Question

Complete all the fields on Work Paper 5-3 below. Additionally, EarthWear Common-Size Financial Statements have been included to aid you in your decisions. Work Paper 5-3 EARTHWEAR CLOTHIERS Identification of Accounts with Unexpected Fluctuations December 31, 2016

1. Establish Threshold for Unexpected Fluctuations To begin identifying accounts with unexpected fluctuations auditors must establish a threshold for account difference. All accounts whose actual 2016 unaudited account balance differs from the expected balance by a value greater than the threshold established will be shown in the charts below. As a general rule the threshold should not exceed materiality. For the purposes of this exercise we assume planning materiality is $3.1 million. Enter this value in the field below as 3,100. (Omit the "$" sign in your response.)

A. Set threshold for account difference in thousands $ 3100

2. Evaluate Threshold for Unexpected Fluctuations Lists of Balance Sheet and Income Statement accounts have been generated below based on your threshold for account difference. In the "Evaluation" column please identify 1 or 2 balance sheet and 1 or 2 income statement accounts where you believe the difference presents increased risk of material misstatement that may require a change in the nature, timing or extent of planned audit procedures. Please indicate possible reasons for the difference, potential risks, and suggested audit plan revisions.

A. Balance Sheet Accounts Account Difference from Expectations Evaluation

Cash and cash equivalents $31,071

Receivables, net ($5,568)

Inventory $8,444

Other prepaid expenses ($3,414)

Computer hardware and software ($7,107)

Lines of credit ($3,892)

Accounts payable ($22,401)

Accrued liabilities $5,456

Income taxes payable $5,711

Deferred income taxes ($4,666)

Additional paid-in capital $3,550

Accumulated other comprehensive income ($3,855)

Treasury stock, 6,654, 7,114, and 6,546 shares at cost, respectively $23,926

B. Income Statement Accounts Account Difference from Expectations Evaluation

Net Sales ($23,193)

Cost of sales ($47,893)

Selling, general and administrative expenses ($18,851)

Income tax provision $10,864

Answer 1

Balance Sheet -

Increase in Cash and Cash equivalent -

The amount of 31,071 looks quite substantial which should be investigated further. This increase can be on account of sales Computer H/w and S/w worth 7107, collection from debtor 5568, increase in paid in capital 3550. However there is substantial decrease in Payables of 22401, line of credit of 3892 which has means there has been payment made to them. Hence proper audit needs to be done to find out the reasons for increase in Cash balance.   

Income Statement -

Cost of Sales - Decrease in Cost of sales is more than decrease in Sales. The reasons for the same needs to be checked. There is an increased risk of material mistatement like understatment of the expenses. The company inorder to minimise the impact of reduced sales on profitability has reduced its expenses even more. Auditor has to investigate this difference in cost of expense, whether there is some irregularity or is there a genuine business reason like fall in price of raw material.