Question

Sports Inc., a retailer of high-quality activewear, has been considering a number of different expansion opportunities in recent years. One option is to purchase Goodlife Co., a manufacturer and distributor of sporting good equipment. The company's sole shareholder is Martin. Goodlife Co’s manufacturing facility is in Winnipeg, and it has sales and distribution branches in Mississauga, Alberta, and in Montreal.

Sports Inc. is considering the acquisition to expand into this market. However, before moving any further with this idea, Sports Inc. has requested an audit of Goodlife Co.

Sen and Ken Chartered Professional Accountants (SK) have been engaged to perform the year-end audit. You, CPA, are the audit manager on the Goodlife Co. year-end audit and are meeting with Martin to discuss the results for the year.

Martin has brought the company's draft financial statements to your office.

Martin: It has been a difficult year. Most of our customers are in Alberta and Montreal. This year, we began selling into the South America and Argentina. We attended major trade shows in the South America and Argentina early in the year to promote our company and products. It was the first time we had attended these types of events, and the related travel and advertising costs were over $40,000.

We received a number of orders, and in anticipation of the increased demand, we purchased raw materials. Things were looking great and then there was a financial crisis. Demand for sporting equipment fell dramatically. In order to remain competitive, we had to reduce our selling prices; even so, a number of our customers have gone bankrupt or are having significant difficulty. I have been really busy and have not spent much time following up with customers and reviewing their outstanding balances.

At the same time, the bank imposed a new covenant requiring that the debt-to-equity ratio remain below 1.0. To avoid any staff reductions, the administrative staff agreed to take a week off without pay and forgo raises for the year. In addition, although I received a $75,000 bonus last year, I didn't take a bonus this year. Unfortunately, one of our main pieces of manufacturing equipment unexpectedly broke down during the year, and we incurred close to $30,000 in costs to repair it.

Question:

You are beginning the risk assessment for the upcoming audit of Goodlife Co. Perform a year-over-year comparison of key ratios including accounts receivable turnover, inventory turnover, current ratio, gross profit margin, and debt to equity, and identify accounts that are at a risk of material misstatement and would warrant further investigation during the audit, given the changes in ratios and considering the provided case facts. In addition, include a procedure to address the identified risks.

Goodlife Co. Balance Sheets As at December 31 (ASPE) Current year (Draft) Prior year (Audited) Assets Current assets: Cash $1,140 $16,635 Accounts receivable 377,602 252,477 Inventory 283,906 195,632 Prepaid expenses        26,744        30,611 689,392 495,355 Property, plant, and equipment (net) 1,840,415 1,788,420 $2,529,807 $2,283,775 Liabilities and shareholders' equity Current liabilities: Demand bank loan $61,600 $65,100 Accounts payable and accruals 319,720 295,793 Income taxes payable 402 638 Current portion of term bank loan        28,000        28,000 409,722 389,531 Term bank loan      658,000      686,000 1,067,722 1,075,531 Share capital 1,000 1,000 Retained earnings 1,461,085 1,207,244 $2,529,807 $2,283,775

Goodlife Co. Statements of income and retained earnings For the years ended December 31 (ASPE) Current year (Draft) Prior year (Audited) Sales $2,791,275 $2,705,030 Cost of sales 1,396,238 1,379,658 Gross profit 1,395,037 1,325,372 Expenses: Amortization 214,105 249,866 Bad debts 11,060 14,004 Interest and bank charges 83,748 93,488 Professional fees 34,221 5,060 Repairs and maintenance 70,530 20,535 Salaries and wages 527,063 553,040 Selling, general, and administrative 142,242 189,273 Income before taxes 312,068 200,106 Income taxes        58,227        34,088 Net income 253,841 166,018 Retained earnings, opening 1,207,244 1,041,226 Retained earnings, closing $1,461,085 $1,207,244

Answer 1

Account Recievable turnover Ratio

Net Credit Sales

Average Accounts recievable

Average Account Recievable

252477+377602

315039.5

2

Current Year

Prior Year

Assume sales is net Credit Sales

2791275

2705030

Assume in Prior Year Opening debtor and closing debtor are same

Current Year

Prior Year

Account Recievable turnover Ratio

8.86007945

9.14501

Account Recievable turnover Ratio in Days

365/8.860079

40.85742

39.91248

Inventory Turnover Ratio

Cost of Good Sold

Average Inventory

Assume in Prior Year Opening Inventory and closing Inventory are same

Average Inventory

Beginning Inventory+Ending Inventory

2

Current Year

Prior Year

COGS

1396238

1379658

Average Inventory

195632+283906

239769

2

Inventory Turnover Ratio

5.823263

7.052313

Inventory Turnover Ratio in days

365/5.823263

62.67964

51.75607

Prior Year

Current Year

Current Assets

495355

689392

Current Liablity

389531

658000

Current Ratio

Current Assets

1.27167

1.047708

Current Liability

Sales

2705030

2791275

Gross Profit

1325372

1395037

Gross Profit Margin

Gross Profit

48.99657

49.97848653

Sales

Debt

686000

658000

Share Capital+retaied Earning

1208244

1462085

Debt Equity Ratio

Long term Debt

0.567766

0.450042234

Equity

Risk Identified

1) Unexpected non routne transaction- cost repair & maintainnace increase of $30000 from prior year due to breakdown in equipment

2) Since Company is facing to collecting the amount from Debtors , they are becoming Bankrupt, It would affect the adverse effect of operating result of entity and financil result

3) Term Loan- Bank has changed one convenant resulting entity leades to financial crises or affect the entity for raisiing finance or making payment

4) Company current ratio is decreased from prior audited year due to Bankruptcy of outstanding balance of debtors and cash will become blocked

5) Unusual transaction in Travel and advertising cost increased in current year of $40000 resulting reduction in profit

6) Inventory turnover in days is increase fom prior year which result increase in investment in Inventory

Procedure to be performed

1) Proper Debtor recovery meachanism should be maintained and folowed includes Credit worthiness, Interest charged from debtor if not paid and no teeming and lading in cash received from debotrs

2) Analytical Procedures to be performed include Trend analysis, ratio analysis to identify fluctuation

3) Communicate with management about reason about unusual transaction and properly accounts in books

4) Wriiten confirmation from Bank about change in convenants