8-21
8–38 (continued)
d. By allocating 75% of the preliminary estimate to accounts
receivable, inventories, and accounts payable, there is far less
materiality to be allocated to all other accounts. Given the total
dollar value of those accounts, this may be a reasonable
It would likely be necessary to audit accounts such as cash
and temporary investments on a 100% basis. That would not be
e. It is necessary for you to be satisfied that the actual estimate of
misstatements is less than the preliminary judgment about
materiality for all of the benchmarks. First you would reevaluate
Case
8–39 This case illustrates the common problem of an audit partner having to
a. Auditing standards incorporate the AICPA statement of quality
control standards governing an audit practice. One of the quality
control standards requires that firms maintain client acceptance
Sarah Beale initiated a communication, but then left it incomplete
8-22
8–39 (continued)
communication occurred.
Can this be remedied? Yes and no. While auditing standards
require communication with the predecessor auditor before accepting
the engagement, a communication with the predecessor auditor
should be conducted now, presumably by Black. However, if alarming
about Beale’s competence and how that affects her performance
on the engagement. Black relied on Beale extensively, yet
Beale’s performance on the new client acceptance was deficient.
Black’s handling of this engagement also implies something
about his attitude and objectivity. This was an initial engagement,
yet he delegated almost all responsibility up to final review to Beale.
b. In the audit of long–term contracts, it is essential to obtain assurance
that the contract is enforceable so that income can be recognized
on the percentage–of–completion basis. It is also important to consider
8-23
8–39 (continued)
unrealistic to assume there is such a thing as a “standard” contract
in the first place. Long–term and short–term contracts are the result of
negotiation and often contain special clauses and changed language.
In this case, not reading the contract was an insufficiency
c. Compliance with auditing standards is a matter that is always
subject to professional judgment. One professional auditor may
conclude he or she has complied with auditing standards, and
in the following ways:
Principles Underlying Auditing Standards note the following: The
auditor must plan the work and supervise any assistants. The
requirements of predecessor and successor auditor communications
Principles Underlying Auditing Standards note the following: The auditor
is responsible for obtaining sufficient appropriate audit evidence
about whether material misstatements exist through designing and
and further evidence is required.
In addition, whenever underlying principles of auditing standards
are not achieved there are implied violations of other standards. It
might be argued that Beale was not proficient as an auditor because
8-24
Integrated Case Application – Pinnacle Manufacturing
P40.xls)
a.
PINNACLE MANUFACTURING―PART I
% Change % Change
Account Balance 2015–2016 2014–2015
Net sales 1.45% 2.70%
Cost of goods sold 2.85% 4.18%
Operating expenses -2.51% 2.40%
b.
Amounts (in thousands)
__________________________
Ratios 2016 2015 2014
Current assets 53,172 41,625 41,406
Current ratio: Current liab. 30,413 21,527 18,942
1.75 1.93 2.19
c. While Pinnacle continues to experience some growth in net sales
in 2016 over 2015, that growth is less than the growth in 2015 over
2014. Unfortunately, cost of goods sold continues to increase at
8-25
8–40 (continued)
Apparently Pinnacle management made changes that have
reduced overall operating expenses given the 2.51% decline in
operating expenses in 2016 over 2015. Those changes resulted in an
While profitable, the review of changes in balance sheet
accounts indicates that receivables are increasing at significant rates
(51.30% in 2016) relative to increases in sales of only 1.45%. This
buildup in receivables may lead to significant collection challenges in
The reduction in the current ratio suggests that liquidity is
decreasing in 2016 relative to prior years. The increase in accounts
to provide cash flow during a time where cash collections from
beyond.
d. See page 8–27 for Pinnacle’s common–size income statement. For
the overall financial statements, the focus is on all accounts except
Estimate of $ Amount
Account Balance of Potential Misstatement
hourly workers or overtime was reduced
in 2016.
8-26
8–40 (continued)
Depreciation expense Increase of almost $700,000, perhaps
partly due to new building and equipment
purchases
45% of 2016 NIBT is $941.9 million.
Actual FIT for 2016 was $883.4 million.
Difference of $585,000
Interest expense Short–term plus long–term interest bearing
debt increased by 22%, from $32.6 million
in 2015 to $39.8 million in 2016, but
best to ignore the allocated expenses.
Estimate of $ Amount
Account Balance of Potential Misstatement
Welburn:
Security Decrease of $70,000 or .36% of sales
relative to .43% in 2015 and 2014.
Solar–Electro:
issues affecting disclosures and asset or
liability valuation.
8-27
8-40 (continued)
(part of requirement d.)
Pinnacle Manufacturing Company
Income Statement – All Divisions
For the Year Ended December 31
2016
Dollar
Value
2016
% of
Sales
2015
Dollar
Value
2015
% of
Sales
2014
Dollar
Value
2014
% of
Sales
Sales
150,918,731
100.00%
148,764,555
100.00%
144,860,245
100.00%
Sales Returns and Allowances
181,103
0.12%
178,518
0.12%
173,832
0.12%
Cost of Sales*
109,284,780
72.41%
106,255,499
71.43%
101,988,165
70.40%
Gross Profit
41,452,848
27.47%
42,330,538
28.45%
42,698,248
29.48%
OPERATING EXPENSES-Allocated
Salaries-Management
2,281,266
1.51%
2,387,993
1.61%
2,295,081
1.58%
Salaries-Office
315,169
0.21%
296,681
0.20%
306,856
0.21%
Licensing and certification fees
190,650
0.13%
172,883
0.12%
162,279
0.11%
Security
550,603
0.36%
637,580
0.43%
630,353
0.44%
Insurance
93,197
0.06%
103,842
0.07%
108,491
0.07%
Medical benefits
23,721
0.02%
29,453
0.02%
28,810
0.02%
Advertising
162,512
0.11%
178,009
0.12%
165,678
0.11%
Business publications
6,989
0.00%
5,555
0.00%
774
0.00%
Property taxes
22,585
0.01%
178,009
0.12%
175,692
0.12%
Bad debts
841,699
0.56%
1,034,060
0.70%
992,094
0.68%
Depreciation expense
5,336,783
3.54%
4,641,982
3.12%
4,367,565
3.02%
Accounting fees
273,956
0.18%
297,777
0.20%
299,789
0.21%
Total operating expenses-Allocated
10,099,130
6.69%
9,963,824
6.70%
9,533,462
6.58%
OPERATING EXPENSES-Direct
Salaries-Sales
14,970,669
9.92%
15,327,777
10.30%
14,904,392
10.29%
Wages Rental
491,794
0.33%
595,389
0.40%
575,725
0.40%
Wages-Mechanics
1,113,539
0.74%
1,339,626
0.90%
1,333,411
0.92%
Wages-Warehouse
4,891,065
3.24%
5,340,271
3.59%
5,473,249
3.78%
Garbage collection
0.02%
0.02%
0.03%
Payroll benefits
2,657,889
1.76%
2,937,730
1.97%
2,894,300
2.00%
Rent- Warehouse
802,855
0.53%
764,346
0.51%
758,345
0.52%
Telephone
32,402
0.02%
45,173
0.03%
57,867
0.04%
Utilities
262,393
0.17%
267,005
0.18%
274,365
0.19%
Postage
89,763
0.06%
133,518
0.09%
151,278
0.10%
Linen service
17,282
0.01%
12,350
0.01%
16,083
0.01%
Repairs and maintenance
166,985
0.11%
168,405
0.11%
178,213
0.12%
Cleaning service
89,800
0.06%
81,589
0.05%
78,088
0.05%
Legal service
396,016
0.26%
190,540
0.13%
152,238
0.11%
Fuel
286,547
0.19%
341,192
0.23%
279,512
0.19%
Travel and entertainment
103,389
0.07%
103,842
0.07%
100,479
0.07%
Pension expense
0.15%
0.16%
0.09%
Office supplies
149,828
0.10%
148,340
0.10%
171,109
0.12%
Miscellaneous
300,188
0.20%
105,931
0.07%
144,012
0.10%
Total operating expenses-Direct
27,078,608
17.94%
28,170,145
18.94%
27,707,646
19.13%
Total Operating Expenses
37,177,738
24.63%
38,133,969
25.63%
37,241,108
25.71%
Operating Income
4,275,110
2.83%
4,196,569
2.82%
5,457,140
3.77%
Other Expense-Interest
2,181,948
1.45%
2,299,217
1.55%
2,397,953
1.66%
Income Before Taxes
2,093,162
1.39%
1,897,352
1.28%
3,059,187
2.11%
Federal Income Taxes
883,437
0.59%
858,941
0.58%
1,341,536
0.93%
Net Income
1,209,725
0.80%
1,038,411
0.70%
1,717,651
1.19%
* Details of manufacturing expenses are not
included in this schedule.