3. Analytical procedures You are the audit manager of a medium-sized firm and have just received a package from Rachel Jones, the financial controller of Telechubbies Ltd, a toy manufacturer. This is your firm's first year as auditor of Telechubbies. The information contained in the statement of financial position and income statement opposite was prepared for a board meeting and Rachel felt it might be useful to you in preparation of the forthcoming audit for the year ended 31 December 2015. During a brief telephone call with Rachel, you made the following notes: 1. One of the conditions of the long-term loan is that the company is not to exceed a debt-to-equity ratio of 2:1 at any time. The loan is reviewed each year on 31 December. 2. Provision against inventory obsolescence is provided for at a flat rate of 10%. The amount provided in previous years was 20%. Rachel said that the company believes it has been overly conservative in previous years and 5% is a more realistic level, given the nature of its products. 3. The long-term loan receivable is from a company involved in the development and production of computer software. It is owned by one of the directors. Required (a) Suggest possible sources of information that would help you gather sufficient knowledge of the business to perform the audit of Telechubbies Ltd. (5 marks) (b) Perform preliminary analytical procedures ising the information provided. Identify key areas that would require special attention during the audit of the 31 December 2015 financial statements. (10 marks) (c) Outline the ways that the analytical procedures performed could be extended using the information collected in (a). (5 marks) (d) Suggest ways of using analytical procedures as a substantive test during the audit of Telechubbies Ltd. (10 marks) 2015 S'000 2014 $'000 2013 $'000 1 586 16 498 12 134 30 218 1 743 11 731 10 700 24 174 830 7 197 9 323 17 350 Statement of financial position Current assets Cash Inventory Trade receivables Total current assets Non-current assets Property, plant and equipment Long-term loan receivable Total non-current assets Total assets Current liabilities Trade payables 14 606 12 840 9 572 5 200 19 806 50 024 3 600 16 440 40 614 3 300 12 872 30 222 9012 6 288 2 021 4 4875 13 887 3821 10 109 4 577 6 598 Provisions Total current liabilities Non-current liabilities Long-term loan payable Total liabilities Net assets Shareholders' equity Ask 20 000 33 887 16 137 16 000 26 109 14 505 12 000 18 598 11 624 At You c 4875 13 887 3 821 10 109 4577 6 598 Provisions Total current liabilities Non-current liabilities Long-term loan payable Total liabilities Net assets Shareholders' equity Share capital Retained earnings Total shareholders' equity 20 000 33 887 16 137 16 000 26 109 14 505 12 000 18 598 11 624 2 000 14 137 16 137 2 000 12 505 14 505 2 000 9624 11 624 Income statement 2015 S'000 72 945 2014 $'000 74 927 2013 $'000 89 735 51 840 Sales Cost of sales Gross profit Depreciation 21 105 5 595 51 765 23 162 4332 63 066 26 669 2 796 Inventory obsolescence Marketing expense Administration expense Interest expense Total expenses Profit before tax 1 650 1 345 8925 1 040 18 555 2 550 2 346 1 980 8 727 1 275 18 660 4502 1 439 2 548 11 516 1 140 19 439 7 230 Tax expense Profit after tax 918 1 632 1621 2 881 2 386 4 844 At 3. Analytical procedures You are the audit manager of a medium-sized firm and have just received a package from Rachel Jones, the financial controller of Telechubbies Ltd, a toy manufacturer. This is your firm's first year as auditor of Telechubbies. The information contained in the statement of financial position and income statement opposite was prepared for a board meeting and Rachel felt it might be useful to you in preparation of the forthcoming audit for the year ended 31 December 2015. During a brief telephone call with Rachel, you made the following notes: 1. One of the conditions of the long-term loan is that the company is not to exceed a debt-to-equity ratio of 2:1 at any time. The loan is reviewed each year on 31 December. 2. Provision against inventory obsolescence is provided for at a flat rate of 10%. The amount provided in previous years was 20%. Rachel said that the company believes it has been overly conservative in previous years and 5% is a more realistic level, given the nature of its products. 3. The long-term loan receivable is from a company involved in the development and production of computer software. It is owned by one of the directors. Required (a) Suggest possible sources of information that would help you gather sufficient knowledge of the business to perform the audit of Telechubbies Ltd. (5 marks) (b) Perform preliminary analytical procedures ising the information provided. Identify key areas that would require special attention during the audit of the 31 December 2015 financial statements. (10 marks) (c) Outline the ways that the analytical procedures performed could be extended using the information collected in (a). (5 marks) (d) Suggest ways of using analytical procedures as a substantive test during the audit of Telechubbies Ltd. (10 marks) 2015 S'000 2014 $'000 2013 $'000 1 586 16 498 12 134 30 218 1 743 11 731 10 700 24 174 830 7 197 9 323 17 350 Statement of financial position Current assets Cash Inventory Trade receivables Total current assets Non-current assets Property, plant and equipment Long-term loan receivable Total non-current assets Total assets Current liabilities Trade payables 14 606 12 840 9 572 5 200 19 806 50 024 3 600 16 440 40 614 3 300 12 872 30 222 9012 6 288 2 021 4 4875 13 887 3821 10 109 4 577 6 598 Provisions Total current liabilities Non-current liabilities Long-term loan payable Total liabilities Net assets Shareholders' equity Ask 20 000 33 887 16 137 16 000 26 109 14 505 12 000 18 598 11 624 At You c 4875 13 887 3 821 10 109 4577 6 598 Provisions Total current liabilities Non-current liabilities Long-term loan payable Total liabilities Net assets Shareholders' equity Share capital Retained earnings Total shareholders' equity 20 000 33 887 16 137 16 000 26 109 14 505 12 000 18 598 11 624 2 000 14 137 16 137 2 000 12 505 14 505 2 000 9624 11 624 Income statement 2015 S'000 72 945 2014 $'000 74 927 2013 $'000 89 735 51 840 Sales Cost of sales Gross profit Depreciation 21 105 5 595 51 765 23 162 4332 63 066 26 669 2 796 Inventory obsolescence Marketing expense Administration expense Interest expense Total expenses Profit before tax 1 650 1 345 8925 1 040 18 555 2 550 2 346 1 980 8 727 1 275 18 660 4502 1 439 2 548 11 516 1 140 19 439 7 230 Tax expense Profit after tax 918 1 632 1621 2 881 2 386 4 844 At