Auditing
Question 1 Cherry's Cupcakes (CC), a rapidly expanding, popular chain of cupcake restaurants has been considering a number of different expansion opportunities in the recent years. One option is to purchase Smiles Inc. (Smiles), a manufacturer and distributor of cake decorating accessories who reports under ASPE. The company's sole shareholder is June. Smile's manufacturing facility is in Saskatoon and the company has sales and distribution branches in Ottawa and Brandon, Manitoba. Before moving forward with the purchase of Smiles, CC has requested an audit of Smiles. Lemon and Custard CPAs has been engaged to perform the year-end audit. You, CPA, are the audit manager on the Smiles year-end audit, and are meeting with June to discuss the results for the year. June has brought the company's draft financial statements to your office (see Exhibit) I June: It has been an interesting year for our company. We expanded our sales into the US and Mexico and spent $40,000 on travel and advertising costs to promote our products to new customers. As a result of the advertising push, Smiles received several orders which we were all very excited about. Unfortunately, the economy took a downturn and many of the orders were cancelled halfway through production leaving Smiles with an excess of unused raw materials. Still other customers went bankrupt or experienced significant financial difficulties. Several of these customers have outstanding receivable balances and I have yet to follow up with them to determine if they can pay. At the same time, the bank imposed a new covenant requiring that the debt to equity ratio remain below 1.0. In order to avoid any staff reductions, the administrative staff agreed to take a week off without pay and forgo raises for the year. In addition, although I received a $75,000 bonus last year, I didn't take a bonus this year. And one last thing... one of our main pieces of manufacturing equipment unexpectedly broke down during the year. We incurred close to $30,000 in costs to repair it. Required: You are beginning the audit planning for the upcoming audit of Smiles. Considering the events at Smiles and using ratio and trend analysis, identify accounts that are at a risk of material misstatement and would warrant further investigation during the audit. Smiles Inc. Balance Sheet As at December 31 Current year Prior year 1,140 498,602 276,905 25,744 802,391 16,435 250,377 195,531 30,610 492,953 1,840,415 1,788,420 2,642,806 2,281,373 2 3 4 5 6 7 Current assets: 8 Cash 9 Accounts receivable 10 Inventory 11 Prepaids 12 Total current assets 13 14 Property, plant and equipment 15 16 Total assets 17 18 Liabilities and shareholder's equity 19 20 Current liabilities: 21 Accounts payable and accruals 22 Income taxes payable 23 Current portion of bank loan 24 Total current liabilities 25 26 Bank loan 27 28 29 Share capital 30 Retained earnings 31 32 Total liabilities and shareholder's equity 33 339,600 302 27,000 366,902 217,050 623 27,000 244,673 659,000 1,025,902 686,000 930,673 500 1,616,404 500 1,350,200 2,642,806 2,281,373 Smiles Inc. Income Statement For the year ended December 31 $ 2,867,500 $ 1,348,975 1,518,525 2,783,924 1,251,895 1,532,029 7 5 6 7 8 9 Sales 0 Cost of goods sold -1 2 3 Depreciation 14. Interest and bank charges 15 Bad debts 26 Professional fees 47 Repairs and maintenance 48 Salaries and wages 49 Selling, general and adminitrative costs 50 Income before taxes 51 Income taxes 52 Net Income 53 54 Retained earnings, opening 55 Retained earnings, closing 56 57 231,407 76,802 10,895 62,002 97,628 568,208 167,402 304,181 86,274 217,907 $ 256,092 82,503 13,285 53,457 87,392 598,207 201,498 239,595 67,293 172,302 $ $ $ $ 1,398,497 $ 1,616,404 $ 1,177,898 1,350,200 Ratio Explanation What does this indicate (improvement/deterioration)? Change in accounts receivable turnover *Note: consider if the change is an increase or decrease What circumstances at Smiles may be causing this is it expected? What is the implication (account over/understated, assertion implication)? Change in inventory turnover What does this indicate (improvement/deterioration)? What circumstances at Smiles may be causing this is it expected? What is the implication (account over/understated, assertion implication)? Change in current ratio What does this indicate (improvement/deterioration)? What circumstances at Smiles may be causing this - given the results of the AR and inventory turnover what is the auditor's concern? What does this indicate (improvement/deterioration)? Change in gross profit margin Given the results of sales and COGS during the year what is the implication (account over/understated, assertion implication)? What does this indicate (improvement/deterioration)? Change in debt to equity Given the new bank covenant this year what is the implication (account over/understated, assertion implication)? Account Explanation Note: only significant differences from prior year, considering a minimum of three accounts Describe the change in the account over the prior year. Identify the change and account considered, i.e. Increase in Salary expense What circumstance(s) at Smiles may be causing this? Given the circumstance(s) at Smiles during the year, describe the implication to the account (over/understated, assertion implication) Question 1 Cherry's Cupcakes (CC), a rapidly expanding, popular chain of cupcake restaurants has been considering a number of different expansion opportunities in the recent years. One option is to purchase Smiles Inc. (Smiles), a manufacturer and distributor of cake decorating accessories who reports under ASPE. The company's sole shareholder is June. Smile's manufacturing facility is in Saskatoon and the company has sales and distribution branches in Ottawa and Brandon, Manitoba. Before moving forward with the purchase of Smiles, CC has requested an audit of Smiles. Lemon and Custard CPAs has been engaged to perform the year-end audit. You, CPA, are the audit manager on the Smiles year-end audit, and are meeting with June to discuss the results for the year. June has brought the company's draft financial statements to your office (see Exhibit) I June: It has been an interesting year for our company. We expanded our sales into the US and Mexico and spent $40,000 on travel and advertising costs to promote our products to new customers. As a result of the advertising push, Smiles received several orders which we were all very excited about. Unfortunately, the economy took a downturn and many of the orders were cancelled halfway through production leaving Smiles with an excess of unused raw materials. Still other customers went bankrupt or experienced significant financial difficulties. Several of these customers have outstanding receivable balances and I have yet to follow up with them to determine if they can pay. At the same time, the bank imposed a new covenant requiring that the debt to equity ratio remain below 1.0. In order to avoid any staff reductions, the administrative staff agreed to take a week off without pay and forgo raises for the year. In addition, although I received a $75,000 bonus last year, I didn't take a bonus this year. And one last thing... one of our main pieces of manufacturing equipment unexpectedly broke down during the year. We incurred close to $30,000 in costs to repair it. Required: You are beginning the audit planning for the upcoming audit of Smiles. Considering the events at Smiles and using ratio and trend analysis, identify accounts that are at a risk of material misstatement and would warrant further investigation during the audit. Smiles Inc. Balance Sheet As at December 31 Current year Prior year 1,140 498,602 276,905 25,744 802,391 16,435 250,377 195,531 30,610 492,953 1,840,415 1,788,420 2,642,806 2,281,373 2 3 4 5 6 7 Current assets: 8 Cash 9 Accounts receivable 10 Inventory 11 Prepaids 12 Total current assets 13 14 Property, plant and equipment 15 16 Total assets 17 18 Liabilities and shareholder's equity 19 20 Current liabilities: 21 Accounts payable and accruals 22 Income taxes payable 23 Current portion of bank loan 24 Total current liabilities 25 26 Bank loan 27 28 29 Share capital 30 Retained earnings 31 32 Total liabilities and shareholder's equity 33 339,600 302 27,000 366,902 217,050 623 27,000 244,673 659,000 1,025,902 686,000 930,673 500 1,616,404 500 1,350,200 2,642,806 2,281,373 Smiles Inc. Income Statement For the year ended December 31 $ 2,867,500 $ 1,348,975 1,518,525 2,783,924 1,251,895 1,532,029 7 5 6 7 8 9 Sales 0 Cost of goods sold -1 2 3 Depreciation 14. Interest and bank charges 15 Bad debts 26 Professional fees 47 Repairs and maintenance 48 Salaries and wages 49 Selling, general and adminitrative costs 50 Income before taxes 51 Income taxes 52 Net Income 53 54 Retained earnings, opening 55 Retained earnings, closing 56 57 231,407 76,802 10,895 62,002 97,628 568,208 167,402 304,181 86,274 217,907 $ 256,092 82,503 13,285 53,457 87,392 598,207 201,498 239,595 67,293 172,302 $ $ $ $ 1,398,497 $ 1,616,404 $ 1,177,898 1,350,200 Ratio Explanation What does this indicate (improvement/deterioration)? Change in accounts receivable turnover *Note: consider if the change is an increase or decrease What circumstances at Smiles may be causing this is it expected? What is the implication (account over/understated, assertion implication)? Change in inventory turnover What does this indicate (improvement/deterioration)? What circumstances at Smiles may be causing this is it expected? What is the implication (account over/understated, assertion implication)? Change in current ratio What does this indicate (improvement/deterioration)? What circumstances at Smiles may be causing this - given the results of the AR and inventory turnover what is the auditor's concern? What does this indicate (improvement/deterioration)? Change in gross profit margin Given the results of sales and COGS during the year what is the implication (account over/understated, assertion implication)? What does this indicate (improvement/deterioration)? Change in debt to equity Given the new bank covenant this year what is the implication (account over/understated, assertion implication)? Account Explanation Note: only significant differences from prior year, considering a minimum of three accounts Describe the change in the account over the prior year. Identify the change and account considered, i.e. Increase in Salary expense What circumstance(s) at Smiles may be causing this? Given the circumstance(s) at Smiles during the year, describe the implication to the account (over/understated, assertion implication)
