The key purpose of the audit risk analysis project is to integrate and operationalize the important concepts and issues you have studied during the term.
You will be assigned a public company for which you will complete an audit risk analysis project. You will assume the role of an audit manager of a public accounting firm who has been asked by an audit partner to assess the acceptability of the given company as an audit client and to write a memo summarizing this assessment.
You are required to analyze the most recent financial data for your assigned company, which is typically obtained from the company's most recent annual report, the EDGAR website, or any of several online financial databases. You should also obtain other pertinent financial and non-financial data regarding your assigned company. These latter data would include information gleaned from articles appearing in The Wall Street Journal, major metropolitan newspapers, and various business publications concerning the company or its industry; peer group data provided for the company's industry or sub-industry by such investment services as RMA, Dun & Bradstreet, Moody's, etc.; and financial disclosure documents filed with the SEC, such as 8-K auditor change announcements.
Your memorandum should be between 7–10 pages, double spaced, not including the title and reference pages. It should cover the following elements/points using these headers:
- Historical Overview of the Company and its Industry:The memorandum should present a brief company profile that comments on, among other items, the history of the firm, its major products, its principal officers, recent developments concerning the firm (such as a merger, planned merger, or new products or technological advancements), etc.
- Potentially Problematic Non-Financial Items:Of particular interest to the partner will be what some audit firms refer to as "key items." These are potential "hot spots" that may demand special attention during the course of the audit. Examples: Existence of a management compensation plan (bonus scheme) tied to reported profits; a significant number of related parties and related-party transactions; new, high-risk projects/products; important technological advancements or changes in the company's industry; a significant increase in bad debts over the past year, etc.
- Analytical Procedures:Somewhere within the memorandum, you will need to discuss the apparent financial condition of the firm and highlight key financial ratios, such as the current ratio, return on assets, inventory turnover, etc. Complete a ratio analysis for your company and its peer group using the format found on page 333, Figure 8.7 in the Boynton Textbook. Here are the ratios to use:
- Liquidity — Current ratio, Quick ratio
- Solvency — Debt to assets, Long-term debt to equity
- Activity — Inventory turnover, Accounts receivable turnover
- Profitability — Gross margin, Profit margin, Return on total assets, Return on equity
This information can be located from industry groups such as Dun & Bradstreet, Robert Morris & Associates, Standard & Poor’s, Morningstar, among others. In particular, you should bring to the partner's attention the ratios and trends that may be indicative of the future prospects of the firm (good or bad). For instance, if the return on sales percentage has plummeted in recent years, that fact should probably be brought to the attention of the partner (and, of course, you should provide some explanation as to why this sharp downturn has occurred).
- Conclusion:Finally, you should conclude your memo with a recommendation for the partner. For example, the recommendation may be that the firm appears to be an acceptable client although it does pose a fairly high level of audit risk and business risk, you may recommend that the company not be considered any further as an audit client, or your recommendation may be that more information is needed before an acceptance/rejection decision is made. (If this latter conclusion is reached, you should identify the additional information you believe needs to be obtained before an acceptance/rejection decision can be made).
Feel free to use all reference sources available in the Library or online, such as Disclosure, Dun & Bradstreet, Moody's, Robert Morris & Associates, Standard & Poor’s, Morningstar, Value Line, WSJ Index, etc., in preparing your memorandum. Those online sources that supply comparative industry data will be particularly helpful. For a discussion of other factors to consider when evaluating a potential client, refer to your auditing textbook (Boynton & Johnson, 2006).