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 $4,800,000. 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.

Answer 1

Comparative income statement
					Adjustment		Profit at 28.82%
	20X1	20X2	20X3	%	Increase/(decrease)%	Amount	20X4
	Audited	Audited	Audited				Expected
Sales	16200	17200	18200			100	19200
cost of goods sold	11180	11880	12590				13666
Gross profit	5020	5320	5610	30.82%	2%		5534
Sales commission	1130	1200	1270	6.98%			1340
Advertising	324	340	360	1.98%			380
salaries	1186	1232	1278				1324
payroll taxes	209	227	245				263
employee benefits	192	199	206				213
rent	85	86	87				88
depreciation	85	86	87		5%	4.35	91.35
supplies	51	52	53				54
utilities	46	47	48				49
legal and accounting	59	60	61				62
miscellaneous	37	38	39				40
interest expense	510	528	540				576
Net income before taxes	1106	1225	1336				1054
income taxes	249	276	301				184
Net income	857	949	1035				869

Increase in sales trend
	=(20X3 sales-20X2 sales)
	=(18200-17200)
	1000
	=(20X2 sales-20X1 sales)
	=(17200-16200)
	1000
Sales for 20X4	=20X3+1000
	=18200+1000
	19200
Profit %	20X3
	=Gross margin/Sales
	=5610/18200
	0.308242
20X4 profit %	=20X3 gross margin-2%
	=30.8242-2
	28.8242
Gross profit	=19200*28.8242%
	5534
Cost of Goods sold	=Sales-gross margin
	=19200-5534
	13666
Tax rate 20X3	=income taxes/net income before taxes
	=301/1336
	22.5%
Tax 20X4	= tax 20X3-5%
	=22.5-5
	17.5
Depreication on equipment will increase on purchase of asset
if purchases are made even throughout the year
Depreciation increase	=average increase in purchase of assets
	=increase in purchase of assets/2
	=10%/2
	=5%
Interest expense	=outstanding balance * effective interest rate
	=4800*12%
	576
% of advertising and sales comission
	=advertising/sales
	=360/18200
	0.01978
For 20X4	=19200*0.01978
	379.776
	=380
	=Sales comission/sales
	=1270/18200
	0.06978
For 20X4	=19200*0.06978
	1339.776
	=1340

Other expenses trend
	20X1	20X2	20X3	20X4
salaries	1186	1232	1278	1324
Increase trend		46	46	=1278+46
payroll taxes	209	227	245	263
Increase trend		18	18	=245+18
employee benefits	192	199	206	213
Increase trend		7	7	=206+7
rent	85	86	87	88
Increase trend		1	1	=87+1
supplies	51	52	53	54
Increase trend		1	1	=53+1
utilities	46	47	48	49
Increase trend		1	1	=48+1
legal and accounting	59	60	61	62
Increase trend		1	1	=61+1
miscellaneous	37	38	39	40
Increase trend		1	1	=39+1

c.

Uden Supply company
Comparative income statement
			Adjustment		Profit at 28.82%		Profit at 30.82%
	20X3	%	Increase/(decrease)%	Amount	20X4
	Audited				Expected
Sales	18200			100	19200		19200
cost of goods sold	12590				13666		13282
Gross profit	5610	30.82%	2%		5534	0.288242	5918
Sales commission	1270	6.98%			1340		1340
Advertising	360	1.98%			380		380
salaries	1278				1324		1324
payroll taxes	245				263		263
employee benefits	206				213		213
rent	87				88		88
depreciation	87		5%	4.35	91.35		91.35
supplies	53				54		54
utilities	48				49		49
legal and accounting	61				62		62
miscellaneous	39				40		40
interest expense	540				576		576
Net income before taxes	1336				1054		1438
income taxes	301				184		252
Net income	1035				869	0	1186

Net income before taxes increase by 384 thousand

=(1438-1054)=384 if there is a mis-statement in estimate