The following table contains calculations of several key ratios for Indianola Pharmaceutical Company, a maker of proprie
The company is publicly held and is considered a small- to medium-size pharmaceutical company. Approximately 80% o
prescription drugs; the remaining 20% have been in medical supplies normally found in drugstores. The primary purpose
to identify potential risk areas for the upcoming audit. The auditor recognizes that some of the data may signal the need
company specific data.
A number of the company’s drugs are patented. Its number-one selling drugs. Anecillin, which will come off of patent in
approximately 20% of the company’s sales during the past five years.
One Year Two years Three Years Current
Ratio Current year Previous previous previous Industry
Current ratio 1.85 1.89 2.28 2.51 2.13
quick ratio 0.85 0.85 1.32 1.76 1.4
interest converage
times interest earned 1.3 1.45 5.89 6.3 4.5
days' sales in receivables 109 96 100 72 69
inventory turnover 2.4 2.21 3.96 5.31 4.33
days' sales in inventory 152 165 92 69 84
Research & development as a percent of sales 1.3 1.4 1.94 2.03 4.26
cost of goods sold as percent of sales 38.5 40.2 41.2 43.8 44.5
debt/equity ratio 4.85 4.88 1.25 1.13 1.25
earnings per share $1.12 $2.50 $4.32 $4.26 n/a
sales/tangible assets 0.68 0.64 0.89 0.87 0.99
sales/total assets 0.33 0.35 0.89 0.87 0.78
sales growth over past years 3.00% 15.00% 2.00% 4.00% 6.00%
Required
a. What are the major conclusions regarding the financial reporting riskcan be drawn from the
information shown in the table?
b. what other critical background information might you want to obtain as part of the planning of the
audit or would you gather during the conduct of the audit. Briefly indicate the probable sources of the
information.
c. based on the infomration, what major actions did the company take during the immediately
preceding year?
mpany, a maker of proprietary and prescription drugs.
any. Approximately 80% of its sales have been in
tores. The primary purpose of the auditor’s calculations is
e data may signal the need to gather other industry- or
h will come off of patent in two years, has accounted for
Companies can gain efficiencies by implementing effective monitoring of their internal control processes.
Required:
a. Explain the importance of monitoring and provide examples of monitoring.
b. Identify the importance procedures that a company might use in assessing its controls over revenue recognition and co
utilized in each of the following situations:
- A convenience store such as 7-eleven
- A chain restaurant such as olive garden
- A manufacturing division making rubberized containers for the consumer market.
c. Can the auditor focus the assessment of internal control on testing the effectiveness of the company’s monitoring? Dis
your conclusion. Discuss, for example, the level of comfort the auditor can get about the effectiveness of other controls b
effectiveness of monitoring controls.
control processes.
ls over revenue recognition and costs that might be
of the company’s monitoring? Discuss and support
e effectiveness of other controls by testing the
For each of the following situations, evaluate the segregation of duties implemented by the company and indicate the follo
a. Any deficiency in the segregation of duties described. Indicate none if no deficiency is present.
b. the potential errors or irregularities that might occur because of inadequate segregation of duties.
c. Compensating, or other, controls that might be added to mitigate potential misstatements.
d. A specific audit test that ought to be performed to determine whether a misstatement had occurred.
Situations:
1. The company’ payroll is computerized had is handled by one person in charge of payroll who enteres all weekly time rep
The payroll system is password protected so that only payroll persons can change pay rates or add/delete company person
checks are prepared weekly, and the payroll person batches the checks by supervisor or department head for subsequent
2. XYZ is a relative small organization but has segregated the duties of cash receipts and cash disbursements. However, the
handling cash receipts also reconciles the monthly bank account.
3. Nick’s is a small family-owned resturant in a northern resort area whose employees are trusted. When the restaurant is
had the ability to operate the cash register and collect the amounts due from the customer. All orders are tabulated on the
place to indicate the waiter or waitress on each ticket, most do not bother to do so, nor does management reconcile the ti
total cash receipts for the day.
4. A purchasing agent for JC Penney had the responsibility for ordering specific products and setting the prices for those pr
eligible for a bonus based on the profitability of his or her line of business. The receipt, demonstrated, and sale of goods
are separate from the purchasing agent.
5. Bass Pro Shops takes customer orders via a toll-free phone number. The order taker sits at a terminal and had complete
previous credit history and a list of inventory available for sale. The order clerk had the ability to input all the customer
invoice and shipment with no additional supervisory review or approval.
6. The purchasing department of Big Dutch is organized around three purchasing agents. The first is responsible for orderin
the second orders fabercation material, and the third orders nuts and bolts and other smaller supplies that go into the ass
accountability to vendors, all receiving slips and vendor invoices are sent directly to the purchasing agent placing the orde
agent to better monitor the performance of vendors. When approved by the purchasing agent for payment, the purchasin
of the purchase order, (b) a copy of the receiving slip, and (c) a copy of the vendor invoice to accounts payable for paymen
an invoice unless all three items are present and match as to quantities, price, and so forth. The receiving department repo
department.
the company and indicate the following:
on of duties.
t had occurred.
oll who enteres all weekly time reports into the payroll system.
tes or add/delete company personel to the payroll file. Payroll
department head for subsequent distribution to employees.
cash disbursements. However, the employee responsible for
e trusted. When the restaurant is very busy, and of the waitstaff
mer. All orders are tabulated on the “tickets.” Although there is a
does management reconcile the ticket numbers and amount with
and setting the prices for those products. The purchasing agent is
emonstrated, and sale of goods are handled by individuals who
ts at a terminal and had complete access to the customer’s
bility to input all the customer’s requests and generate a sales
The first is responsible for ordering electrical gear and motors,
maller supplies that go into the assembly process. To improve the
purchasing agent placing the order. The allows the purchasing
agent for payment, the purchasing agent must forward (a) a copy
e to accounts payable for payment. Accounts payable will not pay
th. The receiving department reports to the purchasing
If a company’s control risk as assessed as low, the auditor needs to gather evidence on the operating effectiveness of the
Required
a. For each of the following control activities, indicates the auditing procedures the auditor would use to determine its op
b. Briefly describe how substantive test of account balances should be modified if the auditor finds that the control proced
planned. In doing so, indicate (a) what could happen because of the control deficiencies, (b) how much the auditors tests
for the potential misstatement.
Controls:
1. Credit approval by the credit department is required before sales persons accept orders of more than $15,000 and for a
due balance higher than $22,000.
2. All merchandise receipts are recorded on pre-numbered receiving slips. The controller’s department periodically accoun
sequence of the receiving slips.
3. Payments for goods received are made only by the accounts payable department on receipt of a vendor invoice, which
quantities with approved purchase orders and receiving slips.
4. The accounts receivable bookkeeper is not allowed to issue credit memos or to approve the write-off of accounts.
5. cash receipts are opened by a mail clerk, who prepares remittances to send to accounts receivables for recording. The c
which is sent to the controller. Deposits are made daily by the controller.
6. Employees are added to the payroll master file by the payroll department only after receiving a written authorization fr
7. The only individuals who have access to the payroll master file are the payroll department head and the payroll clerk re
payroll file. Access to the file is controlled by computer passwords.
8. Edit tests built into the computerized payroll program prohibit the processing of weekly payroll hours in excess of 53 a
employee for more than three different job classifications during a one-week period.
9. Credit memos are issued to customers only on the receipt of merchandise or the approval of the sales department for a
10. a sales person cannot approve a sales return or price adjustment that exceeds 6% of the cumulative sales for the year
divisional sales manger must approve any subsequent approvals of adjustments for such a customer.
he operating effectiveness of the controls.
itor would use to determine its operating effectiveness
uditor finds that the control procedure is not working as
, (b) how much the auditors tests should be expanded to test
ers of more than $15,000 and for all customers who have a past-
r’s department periodically accounts for the numerical
eceipt of a vendor invoice, which is then matched for prices and
ve the write-off of accounts.
ts receivables for recording. The clerk prepares a daily slip,
eceiving a written authorization from the personal department.
ment head and the payroll clerk responsible for maintaining the
kly payroll hours in excess of 53 and the payment to an
oval of the sales department for adjustments.
the cumulative sales for the year of any one customer. The
h a customer.