This week's 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 year's 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 WheelsSK Wheels, Inc.

(Numbers in thousands)Prior Year

(Audited)Forcast for

FinancingCurrent Year

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