Audit And Assurance

(1) Calculate five ratios for both years, which would assist the audit senior in planning the audit:
1 2 3 4 5 Ratios Gross margin Operating margin Inventory days Current ratio Quick ratio 2010 12/23 = 522% 45/23 = 196% 21/11 * 365 = 70 days 66/25 = 26 (66 21)/25 = 18 2009 8/18 = 444% 4/18 = 222% 16/10 * 365 = 58 days 69/12 = 58 (69 16)/12 = 44

(2) Audit risks that arise and describe the appropriate response to these risks:

1. Audit risk:

Management was disappointed with 2009 results and hence undertook strategies to improve the 2010 trading results. There is a risk that lower management might feel some pressure and can change the results for the upper managements pleasure.

Response to risk:
Auditor should inspect all the decisions and activities of management which is taken for better trading results.
2. Audit Risk: A generous sales-related bonus scheme has been introduced in the year. This may lead to sales cut-off errors with employees aiming to maximize their current year bonus by highly increase in sale price, this may be harmful for business and its also effect on customers loyalty.

Response to risk:
Sales cut-off test can be performed here to check out this threat and also review the sales ledger balances with the sale invoices or goods received notices. 3. Audit risk: Gross margin has increased from 444% to 522%. Operating margin has decreased from 222% to 196%. This movement in gross margin is significant and there is a risk that costs may have been omitted or included in operating expenses rather than cost of sales. There has been a significant increase in operating expenses which may be due to the bonus and the advertising campaign but could be related to the misclassification of costs.

Audit And Assurance

Response to risk:
The classification of costs between cost of sales and operating expenses will be compared with the prior year to ensure consistency. 4. Audit risk Extended the credit period there will be a risk for recovery for receivables.

Response to risk:
To assess the value of receivable Auditor inspects the receivable ledgers.

5. Audit risk
Current ration, quick ratio and cash balances are decreased so; there will be a risk of overtrading because sales are increased and ratios are decreased but above the minimum level which may be creates the problem in going concern of the company.

Response to risk:
Detailed going concern testing to be performed during the audit and discussed with management to ensure that the going concern basis is reasonable.