Market value ratios, such as the market-to-book ratio or dividend payout ratio, are helpful to the auditor in assessing risk for an engagement. For example, assume that you are the partner in charge of the audit of Clary Co., a publicly traded cable television company serving several medium-sized cities in the United States. The senior management of Clary Co. is well respected in the industry and your audit firm has enjoyed a good relationship with management in that few conflicts have arisen over misstatements and those that have were quickly resolved to your satisfaction. However, with the latest deregulation moves by the U.S. government and the ensuing volatility in the telecommunications industry, Clary's position in this formerly stodgy marketplace is not clear.

Your audit staff hands you the following market value ratios on Clary Co. using the most recent audited financial statements and up-to-date market information:

a. What steps should you take to determine whether these ratios have any implications for the audit?

b. Assuming that the ratios indicate that the capital markets are undervaluing Clary's stock, what implications does that fact have for your audit of Clary Co.?

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Price-earnings ratio Market-to-book ratio 8.40 1.45