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
Criteria
Criteria HD/ Distinction 5.6-7.5 Credit 4.9-5.55 Pass 3.75-4.8
Use of the formulae which underpin the information provided by the assistant to check the statements made by the assistant for any errors and if errors found to provide the correct interpretation
(2 Marks) All errors in assistant’s judgement identified. Correct interpretation provided Most errors in assistant’s judgement identified. Most alternative interpretations correct Demonstration of understanding of some of the formula. Some errors in assessing the assistant’s judgement. Some errors in alternative interpretation
Correlation of correct interpretation with additional information provided
(2 Marks) All additional information taken into consideration when developing correct interpretation of ratios Most additional information taken into consideration when developing correct interpretation of ratios Some additional information taken into consideration when developing correct interpretation of ratios
Identification of year-end audit tests that will need to be completed to minimise audit risk identified through the analysis of the ratios and the additional information (2 Marks) All appropriate year end audit tests identified with a clear statement as to how these will minimise audit risk Many appropriate year end audit tests identified. Evidence of some understanding as to how these will minimise audit risk Some appropriate year end audit tests identified.
Basic understanding of how these will minimise audit risk
Professional communication
(Note: you are required to space between paragraphs; use Arial 10pt or TNR 12 pt; use 1.5 or double line spacing)
(1 Mark) Work contains distinct understandable statements with no errors.
Extremely well organised.
Content is structured in a manner that facilitates the reader’s understanding. Minor spelling, grammar and punctuation errors. Work shows evidence of proofreading.
Well-structured with one main idea or argument provided per paragraph arguments/ideas.
Some spelling, grammar and punctuation errors found but the work is readable and structured.
Work may include too many ideas in one paragraph.
Appropriate resources including references to the audit standards and correct referencing
(.5 Mark) Used two or more additional sources in addition to the text and annual reports
All work has been referenced correctly as per APA (6th edn) requirements Used one additional source in addition to the text and annual reports.
All work has been referenced within the body of the answer and in the reference list, with some omissions or errors in terms No additional sources used other than text and annual reports.
Others’ work is not always acknowledged and there are a number of errors or non-compliance with the APA (6th edn)
Lectures requirements
1. For each of the four “notes” made by the assistance you must:
a. Identify if each one is a correct interpretation of both the ratio’s and the extra information given.
- When you look at the ratio’s make sure that your interpretation includes the way the ratio’s compare with the prior year, the industry data and also with each other in the same year.
b. Make sure that you offer an alternative explanation
- Even if you agree with the assistant’s interpretation you may be able to find some more information that supports it.
c. Don’t just use the information given – you must use the formula’s (ratio’s) that are given as well.
d. NOTE: you do not have to work out the ratio’s they are already given – you are interpreting ratio’s.
2. Evaluate the implications of your analysis on the year-end audit testing
a. Gather the areas of concern/risk that arise from the interpretation of the ratio’s and data you have gathered and tell me what they are.
b. Are you concerned that certain items are being overstated or understated
c. Identify the types of tests that you would perform at the end of the year that could help detect if there is misstatement in these accounts – remember there is no point in designing a procedure unless you identify the assertion you are testing. So identify the assertion
d. Explain to me how these will help minimise audit risk