Perform preliminary analytical procedures using the information provided to help you identify any relatively risky areas that may need further attention during the audit.

Question

What will be an ideal response?

Answer 1

Below is a list of some of the analytical procedures that can be performed with the data given in this case.
Some of the procedures produce results that suggest further attention, while others produce results
that would not be out of line with expectations. Some additional analytical procedures highlighting the
problems seeded in the case are included in the answer to question #2.
? Average Days Sales in Receivables – This ratio increased 16% from 2017 to 2018 while sales
increased only 4% during the same time period. The auditor would want to find out why the ratio
increased—whether it was due to a change in collection policies or patterns or possibly to inflated
sales.
? Percentage Change in Cost of Goods Sold – The cost of goods sold account increased 3% from the
previous year compared to an increase in sales of 4%.
? Percentage Change in Inventories – The dollar value of the plastics inventory increased 23% over
the previous year, while copper inventory increased 59%, and finished goods inventory increased
41%. These large increases in inventory would necessitate further attention.
? Inventory as a Percent of Sales – In 2017 inventory was 37% of sales and in 2018 it jumped to 53%
of sales. This large difference in inventory as a percentage of sales would clearly necessitate further
audit attention.
? Percentage Change in Accounts Payable – accounts payable increased 6% from the previous year.
This is a relatively small change given the percentage change in inventory. This change in conjunction
with the change in inventory should alert the auditor to investigate further the balances in the
inventory accounts.
? Expected Value of Copper Rod Inventory – Multiplying the inventory quantity on hand by the
market price for copper rod inventory yields an expected amount of $2,640,000. This estimated
amount is greater than the reported account balance of $2,625,000, and thus appears to be
consistent with inventory being carried at the lower of cost or market.
? Expected Value of Plastic Inventory – Multiplying the inventory quantity on hand for plastic
inventory by the market price yields an expected value of $120,000. This estimated amount is
significantly less than the reported account balance of $224,500 and thus does not appear to be
consistent with inventory being carried at the lower of cost or market. This variance should alert
the auditor of an area needing further attention.
? Average Square Feet of Warehouse Space Used by Copper Rod Inventory – Copper rod is the only
inventory for which the auditor can calculate the average space occupied. This calculation shows
that the inventory on hand would be about 3,667 pallets. With each pallet occupying 36 square
feet, the total amount of warehouse space occupied by the copper rod inventory would be 132,012
square feet. This amount is greater than the 125,000 square feet of warehouse space allocated to
inventory, without even considering the other types of items held in inventory. This non-financial
measure is an indicator of possible problems that the auditor would want to follow-up on.
All of the above analytical procedures relate to both the Existence/Occurrence and Valuation
management assertions. With the Existence/Occurrence assertions, the auditor is concerned with
whether or not the transactions and items included in the account balances are valid and actually exist.
The Valuation assertion is concerned with the proper valuation being placed on individual inventory,
accounts receivable, and accounts payable accounts.