This case study is presented in seven parts. Each part deals largely with the ma
ID: 2488300 • Letter: T
Question
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, Chapter 8.
• Part II—Understand factors influencing risks and the relationship of risks to audit evidence, Chapter 9.
• Part III—Understand internal control and assess control risk for the acquisition and payment cycle, Chapter 10.
• Part IV—Conduct fraud brainstorming and assess fraud risks, Chapter 11.
• Part V—Design tests of controls and substantive tests of transactions, Chapter 14.
• Part VI—Determine sample sizes using audit sampling and evaluate results, Chapter 15.
• Part VII—Design, perform, and evaluate results for tests of details of balances, Chapter 16.
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, 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.
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
e. 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 d.
f. Explain whether you believe the information in requirement d or e provides the most useful data for evaluating the potential for misstatements. Explain why.
FIGURE 8-9 Pinnacle Manufacturing Financial Statements
g. Analyze the account balances for accounts receivable, inventory, and short/current long-term debt. Describe any observations about those accounts and discuss additional information you want to consider during the current year audit.
h. Based on your calculations, assess the likelihood (high, medium, or low) that Pinnacle is likely to fail financially in the next 12 months.
Account Balance
% Change 2010 –2011
% Change 2009–2010
Net sales
Explanation / Answer
Ans:
Account balance
% changes of 2010-11
%changes of 2009-10
Net sales
1.45%
2.70%
Cash and cash equivalent
5.41%
-9.19%
Net receivables
50.30%
8.61%
Inventory
26.23%
1.05%
Account payable
37.09%
24.71%
Total shareholders’ equity
2.04%
1.78%
Ratio
2011
2010
2009
Current ratio
1.75
7.93
2.19
Quick ratio
0.72
0.79
0.9
Time Interest Earned
1.96
1.83
2.28
Cash ratio
0.26
0.34
0.43
Inventory Turnover
0.29
0.24
0.25
(F)
I think that using the common – size income statement provides useful data for evaluating potential for misstatements because common-size income statement display all items as percent of common base, such as sales which is very helpful in identifying if there are any decrease/increase on each accounts. Common-size income statements also allow us to compare each division over a different time periods, allow us to see the trends and provide insight on how each division is doing.
(G) Pinnacle Manufacturing company
2011
2010
2009
Net Receivables
$13,042,165
$ 86,19,857.00
$ 79,36,409.00
Net sales
$ 1507,37,628.00
$ 1485,86,037.00
$ 1446,86,413.00
% of sales
8.65%
5.80%
5.49%
Inventory
$ 322,36,021.00
$ 255,37,198.00
$ 252,71,503.00
Net sales
$ 1507,37,628.00
$ 1485,86,037.00
$ 1446,86,413.00
% of sales
21.39%
17.19%
17
Short / current debt
$ 153,75,819.00
$ 102,98,668.00
$ 96,72,670.00
cash and cash equivalents
$ 77,21,279.00
$ 73,24,846.00
$ 80,66,545.00
Account Receivable showed a high increased of receivable from 2010 to 2011. The percent of sales went up by 2.85% from 2010.This is bad for the company because the higher the percent of sales in account receivable the higher the chance that this percentage amount will be uncollectible.
Account balance
% changes of 2010-11
%changes of 2009-10
Net sales
1.45%
2.70%
Cash and cash equivalent
5.41%
-9.19%
Net receivables
50.30%
8.61%
Inventory
26.23%
1.05%
Account payable
37.09%
24.71%
Total shareholders’ equity
2.04%
1.78%
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