Horizontal and Vertical Analysis.

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 Company's 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.

EXHIBIT 4.55.1 Retail Company Prior Year (Audited) Current Year (Unaudited) Balance Common Size Balance Connmon Size Amount Percent Assets: 14.78% 1232 -0.99 3895 9.60% -19.33% $ (116,000) (100,000) Cash Accounts receivable Allowance doubt accts. Inventory S 600,000 500,000 (40,000) 1500,000 $ 484,000 400,000 (30,000 25.00 29.33 9.14 440,000 Total current assets Fixed assets Accum. depreciation 7389 -38.95 100.00% 80.10 36.04 100.00% ,000,00 (300,000 934,000 ,000,000 20.00 23.00% 1500,000 $4060,000 3 450,000 50,000 Total assets Liabilities and equity 12.01% 15.02 800,000 750,000 40,000 10,000 150,000 750,000 (10,000) (50,000) 11.08% 3333% Accounts payable Bank loans, 1 1 % Accrued interest Accrugls and other -83.33 150.00 60,000 500,000 2000,000 28.03 Total current ligb. Long-Term debt, 1096 1232 400,000 Total liabilities Capital stock Retained earnings 49.26 24.63 T070% 2,000,000 1,194,000 1,000,000 19.40 23.00% 194,000 Total liabilities and equity Statement of operations: -10.00% -16.38 $9,000000 8,100,000 100.00% $(900,000) 1 00.00% 6996 Sales (net Cost of goods sold Gross margin General expense Depreciation Operating income Interest expens Income taxes (40%) 0000 .0 1031 900-1858 2,006,000 300,000 22.71 24.75 (39,000) 2,044,000 300000 50,000 124,000 400 056 1.38 40,000 196,000 (10,000) 2,000 47.22 20.00 Net income 58.06% NA mens notappucabie