Question

A simple case for applying an analytical review procedure: One of your clients, A Corporation, has a contractual commitment as a part of bond indenture to maintain 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 that how should this situation affect your audit plan?

Please state your plan with specific audit approach/strategy/procedures.

Answer 1

Answer:

The decrease of the current ratio indicates a liquidity problem for Company since the ratio has dropped to a level close to the requirements of the bond indenture. Special care should be exercised by the auditor to determine that the 2.05 ratio is proper since management would be motivated to hide any lower ratio. The auditor should expand procedures to test all current assets for proper cutoff and possible overstatement and to test all current liabilities for proper cutoff and possible understatement.