Question

In a 2-3 page paper, complete the case below and submit to instructor. Review the income statement for Uden Supply Company and answer the following:

Describe the purpose of analytical procedures performed in the planning stage of the audit.
Uden Supply has projected its 2004 gross profit at 31% of sales despite expectation for some shrinkage in margins. On the basis of Uden's operating performance in years 2001 - 2003 project your best guess for 2004. Project 2004 based on the incremental changes for each line item over the last three years.
Uden’s unaudited financial statements for the current year show a 31 percent gross profit rate. Assuming that this represents a misstatement from the amount that you developed as an expectation, calculate the estimated effect of this misstatement on net income before taxes for 20X4.
Indicate whether you believe that the difference calculated in part (c) is material. Explain your answer. (50-100 words).
Comparative income statement information for Uden Supply Company is presented in the accompanying table.

UDEN SUPPLY COMPANY

Comparative Income Statement

Years Ended December 20X1, 20X2, and 20X3

(Thousands)

20X1 Audited 20X2 Audited 20X3 Audited 20X4 Expected

Sales 8,700 9,400 10,100

Cost of goods sold 6,000 6,500 7,000

Gross profit    2,700 2,900 3,100

Sales Commissions 610 660 710

Advertising 175 190 202

Salaries 1,061 1,082 1,103

Payroll taxes 184 192 199

Employee benefits 167 174 181

Rent 60 61 62

Depreciation   60 63 66

Supplies   26 28 30

Utilities 21 22 23

Legal and accounting 34 37 40

Miscellaneous 12 13 14

Interest expense 210 228 240

Net income before taxes 80 150 230

Incomes taxes 18 33 50

Net income 62 117 180

Answer 1

A.

Analytical procedures performed at the planning stage are designed to help the auditors identify unusual transactions, events, or amounts that might affect the fairness of the financial statements. They are also used to help the auditors increase their understanding of the clients business.

B.

Comparative income statement information for Uden Supply Company is presented in the accompanying table

C.

$10,800 * .31 = $3,348 gross profit

$3,348 - $3,332 (expected gross profit) = $16 expected misstatement

D.

Many would consider the amount as immaterial as a $16,000 misstatement of a net income before taxes of $343,000 is less that 5% of income. A difference such as this makes clear the difficult task of determining what is actually a material misstatement.

Reference:

Whittington, R.O. & Pany, K. (2012). Principles of auditing & other assurance services.

New York: The McGraw-Hill Companies, Inc.