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Question 3 (10 marks)
In analysing the financial statements of an entity, the following ratios were calculated:
Current ratio 1.1:1 1.3:1
Quick ratio 0.5:1 0.7:1
Receivables turnover 30 days 45 days
Inventory turnover 3 times 4 times
Profit margin 10% 7%
What conclusion(s) can be made about the entity based on the above ratios?
Cash Vs Profit
Question 1 (10 marks)
Rachel Green, the owner-manager of a small business, had carefully monitored her cash position over the past
financial year, and was pleased to note at the end of the year that the cash position was strong and had shown
a healthy 50% increase over the year. When presented with the income statement for the year, she was
dismayed to note that the profit earned in the last year had deteriorated significantly and had become a loss for
the current financial year. In her anger, she accuses you of having made errors in the accounting records since
“such a silly situation could not possible exist”.
Draft a response to Rachel.
Part 3 (20 marks)
ASA 500 mentions that the auditor should obtain sufficient appropriate audit evidence.
Explain what is meant by sufficient appropriate audit evidence. Discuss what you understand by reliability of audit evidence and how the reliability of audit evidence may be influenced.
Part 2 (60 marks)
You are the audit senior on the audit of 21st Century Accessories Pty Ltd, a large distributor of technology accessories, whose main market lies in the 18-24 age group.
This is the first year your audit firm has performed the audit. As part of the planning work, you have performed analytical procedures on an annualised basis and compared the results to industry averages and lasts year’s audited financial information. The results are given below:
Industry Average 21st Century Accessories Pty Ltd
Ratio 2014 2013 2014 2013
1. Current ratio 2.84 3.27 1.89 2.24
2. Accounts Receivables turnover 4.9 4.6 6.3 7.0
3. Inventory turnover ratio 3.7 3.8 5.0 5.5
4. Return on assets 7% 5% 13% 11%
5. Profit margin 0.06 0.06 0.04 0.04
6. Gross profit per cent 20% 26% 20% 18%
Based on the information given:
(i) explain the general meaning of each of the above ratios;
(ii) discuss the conclusions that you can draw about 21st Century Accessories Pty Ltd financial position; and
(iii) identify potential audit risks to be investigated further.
Part 1 (20 marks)
According to ASA 520 analytical procedures are defined as follow:
…the term means evaluations of financial information through analysis of plausible relationships among both financial and non-financial data…
Identify and explain the most important reasons for performing analytical procedures.
Profit & Loss Statement and Balance Sheet
a) Profit and Loss Statement and Balance sheet are the two key components of the financial statements. Compare and contrast these two components and critically discuss why all public limited companies should ensure that these two components are prepared at least annually?
Accounting Standards and IFRS
b) Why accounting standards are needed? Critically discuss what is IFRS and its development in U.K.
Situation E: BlackBurn Company purchased the following on January 1, 2012:
• Office Equipment at a cost of $100,000 with an estimated useful life to the company of five years and a residual value of $10,000. The company uses the double-declining-balance method of depreciation for the equipment.
• Factory equipment at an invoice price of $780,000 plus shipping costs of $20,000. The equipment has an estimated useful life of 100,000 hours and no residual value. The company uses the units-of-production method of depreciation for the equipment.
• A patent at a cost of $450,000 with an estimated useful life of 15 years. The company uses the straight-line method of amortization for intangible assets with no residual value.
Use the information above to complete the following:
1 Prepare a partial depreciation schedule for 2012, 2013, and 2014 for the following assets. Round your answers to the nearest dollar.
a Office equipment.
b Factory equipment. The company used the equipment for 8,000 hours in 2012; 9,000 hours in 2013; and 8,500 hours in 2014.
2 On January 1, 2014, BlackBurn altered its corporate strategy dramatically. The company sold the factory equipment for $700,000 in cash. Record the entry related to the sale of the factory equipment.
3 On January 1, 2014, when the company changed its corporate strategy, its patent had estimated future cash flows of $300,000 and a fair value of $250,000. What would the company report on the income statement (account and amount) regarding the patent on January 2, 2014? Explain your answer. Hint: You may need to research this question using Internet sources.
Bad Debt calculation
Situation C: At the end of 2012, the unadjusted trial balance of Donovan, Inc. included $6,000,000 in accounts receivable, a credit balance of $50,000 in the allowance for doubtful accounts, and sales revenue (all on credit) of $200,000,000. Based on knowledge that the current economy is in distress, Donovan increased its bad debt rate estimate to 0.4 percent on credit sales. Use this information to answer the following:
1 What amount of bad debt expense should be recorded for 2012?
2 What amount will be reported on the 2012 balance sheet for the net realizable amount of accounts receivable, after being reduced by the balance in the allowance for uncollectible accounts?
Situation B: The Israel Manners Entertainment Group uses the allowance approach to estimate bad debt expense, as is required of all companies with significant sales on accounts receivable. At the end of 2012, the Manners Group reported a balance in accounts receivable of $4,350,000 and estimated that $44,000 of its accounts receivable would likely be uncollectible. The allowance for doubtful accounts has a $1,500 debit balance at year-end, prior to the adjustment needed to raise it to the $44,000 desired amount. Use this information to answer the following questions:
1 How is it possible that the allowance for doubtful accounts has developed a debit balance instead of a credit balance?
2 What amount of bad debt expense should be recorded for 2012?
What amount will be reported on the 2012 balance sheet as the net realizable amount of accounts receivable?
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