The following operating data has been provided to Erica Chavez by her audit client, Grimes Hardware. Sales commissions average 6 percent of sales:
2002 % 2003 % Change (%)
Sales $18,000 100% 22,000 100% 22%
Cost of sales 10,000 11,000 Sales commissions 1,080 1 100 Gross profit 6,920 9,900 Operating expenses 3,200 3,600 Income before taxes 3,720 6,300 Income taxes 1,200 2,000 Net income $2,520 4,300 ===== =====
Required:
a. Complete the vertical and horizontal analysis by calculating the
correct percentages.
b. Why are both vertical and horizontal analysis important inputs to
analytical procedures?
c. Assuming sales commissions have been accurately
computed based on 2003 sales, what are the possible explanations for any abnormalities produced by your percentage calculations?
2. The following financial data have been extracted from
the records of Blackwell Wholesale Tires:
2003 2002
Sales $15,660 14,980
Cost of sales 7,800 7,400 Ending inventory 6,200 4,300 Accounts receivable-trade 2,200 1,300 Total current assets 12,300 10,100 Total current liabilities 7,300 4,980 Customer payment terms: 2/10;n/30 Industry averages: Gross margin 51% Current ratio 2:1 Inventory turnover 2.5 Accounts receivable turnover 11.0 Required: Based on the above data, in which areas do you recommend concentrating audit resources for the 2003 audit? Support your answer by citing the relevant data. 3. Louis Hernandez set the following materiality thresholds for the Sanders Wholesale audit:
Individual item materiality - income statement:
$30,000 (5% of unaudited net income, $600,000) Individual item materiality - balance sheet: (2% of unaudited net assets, $3,500,000)$70,000 Aggregate materiality (20% of individual item) Income statement $6,000 Balance sheet $14,000
Required:
a. What factors should Hernandez have considered in
setting the above thresholds? Why is the aggregate threshold set at 20% rather than, say 10% or 5%? b. In the process of testing Sanders internal controls, Hernandez discovered significant weaknesses that, in his opinion, may have materially impacted the financial statements. Moreover, the application of analytical procedures revealed the likelihood of a material overstatement of unaudited net income and net assets. What effect should these findings have on the materiality thresholds?
4. For each of the listed scenarios, determine whether
inherent risk or control risk or both should be assessed at a high level. Then describe an appropriate audit approach. In developing your approach, consider whether the auditor should decrease reliance on internal evidence and suggest specific kinds of audit evidence you would recommend in the circumstances.
Situation 1.
In planning the audit of Jayco Corporation, Charles Lawson,
the in-charge senior auditor found Jaycos internal controls to be effective in all transaction cycles. Analytical procedures revealed that Jaycos operating income declined 30% in 2000, based on unaudited data. Increased competition from imports, combined with more stringent emission requirements, contributed to the decline. Lawson is concerned, however, that Jayco reported operating income while its nearest competitors reported losses. He notes that Jayco is not showing a capacity loss notwithstanding a significant decrease in production and fixed overhead absorption. Ending inventories seem high relative to cost of goods sold for the year. Situation 2.
Although the internal controls for Montrose, Inc., a local
cable broadcasting company, are effective for the revenue cycle, they are lacking in the expenditure cycle. Of particular concern to Eva Bresky, the in-charge auditor, is the absence of internal control over the processing of invoices from and payments to network providers. The Montrose engagement is an initial audit for Breskys firm and a first audit for Montrose. Analytical procedures do not reveal any apparent abnormalities.