Question

Rainbow Appliance Company has been in business for 10 years manufacturing and selling various household appliances. Four years ago Rainbow had an R&D breakthrough when the developed a new vacuum cleaner and sales for this product took off! The fiscal year of 2018 and 2019 have experienced the most growth. The company currently holds appox. 25% of the household vacuum market in the U.S.

You have been assigned to the 2019 audit of Rainbow. In 2017, Rainbow executive accomplished a leveraged stock buyout and Rainbow has experienced earners per share growth since, with the unaudited 2019 financial statements reflected an earnings per share of $1.21 (up from the 2017 amount of $0.46), which is more than analysts had projected. Sales and net income have also experienced impressive increases over the same period of time.

It's time to start the risk assessment analytical procedures for audit the 2019 financial statements and start planning the nature, timing, and extent of the needed audit procedures. You will begin by identifying areas that may represent the most risk relevant to this year's audit.

Financial Statements Results Vertical Analysis Horizontal Analysis audited audited unaudited audited audited unaudited audited audited 12/31/2017 12/31/2018 12/31/2019 12/31/2017 12/31/2018 12/31/2019 2017-2018 2018-2019 $ 72% 63 $ 14,402 514 $ 27,801 885 51,076 0% 33% 1% 43% 1% 43% 716% 93% 84% 2,682 491 6,589 9,762 708 18,267 43,202 $ 9,182 18,049 638 4,151 9,757 16,935 19,577 39,135 1,449 3,015 15,900 24,029 65,241 $ 118,140 6% 1% 15% 23% 2% 42% 100% 14% 1% 15% 30% 15% 4% 14% 33% 3% 20% 100% 242% 30% 48% 101% 105% -13% 51% 97% 551% 74% 100% 108% 51% 81% 2% $ 24% 100% 23% 11% ASSETS Cash Accounts Receivable Inventory Raw Material Work In Process Finished Goods Total Inventory Other current assets Net fixed assets Total Assets LIABILITY AND EQUITY Accounts Payable Accrued Liabilities Current portion of L/T debt Income taxes payable Total current liabilities Bank debt Deferred income taxes Total liabilities Common Stock Retained earnings Total liabilities and equity Rainbow Appliance Company Income Statement (in thousands) 8% 7,344 $ 3,127 2,707 1,554 14,732 14,800 3% 15,072 $ 13,288 5,468 4,710 900 1,250 2,619 3,782 24,059 23,030 19,841 62,057 1,254 1,881 45,154 86,968 7,775 7,903 12,312 23,269 65,241 $ 118,140 17% 7% 6% 4% 34% 34% 2% 70% 18% 12% 100% 1% 4% 37% 30% 2% 69% 12% 19% 100% 105% 75% -67% 69% 63% 34% 83% 49% 0% 136% 51% 19% 53% 2% 74% 685 -12% -14% 39% 44% -4% 213% 50% 93% 2% 89% 81% 7% 30,217 7,775 5,210 43,202 $ $ 20% 100% 1% -50% 55% Financial Statements Results Vertical Analysis Horizontal Analysis audited audited unaudited audited audited unaudited audited audited 12/31/2017 12/31/2018 12/31/2019 12/31/2017 12/31/2018 12/31/2019 12/31/2017 12/31/2018 $ 78,428 $ 133,504 $ 183,767 43% 104% 101% 70% 38% 2,284 5,270 2,644 1% 4% 131% 76,144 128,234 181,123 100% 100% 100% 68% 41% 46,213 70,756 94,934 61% 52% 53% 34% 29,931 57,478 86,189 39% 45% 48% 92% 50% 20,105 42,600 64,285 26% 35% 112% 51% 9,826 14,878 21,904 13% 12% 12% 51% 47% 1,930 1,584 3,189 3% 1% -18% 101% 7,896 13,294 18,715 10% 10% 10% 68% 41% 3,807 6,189 7 ,761 25% 4,089 $ 7,105 $ 10,954 74% 54% 0.46 0.78 1.21 33% Gross Sales Less: Returns and Allowances Net Sales COGS Gross Margin Selling, Adv., and R&D expenses Income from Operations Interest Expense Income Before Taxes Income Taxes Net Income Earning Per Share Ratios Current Quick Receivables Turnover Days' Sales in Receivables 2% 5% 63% 1.7 1.0 2.1 1.2 6.3 57.1 4.1 2.3 4.7 76.6 5,3 68.1

Answer 1

SOLUTION

areas that may represent the most risk relevant to this year's audit are as follows

Current Assets

The quick ratio is a measure of how well a company can meet its short-term financial liabilities. Also known as the acid-test ratio, it can be calculated as follows:

(Cash + Marketable Securities + Accounts Receivable) / Current Liabilities

A common rule of thumb is that companies with a quick ratio of greater than 1.0 are sufficiently able to meet their short-term liabilities.

The current ratio is a liquidity ratio that measures a company's ability to pay short-term obligations or those due within one year.

A common rule of thumb is that companies with a current ratio of greater than 2:1 are sufficiently able to meet their short-term liabilities.

In the present case, the quick ration is increasing year on year and in the current year it is 2.3 , where as current ratio inreased to 4.1

It should be checked why both quick and current ratios have increased.

Days sales outstanding (DSO) is a measure of the average number of days that it takes a company to collect payment after a sale has been made. DSO is often determined on a monthly, quarterly or annual basis, and can be calculated by dividing the amount of accounts receivable during a given period by the total value of credit sales during the same period, and multiplying the result by the number of days in the period measured.

Days sales outstanding is an element of the cash conversion cycle and is often referred to as days receivables or average collection period.

receivables turnover ratio is decreasing and DSO has increased. The reason should be checked and reported.