ABC, Inc. Analytical Review Procedures Year Ended December 31, 2017 It is January 2018 and you are a staff accountant assigned to the 2017 audit of ABC Inc. ABC is a closely held corporation managed by the founder and principal shareholder, Agatha Bernice Christy. Your firm has audited ABC for the last five years. The audited financial statements for the years ended December 31, 2016 and 2015 are presented below, with the client's unaudited financial statements for 2017. Additional Information: - ABC manufactures and sells drones for industrial use and cattle prods for ranching. - All sales are on credit. Credit terms are net 30 days. - ABC offers a one-year warranty covering manufacturing defects. - ABC uses a periodic inventory system and determines its year-end inventory by taking a physical count on December 31. You and your supervisor observed the count on December 31, 2017 and performed numerous test counts, but you have not performed further audit tests regarding inventory. - The interest rate on all debt is 8 percent. Annual interest and principal payments are due each December 1. - Average Common Shares Outstanding is 10,000 for each year. INCOME STATEMENTS ($000's) Years ended December 31 2017 2016 2015 Sales revenue $ 7,750 $ 7,713 $ 7,493 Cost of goods sold 5,505 5,381 5,225 Gross profit 2,245 2,332 2,268 Selling and general expenses 1,631 1,622 1,577 Depreciation expense 46 55 49 Warranty expense 75 65 55 Bad debt expense 90 85 90 Legal fees 53 14 12 Interest expense 110 127 135 Income before taxes 240 364 350 Income tax expense 71 109 104 Net income $ 169 $ 255 $ 246 Dividends paid $ 125 $ 125 $ 100 The following schedule shows the sales revenue and components of costs of goods sold for each of ABC's two products. SCHEDULES OF GROSS PROFIT ($000's) Years ended December 31 2017 2016 2015 Drones Sales $ 4,880 $ 4,932 $ 4,791 Cost of goods sold: Materials 1,895 1,835 1,781 Labor 1,103 1,074 1,043 Overhead 689 664 662 Standard cost variances 3 5 (4) Depreciation 50 70 68 3,740 3,648 3,550 Gross Profit $ 1,140 $ 1,284 $ 1,241 Cattle Prods Sales $ 2,870 $ 2,781 $ 2,702 Cost of goods sold: Materials 888 868 840 Labor 537 532 505 Overhead 301 276 270 Standard cost variances (2) (3) 2 Depreciation 41 60 58 1,765 1,733 1,675 Gross Profit $ 1,105 $ 1,048 $ 1,027 BALANCE SHEETS ($000's) December 31 2017 2016 2015 Cash $ 36 $ 165 $ 77 Accounts receivable 795 674 658 Allowance for Doubtful AcctsBad debt allowance (70) (60) (60) Inventories: Raw materials (at cost) 322 304 286 Finished goods: (at standard) Drones 913 738 710 Cattle Prods 405 390 374 Prepaid expenses 8 2 4 Current assets 2,409 2,213 2,049 Land 450 450 450 Building and equipment 1,865 1,858 1,831 Accumulated Depr. depreciation (895) (790) (610) Total assets $ 3,829 $ 3,731 $ 3,720 Accounts payable $ 837 $ 675 $ 694 Taxes payable 16 14 13 Accrued interest - 10 11 Warranty liability 40 40 40 Current portion of long-term debt 100 100 100 Current liabilities 993 839 858 Long-term debt 1,300 1,400 1,500 Total liabilities 2,293 2,239 2,358 Paid-in-capital 550 550 550 Retained earnings 986 942 812 Total stockholders'equity 1,536 1,492 1,362 Total liabilities and equity $ 3,829 $ 3,731 $ 3,720 Required: You are in the Planning phase of the audit. The engagement partner has asked you to perform analytical procedures to identify potential risks and areas of audit focus in ABC Inc's 2017 financial statements. Perform the following analytical procedurres on the financial statements and identify issues that you believe require special attention in the 2017 audit. 1.) Prepare a Horizontal (Trend) Analysis of the Balance Sheet and Income Statement for 2017 compared to 2016. Show the change in dollars and the percentage change for each account. Your audit planning materiality indicates that any variances greater than 10% year over year should be further investigated. Identify the potential audit implications for each balance to be investigated. 2.) Prepare Common Size Financial Statements (Vertical Analysis) for 2017, 2016 and 2015. Identify fluctuations you believe should be investigated and indicate the potential accounting and/or operating issues that should be investigated. 3.) Compute the ratios included on the KPI Ratio Listing for 2017 and 2016. Determine if there are ratios that you should investigate and indicate the potential causes of these ratio changes. 4.) Using the information from Steps 1. 2. and 3. above, identify 4 findings and complete the Interim Audit Findings worksheet and briefly state the primary audit procedure(s) you recommend. Hand in Horizontal Analysis Vertical Analysis KPI Ratios Interim Audit Findings 2017v2016 2017v2016 December 31 2017 2016 $ Change % Change F/U? Yes or No If yes, what is the Audit Implictation $$$$ %%%% December 31 2017 2016 2015 2017 2016 2015 F/U? Yes or No If yes, what is Cause/Trend to investigate 2017 2016 Change F/U?? Yes or No. If yes, what is Cause/Trend to investigate 1.) Current Ratio Current Assets/Current Liabilities 2.) Working Capital Current Assets - Current Liabilites 3.) Earnings Per Share (Net Income - Preferred Dividends) / Avg. Common Shares Outstanding 4.) Gross Profit % (Overall) Gross Profit / Net Sales 4.a.) Gross Profit % (Drones) Gross Profit / Net Sales 4.b.) Gross Profit % (Cattle Prods) Gross Profit / Net Sales 5.) Inventory Turnover (Overall) Cost of Goods Sold / Avg. Inventory 5.a.) Inventory Turnover (Drones) Cost of Goods Sold / Avg. Inventory 5.b.) Inventory Turnover (Cattle Prods) Cost of Goods Sold / Avg. Inventory 6.) Days in Inventory (Overall) 365 / Inventory Turnover 6.a.) Days in Inventory (Drones) 365 / Inventory Turnover 6.b.) Days in Inventory (Cattle Prods) 365 / Inventory Turnover 7.) Accounts Receivable Turnover Net Credit Sales / Avg. Accounts Receivable 8.) Avg, Collection Period 365 / Accounts Receivable Turnover 9.) Return on Assets Net Income / Avg Total Assets 10.) Times Interest Earned (Net Income + Interest Expense + Income Tax Expense) / Interest Expense # Unusual Account Fluctuation/Ratio Potential Business Issue Audit Procedure(s) to be Performed EXAMPLE Slowdown in A/R Collections Overstatement of A/R Valuation Inquire about collection issue, review calculation of AFDA 1 2 3 4