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 these:

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 percentage 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 5 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. Purchases of equipment occurred relatively evenly throughout the year.
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 12 percent. The average outstanding balance of the line of credit is $3,100,000. This line of credit is the company’s only interest-bearing debt.
6. Based on her discussions with management the advertising and sales commission percentages are expected to stay the same. Based on 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	11,100	12,600	14,100
Cost of goods sold	7,660	8,700	9,760
Gross profit	3,440	3,900	4,340
Sales commissions	780	880	990
Advertising	222	250	280
Salaries	1,101	1,130	1,159
Payroll taxes	192	204	216
Employee benefits	175	186	197
Rent	68	72	76
Depreciation	68	72	76
Supplies	34	38	42
Utilities	29	33	37
Legal and accounting	42	46	50
Miscellaneous	20	24	28
Interest expense	306	324	336
Net income before taxes	403	641	853
Income taxes	91	144	192
Net income	312	497	661

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.)

c. Uden’s unaudited financial statements for the current year show a 30.78 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. (Enter your answers in thousands.)

Expected misstatement=

Answer 1

As per the given information the expected income statement for 2014
b.	2014 Expected
	$ Thousands
Sales	15600
Cost of goods sold	11110.3044
	4489.6956
Sales commission	1092
Advertising	308.88
Salaries	1188
Payroll taxes	228
Employee benefits	208
Rent	80
Depreciation	83.6
Supplies	46
Utilities	41
Legal and accounting	54
Miscellaneous	32
Interest expense	372
Net income before taxes	756.2156
Income taxes	132.4042014
Net Income	623.8113986
C. Gross profit ratio is 30.78%	2014 Expected
	$ Thousands
Sales	15600
Cost of goods sold	10798.3044
	4801.6956
Sales commission	1092
Advertising	308.88
Salaries	1188
Payroll taxes	228
Employee benefits	208
Rent	80
Depreciation	83.6
Supplies	46
Utilities	41
Legal and accounting	54
Miscellaneous	32
Interest expense	372
Net income before taxes	1068.2156
Net income before taxes when Gross profit ratio is 28.78%		756.2156
Net income before taxes when Gross profit ratio is 30.78%		1068.216
Misstatement- Increase in Net income before taxes		312
Advertising expenses is 1.98% on sales has taken based on previous years figures
Sales commission expenses 7% on sales has taken based on previous years figures
Income tax rate for 2013 is 22.51, it decreases 5% in 2014 so I have taken 17.51 income tax rate
Other expenses increased fixed amounts irrespective of the sales so I have followed that trend
irrespective of increase/decrese in the sales.