ProSaturn Manufacturing Bhd Accepted As A Client; Essay.

Your Tack I  To undertake the follow ing in regard to acceptance of ProSaturn Manufacturing Bhd as a client I. Identify five procedures an auditor should perform in determining whether to accept a client. Which of these lice are required by auditing standards?

2. Using ProSalam's financial information. calculate relevant preliminary analytical procedures (e.g., ratio tests. and other financial statistics) to obtain a better understanding of the prospective client and to determine how ProSalam is doing financially. Compare ProSalam 's ratios to the industry ratios provided. Identify any major differences.

3. What nonfinancial matters should be comidered bethre accepting ProSulam as a client? I low important are these issus. to the client acesaxa,: docision? Why?

4. Naya wants Siti& Co to aid in developing and improving their IT system. What are the advantages and disadvantages of having the same Audit firm provide both auditing and consulting services? Given current IAASII/AICPA independence rules, will Siti & Co he able to help ProSalam with their IT system and still provide a financial statement audit?
Your Task 2  I. Make a recommendation as to whether Siti & Co. should or should not accept PmSalam Manufacturing Bhd as an audit client.

2. Carefully justify your position in light of the information in the case. Include consideration of reasons both for and against acceptance and be sure to address both financial and nonfinancial issues to justify your recommendation.
3. Prepare a list of the five or six most important factors or risk areas that will likely affect how the audit is ounducted lithe ProSalam engagtment is aecepted. Be sure to indicate specific ways in which the audit firm should tailor its audit program to address the risks you identify.

Procedures for Determining Whether to Accept a Client

ProSalam manufacturing Bhd is considering having a nationally competent audit firm to review its annual reports in order to allow it to make an initial public offer. Khlif and Samaha (2014) assert that a corporation should have competently audited statements in order to float its shares. Since, the company wants to engage Siti & Co., the audit firm asks its assistant audit manager to carry out preliminary investigations of the prospective client in order for the firm to make a prudent acceptance or non-acceptance decision. Following the challenges in ProSalam manufacturing Bhd, the assistant audit manager will carry out the analytical procedures and compare with the industry’s ratios for 2016 audited statements. Furthermore, the manager will perform the walkthrough and substantive tests to understand Prosalam’s business, hence, gather enough evidence.

A company to be allowed to Task 1

1. Five Procedures an Auditor should Perform to Determine Whether to Accept a Client. Which of the Five is Required by Auditing Standards?

An auditor should perform the following procedures to determine whether to accept a client or not.

Request Information on the Characters of the Top Management, the Organization, and the Influential Stockholders 

The auditor should look for the information on the characters of the top management, the organization, and the influential stockholders. According to Furnham and Gunter (2015), the auditor should consider in a prudent way any issue, which might damage the integrity of the administrators. The auditor should confirm such information from the bankers and lawyers of the prospective client, among other third parties.

Understand the Business of the Client and how they Operate

An auditor should understand the business of the client and how they operate before engaging them by looking at the client’s financial statements, which include the balance sheets, income statements, and the tax returns (Knechel and Salterio 2016).
The Reaction to the Opinions for the Internal Controls’ Enhancements

The auditor should look at the reaction of the management to the opinions for the internal controls’ enhancements that both the internal and the outgoing auditors made before (Mbewu and Barac 2017).

Independence between the Audit Committee and Board Members

Samaha, Khlif, and Hussainey (2015) assert that the auditor should look at the structure, and the independence that exists between the audit committee and board members, and also the external directors’ number.

Communication with the Outgoing Auditor

Chen, Peng, Xue, Yang, and Ye (2016) assert that the auditor needs to communicate with the outgoing auditor in order to know the management’s integrity as well as why the client wants to change the auditing firm.

Performing Preliminary Analytical Procedures and Comparing with Industry Ratios

Of the five procedures above, the auditing standards require the auditor to communicate with the outgoing auditor. According to Chen, Khalifa, Morgan, and Trotman (2018), the Statement on Auditing Standards number 84 (AU315) requires the auditor to investigate the management’s integrity and know why the client wants to change the auditing firm.

2. Prosalam’s Preliminary Analytical Procedures. MajorDifferences with the Industry’s Ratios

The financial statements presented in the question are for 2015, 2016, and 2017. Since, the question requires the comparison and the major differences with the industry’s ratios, I will use the firm’s 2016 figures to perform the analytical procedures and compare with the industry’s ratios for 2016. The reason for choosing to use the firm’s 2016 figures is because they are the latest audited results of the company.

Return on Equity (ROE)

ROE = (Net Earnings /Total Shareholders' Equity) X 100

         = ($2,521,000/$35,469,000) x100 = 7.11%

The industry’s 2016 ROE = 28.50%.

Therefore, ProSalam manufacturing Bhd produces less income from every dollar of the ordinary shareholders' equity than the industry. This performance shows that the firm needs to work harder in order to match other companies in the sector. According to Raza and Farooq (2017), the ROE measures the extent to which the organization is able to make profits from the funds of the firm’s stockholders.

Return on Assets (ROA)

ROA = (Net Earnings / Total Assets) X 100

           = ($2,521,000/$66,821,000) x100 = 3.77%

The industry’s 2016 ROA = 8.80%.

Therefore, ProSalam manufacturing Bhd produces less income from its total assets than the industry. The performance means that the firm should work harder in order to match other companies in the sector. According to Idawati and Wahyudi (2015), the ROA shows how better an organization performance is through comparing the earnings that the firm makes to the total assets value.

Assets to Equity

Assets to Equity = Total Assets / Total Shareholders' Equity

= $66,821,000/$35,469,000= 1.88

The industry’s 2016 assets to equity = 3.06.

Therefore, ProSalam manufacturing Bhd shareholders and debt providers own less total assets in the company than what the shareholders and debt providers in the industry own. This situation shows that ProSalam’s position is favorable than other companies in the sector because its leverage is lower. According to Choi and Richardson (2016), the assets to equity ratio shows the leverage that the corporation uses to finance its business.

Accounts Receivable Turnover

Accounts Receivable Turnover = Sales / Account receivable

= $104,026,000/$7,936,000 = 13.11

The industry’s 2016 Accounts Receivable Turnover = 7.57.

Therefore, ProSalam manufacturing Bhd collects its accounts receivables more times in a year than the industry. This situation shows that ProSalam’s position is favorable than other companies in the sector because it is able to give its clients goods on credit in an effective manner, hence, collect the money from the customers in a timely way. According to Dencic-Mihajlov, et al. (2015), the accounts receivable turnover ratio assesses the corporation’s capability to effectively give its clients goods on credit, hence, collect the money from the customers in a timely way.

Considering Non-Financial Matters before Accepting a Client

Average Collection Period

Average Collection Period = (Account receivable / Sales) X 365 days in a year

= ($7,936,000 /$104,026,000) X 365 = 27.85

The industry’s 2016 Average Collection Period = 48.21.

Therefore, ProSalam manufacturing Bhd has a stricter credit policy and the more collection efforts than the industry. This condition shows that ProSalam’s position is favorable than other companies in the sector because its accounts receivables, which are in arrears past their due dates are fewer, hence, can help the firm to increase its working capital.

Inventory Turnover

Inventory Turnover = Cost of sales / Inventory

Inventory = raw and in-process inventory + finished goods inventory

= $10,487,000 + $4,843,000 = $15,330,000

Inventory Turnover = $69,177,000 /$15,330,000 = 4.51

The industry’s 2016 Inventory Turnover = 7.5.

Therefore, ProSalam manufacturing Bhd sells and replaces its inventory lesser times than the industry in a year. Hence, ProSalam’s position is not as favorable as the other companies in the sector because it does not as much as the other firms. Hançerliogullari, Sen, and Aktunc (2016) assert that the inventory turnover of a corporation shows the days the company takes to vend its stock on hand.

Days in Inventory

Days in Inventory = (Inventory / Cost of sales) X 365 days in a year

($15,330,000 /$69,177,000) x365= 80.89

The industry’s 2016 Days in Inventory = 47.67.

Hence, ProSalam manufacturing Bhd takes a lot of time to sell its inventory than the industry, which means that the firm’s position is not as favorable as that of the other companies in the sector. Pais and Gama (2015) assert that the days in inventory indicates the corporation's performance financially, with a smaller number showing a better position.

Debt to Equity

Debt to Equity = Total Liabilities / Total Shareholders' Equity

= $31,352,000 /$35,469,000= 0.88

The industry’s 2016 Debt to Equity = 2.06.

Hence, ProSalam manufacturing Bhd uses lesser bank loans than the shareholders’ money compared to the industry, which means that the firm’s position is favorable than the other companies in the sector. Coleman, Cotei, and Farhat (2016) assert that a greater ratio of the debt to equity shows that most of the firm’s financing comes from the creditors compared to the investors. 

Times Interest Earned

Times Interest Earned = Operating income / Interest expense

= $6,242,000 /$1,474,000= 4.23

The industry’s 2016 Times Interest Earned = 2.2.

From the calculation, ProSalam manufacturing Bhd is able to pay its debt better than other firms in the industry, which is a favorable position for the firm. Tiwari, Cardenas-Barron, Khanna, and Jaggi (2016) assert that a corporation with a smaller times interest earned means that it cannot pay its debt better than the one with a higher times interest earned.  

Advantages and Disadvantages of Having the Same Audit Firm Provide Both Auditing and Consulting Services

Current Ratio

Current Ratio = Current assets/ Current liabilities

= $27,064,000 /$14,118,000=1.92

The industry’s 2016 Current Ratio = 1.3.

From the calculation, the liquidity position of ProSalam manufacturing Bhd is more favorable than that of other firms in the industry. The figure shows that the company can meet its obligations well.

Profit Margin

Profit Margin = (Operating income/ Sales) X 100

= $6,242,000 /$104,026,000 X100 = 6.00%

The industry’s 2016 Profit Margin = 10.00%.

From the calculation, the profitability position of ProSalam manufacturing Bhd is not as favorable as that of other firms in the industry because the business makes lesser earnings from its sales. Heikal, Khaddafi, and Ummah (2014) assert that the greater the profit margin of a firm, the more effective the corporation is at making incomes from its sales.

3. Non-Financial Matters to Consider Before AcceptingProsalam as a Client. How and Why the Issues are Important to the Client’s Acceptance Decision

Change of Auditors

About three auditors have audited Prosalam in the last decade, which means that the company is active at opinion shopping.

The Resignation of the Upper Management

Prosalam’s vice-president and the financial controller resigned in October 2017 to work in other towns due to “personal issues.” The auditor needs to know other reasons for the resignations because it could be due to fraud. Internal instability and the management not agreeing on business matters, which is not ethical can be other causes for the resignations. Such issues are important to the client’s acceptance decision because if they exist the auditor might not collect evidence successfully during his or her reviews. Mr. Muniru, the new controller does not have enough knowledge and is not satisfied with Prosalam’s new IT system. The reason for ProSalam manufacturing Bhd to employ a financial controller who does not have enough knowledge is questionable. Maybe the firm tries to hide something from the public and this could jeopardize Prosalam’s going concern because of allowing inexperienced personnel to work at the management level.

Hesitation to Deliberate about the Previous Auditor

The company’s vice-president is not quick to allow the prospective auditor to talk about the previous one. Fearing to reveal such information means that the client will be difficult to handle once the engagement begins.

4. Advantages and Disadvantages of the same Audit Firm Providing both Auditing and Consulting Services.

Disadvantages

Not Able to Satisfy the Clients' Requirements

When an audit firm expands its existing services, the customers get happy as the auditor can tackle their assignments without many difficulties. The problem is that the firm’s workers cannot have experience in all the areas, which can lead to the loss of clients as they look for services elsewhere.

Recommendation on Accepting ProSalam Manufacturing Bhd as an Audit Client

The problem of Free Services

Most audit firms begin providing the extra services free to attract customers. When a firm finally asks the clients to start paying for such services, it might lose some of them who go looking for an accommodating auditor.

Advantage

More Profits

When an audit firm expands its existing services, it gets more customers, which means more money.

Whether under the Current IAASB/AICPA Independence Rules, Siti & Co. will be Able to Help Prosalam with I.T System and Provide the Audit

Under the current IAASB/AICPA independence rules, Siti & Co. will not be able to help Prosalam with I.T system and provide the audit. Tiron-Tudor, Cordos, and Fulop (2018) assert that the auditors who provide consulting services especially on the I.T systems can have grave independence risks where there is the financial data.

Task 2

1. The Recommendation whether Siti & Co. should Accept or not Prosalam as a Client

Siti & Co. should accept Prosalam as a client because from the analytical procedures and the comparison with the industry’s ratios for 2016, Prosalam seems to have a favorable position.

2. Justification of the Recommendation. Reasons for and against Acceptance (Financial and Non-Financial Issues)

The reasons why Siti & Co. should accept Prosalam as a client include the company’s vice-president allowing the prospective auditor to talk to the previous one though at first was hesitant. Furthermore, other auditors have audited Prosalam in the past, and from the analytical procedures and the comparison with the industry’s ratios for 2016, Prosalam seems to have a favorable position.

The reasons why Siti & Co. could not accept Prosalam as a client include the resignation of the upper management, though was due to “personal issues.” However, Prosalam replaces them. Also, the Company produces less income from both its total assets and the shareholders’ equity than the industry. Still, the organization is able to make profits from the various funds.

3. Five most Important Factors (Risk Areas) that will Affect the Conduct of the Audit once Siti & Co. Accepts Prosalam as a Client. How Siti & Co. should Tailor its Audit Program to Address the Risks above

Accounting and Control Systems

Since, Prosalam switched to a new computer-based accounting system, it will be a challenge for Siti & Co. to understand the systems. Therefore, the auditor will have to seek the services of an I.T expert.

Inventory Tracking and Cost Accumulation

There is a challenge in Prosalam’s inventory tracking and cost accumulation due to inexperienced workers. Hence, the auditor will need to observe the physical count of inventory and test their costs.

Failing to Keep Conventional Audit Trails

Since, Prosalam failed to keep the conventional audit trails, the auditor will need to perform substantive tests to get enough evidence.

Inaccurate Company Reports

Most of Prosalam’s reports are not accurate such as the budgets and receivables billings. Therefore, the auditor will need to perform substantive tests to get enough evidence.

Factors Affecting how the Audit is Conducted and Tailoring the Audit Program to Address these Risks

No Enough Understanding of Prosalam’s Business and the Industry Environment

As Siti & Co. has never audited a client in the small home appliances, it does not have enough understanding of Prosalam’s business and the industry environment. The auditor will need to perform the walkthrough tests to understand Prosalam’s business then start collecting evidence.

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