Ch5 Mini Case Analytics
Ch5 Mini Case Analytics
5
EarthWear Hands-on Mini-case
Chapter 5 - Preliminary Analytical Procedures
© The McGraw-Hill Companies, Inc., 2014
In this mini-case you will complete the preliminary analytical procedures for the audit of EarthWear
Clothiers, Inc.
INSTRUCTIONS:
Review the ratio analyses contained on Work Paper 5-1. You can read the Advanced Module: Selected
Financial Ratios in Chapter 5 of the text for a description of these ratios.You will be asked to provide
further analyses of these ratios as you complete Work Paper 5-2.
Fields you are to complete on work papers are colored yellow. The color will disappear when the field is completed.
Complete all the fields on Work Paper 5-3 indicated in yellow. Additionally, EarthWear Common-Size
Financial Statements have been included to aid you in your decisions.
Fields you are to complete on work papers are colored yellow. The color will disappear when the field is completed.
When completed with the work papers, enter your initials in the yellow box in the upper right-hand
corner of Work Paper 5-2 and 5-3 (box indicates "Initial Here").
Please print hard copies of work papers 5-2 and 5-3 to submit unless your instructor requests an
electronic submission. The work papers are each formatted to fit on one page.
EARTHWEAR CLOTHIERS 5-1
Ratio Analyses SAA
December 31, 2014 1/3/2015
December 31
2010 2011 2012 2013 2014 2014 Difference Industry
Actual from Difference
(Audited) (Audited) (Audited) (Audited) Expected* Average
(unaudited) Expected (from 2014)
SHORT-TERM LIQUIDITY RATIOS:
Current Ratio 1.64 1.43 1.92 1.80 1.94 2.17 0.23 2.10 0.07
current assets / current liabilities
Quick Ratio 0.39 0.44 0.62 0.53 0.65 0.73 0.08 0.80 -0.07
liquid assets / current liabilities
Operating Cash Flow Ratio 0.69 0.42 0.81 0.34 0.40 0.40 0.00 N/A N/A
cash flow from operations / current liabilities
ACTIVITY RATIOS:
Receivables Turnover 71.18 77.25 74.34 73.82 75.41 118.00 42.60 N/A N/A
net sales / net ending receivables
Days Outstanding in Accounts Receivable 5.13 4.73 4.91 4.94 4.84 3.09 -1.74 14.10 -11.01
365 days / receivables turnover
Inventory Turnover 3.43 4.27 4.48 4.47 4.99 3.87 -1.12 6.20 -2.33
cost of sales / inventory
Days of Inventory on Hand 106.41 85.51 81.40 81.72 69.22 94.99 25.78 58.70 36.29
365 / (cost of sales / inventory)
COVERAGE RATIOS:
Debt to Equity 0.79 0.88 0.58 0.61 0.51 0.50 -0.01 0.84 -0.34
total liabilities / shareholders' investment
Times Interest Earned 53.88 26.31 26.41 23.92 10.19 50.57 40.38 N/A N/A
(net income + interest expense) / interest expense
* Expected values are obtained by using the forecast function in Excel (using the row of data from 2010 and 2013 to obtain the expected value for 2014).
† Industry Source: Dun & Bradstreet (D&B). The median values of the industry ratios are used for comparison purposes. For ratios not specifically included on D&B, ratios were
calculated from average financial statement data provided.
Class:
EARTHWEAR CLOTHIERS 5-2
Preliminary Analytical Procedures RC
Summary of Ratio Analyses & Assessment of Financial Condition 4/2/2021
December 31, 2014
ACTIVITY RATIOS:
Receivable turnover ratio A high receivable turnover will indicate that the company collects it's dues from its customers quickly. If this ratio is too high compared to the industry, this may indicate that the company does
not offer its clients a long enough credit facility, As a result may be losing sales. A decreasing receivable turnover ratio may indicate that the company is having difficulties collecting cash from customers, and may be a
sign that sales are perhaps overstated. Earthware has a relative high receivable ratio of 118 for the actual but unaudited year of 2014. This could indicate that the company collects its dues from its customers quickly
but doesn't extend the credit terms of credit lines enough to its customers. Which could mean a decrease in sales. Inflating the AR turnover ratio indicated possible revenue recognition fraud. The decrease in the AR
turnover ratio would indicate fictitious receivables an inflating the values of the receivables.
Inventory turnover provides an indication of how efficiently the company’s inventory is utilized by management. A high inventory ratio is an indicator that the company sells its inventory rapidly
COVERAGE RATIOS:
Debt to equity ratio Shows the debt structure of the company in example how much that is financed externally and internally. A high debt to equity ratio shows the company acquired a lot off debt and since payments are
fixed, it can put a constraint in cash. Compared to the industry, for 2014 the ratio was .50 compared to the industry ratio of .84.
Based on your review of work paper 5-1, assess the client's ability to continue as a going concern (to stay in business) by responding to the following questions.
A. Identify ratios and trends, if any, that cause concern about the client's ability to continue as a going concern
Coverage ratios appear to have a high risk of misstatements and can be a concern of a going concern
B. Identify ratios and trends, if any, that indicate a high likelihood that the client will continue successfully as a going concern
Short-term liquidity ratios show are above average for Earthwear, not a concerm
C. Assess the client's financial condition as one of the following (select one from the drop down list in cell B35)
Moderate possibility that the company will NOT successfully continue in business for at least one year and be able to pay its debts as they become due.
Moderate possibility that the company will NOT successfully continue in business for at least one year and be able to pay its debts as they become due.
Inventory $8,444 Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
Other prepaid expenses ($3,414) Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
Computer hardware and software ($7,107) Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
Lines of credit ($3,892) Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
Accounts payable ($22,401) Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
Accrued liabilities $5,456 Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
Income taxes payable $5,711 Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
Deferred income taxes ($4,666) Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
Additional paid-in capital $3,550 Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
Accumulated other comprehensive income ($3,855) Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
Treasury stock, 6,654, 7,114, and 6,546 shares at cost, respectively $23,926 Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
Cost of sales ($47,893) the cost for goods sold represents the outflow of purchase is caused by the sale of inventory in is
the most important expense on the income statement of companies that sell goods instead of
services. This explains why cogs is match against net sales
Selling, general and administrative expenses ($18,851) Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
Income tax provision $10,864 Indicate possible reasons for difference, potential risks, and suggested audit plan revisions here.
EARTHWEAR CLOTHIERS 5-4
Common-size Consolidated Balance Sheet SAA
(In thousands) 1/3/2015
December 31
2014
2012 2013 Expected* Actual Difference
Dollar Value % of Total Dollar Value % of Total Dollar Value % of Total Dollar Value % of Total Dollar Value % of Total
Assets Assets Assets Assets Assets Assets
Current Assets:
Cash and cash equivalents $49,668 16.75% $48,978 14.84% $48,288 13.29% $79,359 20.38% $31,071 7.09%
Receivables, net $11,539 3.89% $12,875 3.90% $14,211 3.91% $8,643 2.22% ($5,568) -1.69%
Inventory $105,425 35.55% $122,337 37.08% $139,249 38.32% $147,693 37.93% $8,444 -0.39%
Prepaid advertising $10,772 3.63% $11,458 3.47% $12,143 3.34% $10,212 2.62% ($1,932) -0.72%
Other prepaid expenses $3,780 1.27% $6,315 1.91% $8,849 2.44% $5,435 1.40% ($3,414) -1.04%
Deferred income tax benefits $6,930 2.34% $7,132 2.16% $7,335 2.02% $10,338 2.65% $3,003 0.64%
Total current assets $188,115 63.44% $209,095 63.37% $230,075 63.31% $261,680 67.20% $31,604 3.88%
Property, plant and equipment, at cost 0.00%
Land and buildings $66,804 22.53% $70,918 21.49% $75,031 20.65% $76,560 19.66% $1,529 -0.99%
Fixtures and equipment $66,876 22.55% $67,513 20.46% $68,150 18.75% $68,632 17.62% $482 -1.13%
Computer hardware and software $47,466 16.01% $64,986 19.70% $82,507 22.70% $75,400 19.36% ($7,107) -3.34%
Leasehold improvements $2,894 0.98% $3,010 0.91% $3,125 0.86% $3,144 0.81% $20 -0.05%
Total property, plant and equipment $184,040 62.07% $206,426 62.56% $228,812 62.97% $223,737 57.45% ($5,076) -5.51%
Less - accumulated depreciation and amortization $76,256 25.72% $85,986 26.06% $95,716 26.34% $97,722 25.09% $2,007 -1.25%
Property, plant and equipment, net $107,784 36.35% $120,440 36.50% $133,097 36.63% $126,014 32.36% ($7,082) -4.27%
Intangibles, net $628 0.21% $423 0.13% $218 0.06% $1,734 0.45% $1,516 0.39%
Total assets $296,527 100.00% $329,959 100.00% $363,390 100.00% $389,428 100.00% $26,038 0.00%
* Expected values are obtained by using the forecast function in Excel (using the row of data from 2012 and 2013 to obtain the expected value for 2014).
* Expected values are obtained by using the forecast function in Excel (using the row of data from 2012 and 2013 to obtain the expected value for 2014).