The use of financial ratios assists the auditor in analyzing any unusual deviations from the expected results, (Gupta, 2004). The financial ratios are then compared with the entity's ratios for prior periods as well as with ratios for other businesses in the same industry. A comparison with the industry ratios would have warned BDO of some irregularities in Leslie Fay's financial statements. BDO Seidman should have been interested some important ratios that would help in determining the accuracy of the financial statements that had been prepared by Polishan and his staff. The important ratios include the liquidity ratios, the profitability ratios and the operating ratios, the leveraging ratios and the solvency ratios. Of higher importance should have been the profitability apart from the gross profitability ratio. An example would be the assets turnover ratio which provides information on the efficiency on how the assets that have been purchased are being utilized. The liquidity ratios would have assisted in knowing if and how the entity was going to repay its liabilities especially in the short term. An important ratio to investors and one that BDO Seidman should have considered is the price/cash flow ratio. This indicates the relationship between the stock price and the operating cash flow. This is considered as the best way to determine the entity's profits. The capital turnover ratio is an important ratio to compare the sales and the capital employed. A change in the capital turnover ratio would mean a manipulation of sales or one or more of the elements that make part of the capital employed, that is, fixed assets, cash, debtors or inventory. The use of ratios by the auditors is an important but it requires skills and experience in order to get the correct analytical results. Other financial information required during the audit
The auditors should have done more testing in the controls of the financial process by a plan to audit other important financial statements such as the cash flow statement and the bank reconciliation statement. The auditors should have also followed the financial transactions that had resulted to the balances in Leslie Fay's balance sheets and the income statement. This would include conducting tests of control in the transaction cycle. The auditors should have audited Leslie Fay's sales system, the purchases system, the inventory system, the cash system and the payroll system. In addition to this the auditor should have asked questions about ant subsequent events. Subsequent events are those events that occur in the period between the financial period closing date and the date that the auditors conduct the auditor, both the adjusting and the non-adjusting events. In addition to the balance sheet, the income statement and the ratios, the auditor should have also asked for the period's cash flow statement. The cash flow statement is an important tool to investors and the management as it assists them in knowing the financial health of the organization. It is a statement that supports the income statements as there must be a connection between cash sales and credit sales especially if they have not been paid by the end of the financial period. Huge sales in the income statement without corresponding huge cash flow from the organizations operations should raise questions and should be explained by reconciliation. It has a link with the balance sheet as it records ay new cash sales and purchases and other payments. The cash and bank balances can then be verified by a physical cash count for the cash balances and confirmation by the bank through a bank letter that is sent by the auditor. The auditor should also request for the bank reconciliations and explanations for all the cheque shown in the bank reconciliation. A comparison of the ratios by the competing firms would have been important to the auditor in discovering the irregular variances....
Please join StudyMode to read the full document