Sports Inc., a retailer of high-quality activewear, has been considering a number of different expansion opportunities in recent years. One option is to purchase Goodlife Co., a manufacturer and distributor of sporting good equipment. The company's sole shareholder is Martin. Goodlife Co's manufacturing facility is in Winnipeg, and it has sales and distribution branches in Mississauga, Alberta, and in Montreal.

Sports Inc. is considering the acquisition to expand into this market. However, before moving any further with this idea, Sports Inc. has requested an audit of Goodlife Co.

Sen and Ken Chartered Professional Accountants (SK) have been engaged to perform the year-end audit. You, CPA, are the audit manager on the Goodlife Co. year-end audit and are meeting with Martin to discuss the results for the year.

Martin has brought the company's draft financial statements to your office.

Martin: It has been a difficult year. Most of our customers are in Alberta and Montreal. This year, we began selling into the South America and Argentina. We attended major trade shows in the South America and Argentina early in the year to promote our company and products. It was the first time we had attended these types of events, and the related travel and advertising costs were over $40,000.

We received a number of orders, and in anticipation of the increased demand, we purchased raw materials. Things were looking great and then there was a financial crisis. Demand for sporting equipment fell dramatically. In order to remain competitive, we had to reduce our selling prices; even so, a number of our customers have gone bankrupt or are having significant difficulty. I have been really busy and have not spent much time following up with customers and reviewing their outstanding balances.

At the same time, the bank imposed a new covenant requiring that the debt-to-equity ratio remain below 1.0. To avoid any staff reductions, the administrative staff agreed to take a week off without pay and forgo raises for the year. In addition, although I received a $75,000 bonus last year, I didn't take a bonus this year. Unfortunately, one of our main pieces of manufacturing equipment unexpectedly broke down during the year, and we incurred close to $30,000 in costs to repair it.

Question:

You are beginning the risk assessment for the upcoming audit ofGoodlife Co. Perform a year-over-year comparison of key ratios including accounts receivable turnover, inventory turnover, current ratio, gross profit margin, and debt to equity, and identify accounts that are at a risk of material misstatement and would warrant further investigation during the audit, given the changes in ratios and considering the provided case facts. In addition, include a procedure to address the identified risks.

Goodlife Co.

Balance Sheets

As at December 31 (ASPE)

Current year (Draft)

Prior year

(Audited)

Assets

Current assets:

Cash

$1,140

$16,635

Accounts receivable

377,602

252,477

Inventory

283,906

195,632

Prepaid expenses

26,744

30,611

689,392

495,355

Property, plant, and equipment (net)

1,840,415

1,788,420

$2,529,807

$2,283,775

Liabilities and shareholders' equity

Current liabilities:

Demand bank loan

$61,600

$65,100

Accounts payable and accruals

319,720

295,793

Income taxes payable

402

638

Current portion of term bank loan

28,000

28,000

409,722

389,531

Term bank loan

658,000

686,000

1,067,722

1,075,531

Share capital

1,000

1,000

Retained earnings

1,461,085

1,207,244

$2,529,807

$2,283,775

Goodlife Co.

Statements of income and retained earnings

For the years ended December 31 (ASPE)

Current year (Draft)

Prior year (Audited)

Sales

$2,791,275

$2,705,030

Cost of sales

1,396,238

1,379,658

Gross profit

1,395,037

1,325,372

Expenses:

Amortization

214,105

249,866

Bad debts

11,060

14,004

Interest and bank charges

83,748

93,488

Professional fees

34,221

5,060

Repairs and maintenance

70,530

20,535

Salaries and wages

527,063

553,040

Selling, general, and administrative

142,242

189,273

Income before taxes

312,068

200,106

Income taxes

58,227

34,088

Net income

253,841

166,018

Retained earnings, opening

1,207,244

1,041,226

Retained earnings, closing

$1,461,085

$1,207,244