This case study is presented in seven parts. Each part deals largely with the material in the chapter to which that part relates. However, the parts are connected in such a way that in completing all seven, you will gain a better understanding of how the parts of the audit are interrelated and integrated by the audit process. The parts of this case appear in the following textbook chapters: 

• Part I—Perform analytical procedures for different phases of the audit, 

• Part II—Understand factors influencing risks and the relationship of risks to audit evidence, 

• Part III—Understand internal control and assess control risk for the acquisition and payment cycle, 

• Part IV—Conduct fraud brainstorming and assess fraud risks, 

• Part V—Design tests of controls and substantive tests of transactions, 

• Part VI—Determine sample sizes using audit sampling and evaluate results, 

• Part VII—Design, perform, and evaluate results for tests of details of balances, 

Background 

Information Your audit firm has recently been engaged as the new auditor for Pinnacle Manufacturing effective for the audit of the financial statements for the year ended December 31, 2011. Pinnacle is a medium-sized corporation, with its headquarters located in Detroit, 245246Michigan. 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. PART 1 The purpose of Part I is to perform preliminary analytical procedures as part of the audit planning process. You have been asked to focus your attention on two purposes of analytical procedures: obtain an understanding about the client’s business and indicate where there is an increased likelihood of misstatements. Required a. Refer to the financial statement data in Figure 8-9 for the current year and prior two years. Analyze the year-to-year change in account balance for at least five financial statement line items. Document the trend analysis in a format similar to the following: Account Balance % Change 2010 –2011 % Change 2009–2010 Net sales b. Calculate at least five common ratios shown on pages 232-233 and document them in a format similar to the following: Ratio 2011 2010 2009 Current ratio c. Based on the analytical procedures calculated in parts a. and b., summarize your observations about Pinnacle’s business, including your assessment of the client’s business risk. d. 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 Please answer C & D

Below is the data

Trend Analysis

Account Balance	% Change 2010 –2011	% Change 2009–2010
Net sales Cost of Goods Sold Gross Profit Operating Expenses Income from Operations	1.45% 2.85% -2.07% -2.51% 1.87%	2.70% 4.18% -0.86% 2.40% -23.10%

b. Common Ratios

Ratio	2011	2010	2009
Cash Ratio 25.39% 34.03% 42.59% Quick Ratio 68.27% 74.07% 84.49% Current Ratio 174.83% 193.36% 218.60% Gross Profit Ratio 27.50% 28.49% 29.51% Profit Margin 2.84% 2.82% 3.77%