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 12 percent. The average outstanding balance of the line of credit is $3,200,000. 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	$ 9,900	$ 10,900	$ 11,900
Cost of goods sold	6,435	7,630	8,449
Gross profit	3,465	3,270	3,451
Sales commissions	790	436	476
Advertising	265	218	238
Salaries	1,151	1,184	1,217
Payroll taxes	220	227	234
Employee benefits	221	227	233
Rent	96	97	98
Depreciation	114	117	120
Supplies	62	64	66
Utilities	57	58	59
Legal and accounting	88	91	94
Miscellaneous	30	31	32
Interest expense	300	318	330
Net income before taxes	71	202	254
Income taxes	16	44	55
Net income	$ 55	$ 158	$ 199

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

COMPANYComparative 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

     

c.

Uden’s unaudited financial statements for the current year show a 32 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. (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.)

expected misstatement:

Answer 1

UDEN SUPPLY COMPANY
Comparative Income Statements
Years Ended December 20X1, 20X2, and 20X3
(Thousands)					Expected
	20X1 Audited	20X2 Audited	20X3 Audited	Trends	20X4
Sales	$9,900.00	$10,900.00	$11,900.00	$1,000.	$12,900.
Cost of goods sold	6,435	7,630	8,449	70.00%	$9,030.
Gross profit	3,465	3,270	3,451	29.00%	$3,870.
Sales commissions	790	436	476	4.00%	$516.
Advertising	265	218	238	2.00%	$258.
Salaries	1,151	1,184	1,217	$33.	$1,250.
Payroll taxes	220	227	234	$7.	$241.
Employee benefits	221	227	233	$6.	$239.
Rent	96	97	98	$1.	$99.
Depreciation	114	117	120	$3.	$123.
Supplies	62	64	66	$2.	$68.
Utilities	57	58	59	$1.	$60.
Legal and accounting	88	91	94	$3.	$97.
Miscellaneous	30	31	32	$1.	$33.
Interest expense	300	318	330	$12.	$342.
Net income before taxes	71	202	254		$544.
Income taxes	16	44	55	21.65%	$117.8
Net income	$55.00	$158.00	$199.00		$426.2
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
COMPANYComparative Income Statements
Years Ended December 20X4
(Thousands)
Sales	$12,900.
Cost of goods sold =	$9,030.
Gross profit	$3,870.
Sales commissions	$516.
Advertising	$258.
Salaries	$1,250.
Payroll taxes	$241.
Employee benefits	$239.
Rent	$99.
Depreciation	$123.
Supplies	$68.
Utilities	$60.
Legal and accounting	$97.
Miscellaneous	$33.
Interest expense	$342.
Total Expenses	$3,326.
Net income before taxes	$544.
Income taxes	$117.8
Net income	$426.2
c.	Uden’s unaudited financial statements for the current year show a 32 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. (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.)
expected misstatement:
Gross profit 32% of Sales	$4,128.
less: Expected Gross profit	$3,870.
expected misstatement	$258.

A B с D E F 20X1 Audited 9900 6435 3465 790 265 1151 220 221 96 114 62 57 88 30 300 71 16 55 20X2 Audited 10900 7630 3270 436 218 1184 227 227 97 117 64 58 91 31 318 202 44 158 20x3 Audited 11900 8449 3451 476 238 1217 234 233 98 120 66 59 94 32 330 254 55 199 Trends =C17-B17 =C18/C17 =D19/D17 =D20/D17 =D21/D17 =D22-C22 =D23-C23 =D24-C24 =D25-C25 3 =D27-C27 =D28-C28 =D29-C29 =D30-C30 =D31-C31 Expected 2074 =D17+E17 =F17'E 18 =F17-F18 =F17'E20 =F17E21 =D22+E22 =D23+E23 =D24+E24 =D25+E25 =D26+E26 =D27+E27 =D28+E28 =D29+E29 =D30+E30 =D31+E31 =F19-SUM(F20:F31) =F32E33 =F32-F33 =D33/D32 12 UDEN SUPPLY COMPANY 13 Comparative Income Statements 14 Years Ended December 20X1, 20X2, and 20X3 15 (Thousands) 16 17 Sales 18 Cost of goods sold 19 Gross profit 20 Sales commissions 21 Advertising 22 Salaries 23 Payroll taxes 24 Employee benefits 25 Rent 26 Depreciation 27 Supplies 28 Utilities 29 Legal and accounting 30 Miscellaneous 31 Interest expense 32 Net income before taxes 33 Income taxes 34 Net income 35 36 37 Required: 38 b. 39 UDEN SUPPLY 40 COMPANY Comparative Income Statements 41 Years Ended December 20X4 42 (Thousands) 43 Sales 44 Cost of goods sold = 45 Gross profit 46 Sales commissions 47 Advertising 48 Salaries 49 Payroll taxes 50 Employee benefits 51 Rent 52 Depreciation 53 Supplies 54 Utilities 55 Legal and accounting 56 Miscellaneous 57 Interest expense 58 Total Expenses 59 Net income before taxes 60 Income taxes 61 Net income 62 Determine the expected am =F17 =F18 =B43-B44 =F20 =F21 =F22 =F23 =F24 =F25 =F26 =F27 =F28 =F29 =F30 =F31 =SUM(B46:B57) =B45-B58 =F33 =B59-B60 63 c. Uden's unaudited financial 64 expected misstatement: 65 Gross profit 32% of Sales 66 less: Expected Gross profit 67 expected misstatement =B43'0.32 =B45 =B65-B66