You are a senior auditor assigned to the ABC, Inc. manufacturing audit. This is the first year your firm has conducted the audit for this particular client. In fact, although ABC previously engaged accountants to perform limited review services for the purpose of obtaining bank loans. This is the first year ABC will have a full audit. The company is planning an initial public offering (IPO) of its stock in the next two or three years and has hired your firm to conduct its first financial statement audit in preparation for that IPO. ABC is a medium-sized company that buys Inventory A and Inventory B to make a special product used in creating computer chips. ABC operates out of a single building complex totaling 400,000 square feet, which includes office space (3%), production area (62%), shipping and receiving (15%), and finished goods and raw materials inventory warehousing (20%). ABC supplies its product to the southwestern part of the United States. The company has a good reputation for quality products and has had a good working relationship with its outside accountants over the past 10 years. You have been assigned responsibility for auditing ABCs inventories. You are in the planning stages of the audit, and you are preparing to conduct some analytical procedures to identify areas that may represent heightened risk and that thus may require further attention. Your staff accountant prepared information relating to inventories and other items, including a brief description of ABCs production and inventory areas. Because your assistant is new, he is not very good about weeding out irrelevant information, so you may not need to use every piece of information he has provided. The information is listed below. 2014 2013 Sales $8,550,000 $8,150,000 Cost of goods sold 6,150,000 6,000,000

Finished Goods Inventory ($250 Million Units) 1,554,500 1,058,000

Raw Materials Inventory A (5.5 million lbs.) 2,480,000 1,450,000 Raw Materials Inventory B (1 Million lbs.) 220,000 172,000 Accounts Payable (for inventory) 450,000 415,000 Days Purchases in Accts Payable 25.4 days 27.1days Days Sales in Receivables 59.3 days 47.9days

Market price of Inventory A $ 0.46 per lb. $0.46 per lb.

Market price for Inventory B $ 0.12 per lb. $0.19 per lb. ABCs production area is divided into three areas, with each area specializing in a particular product group, including mainframes, personal computers and special-order products. Production is done in batches according to orders placed with the firm. For each batch, machinery is adjusted and calibrated according to the type and size of product to be manufactured, and the size of the batch depends on the amount of product needed. Average machine setup time from start to finish is approximately four hours, which is slightly better than the industry average. The different types of products ABC manufactures all use similar raw materials, so raw materials inventory is stored in a single location, divided into Inventory A and Inventory B. Finished good units are stored on large crates, with approximately 500,000 units of finished goods per crate. Inventory A is stored in boxes that cannot be stacked. Each box holding Inventory A measures 5 feet by 5 feet, stands 5 feet tall, and holds 1,250 pounds Inventory A. Inventory B is stored in barrels, with approximately 350 lbs. Inventory B per barrel. The raw materials inventory storage area is located near the shipping and receiving area for convenience. Inbound and outbound shipments of inventory are trucked to the nearest rail yard, from which they are distributed around the southwester region of the U.S. A single 18wheeler can carry up to 15 boxes of Inventory A, 40 barrels of Inventory B, or 2,000 cases of finished goods. ABCs production process includes some automation but still requires a relatively large amount of labor. Thus, ABCs conversion costs are fairly evenly divided between direct labor and factory overhead. Overhead consists primarily of the costs of the production facilities a depreciation and maintenance on the machinery. XYZ uses a hybrid product costing system (i.e., a system that combines characteristics of both job-order and process costing systems) to accommodate both the continuous and homogeneous nature of the manufacturing process and the fact that production runs are performed in separately identifiable batches. In accordance with the relatively homogenous nature of ABC's products, overhead is allocated from a single cost pool based on a combination of machine and direct labor hours. As the finished product is completed, it is packaged into large cases with 500 units in each case. These units of finished goods inventory are stored next to the raw materials inventory near the facilitys eight loading and unloading docks. In many cases, the inventory is produced in response to specific customer orders received. The finished units are tagged for shipment to customers according to date requested. Inventory that has been produced to provide a cushion for rush orders is stored toward the far end of the finished goods storage area, away from the shipping area. The inventory and production areas are well organized and seem to flow smoothly. Machines appear to be well maintained. A cursory visual examination of inventories reveals no problems. Two hundred cases in the finished goods area were tagged as being of a type of residential items that are now banned by federal safety guidelines. These cases are clearly marked, and the inventories supervisor indicated they are to be reworked or destroyed within the next week. Procedures and records for tracking materials upon arrival, through the production process, and into finished goods and shipping, appear to be well designed. REQUIRED [1] Perform analytical procedures to help you identify relatively risky areas that indicate the need for further attention during the audit, if any. Justify your procedures and conclusions. [2] Prepare a memo to your Audit Manager that focuses upon the results of your analytical procedures and each of the following balance-related management assertions for the inventory account: existence, completeness, valuation, and rights and obligations. Briefly explain identified risks for the inventory account that require further attention, if any. [3] Discuss in your memo why s/he might adopt a client's judgment frame in performing preliminary analytical procedures, and how might that frame affect her or his evaluation of the findings from the procedures that were performed?