Pinnacle Case Part Ii

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Part A - Acceptable Audit Risk and Engagement Risk Issues:

External users’ reliance on financial statements:

Pinnacle Manufacturing Company is a privately owned, however it relays on loans and has a substantial amount of debt. For that reason, the financial statements are extremely useful to investors.

Pinnacle management is planning to sell their Machine – Tech division if profits don’t increase in the coming years. If Pinnacle sells, the financial statements will be extremely important for buyers.

The financial statements will be of great importance to investors, in case Pinnacle decides to raise capital for the building of the new manufacturing plant for its Solar – Electro division as describe in item 6 of the planning phase.

Likelihood of financial difficulties:

The conclusion of Part I of the case was that the likelihood of financial failure is medium to low. The conclusion was made taking into consideration the amount of debt and the issues with Solar – Electro division. Pinnacle Manufacturing is a high tech manufacturer that could possibly suffer from quick inventory obsolesces due to rapid change in technology.

Item 9 of the planning phase indicates there is a debt covenant requiring the current ratio to be kept above 2.0 and the debt to equity ratio below 1.0 at all times. The current ratio of 1.748 and a debt to equity ratio of 1.10 and additional debt plans can cause a waiver of the covenant.

Item 5 of the planning phase might indicate the company is having a major collection problem and possibly an understatement of the allowance for uncollectible accounts.

Management integrity:

The auditor should have done an extensive amount of research before accepting the client, however at this moment there is no indication of any management integrity issues. Except for phase planning 8, where it was discovered that upper level employees from the internal audit department have a high turnover rate. It could be due to...
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