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Question: horizontal and vertical analysis horizontal analysis refers to changes of...

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Horizontal and Vertical Analysis. Horizontal analysis refers to changes of financial statement numbers and ratios across two or more years. Vertical analysis refers to financial statement amounts expressed each year as proportions of a base such as sales for the income-statement accounts and total assets for the balance-sheet accounts. Exhibit 4.55.1 contains Retail Companys prior-year (audited) and current-year (unaudited) financial statements, along with amounts and percentages of change from year to year (horizontal analysis) and common-size percentages (vertical analysis). Exhibit 4.55.2 contains selected financial ratios based on these financial statements. Analysis of these data can enable auditors to discern relationships that raise questions about misleading financial statements Required Study the data in Exhibits 4.55.1 and 4.55.2. Write a memorandum identifying and explaining potential problem areas where misstatements in the current-year financial statements could exist Additional information about Retail Company is as follows The new bank loan, obtained on July 1 of the current year, requires maintenance of a 2:1 current ratio Principal of $100,000 plus interest on the 10 percent long-term note obtained several years ago in the original amount of $800,000 is due each January 1 The company has never paid dividends on its common stock and has no plans for a dividend.

EXHIBIT 4.55.1 Retail Company Change Prior Year (Audited) Balance Common Size Current Year (Unaudited) ance Common Size Amount Percent Assets: Cash Accounts receivable Allowance doubt. accts. Inventory 9.69% S 600,000 500,000 (40,000) 1,500,000 (116,000) (100,000) 10,000 440,000 12.32 400,000 (30,000) 1,940,000 -0.60 38.85 55.95 -20.00 -25.00 29.33 36.95 63.05 Total current assets Fixed assets Accum. depreciation 3,000,000 (1,500,000) 4,000,000 (1,800,000) 994,000 1,000,000 (300,000) -36.95 100.00% -36.04 Total assets Liabilities and equity 23.00% 11.08% Accounts payable Bank loans, 11% Accrued interest Accruals and other $ 450,000 $ 600,000 750,000 40,000 10,000 12.01% 15.02 150,000 750,000 (10,000) 50,000 60,000 500,000 2,000,000 20.00 150.00 69.81 19.40 Total current liab. Long-Term debt, 10% 12.32 400,000 (100,000) -20.00 Total liabilities Capital stock Retained earnings 9.26 24.63 100.00% 2,000,000 1,194,000 40.05 23.91 100.00% 1,000,000 194,000 Total liabilities and equity Statement of operations: 23.00% Sales (net) Cost of goods sold Gross margin General expense $9,000,000 6,296,000 s(900,000) (1,031,000 100.00% $8,100,000 5,265,000 1 00.00% 65.00 -16.38 2,044,000 300,000 2,005,000 300,000 24.75 (39,000) 3.33 47.22 Operating income Interest expense Income taxes (40%) 50,000 124,000 40,000 196,000 72,000 108,000 58.06 58.06% Net income NA means not applicable

EXHIBIT 4.55.2 Retail Company Prior Year Audited) Current Year (Unaudited) Percent Change Balance-sheet ratios: Current ratio Days sales in receivables Doubtful accounts ratio Days sales in inventory Debt/equity ratio 4.57 18.40 0.0800 85.77 0.35 -56.34% 10.63 6.25 54.66 40.89 2.0 16.44 0.0750 32.65 0.56 Operations ratios: Receivables turnover Inventory turnover Cost of goods sold/sales Gross margin % Return on equity 11.89 35.34 19.57 4.20 69.96% 30.04% 6.61% 21.89 2.71 65.00% 35.00% 16.49 48.26 9.80%

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