It is January 2017 and you are a staff accountant assigned to the December 31, 2016 year-end audit for ABC Electronics (ABC). ABC is a new client for your firm. They are a closely-held private corporation managed by the founder and principal shareholder, Adam B. Clark, with a small board of directors for oversight (predominantly long-time friends that Clark met while enrolled in an MBA at Elon University). ABC previously only had negative assurance on their financial statements, however, as Clark is looking to sell ABC in the next few years, he is thinking this might be a good time to have an audit performed. In addition, ABCs main creditor has also started asking for audited financial statements.

ABC manufactures and sells mp3 players, travel alarm clocks and a newly developed high-tech watch for which they have high hopes. While the mp3 player and travel alarm clock are mature products for ABC, the new high-tech watch was brought to market in July 2016 and there have been a few challenges with it. One of ABCs main competitor released a similar watch with a few bells and whistles that ABC was not able to implement with their first release. There is also a potential lawsuit on the horizon due to patent infringement regarding the development of the high-tech watch from competitor Macrohards new Kiwi Watch which was brought to market in August 2016. Macrohard states that they had filed for and was awarded patent 6,736,759 titled Detachable Beeper Disc Digital Gym Shoe with Sensor 3 years ago. Additionally, RadioWhack, the largest customer of the travel alarm clock has filed for bankruptcy.

This will be your firms first engagement with ABC. Clark has requested that your firm provide the final audit opinion within 60 days of year-end, as he will be heading out on a 2-month trip (part business, part pleasure) and the Board would like everything finalized before his departure.

The partner on the engagement had a brief discussion with the CFO who indicated that there is nothing really complex or challenging in the F/S, other than perhaps an investment in crypto-currency made by the previous CFO. ABC does have debt with an external lender and this debt has a specific debt covenant restriction related to its Quick Ratio (1:1 requirement) Under the direction of the previous CFO, the company, in 2016, also converted its AIS to cloud-based Sage Intacct Accounting Software in order to reduce costs and improve efficiency. Unfortunately, Clark and the CFO had a falling out in August 2016 which culminated in the CFO being replaced. The new CFO joined ABC in October 2016.

Required:

Using the excel spreadsheets provided (see ABC Excel Workbook), perform planning analytical procedures (horizontal trend analysis, vertical analysis and ratio analysis) in the appropriate columns on ABCs financial statements. Highlight specific accounts and ratios that have significant variances or which you are concerned about.

On Sheet 4 of the Excel Workbook, note your assessment of ABCs business risks and financial reporting risks as well as assess engagement risk and set audit risk. Provide 2-3 bullet points in support of each of your risk assessments. Also, calculate a recommended planning materiality for the audit (show your calculations, clearly indicating which benchmark you utilized eg. Total assets, or total revenues or NIBT etc.)

2. Indicate the recommended materiality for this engagement (show your calculations as well) and indicate the base you used (eg Total Revenues, Total Assets, NIBT etc) ABC Ratio Analysis (you may refer to Appendix 4A in your textbook for formulas as needed). 1 \begin{tabular}{l|l} \hline & 2016 \\ \hline & Balance-Sheet Ratios \\ \hline 5 & Current ratio \\ \hline & Quick ratio \\ \hline & Days' sales in receivables \\ \hline Days' sales in inventory \\ \hline & Debt/equity ratio \\ \hline \end{tabular} Operations Ratios \begin{tabular}{l} Receivables turnover \\ Inventory turnover \\ \hline COGS/Sales \\ \hline Gross Margin \% \end{tabular} Other \begin{tabular}{l|l|l|l} & ABC Financials & Horizontal Trend Analysis & Vertical Analysis Ratios \\ \end{tabular} 5 Years ended December 31 6 Sales revenue 7 Cost of goods sold Gross profit Selling and general expe Depreciation expense Warranty expense Bad debt expense Legal fees Interest expense Income before taxes Income tax expense Net income \begin{tabular}{lll} \hline \multicolumn{3}{|c|}{ VERTICAL ANALYSIS } \\ \hline 2016 & 2015 & 2014 \\ \hline 100.00% & 100.00% & 100.00% \\ \hline & & \\ \hline & & \\ \hline & & \\ \hline \end{tabular} 2. Indicate the recommended materiality for this engagement (show your calculations as well) and indicate the base you used (eg Total Revenues, Total Assets, NIBT etc) ABC Ratio Analysis (you may refer to Appendix 4A in your textbook for formulas as needed). 1 \begin{tabular}{l|l} \hline & 2016 \\ \hline & Balance-Sheet Ratios \\ \hline 5 & Current ratio \\ \hline & Quick ratio \\ \hline & Days' sales in receivables \\ \hline Days' sales in inventory \\ \hline & Debt/equity ratio \\ \hline \end{tabular} Operations Ratios \begin{tabular}{l} Receivables turnover \\ Inventory turnover \\ \hline COGS/Sales \\ \hline Gross Margin \% \end{tabular} Other \begin{tabular}{l|l|l|l} & ABC Financials & Horizontal Trend Analysis & Vertical Analysis Ratios \\ \end{tabular} 5 Years ended December 31 6 Sales revenue 7 Cost of goods sold Gross profit Selling and general expe Depreciation expense Warranty expense Bad debt expense Legal fees Interest expense Income before taxes Income tax expense Net income \begin{tabular}{lll} \hline \multicolumn{3}{|c|}{ VERTICAL ANALYSIS } \\ \hline 2016 & 2015 & 2014 \\ \hline 100.00% & 100.00% & 100.00% \\ \hline & & \\ \hline & & \\ \hline & & \\ \hline \end{tabular}