7-49 LO 5, 7 The following information shows the past two periods of results for a fictional...

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7-49 LO 5, 7 The following information shows the past two periods of results for a fictional company, Jones Manufacturing, and a com- parison with industry data for the same period:

ANALYTICAL DATA FOR JONES MANUFACTURING

	Prior Period (000 omitted)	Percent of Sales	Current Period (000 omitted)	Percent of Sales	Percent Change	Industry Average as a Percent of Sales
Sales	$10,000	100	$11,000	100	10	100
Inventory	$2,000	20	$3,250	29.5	57.5	22.5
Cost of goods sold	$6,000	60	$6,050	55	0.83	59.5
Accounts payable	$1,200	12	$1,980	18	65	14.5
Sales commissions	$500	5	$550	5	10	Not available
Inventory turnover	6.3	—	4.2	—	(33)	5.85
Average number of days to collect	39	—	48	—	23	36
Employee turnover	5%	—	8%	—	60	4
Return on investment	14%	—	14.3%	—		13.8
Debt/Equity	35%	—	60%	—	71	30

a. From the preceding data, identify potential risk areas and explain why they represent potential risk. Briefly indicate how the risk analysis should affect the planning of the audit engagement.

b. Identify any of the above data that should cause the auditor to increase the level of professional skepticism.

David · Accepted Answer

Answer a 
The Potential risk areas and its impact on the audit engagement for Jones Manufacturing are 
as follows: 
 The company in the current year has increased its inventory holding levels by 57% as 
compared to previous year. On the other hand, the corresponding increase in sales is 
just 10%. The company has relatively blocked more cash in inventory than required 
being the increase in sales is relatively minimal. 
The auditors in this case is required to extend their audit procedures for inventory and 
check the cut off dates at year end to ensure the completeness of inventory levels. 
 The debt equity ratio for the company in the current year has crossed 60% which is 
relatively on a higher side. For the industry the ratio stands close to 30%. This shows 
the company is more dependent on debt sources for financing its operational 
activities. 
The auditors in this case is likely to ensure that the company meets out all the terms 
and conditions that are required for carrying out the debt.

7-49 LO 5, 7 The following information shows the past two periods of results for a fictional company, Jones Manufacturing, and a com- parison with industry data for the same period: ANALYTICAL DATA...

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