50.1K

Verified Solution

Link Copied!

Horizontal analysis refers to changes of financial statement numbers and ratios across two or more years. Vertical analysis refers to financial statement amounts expressed each year as proportions of a base such as sales for the income-statement accounts and total assets for the balance-sheet accounts. Exhibit 4.55.1 contains Retail Companys prior-year (audited) and current-year (unaudited) financial statements, along with amounts and percentages of change from year to year (horizontal analysis) and common-size percentages (vertical analysis). Exhibit 4.55.2 contains selected financial ratios based on these financial statements. Analysis of these data can enable auditors to discern relationships that raise questions about misleading financial statements.

Required:

Study the data in Exhibits 4.55.1 and 4.55.2. Write a memorandum identifying and explaining potential problem areas where misstatements in the current-year financial statements could exist. Additional information about Retail Company is as follows:

The new bank loan, obtained on July 1 of the current year, requires maintenance of a 2:1 current ratio.

Principal of $100,000 plus interest on the 10 percent long-term note obtained several years ago in the original amount of $800,000 is due each January 1.

The company has never paid dividends on its common stock and has no plans for a dividend.

company has never paid dividends on its common stock and has no plans for a dividend.

	Prior Year Audited		Current Year (Unaudited)		Change
	Balance	Common Size	Balance	Common Size	Amount	Percent
Assets:
Cash	$ 600,000	14.78%	$484,000	9.69%	$ (116,000)	-19.33%
Accounts Receivable	500,000	12.32	400,000	8.01	(100,000)	-20.00
Allowance doubt accts	(40,000)	-0.99	(30,000)	-0.60	10,000	-25.00
Inventory	1,500,000	36.95	1,940,000	38.85	440,000	29.33
Total current assets	2,560,000	63.05	2,794,000	55.95	234,000	9.14
Fixed assets	3,000,000	73.89	4,000,000	80.10	1,000,000	33.33
Accum. depreciation	(1,500,000)	-36.95	1,800,000	-36.04	(300,000)	20.00
Total assets	$4,060,000	100.00%	$4,994,000	100.00%	$934,000	23.00%
Liabilities and equity:
Accounts payable	$450,000	11.08%	$ 600,000	12.01%	$ 150,000	33.33%
Bank loans, 11%	0	0.00	750,000	15.02	750,000	NA
Accrued Interest	50,000	1.23	40,000	0.80	(10,000)	-20.00
Accruals and others	60,000	1.48	10,000	0.20	(50,000)	-83.33
Total current liab.	560,000	13.79	1,400,000	28.03	840,000	150.00
Long-term debt , 10%	500,000	12.32	400,000	8.01	(100,000)	-20.00
Total liabilities	1,060,000	26.11	1,800,000	36.04	740,000	69.81
Capital stock	2,000,000	49.26	2,000,000	40.05	0	0
Retained earnings	1,000,000	24.63	1,194,000	23.91	194,000	19.40
Total liabilities and equity	$4,060,000	100.00%	$4,994,000	100.00%	934,000	23.00%
Statement of operations:
Sales (net)	$9,000,000	100.00%	$8,100,000	100.00%	$(900,000)	-10.00%
Cost of goods sold	6,296,000	69.96	5,265,000	65.00	(1,031,000)	-16.38
Gross margin	2,704,000	30.04	2,835,000	35.00	131,000	4.84
General expenses	2,044,000	22.71	2,005,000	24.75	(39,000)	-1.91
Depreciation	300,000	3.33	300,000	3.70	0	0
Operating income	360,000	4.00	530,000	6.54	170,000	47.22
Interest expense	50,000	0.56	40,000	0.49	(10,000)	-20.00
Income taxes (40%)	124,000	1.38	196,000	2.42	72,000	58.06
Net income	$186,000	2.07%	$294,000	3.63%	$108,000	58.06%

EXHIBIT 4.55.1 Retail Company

EXHIBIT 4.55.2

Retail Company

	Prior Year (Audited)	Current Year (Unaudited)	Percent Change
Balance-sheet ratios:
Current ratio	4.57	2.0	-56.34%
Days sales in receivables	18.40	16.44	-10.63
Doubtful accounts ratio	0.0800	0.0750	-6.25
Days sales in inventory	85.77	132.65	54.66
Debt/equity ratio	0.35	0.56	40.89
Operations ratios:
Receivables turnover	19.57	21.89	11.89
Inventory turnover	4.20	2.71	-35.34
Cost of goods sold/sales	69.96%	65.00%	-7.08
Gross Margin%	30.04%	35.00%	16.49
Return on equity	6.61%	9.80%	48.26

Answer & Explanation Solved by verified expert

See Answer