In this and select cycle chapters, we present a case set in the pharmaceutical industry. The case enables students to practice developing and conducting planning and substantive analytical procedures. The case was developed using the published financial statements of three prominent companies in this industry, with adaptations to make the case suitable for classroom use. The fictional company names are PharmaCorp, Novartell, and AstraZoro.

LO 5, 8 This case will enable you to practice conducting planning and substantive analytical procedures for accounts in the revenue cycle. When analyzing the financial data, you may assume that the 2015 information is unaudited, while prior year data is audited.

As you complete this case, consider the following features of and trends in the pharmaceutical industry and for PharmaCorp specifically:

After a long period of industry dominance by companies in the United States, the United Kingdom, and Europe, these companies are facing increasing competition from companies domiciled in emerging economies, such as Brazil, India, and China.

There exists significant uncertainty in the market because of recent regulations covering health care and government payouts for certain procedures and related pharmaceuticals.

Health care policymakers and the government are increasingly mandating what physicians can prescribe to patients.

Health care policymakers and the government are increasingly focusing on prevention regimens rather than treatment regimens, thereby leading to shifts in the demand for various pharmaceuticals.

The global pharmaceutical market is anticipated to grow by 5 to 7% in 2016 compared with a 4 to 5% growth rate in 2015, according to a leading industry analyst publication.

Beginning in 2014, PharmaCorp initiated and executed a significant company-wide cost-reduction initiative aimed at improving manufacturing efficiency, cutting back on research and development expenses, and eliminating unnecessary corporate overhead.

PharmaCorp's policies for extending credit to customers has remained stable over the last three years. PharmaCorp's credit-granting policies are considered stringent within the industry, and analysts have sometimes criticized the company for this, contending that such policies have hindered the company's revenue growth relative to industry peers.

Two of PharmaCorp's popular pharmaceuticals, Selebrax and Vyvox, came off patent during the fourth quarter of FYE 2015. These pharmaceuticals now face competition in the generic drug portion of the overall industry market.

Part I: Planning Analytical Procedures

a. Step 1: Identify Suitable Analytical Procedures. Your audit senior has suggested that you should use the following ratios (on an overall financial statement level) for planning analytical procedures in the revenue cycle at PharmaCorp:

Gross margin: (revenues - cost of sales)/revenues

Turnover of receivables: (revenues/average accounts receivable); for ease of computation simply use ending accounts receivable

Receivables as a percentage of current assets and as a percentage of total assets: (accounts receivable/total current assets) and (accounts receivable/total assets)

Allowance for uncollectible accounts as a percentage of accounts receivable: (allowance/accounts receivable)

As part of Step 1, identify any other relevant relationships or trend analyses that would be useful to consider as part of planning analytics. Explain your reasoning.

b. Step 2: Evaluate Reliability of Data Used to Develop Expectations. The audit team has determined that the data you will be using to develop expectations in the revenue cycle are reliable. Indicate the factors that the audit team likely considered in making that determination.

c. Step 3: Develop Expectations. Complete Step 3 of planning analytical procedures by developing expectations for relevant accounts in the revenue cycle and for the ratios from part (a). Develop expectations by considering both historical trends of PharmaCorp and also by considering features of and historical trends in the industry. Given that this is a planning analytical procedure, the expectations are not expected to have a high level of precision. You might indicate that you expect a ratio to increase, decrease, or stay the same, and possibly indicate the size of any expected increases or decreases, or the range of the expected ratio. PharmaCorp's financial information is on the first tab of the Excel file, while the financial information for Novartell and AstraZoro are provided on the last two tabs of the Excel file.

d. Step 4 and Step 5: Define and Identify Significant Unexpected Differences. Refer to the guidance in Chapter 7 on overall materiality, performance materiality, and posting materiality. Apply those materiality guidelines to Step 4 of planning analytical procedures in the revenue cycle for PharmaCorp, to define what is meant by a significant difference. Explain your reasoning. Also, comment on qualitative materiality considerations in this context. Now that you have determined what amount of difference would be considered significant, calculate the ratios identified in Step 1 (and any additional ratios or trend analyses that you suggested), based on PharmaCorp's recorded financial statement amounts. Identify those ratios where there is a significant unexpected difference.

e. Step 6 and Step 7: Investigate Significant Unexpected Differences and Ensure Proper Documentation. Complete Step 6 of planning analytical procedures by describing accounts or relationships that you would investigate further through substantive audit procedures. Explain your reasoning. To complete Step 7, describe what information should be included in the auditor's workpapers.

Part II: Substantive Analytical Procedures

f. In the Excel file, you will see three tabs that you should review: PharmaCorp Segment Information, PharmaCorp Geographic Information, and PharmaCorp Other Revenue Info. These tabs provide excerpts from PharmaCorp's footnote disclosures regarding segment, geographic, and other revenue information. Read these disclosures and describe the various operating segments and geographic regions in which the company operates.

g. Which operating segments are most important to the company in terms of revenue generation? Which geographic regions are most important to the company? What are the three most important products produced by PharmaCorp? Comment on trends that you notice in revenue in each of these categories.

h. Explain the types of ratio analysis that you could conduct in substantive analytical procedures using the data provided in the segment, geographic, and other revenue information, for example, research and development expenses/revenues. How would the substantive analytics differ from the planning analytics? Comment on the trends and relationships that you believe are most relevant and implications for further substantive testing.