Question: Horizontal analysis refers to changes of financial
Horizontal analysis refers to changes of financial statement numbers and ratios across two or more years. Vertical analysis refers to financial statement amounts expressed each year as proportions of a base such as sales for the income statement accounts and total assets for the balance-sheet accounts. Exhibit 4.53.1 contains Retail Company’s prior-year (audited) and current-year (unaudited) financial statements, along with amounts and percentages of change from year to year (horizontal analysis) and common-size percentages (vertical analysis). Exhibit 4.53.2 contains selected financial ratios based on these financial statements. Analysis of these data can enable auditors to discern relationships that raise questions about misleading financial statements.
Required:
Study the data in Exhibits 4.53.1 and 4.53.2. Write a memorandum identifying and explaining potential problem areas where misstatements in the current-year financial statements could exist. Additional information about Retail Company is as follows:
The new bank loan, obtained on July 1 of the current year, requires maintenance of a 2:1 current ratio.
Principal of $100,000 plus interest on the 10 percent long-term note obtained several years ago in the original amount of $800,000 is due each January 1.
The company has never paid dividends on its common stock and has no plans for a dividend.
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Prior Year (Audited) Current Year (Unaudited) Change Balance Common Size Balance Common Size Amount Percent Assets: $ 600,000 $ 484,000 $ (116,000) Cash 14.78% 9.69% -19.33% Accounts receivable 500,000 12.32 400,000 8.01 (100,000) 10,000 -20.00 Allowance doubt. accts. (40,000) -0.99 (30,000) -0.60 -25.00 440,000 234,000 Inventory 1,500,000 2,560,000 36.95 1,940,000 38.85 29.33 Total current assets 63.05 2,794,000 55.95 9.14 3,000,000 73.89 -36.95 Fixed assets 4,000,000 80.10 1,000,000 33.33 Accum. depreciation (1,500,000) $4,060,000 (1,800,000) $4,994,000 -36.04 (300,000) $ 934,000 20.00 Total assets 100.00% 100.00% 23.00% Liabilities and equity: Accounts payable $ 450,000 $ 600,000 $ 150,000 11.08% 12.01% 33.33% Bank loans, 11% 0.00 750,000 15.02 750,000 NA Accrued interest 50,000 1.23 40,000 0.80 (10,000) -20.00 Accruals and other 10,000 60,000 560,000 1.48 0.20 (50,000) 840,000 -83.33 Total current liab. 13.79 1,400,000 28.03 150.00 Long-term debt, 10% 500,000 1,060,000 (100,000) -20.00 12.32 400,000 8.01 Total liabilities 26.11 1,800,000 36.04 740,000 69.81 Capital stock Retained earnings 2,000,000 49.26 2,000,000 40.05 1,000,000 24.63 1,194,000 23.91 194,000 19.40 $4,060,000 $4,994,000 100.00% Total liabilities and equity Statement of operations: Sales (net) Cost of goods sold Gross margin General expense 100.00% 934,000 23.00% $ (900,000) (1,031,000) $9,000,000 100.00% $8,100,000 100.00% -10.00% -16.38 6,296,000 2,704,000 69.96 5,265,000 65.00 30.04 2,835,000 35.00 131,000 4.84 2,044,000 22.7 2,005,000 24.75 (39,000) -1.91 300,000 depreciation Operating income Interest expense Income taxes (40%) 3.33 300,000 3.70 360,000 4.00 530,000 6.54 170,000 47.22 50,000 0.56 40,000 0.49 (10,000) -20.00 124,000 1.38 196,000 2.42 72,000 58.06 Net income $ 186,000 2.07% $ 294,000 3.63% $ 108,000 58.06% Prior Year Current Year Percent (audited) (unaudited) Change Balance-sheet ratios: Current ratio 4.57 2.0 -56.34% Days' sales in receivables 18.40 16.44 -10.63 Doubtful accounts ratio 0.0800 0.0750 -6.25 Days' sales in inventory 85.77 132.65 54.66 Debtlequity ratio Operations ratios: 0.35 0.56 40.89 Receivables turnover 19.57 21.89 11.89 Inventory turnover 4.20 2.71 -35.34 Cost of goods sold/sales Gross margin % Return on equity 69.96% 65.00% -7.08 30.04% 35.00% 16.49 6.61% 9.80% 48.26
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