indicate the assertion(s) at risk of material misstatement.

Decreasein inventory turnover

1. Inventory turnover has decreased, indicating that inventory is not being sold as quickly as it was in the past. This decrease is likely due to the excess of unused raw materials on hand related to cancelled orders.

Slower turnover increases the risk that inventory is damaged and/or cannot be sold at market prices and may indicate an overstatement of the inventory balance, which has increased by 42% from prior year.

Increasein current ratio

The current ratio has increased over prior year, indicating that the company has more current assets available to settle current liabilities and is therefore more liquid. The increase is mainly due to the large increase in accounts receivable and inventory balances.

However, the quality of these current assets needs to be investigated. As noted in the analysis above, it is possible that the receivables are not collectible, and that inventory is not saleable. Cash has also decreased significantly over the prior year, indicating that there may be liquidity issues.

Decreasein gross profit margin

The gross profit margin has remained relatively stable over prior year, decreasing only slightly.

Since sales have increased by 3% from prior year, this indicates the possibility that sales are understated and/or cost of sales are overstated.

Decreasein debt to equity

The debt to equity ratio has improved over the prior year, indicating a lower percentage of equity has been financed through debt.

This ratio is of particular concern because it may put Smiles offside its new bank covenant, which cannot exceed 1.0. There is a risk that debt has been understated or income overstated to ensure compliance with the new covenant.

Decreasein salaries and wages

Salaries and wages have decreased by 5% and $30,000 from the prior year. Sales have also decreased as a percentage of revenue. The decrease is expected due to the administrative staff taking time off without pay, the owner forgoing her $75,000 bonus and the lack of raises.

However, the total decrease was only $30,000; a larger decrease would be expected, given the prior year bonus was $75,000. Further investigation is required to determine if salary and wage expense is overstated. There could be cut-off errors or payments being made to fictitious employees.

Decreaseinselling, general andadministrative

Selling, general and administrative have decreased by 17% or $34,000 from the prior year and as a

percentage of total sales. The decrease is not expected, given that an additional $40,000 was spent on travel and advertising related to trade shows. There is a risk that selling, general and administrative costs are understated. This could also be linked to an understatement of accounts payable. This is a concern given the new debt to equity covenant ratio, as management may be manipulating results in an effort to remain in compliance with the covenant.

Decreasein depreciation expense

Depreciation expense has decreased by 10% or $24,500 even though property, plant and equipment assets have increased by 3% from prior year. This decrease is not expected given that there has been an increase in the property, plant and equipment balance from the prior year. There is a risk that depreciation expenses are understated. This is a concern given the new debt to equity covenant ratio,

as management may be manipulating results in an effort to remain in compliance with the covenant.