessen our concerns regarding obsolescence.
3. Debtors are now being collected 15 days (or 16%) faster than the prior year, reducing cash flow concerns and lessening pressure on the provision for doubtful debts.
4. Current assets to current liabilities has increased, indicating an improvement in RC Pty Ltd's liquidity position. In addition, this ratio is above industry average.

Required

• Examine the validity of your assistant's comments, and where appropriate provide an alternative interpretation and analysis.
• Evaluate the implications of your analysis on the year-end audit testing.

 Adapted from the Professional Year Programme of The Institute of Chartered Accountants in Australia - 2000 Accounting 2 Module.