This week's assignment will help you demonstrate the value of the planning process for identifying risks and process selection for audit procedures.

Examine the following case information.

Identify four areas of risk, then

Determine the testing that should occur during the audit.

SK Wheels, Inc. wanted to expand its manufacturing operations and showrooms and needed working capital. The company provided the finance company the previous year's audited financial statements, a set of projections, and the current year's statements (unaudited). The fiscal year-end was December 31. After careful review, the finance company gave SK Wheels, Inc. a loan at 8% interest for $1.75 million on July 1, for working capital. The loan had a due date of December 31 of the next year (18-month term) because SK Wheels planned to finance the loan through a stock offer. Interest payments on the loan were due quarterly.

As part of the pre-engagement process, the auditor conducted interviews with some of SK Wheels key personnel and learned:

The operations expansion and showroom costs were lower than predicted.

The company expanded its return policy to customers, and sales were slow.

SK Wheels' officers wanted to show more income and preserve the $120,000 dividend (paid in the previous year) to impress the finance company.

In the production area, managers met the target of maintaining a 4.0 inventory turnover ratio; However, compared to sales volume, materials/supplies costs went up by 2%. Spreadsheet Provided.

Common-size Statement for SK Wheels:

Table 1. Common-size statement for SK Wheels

SK Wheels, Inc.

(Numbers in thousands)

Prior Year

(Audited)

Forcast for

Financing

Current Year

(Unaudited)

Revenue and Expense

Sales (net)

$9,000

$9,000

$9,270

Cost of goods sold

$6,296

$6,926

$7,000

Gross margin

$2,704

$2,974

$2,720

General expense

$2,044

$2,000

$2,003

Depreciation

$300

$334

$334

Operating income

$360

$640

$383

Interest expense

$60

$110

$75

Income taxes (40%)

$120

$212

$123

Net income

$180

$318

$185

Assets

Cash

$600

$880

$690

Accounts receivable

$500

$600

$900

Allowance for doubtful accounts

-$40

-$48

-$90

Inventory

$1,500

$1,500

$1,350

Total current assets

$2,560

$2,932

$2,850

Fixed assets

$3,000

$4,700

$4,500

Accumulate ddepreciation

-$1,500

-$1,832

-$1,834

Total Assets

$4,060

$5,798

$5,517

Liabilities and Equity

Accounts payable

$150

$450

$330

Bank loans at 8%

$-

$1,750

$1,750

Accrued interest

$60

$40

$40

Accruals and other

$50

$60

$32

Total current liabilities

$560

$2,300

$2,152

Long-term debt at 10%

$600

$400

$400

Total liabilities

$1,160

$2,700

$2,552

Capital stock

$2,000

$2,000

$2,000

Retained earnings

$900

$1,098

$965

Total liabilities and equity

$4,060

$5,798

$5,517

Table 1. Common-size statement for SK Wheels