One of the partners of the CPA firm you work for has engaged a new audit client, Pinnacle Manufacturing, for the year ended December 31, 2009. Pinnacle is a medium-sized corporation, with its headquarters located in Detroit, Michigan. The company is made up of three divisions. The first division, Welburn, has been in existence for 35 years and creates powerful diesel engines for boats, trucks, and commercial farming equipment. The second division, Solar-Electro, was recently acquired from a high-tech manufacturing firm based out of Dallas, Texas. Solar-Electro produces state-of-the-art, solar-powered engines. The solar-powered engine market is relatively new, and Pinnacle?s top management believes that the Solar-Electro division will be extremely profitable in the future as the focus on global climate change continues and when highly anticipated EPA regulations make solar-powered engines mandatory for certain public transportation vehicles. Finally, the third division, Machine-Tech, engages in a wide variety of machine service and repair operations. This division, also new to Pinnacle, is currently in its second year of operations. Pinnacle?s board of directors has recently considered selling the Machine-Tech division in order to focus more on core operations?engine manufacturing. However, before any sale will be made, the board has agreed to evaluate this year?s operating results. Excellent operating results may have the effect of keeping the division a part of Pinnacle for the next few years. The vice president for Machine-Tech is committed to making it profitable. The purpose of Part I is to perform preliminary analytical procedures. You have been asked to focus your attention on two purposes of analytical procedures: assess going concern and indicate where there is an increased likelihood of misstatements. a. Calculate at least five ratios that are useful to assess going concern using Pinnacle?s financial statements, which are included in Figure 8-9. Document the ratios in a format similar to the following: Ratio 2009 2008 2007 Current ratio b. Based on your calculations, assess the likelihood (high, medium, or low) that Pinnacle is likely to fail financially in the next 12 months. c. Go to the Pinnacle link on the textbook Web site (www.prenhall.com/arens) and open the Pinnacle income statement, which is located in the Pinnacle Income Statement worksheet of the Pinnacle_Financials Excel file. Use the income statement information to prepare a common-size income statement for all three years. See Figure 8-7 (p. 229) for an example. Use the information to identify accounts for which you believe there is a concern about material misstatements. Use a format similar to the following: Account Balance Estimate of $ Amount of Potential Misstatement d. Use the three divisional income statements in the Pinnacle_Financials Excel file on the Web site to prepare a common-size income statement for each of the three divisions for all three years. Each division?s income statement is in a separate worksheet in the Excel file. Use the information to identify accounts for which you believe there is a concern about material misstatements. Use a format similar to the one in requirement c. e. Explain whether you believe the information in requirement c or d provides the most useful data for evaluating the potential for misstatements. Explain why. f. Your aging analysis of accounts receivable and discussions with management indicate that collections of accounts receivable have been somewhat slower than in the previous year. Evaluate whether or not you believe the allowance for uncollectible accounts is fairly valued. If you believe the account is misstated, calculate the potential misstatement.
Figure 8-9 Pinnacle Manufacturing Financial Statements Pinnacle Manufacturing Company Income Statement For the Year ended December 31 2009 $149,245,176 104,807,966 44,437,210 38,265,708 6,171,502 1,897,346 4,274,156 1,013,745 3,260,411 3.26 2008 $137,579,664 96,595,908 40,983,756 34,985,293 5,998,463 2,128,905 3,869,558 1,399,001 2,470,557 2.47 2007 $125,814,272 88,685,361 37,128,911 32,383,572 4,745,339 2,085,177 2,660,162 1,166,553 1,493,609 1.49 2009 2008 2007 $6,714,156 9,601,883 28,031,323 149,807 44,497,169 58,489,606 $6,369,431 7,495,528 22,206,259 124,527 36,195,745 53,596,113 $7,014,387 6,901,225 21,975,220 114,558 36,005,390 50,668,463 Total Assets $102,986,775 $89,791,858 $86,673,853 Liabilities Current Liabilities Accounts Payable Short/Current Long Term Debt Other Current Liabilities Total Current Liabilities Long Term Debt Total Liabilities $11,277,988 12,935,495 1,712,675 25,926,158 21,234,861 47,161,019 $8,200,059 7,868,407 1,536,835 17,605,301 19,427,831 37,033,132 $6,466,412 8,411,017 1,463,088 16,340,517 19,460,800 35,801,317 1,000,000 13,667,517 41,158,239 55,825,756 $102,986,775 1,000,000 13,667,517 38,091,209 52,758,726 $89,791,858 1,000,000 13,667,517 36,205,019 50,872,536 $86,673,853 Net Sales Cost of goods sold Gross Profit Operating expenses Income from operations Other revenues and gains Other expenses and losses Income before income tax Income tax Net income for the year Earnings per share Pinnacle Manufacturing Company Balance Sheet As of December 31 Assets Current Assets Cash and Cash Equivalents Net Receivables Inventory Other Current Assets Total Current Assets Property, Plant and Equipment Stockholders' Equity Common Stock Additional paid-in capital Retained Earnings Total Stockholders' Equity Total Liabilities & Stockholders' Equity Pinnacle Manufacturing Company Balance Sheet - All Divisions As of December 31 2009 Dollar Value 2008 Dollar Value 2007 Dollar Value $6,714,156 10,300,466 (698,583) 28,031,323 103,549 46,258 44,497,169 $6,369,431 8,194,111 (698,583) 22,206,259 92,481 32,046 36,195,745 $7,014,387 7,582,803 (681,578) 21,975,220 89,261 25,297 36,005,390 10,793,681 249,950 (186,207) 5,161,773 (2,782,971) 13,075,454 (3,118,820) 38,616,063 (10,426,337) 12,458,224 (5,351,204) 58,489,606 $102,986,775 10,793,681 206,964 (156,726) 4,920,966 (2,006,947) 10,278,700 (2,570,611) 32,072,816 (8,018,204) 12,235,566 (4,160,092) 53,596,113 $89,791,858 4,584,363 206,964 (115,330) 4,659,634 (1,331,164) 9,563,000 (2,232,843) 32,072,816 (6,949,110) 12,235,566 (2,025,433) 50,668,463 $86,673,853 CURRENT LIABILITIES Note payable: Bank Accounts payable: Trade Current portion of long-term debt Accrued payroll and withholding taxes Accrued interest Federal income taxes payable Total current liabilities $9,802,525 11,277,988 3,132,970 1,316,757 189,731 206,187 25,926,158 $7,835,437 8,200,059 32,970 1,111,541 156,545 268,749 17,605,301 $8,378,047 6,466,412 32,970 1,095,991 138,478 228,619 16,340,517 LONG-TERM DEBT 21,234,861 19,427,831 19,460,800 STOCKHOLDERS' EQUITY Common stock: $1 par value Authorized: 1,500,000 shares Issued and outstanding: 1,000,000 shares Additional paid-in capital Retained earnings Total stockholders' equity 1,000,000 13,667,517 41,158,239 55,825,756 1,000,000 13,667,517 38,091,209 52,758,726 $89,791,858 1,000,000 13,667,517 36,205,019 50,872,536 $86,673,853 ASSETS CURRENT ASSETS Cash and cash equivalents Accounts receivable: Trade Less: Allowance for bad debts Inventory Prepaid expenses Deposits Total current assets PROPERTY, PLANT, AND EQUIPMENT Land Automobiles Accum. depreciation: Automobiles Office equipment Accum.depreciation: Office equipment Manufacturing equipment Accum. depreciation: Manufacturing equipment Manufacturing building Accum. depreciation: Manufacturing building Office building Accum.depreciation: Office building Total property, plant, and equipment TOTAL ASSETS LIABILITIES AND STOCKHOLDERS' EQUITY TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $102,986,775 Pinnacle Manufacturing Company Income Statement - All Divisions For the Year Ended December 31 Sales Sales Returns and Allowances Cost of Sales* Gross Profit OPERATING EXPENSES-Allocated Salaries-Management Salaries-Office Licensing and certification fees Security Insurance Medical benefits Advertising Business publications Property taxes Bad debts Depreciation expense Accounting fees Total operating expenses-Allocated OPERATING EXPENSES-Direct Salaries-Sales Wages Rental Wages-Mechanics Wages-Warehouse Garbage collection Payroll benefits Rent- Warehouse Telephone Utilities Postage Linen service Repairs and maintenance Cleaning service Legal service Fuel Travel and entertainment Pension expense Office supplies Miscellaneous Total operating expenses-Direct Total Operating Expenses Operating Income Other Expense-Interest Income Before Taxes Federal Income Taxes Net Income 2009 Dollar Value $149,424,646 179,470 104,807,966 44,437,210 2008 Dollar Value $137,741,766 162,102 96,595,908 40,983,756 2007 Dollar Value $125,982,294 168,022 88,685,361 37,128,911 2,348,025 324,392 196,229 566,716 95,924 24,415 167,268 7,194 23,246 866,330 5,492,959 281,973 10,394,671 2,190,819 272,185 158,608 584,936 95,268 27,021 163,311 5,096 163,311 948,679 4,258,699 273,190 9,141,123 1,995,723 266,831 141,112 548,133 94,340 25,052 144,068 673 152,776 862,690 3,797,885 260,684 8,289,967 15,408,771 506,186 1,146,126 5,034,197 28,458 2,735,670 826,350 33,350 270,072 92,390 17,788 171,872 92,428 407,605 294,933 106,415 235,244 154,213 308,969 27,871,037 38,265,708 6,171,502 1,897,346 4,274,156 1,013,745 $3,260,411 14,062,181 546,228 1,229,015 4,899,331 27,313 2,695,165 701,235 41,443 244,959 122,494 11,330 154,500 74,852 174,807 313,020 95,268 217,752 136,092 97,185 25,844,170 34,985,293 5,998,463 2,128,905 3,869,558 1,399,001 $2,470,557 12,960,341 500,630 1,159,488 4,759,347 33,017 2,516,783 659,430 50,319 238,578 131,546 13,985 154,968 67,903 132,381 243,054 87,373 110,444 148,790 125,228 24,093,605 32,383,572 4,745,339 2,085,177 2,660,162 1,166,553 $1,493,609 * Details of manufacturing expenses are not included in this schedule. Pinnacle Manufacturing Company Income Statement - Welburn Division For the Year Ended December 31 Sales Sales Returns and Allowances Cost of Sales* Gross Profit OPERATING EXPENSES-Allocated Salaries-Management Salaries-Office Licensing and certification fees Security Insurance Medical benefits Advertising Business publications Property taxes Bad debts Depreciation expense Accounting fees Total operating expenses-Allocated OPERATING EXPENSES-Direct Salaries-Sales Wages Rental Wages-Mechanics Wages-Warehouse Garbage collection Payroll benefits Rent- Warehouse Telephone Utilities Postage Linen service Repairs and maintenance Cleaning service Legal service Fuel Travel and entertainment Pension expense Office supplies Miscellaneous Total operating expenses-Direct Total operating expenses OPERATING INCOME 2009 Dollar Value $121,371,795 126,522 86,671,580 34,573,693 2008 Dollar Value $111,877,873 113,483 79,914,454 31,849,936 2007 Dollar Value $102,308,887 117,627 73,370,003 28,821,257 1,905,965 263,320 144,046 460,017 77,861 19,956 135,777 4,336 18,396 708,015 1,774,466 220,457 117,118 473,767 77,159 22,048 132,276 2,735 132,276 762,910 3,449,347 220,363 7,384,922 1,616,447 216,121 104,199 443,958 76,407 20,441 116,690 361 123,743 693,759 3,076,109 210,276 6,698,511 4,329,633 230,075 8,297,397 12,947,327 11,646,277 - 4,124,063 3,968,235 2,099,069 690,375 26,659 200,398 80,204 14,539 127,063 67,780 119,122 224,342 82,614 193,389 125,176 58,819 21,180,939 29,478,336 $5,095,357 * Details of manufacturing expenses are not included in this schedule. 2,182,959 571,916 33,069 198,409 99,207 9,642 107,833 60,628 120,490 253,526 77,159 176,367 110,228 53,130 19,669,075 27,053,997 $4,795,939 10,733,735 3,854,855 2,038,477 537,821 40,152 193,240 106,538 11,900 108,159 55,000 91,247 196,858 70,765 89,454 120,513 68,461 18,317,175 25,015,686 $3,805,571 Pinnacle Manufacturing Company Income Statement - Solar-Electro Division For the Year Ended December 31 Sales Sales Returns and Allowances Cost of Sales* Gross Profit OPERATING EXPENSES-Allocated Salaries-Management Salaries-Office Licensing and certification fees Security Insurance Medical benefits Advertising Business publications Property taxes Bad debts Depreciation expense Accounting fees Total operating expenses-Allocated OPERATING EXPENSES-Direct Salaries-Sales Wages Rental Wages-Mechanics Wages-Warehouse Garbage collection Payroll benefits Rent- Warehouse Telephone Utilities Postage Linen service Repairs and maintenance Cleaning service Legal service Fuel Travel and entertainment Pension expense Office supplies Miscellaneous Total operating expenses-Direct Total operating expenses OPERATING INCOME 2009 Dollar Value $22,381,936 43,430 16,311,635 6,026,871 2008 Dollar Value $20,073,876 35,208 14,687,724 5,350,944 347,907 48,064 19,868 83,967 14,212 3,641 24,783 900 3,360 124,019 323,147 40,146 14,025 86,281 14,054 4,015 24,087 497 24,087 144,706 628,135 40,999 1,344,179 915,513 40,824 1,627,058 2,256,643 2007 Dollar Value $18,373,763 36,494 13,484,900 4,852,369 294,370 39,356 12,478 80,853 13,917 3,722 21,249 66 22,533 131,590 560,167 39,122 1,219,423 2,204,049 - 716,283 722,659 492,677 107,026 4,868 54,837 7,340 2,653 35,120 21,300 276,825 55,555 18,729 35,301 22,849 241,764 4,349,770 5,976,828 $50,043 * Details of manufacturing expenses are not included in this schedule. 397,542 100,370 6,025 36,131 18,069 1,367 36,131 11,039 42,156 46,171 14,054 31,182 20,073 39,433 3,726,451 5,070,630 $280,314 2,031,351 702,011 371,231 94,386 7,315 35,190 19,404 1,688 36,241 10,014 31,925 35,851 12,889 15,815 21,946 50,811 3,478,068 4,697,491 $154,878 Pinnacle Manufacturing Company Income Statement - Machine-Tech Division For the Year Ended December 31 Sales Sales Returns and Allowances Cost of Sales* Gross Profit OPERATING EXPENSES-Allocated Salaries-Management Salaries-Office Licensing and certification fees Security Insurance Medical benefits Advertising Business publications Property taxes Bad debts Depreciation expense Accounting fees Total operating expenses-Allocated OPERATING EXPENSES-Direct Salaries-Sales Wages Rental Wages-Mechanics Wages-Warehouse Garbage collection Payroll benefits Rent- Warehouse Telephone Utilities Postage Linen service Repairs and maintenance Cleaning service Legal service Fuel Travel and entertainment Pension expense Office supplies Miscellaneous Total operating expenses-Direct Total operating expenses OPERATING INCOME 2009 Dollar Value $5,670,915 9,518 1,824,751 3,836,646 2008 Dollar Value $5,790,017 13,411 1,993,730 3,782,876 2007 Dollar Value $5,299,644 13,901 1,830,458 3,455,285 94,153 13,008 32,315 22,732 3,851 818 6,708 1,958 1,490 34,296 247,813 11,074 470,216 93,206 11,582 27,465 24,888 4,055 958 6,948 1,864 6,948 41,063 181,217 11,828 412,022 84,906 11,354 24,435 23,322 4,016 889 6,129 246 6,500 37,341 161,609 11,286 372,033 204,801 211,855 506,186 1,146,126 546,228 1,229,015 193,851 208,437 28,458 143,924 28,949 1,823 14,837 4,846 596 9,689 3,348 11,658 15,036 5,072 6,554 6,188 8,386 2,340,328 2,810,544 $1,026,102 27,313 114,664 28,949 2,349 10,419 5,218 321 10,536 3,185 12,161 13,323 4,055 10,203 5,791 4,622 2,448,644 2,860,666 $922,210 * Details of manufacturing expenses are not included in this schedule. 195,255 500,630 1,159,488 202,481 33,017 107,075 27,223 2,852 10,148 5,604 397 10,568 2,889 9,209 10,345 3,719 5,175 6,331 5,956 2,298,362 2,670,395 $784,890
