Question

Marilyn Terrill is the senior auditor for the audit of Uden Supply Company for the year ended December 31, 20X4. In planning the audit, Marilyn is attempting to develop expectations for planning analytical procedures based on the financial information for prior years and her knowledge of the business and the industry, including:

  

1.	Based on economic conditions, she believes that the increase in sales for the current year should approximate the historical trend.

  

2.	Based on her knowledge of industry trends, she believes that the gross profit for 20X4 should be about 2 percent less than the percentage for 20X3.

3.	Based on her knowledge of regulations, she is aware that the effective tax rate for the company for 20X4 has been reduced by 3 percent from that in 20X3.

4.	Based on a review of the general ledger, she determined that average depreciable assets have increased by 10 percent.

5.	Based on her knowledge of economic conditions, she is aware that the effective interest rate on the company’s line of credit for 20X4 was approximately 13 percent. The average outstanding balance of the line of credit is $2,600,000. This line of credit is the company’s only interest-bearing debt.

6.	Based on her discussions with management and her knowledge of the industry, she believes that the amount of other expenses should be consistent with the trends from prior years.

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

    

UDEN SUPPLY COMPANY
Comparative Income Statements
Years Ended December 20X1, 20X2, and 20X3
(Thousands)
	20X1 Audited	20X2 Audited	20X3 Audited	20X4 Expected
Sales	$ 8,500	$ 9,600	$ 10,700
Cost of goods sold	5,525	6,720	7,597
Gross profit	2,975	2,880	3,103
Sales commissions	670	480	535
Advertising	205	192	214
Salaries	1,091	1,112	1,133
Payroll taxes	196	205	214
Employee benefits	185	193	201
Rent	72	73	74
Depreciation	78	81	84
Supplies	38	40	42
Utilities	33	34	35
Legal and accounting	52	55	58
Miscellaneous	18	19	20
Interest expense	240	258	270
Net income before taxes	97	138	223
Income taxes	22	30	48
Net income	$ 75	$ 108	$ 175

Required:

b.

Determine the expected amounts for 20X4 for each of the income statement items. (Round gross profit ratio and income taxes ratio to nearest four decimal places. Round other ratios to nearest two decimal places. Round all other intermediate computations to the nearest whole value. Enter your answers in thousands.)

UDEN SUPPLY COMPANY Comparative Income Statements Years Ended December 20X4 (Thousands) Sales Cost of goods sold Gross profit Sales commissions Advertising Salaries Payroll taxes Employee benefits Rent Depreciation Supplies Utilities Legal and accounting Miscellaneous Interest expense Net income before taxes Income taxes Net income

Answer 1

Comparative Income statement
	20X2	20X3	Increase / Decrease	20X4
Sales	9600.0000	10700.0000	1100.0000	11800.0000
Cost of goods sold	6720.0000	7597.0000	877.0000	8614.0000	11800 less 3186
Gross profit	2880.0000	3103.0000	223.0000	3186.0000	(2% less than (3103/10700) = 29-2 = 27%
Sales commissions	480.0000	535.0000	55.0000	590.0000
Advertising	192.0000	214.0000	22.0000	236.0000
Salaries	1112.0000	1133.0000	21.0000	1154.0000
Payroll taxes	205.0000	214.0000	9.0000	223.0000
Employee benefits	193.0000	201.0000	8.0000	209.0000
Rent	73.0000	74.0000	1.0000	75.0000
Depreciation	81.0000	84.0000	3.0000	92.4000	If depreciable assets in 20X3 were 100, depreciation expense is 84%. For 20X4, depreciable assets are 110, Implies depreciation expense is 110*84%, i.e. 92.4
Supplies	40.0000	42.0000	2.0000	44.0000
Utilities	34.0000	35.0000	1.0000	36.0000
Legal and accounting	55.0000	58.0000	3.0000	61.0000
Miscellaneous	19.0000	20.0000	1.0000	21.0000
Interest expense	258.0000	270.0000	12.0000	338.0000	2600000*13%
Net income before taxes	138.0000	223.0000	85.0000	106.6000
Income taxes	30.0000	48.0000	18.0000	19.7423	Effective tax rate = (48/223)= 21.52%. Tax rate for 20X4 will be 21.52-3 = 18.52%
Net income	108.0000	175.0000	67.0000	86.8577