Instructions

Last week, you learned how crucial and time-intensive the planning stage is for the audit process. Like planning for any event, being proactive and deliberate produces the best results.

This weeks assignment will help you demonstrate the value of the planning process for identifying risks and process selection for audit procedures.

• Examine the following case information.
• Identify four areas of risk, then
• Determine the testing that should occur during the audit.

SK Wheels, Inc. wanted to expand its manufacturing operations and showrooms and needed working capital. The company provided the finance company the previous years audited financial statements, a set of projections, and the current year's statements (unaudited). The fiscal year-end was December 31. After careful review, the finance company gave SK Wheels, Inc. a loan at 8% interest for $1.75 million on July 1, for working capital. The loan had a due date of December 31 of the next year (18-month term) because SK Wheels planned to finance the loan through a stock offer. Interest payments on the loan were due quarterly.

As part of the pre-engagement process, the auditor conducted interviews with some of SK Wheels key personnel and learned:

• The operations expansion and showroom costs were lower than predicted.
• The company expanded its return policy to customers, and sales were slow.
• SK Wheels officers wanted to show more income and preserve the $120,000 dividend (paid in the previous year) to impress the finance company.
• In the production area, managers met the target of maintaining a 4.0 inventory turnover ratio; However, compared to sales volume, materials/supplies costs went up by 2%. Spreadsheet Provided.

Common-size Statement for SK Wheels:

Table 1. Common-size statement for SK Wheels

SK Wheels, Inc. (Numbers in thousands)	Prior Year (Audited)	Forcast for Financing	Current Year (Unaudited)
Revenue and Expense
Sales (net)	$9,000	$9,000	$9,270
Cost of goods sold	$6,296	$6,926	$7,000
Gross margin	$2,704	$2,974	$2,720
General expense	$2,044	$2,000	$2,003
Depreciation	$ 300	$ 334	$ 334
Operating income	$ 360	$ 640	$ 383
Interest expense	$ 60	$ 110	$ 75
Income taxes (40%)	$ 120	$ 212	$ 123
Net income	$ 180	$ 318	$ 185
Assets
Cash	$ 600	$ 880	$ 690
Accounts receivable	$ 500	$ 600	$ 900
Allowance for doubtful accounts	-$40	-$48	-$90
Inventory	$1,500	$1,500	$1,350
Total current assets	$2,560	$2,932	$2,850
Fixed assets	$3,000	$4,700	$4,500
Accumulate ddepreciation	-$1,500	-$1,832	-$1,834
Total Assets	$4,060	$5,798	$5,517
Liabilities and Equity
Accounts payable	$ 150	$ 450	$ 330
Bank loans at 8%	$ -	$1,750	$1,750
Accrued interest	$ 60	$ 40	$ 40
Accruals and other	$ 50	$ 60	$ 32
Total current liabilities	$ 560	$2,300	$2,152
Long-term debt at 10%	$ 600	$ 400	$ 400
Total liabilities	$1,160	$2,700	$2,552
Capital stock	$2,000	$2,000	$2,000
Retained earnings	$ 900	$1,098	$ 965
Total liabilities and equity	$4,060	$5,798	$5,517

Table 1. Common-size statement for SK Wheels