1. External users’ reliance on financial statements
External users rely heavily on the financial statement of Pinnacle Manufacturing. Although, Pinnacle manufacturing is a privately held company it incurs a large amount of debt. As a result potential users rely heavily on financial statements.
Pinnacle is selling the machine tech division to focus on engine manufacturing, the company’s core operations. This causes buyers to also rely heavily on financial statements.
In No. 6 the board chooses to finance the construction project mentioned in No. 4 by raising more debt. Again bringing focus to the Financial statements.
Likelihood of financial difficulties
The Solar Power engine business is focused on habitual transformation of technology, which makes the business riskier than other business and brings about a greater chance of bankruptcy. In No. 1, concerns are expressed about Pinnacle’s Solar-Electro Division.
No. 9 identifies restrictive covenants. The requirements are to keep the current ratio above 2.0 and the debt-to-equity below 1.0. In Part I, the calculation of the current ratio fell below the requirement and thus the need for the loan.
In No. 8 there is a significant turnover amongst higher-level positions. This turnover is possibly intentional and thus a greater chance for fraudulent activities.
2. No.1 – The acceptable audit risk is Medium. The auditor would have to prove that the articles are material. No. 6 – Pinnacle Manufacturing is a risky client and the auditors should check and verify each account. The acceptable audit risk is assessed as low. No. 8 – Management is changing its internal audit team. New members would learn the company and the way the audits are done. The audit risk is low because auditors would not rely on management representation. No. 9 – Because the current ratio and debt-to-equity ratio are below the requirements management will constantly check to either increase or decrease current assets to meet criteria. Thus the audit risk is low.