Problem 3 - Preliminary Planning & Investigation (18 marks)

Your comparison of the gross margin percent for Just In Time Drugs for the years 2023 through 2026 indicates a significant decline. This is shown by the following information:

	2026	2025	2024	2023
Sales (thousands)	$14,211	$12,916	$11,462	$10,351
COGS (thousands)	9,223	8,266	7,313	6,573
Gross Margin	$4,988	$4,650	$4,149	$3,778
Percent	35.1	36.0	36.2	36.5

A discussion with Morgana, the controller, brings to light two possible explanations. She informs you that the industry gross profit percent in the retail drug industry declined fairly steadily for three years, which accounts for part of the decline. A second factor was the declining percent of the total volume resulting from the pharmacy part of the business. The pharmacy sales represent the most profitable portion of the business, yet the competition from discount drugstores prevents it from expanding as fast as the non-drug items such as magazines, candy, and many other items sold. Morgana feels strongly that these two factors are the cause of the decline.

The following additional information is obtained from independent sources and the client's records as a means of investigating the controller's explanations:

Just In Time Drugs ($ in thousands)
	Drug Sales	Nondrug Sales	Drug COGS	Nondrug COGS	Industry Gross Profit % for Retailers of Drugs and Related Products
2026	$5,126	$9,085	$3,045	$6,178	32.7
2025	5,051	7,865	2,919	5,347	32.9
2024	4,821	6,641	2,791	4,522	33.0
2023	4,619	5,732	2,665	3,908	33.2

Required

Evaluate the explanation provided by Morgana. Show calculations to support your conclusions.

Which specific aspects of the client's financial statements require intensive investigation in this audit?