Analysis of ProSalam Manufacturing Bhd: Acceptance Decision Report

This report evaluates the audit acceptance decision for ProSalam Manufacturing Bhd, considering its potential IPO. It outlines five procedures an auditor should perform, with emphasis on the required communication with the outgoing auditor. The report conducts preliminary analytical procedures, comparing ProSalam's 2016 financial ratios (ROE, ROA, assets to equity, etc.) with industry benchmarks, highlighting significant differences and their implications. Non-financial matters, such as changes in management, auditor resignations, and reluctance to discuss previous auditors, are examined for their impact on the acceptance decision. Finally, the report discusses the advantages and disadvantages of a single audit firm providing both auditing and consulting services, offering a comprehensive analysis of the considerations involved in the acceptance decision.

Acceptance Decision on ProSalam Manufacturing Bhd 1
ACCEPTANCE DECISION ON PROSALAM MANUFACTURING BHD
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Date:

Acceptance Decision on ProSalam Manufacturing Bhd 2
Acceptance Decision on ProSalam Manufacturing Bhd
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.

Acceptance Decision on ProSalam Manufacturing Bhd 3
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.
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.

Acceptance Decision on ProSalam Manufacturing Bhd 4
2. Prosalam’s Preliminary Analytical Procedures. Major Differences 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.

Acceptance Decision on ProSalam Manufacturing Bhd 5
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.
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.

Acceptance Decision on ProSalam Manufacturing Bhd 6
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.

Acceptance Decision on ProSalam Manufacturing Bhd 7
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.
Current Ratio
Current Ratio = Current assets/ Current liabilities
= $27,064,000 /$14,118,000=1.92
The industry’s 2016 Current Ratio = 1.3.

Acceptance Decision on ProSalam Manufacturing Bhd 8
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 Accepting Prosalam 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

Acceptance Decision on ProSalam Manufacturing Bhd 9
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.
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.

Acceptance Decision on ProSalam Manufacturing Bhd 10
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

Acceptance Decision on ProSalam Manufacturing Bhd 11
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.
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

Acceptance Decision on ProSalam Manufacturing Bhd 12
need to perform the walkthrough tests to understand Prosalam’s business then start collecting
evidence.

Acceptance Decision on ProSalam Manufacturing Bhd 13
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