Cherry's Cupcakes (CC), a rapidly expanding, popular chain of cupcake restaurants has been considering a number of different expansion opportunities in the recent years. One option is to purchase Smiles Inc. (Smiles), a manufacturer and distributor of cake decorating accessories who reports under ASPE. The company's sole shareholder is June. Smile's manufacturing facility is in Saskatoon and the company has sales and distribution branches in Ottawa and Brandon, Manitoba.

Before moving forward with the purchase of Smiles, CC has requested an audit of Smiles.

Lemon and Reed CPAs has been engaged to perform the year-end audit. You, CPA, are the audit manager on the Smiles year-end audit, and are meeting with June to discuss the results for the year.

June has brought the company's draft financial statements to your office?

June:

It has been an interesting year for our company. We expanded our sales into the US and Mexico and spent $40,000 on travel and advertising costs to promote our products to new customers. As a result of the advertising push, Smiles received a number of orders which we were all very excited about. Unfortunately, the economy took a downturn and many of the orders were cancelled half way through production. Still other customers went bankrupt or experienced significant financial difficulties. Several of these customers have outstanding receivable balances and I have yet to follow up with them to determine if they can pay.

At the same time, the bank imposed a new covenant requiring that the debt to equity ratio remain below 1.0. In order to avoid any staff reductions, the administrative staff agreed to take a week off without pay and forgo raises for the year. In addition, although I received a $75,000 bonus last year, I didn't take a bonus this year.

 

And one last thing one of our main pieces of manufacturing equipment unexpectedly broke down during the year. We incurred close to $30,000 in costs to repair it.

Required: You are beginning the audit planning for the upcoming audit of Smiles. Using ratio and trend analysis, identify accounts that are at a risk of material misstatement and would warrant further investigation during the audit.

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Current assets: Cash Accounts receivable Inventory Prepaids Total current assets Property, plant and equipment Total assets Liabilities and shareholder's equity Current liabilities: Accounts payable and accruals Income taxes payable Current portion of bank loan. Total current liabilities Bank loan Share capital Retained earnings Total liabilities and shareholder's equity Sales Cost of goods sold Depreciation Interest and bank charges Bad debts Smiles Inc. Balance Sheet As at December 31 Current year 1,140 498,602 276,905 25,744 802,391 1,840,415 2,642,806 339,600 302 27,000 366,902 659,000 1,025,902 500 1,616,404 2,642,806 Prior year 16,435 250,377 195,531 30,610 492,953 231,407 76,802 10,895 1,788,420 2,281,373 217,050 623 27,000 244,673 686,000 930,673 500 1,350,200 2,281,373 Smiles Inc. Income Statement For the year ended December 31 $ 2,867,500 $ 2,783,924 1,348,975 1,251,895 1,518,525 1,532,029 256,092 82,503 13,285 Current assets: Cash Accounts receivable Inventory Prepaids Total current assets Property, plant and equipment Total assets Liabilities and shareholder's equity Current liabilities: Accounts payable and accruals Income taxes payable Current portion of bank loan. Total current liabilities Bank loan Share capital Retained earnings Total liabilities and shareholder's equity Sales Cost of goods sold Depreciation Interest and bank charges Bad debts Smiles Inc. Balance Sheet As at December 31 Current year 1,140 498,602 276,905 25,744 802,391 1,840,415 2,642,806 339,600 302 27,000 366,902 659,000 1,025,902 500 1,616,404 2,642,806 Prior year 16,435 250,377 195,531 30,610 492,953 231,407 76,802 10,895 1,788,420 2,281,373 217,050 623 27,000 244,673 686,000 930,673 500 1,350,200 2,281,373 Smiles Inc. Income Statement For the year ended December 31 $ 2,867,500 $ 2,783,924 1,348,975 1,251,895 1,518,525 1,532,029 256,092 82,503 13,285

Answer rating: 100% (QA)

Here are some accounts that are at a risk of material misstatement and would warrant further investigation during the audit based on the information you provided Accounts receivable The increase in sa... View the full answer