Audit Problem 4-58 Essay Example

another liquidity indicator. The quick ratio further delineates the current ratio by measuring the portion of highly liquid current assets available to cover current liabilities. The quick ratio is considered more conservative than the current ratio because it excludes inventory and other current assets that are not easily converted into cash.

The quick ratios of Indianola Pharmaceutical Company have been consistently decreasing over the past three years and are different from each other. Furthermore, there is a significant difference between the current quick ratio and the industry average. This indicates that the company is facing liquidity issues. Additionally, the company's health is a concern due to the times interest earned or interest coverage ratio, which is another financial risk ratio.

The times interest earned is a measure of the protection available to creditors, indicating the extent to which earnings cover required interest payments. A lower interest coverage ratio indicates a higher burden and greater risk of default for a company. This ratio serves as a safety gauge for creditors and bond holders, showing how much a company's earnings can decrease before it defaults on bond payments. The times interest earned for Indianola Pharmaceutical Company has put the company in a challenging situation.

The analysis figures indicate that the company is facing challenges in meeting its interest payments. Over the past three years, Indianola had a strong interest coverage ratio, but it has recently decreased to approximately half of what it was before. Both the current and previous year's figures are significantly lower compared to the industry average at present. The audit engagement team should thoroughly investigate this notable disparity between the current ratio and industry average. Furthermore, they

should also assess the debt equity ratio, which is a reflection of a company's financial leverage.

The debt equity ratio is a measure that determines the proportion of a company's assets financed by both equity and debt. It assesses the total liabilities against the total shareholders of a company. A high debt equity ratio implies that the company heavily depends on external financing to support its operations, leading to a significant portion of expenses being directed towards loan repayments. For Indianola Company, its current elevated debt to equity ratio indicates reliance on external funding rather than revenue for its operational needs.

The company's current debt to equity ratio is over 50% of the industry ratio, showing an unfavorable position. Furthermore, comparing it to the previous two years indicates a more than 50% increase in the debt to equity ratio. As a result, the auditor must plan for a high audit risk due to the risky financial statement of the company. Additionally, acquiring a sufficient understanding of Indianola Pharmaceutical Company's internal control structure is necessary for determining the nature, timing, and extent of tests during the audit process.

The auditor must utilize the audit risk model during the planning of the audit, which consists of inherent risk, control risk, and detection risk. Inherent risk aids the auditor in assessing the vulnerability of financial statement assertions to material misstatements based on the nature of the client's business. Various factors, such as environmental and external factors, influence inherent risk. For instance, a company with a high level of obsolete inventory will likely experience elevated inherent risk. Additionally, the presence of expiring patents may also contribute to inherent risk.

Indianola Pharmacy may

face high inherent risk due to competition if it has an expired or soon-to-expire patent. Additionally, prior period misstatements could also contribute to high inherent risk for Indianola. In planning the audit, the auditor must assess the inherent risk and factors that influence it. Control risk, on the other hand, pertains to the effectiveness of the client's internal control policies and procedures. It is a risk associated with the possibility of misstatements in an account balance or class of transactions that could be individually material.

The risk associated with the Pharmaceutical Company may stem from inadequate internal control, which could prevent the detection of significant errors. To ensure an accurate audit, the auditor must evaluate Indianola's internal control measures for financial reporting. Detection risk arises when the auditor fails to utilize proper audit procedures or utilizes them incorrectly. Subsequently, the auditor can address the audit risk equation by assigning an appropriate level of detection risk to mitigate overall audit risk.

It is improbable to completely eliminate detection risk as the auditor cannot examine every transaction. The auditor's responsibility is to plan the audit using the aforementioned audit risk model. Other crucial background information for planning the audit includes comprehending the business and its associated risk, comprehending essential business processes, and comprehending management's risk management and control processes.

The auditor must use different tools available to comprehend the client's business and its business risk. The auditor must monitor the financial press as well as Security and Exchange filings from businesses within the client's industry. In the case of Indianola, the audit clients must understand the Pharmaceutical business by examining various Security and Exchange Commission filings and brokerage analysis. This

will allow the audit team to gain insight into the client and its operations.

The audit team's responsibilities include comprehending crucial business processes, recognizing the company's competitive edge, and grasping management's risk management and control. To accomplish this, the auditor employs diverse techniques, like acquiring knowledge about Indianola's board of directors and management's risk assessment and control procedures. Moreover, the engagement team conducts interviews with management and key employees to gather insights into their risk approach.

It is crucial for every company to assess how they handle both internal and external risks. It is necessary to thoroughly examine important documents pertaining to these risks. After analyzing the provided information, it becomes evident that the company took significant steps in the prior year. The numbers indicate a resemblance between the current year and the year immediately preceding it. Moreover, when comparing the two most recent years with the two years before them, Indianola Pharmaceutical Company made alterations to its financial statements.