Part B

You are a senior internal auditor at BHEL Ltd., a machine toolmanufacturer. A draft set of financial statements for the year havebeen prepared by management, and it has fallen to you to examinethe figures for reasonableness and at the same time identifysignificant audit areas which may require further work even thoughyour systems audit during the year has proved satisfactory.

You are aware of the fact that the company is at presentcontemplating an issue of $2,000,000 15% loan stock (redeemable inthe year 20X0) in order to assist the remodeling of its presentproduction facilities. The majority of the directors are in favourof making the issue but a few are reluctant to do so in view of thefact that the machine tools industry is subject to wide-rangingfluctuations in sales and profits. Abbreviated financial statementsfor BHEL Ltd. together with typical ratios for firms in the machinetool industry are as follows.

INCOME STATEMENTS FOR THE YEARS ENDED 31 DECEMBER

                                               20X2                       20X1

Particular	$'000	$'000	$'000	$'000
Sales		23,500		20,500
Cost of goods sold		16,000		14,000
Gross profit		7,500		6,500
Selling expenses	2,700		1,900
Administration expenses	2,300		2,600
		5,000		4500
Profit from operations		2,500		2000
Interest paid		500		300
Net profit before taxation		2,000		1,700
Taxation		1,200		1,020
Net profit after taxation		800		680
Dividends paid		525		280
Profit for the year retained		275		400
Retained profit brought forward		6,090		5,690
Retained profit carried forward		6,365		6,090
STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER
Total assets
Tangible non-current assets (net)		6,315		5,600
Other non-current assets		800		750
		7,115		6,350
Current assets
Inventory	5,100		3,200
Receivables	2,900		1,900
Prepayments	100		100
Cash and bank	600		590
		8,700		5,790
		15,815		12,140
Equity and liabilities				350
Called up share capital Ordinary 50p shares authorised, issuedand fully paid		350		350
Retained profits		6,365		6,090
		6,715		6,440
8% loan stock (20Y0 – 20Y3)		5,500		3,300
Current liabilities		3,600		2,400
		15,815		12,140

1. (Inventory valuation at 31 December 20X0 was $2,500,000)

2. (Receivables' balance at 31 December 20X0 totaled$1,700,000)

Typical industrial averages for 20X2 and 20X1 are as follows

Gross profit on sales	34%	Acid test ratio	1.2:1
Net profit before tax on sales	11%	Average age of receivables	30 days
Net profit before tax on net assets employed	19.5%	Average age of inventory	73 days
Working capital ratio	2.5:1	Interest cover	8 times

Required

1.     Review and communicate parameters forvariances in financial outcomes of the BHEL compared to year 20X1of the financial statement and explains areas which may cause yousome concern, describe the main matters (consider risk) which youwould need to investigate for future decision making and riskminimisation. Write your response in 400-500 words.