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Irrational Ratios and Analysis in Examples Case Study


Introduction

Analytical procedures involve the comparison of two or more variable to determine whether they are reasonable or whether they have been manipulated in any way. These analytical procedures may be done through different ways which include horizontal and vertical analysis, variance analysis, ratio analysis and comparison with expectations and other auditor information. It is, therefore, important for the auditors to include ratios which can help them detect frauds, omissions and errors in their analysis. Some ratios have over the time shown that they can be used to detect errors.

The major key ratios that can be used for the detection of this fraud include day’s sales in receivables, gross margin, asset quality index, sales growth index and total accruals to total assets index. The analysis of irrational ratios was done on the following companies.

Ratios for Dell limited

Dell

The day’s sale in receivables in the year 2003 and 2005 indicates that the sales had been manipulated by management and there was a problem with the receivables. The auditors should raise a red flag in the year 2003 and also note there is a possible fraud in the year 2004 and 2005. The gross margin index of Dell indicates there was possible fraud in the statements of this company in the year 2003, but there is none in the subsequent years.

Dell’s asset quality index is 1.8, 2.1 and 1.9 respectively. All this indicate that there is manipulation and a need for the auditor to raise a red flag about the existing fraud. In simpler terms, the management is capitalizing the assets to cover the declining financial situations. The sales growth index of Dell has increased initially and then reduced. This shows a lot of manipulation of revenues for the year 2004, but none in the year 2005. There is a need for auditors to raise a red flag about fraud. Total accruals to total assets index of indicates that there is no manipulation of the assets to cover the deteriorating financial conditions.

Analysis for the Health south limited

HealthSouth
HealthSouth.

Health south limited has day sales receivables of 4.5, 1.8 and 2.3 respectively over the three years. In the year 2000, the company has day sales in receivable of 4.5 indicating a red flag. The same case happened with the other consecutive years. The non manipulators mean index is set at 1.031. From the analysis of this ratio, there is a high chance that financial statements information had been manipulated. All these figures represented high value as compared to the set mean.

The gross margin index of this company over the three years is 1.03, 0.93, and 0.99 respectively. In the year 2000, the ratio is slightly below the mean manipulators index of 1.04. This indicates a possible manipulation. However, in the subsequent years there is no link for the manipulation of the information. The asset quality index has a manipulation index of 1.014. Health south has the values of 2.5, 2.6 and 2.6 respectively.

This means that the assets of this entity have been manipulated to favor the reported revenues. The sales growth index has declined over the period of three years indication sales have reduced tremendously. The manipulators mean index is 1.067, an indication that sales have not been manipulated by the management. Total accruals to assets index of this company moved from 2.0 to 0.4. There is a need for red flag by the auditors as the management is offsetting accruals to manage the declining economic performance.

Analysis of overstock

Overstock
Overstock.com

The day sales in receivables of overstock indicate that there is a lot of manipulation in the financial statements of this company in the years 2008 and 2010. The ratios in these two years exceed the mean manipulation ratio of 1.465.

However, there is no manipulation in the final year since this ratio does not exceed the mean manipulation ration of 1.031. There is a need for the auditors of this company to raise a red flag of the financial fraud against this company. Based on the gross margin index, it shows that there is no fraud in Overstock.com as they are less than the manipulation level. According to the assets quality index, there is a need for the auditor to raise a red flag about a possible fraud in this company since earning manipulations has already happened in these three consecutive years.

Sales growth index of Overstock indicates that in the year 2008, the auditors should have raised the red flag about involvement of fraud by management as well as in the following year of 2009. However, there is no fraud in Overstock.com in the final year 0.62 is lesser than the mean manipulation index. Using the total accrual to total assets index, there is fraud as top management is using the assets to cover for the accrued negative influence due to poor economic conditions. There is a lot of manipulation from the mean manipulation index of 0.031.

Ratio analysis of Tyco

Tyco
Tyco.

Tyco was another company which experienced fraud. The day sales in receivables had already indicated that there was a financial fraud as well the manipulation of revenues to suit the tough prevailing economic conditions. The value of the day sales in receivables is the same as the mean manipulation index hence the revenue is manipulated. There is possible fraud in the years 2002, but there is none in the years 2004.

Gross margin index in the consecutive years indicate that it is possible for the existence of fraud in the year in 2002 but there is none in the subsequent years. In the year 2002, the ratio was higher than the mean manipulation index. Contrary to this is the case in the year 2003 and 2004. According to the sales growth index calculated from the financial statements, in the year 2002, there is the manipulation of sales and revenues by management as the index indicate 1.61 as compared to mean manipulation index of 1.607.

There is no manipulation in the year 2003, and 2002 as 1.2 and 1.16 is less than the non manipulation index of 1.134. From this data, the auditors should have raised a red flag in the year 2002. It was possible for the existence of fraud in the year 2004 but none in the year 2003. In these three years, the total accruals to total asset index indicates the presence of fraud since the management was using assets to compensate for accrued expenses.

Ratio analysis of Adelphia

Adelphia
Adelphia.

Adelphia experienced irrational ratios as a result of fraud. The day sales in receivables had initially indicated no manipulation compared to Mean Manipulation Index but possible fraud in the year 2000. The final year before the fraud was discovered shows the need to raise a red flag by the auditors as fraud was possible. Gross margin index in the consecutive years indicate that it is possible for the existence of fraud in the year 200 and 2002 because the index were 1.19 and 1.08. This indicated fraud was possible.

Assets quality index over the years show possible fraud over the three years. The indexes are equal to the Mean Manipulation Index hence the assets values had been highly manipulated. Analyses of the sales growth index indicate that in the year 2000 and 2003, the management had manipulated revenue values. In the year 2001, the fraud has occurred but in 2002 the auditors should have raised a red flag. Total accrual to total assets index shows there is fraud in 2002 but none in the other years. Total assets had not been manipulated.

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IvyPanda. (2021, February 4). Irrational Ratios and Analysis in Examples. Retrieved from https://ivypanda.com/essays/irrational-ratios-and-analysis-in-examples/

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"Irrational Ratios and Analysis in Examples." IvyPanda, 4 Feb. 2021, ivypanda.com/essays/irrational-ratios-and-analysis-in-examples/.

1. IvyPanda. "Irrational Ratios and Analysis in Examples." February 4, 2021. https://ivypanda.com/essays/irrational-ratios-and-analysis-in-examples/.


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IvyPanda. "Irrational Ratios and Analysis in Examples." February 4, 2021. https://ivypanda.com/essays/irrational-ratios-and-analysis-in-examples/.

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IvyPanda. 2021. "Irrational Ratios and Analysis in Examples." February 4, 2021. https://ivypanda.com/essays/irrational-ratios-and-analysis-in-examples/.

References

IvyPanda. (2021) 'Irrational Ratios and Analysis in Examples'. 4 February.

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