Question

One of your clients, De Anza Corporation, has a contractual commitment as a part of bond indenture to maintain the current ratio of 2.0. If the ratio falls below that level on the balance sheet date, the entire bonds become payable immediately. In the current year, the client's financial statement shows that the ratio has dropped from 2.6 to 2.05 over the past year. Please discuss how should this situation affect your audit plan? Please state your plan with specific audit approach/strategy/procedures.

Answer 1

The scope of testing would be increased on current assets and current liabilities to test whether no assets or liabilities were over or under stated to show ratio above 2 and to escape its obligation that may arise if Current Ratio falls below 2.

Current Ratio has been kept slightly above 2 which may be doubtful and has to be focused on by the auditor.

The approach used here will be Balance Sheet Audit Approach where the auditor focuses on balance sheet items specifically.