USSC Audit Income

USSC Audit IncomeCase 1.11 united States working(a) CorporationQ3. Prepare common-sized financial statements for USSC for the menstruation 1979-1981. Also compute key liquidity, solvency, activity, and profitability ratios for 1980 and 1981. Given these data, identify what you believe were the high-risk financial statement points for the 1981 USSC analyse.U.S. functional CorporationCommon Size Income mastery 1979-1981 (000s omitted)1981 % Sales 1980 %Sales 1979 %Sales Net Sales 111,800 100 86,214 100 60,876 100 Costs and ExpensesCOGS 47,983 43 32,300 37.5 25,659 42.1Selling, GeneralAnd Admin. 45,015 40.3 37,740 43.7 23,935 39.3 Interest 5,898 5.2 4,063 4.7 3,403 5.698,896 88.5 74,103 85.9 52,997 87.0 Income Before Taxes 12,904 11.5 12,111 14.0 7,879 12.9Income Taxes 1,120 1.0 4,226 4.9 2,750 4.5 Net Income 11,784 10.5 7,885 9.1 5,129 8.4U.S. Surgical CorporationCommon Size Balance Sheet 1979-1981 (000s omitted) modern Assts 1981 %Assets 1980 %Assets 1979 %Assets Cash 426 .21 1 ,243 1.04 596 .85 Receivables (net) 36,670 17.7 30,475 25.6 22,557 31.9InventoriesFinished Goods 29,216 14.1 9,860 8.3 5,685 8.1Work in Process 5,105 2.5 2,667 2.2 1,153 1.6Raw Materials 20,948 10.1 18,806 15.8 7,365 10.455,269 26.7 31,333 26.3 14,203 20.1Other Current Assets 7,914 3.8 1,567 2.4 1,820 2.6 heart and soul Current Assets 100,279 48.4 64,618 54.3 39,176 55Assets 1981 %Assets 1980 %Assets 1979 %AssetsProperty, Plant, EquipLand 2,502 1.2 2,371 2.0 1,027 1.5 Buildings 32,416 15.6 18,511 15.5 13,019 18.5Molds and Dies 32,082 15.5 15,963 13.4 8,777 12.4Mach. Equip. 40,227 19.4 23,762 20.0 12,362 17.5Allowance forDepreciation (14,953) (9,964) (6,340)Other Assets 14,786 7.1 3,842 3.2 2,499 3.5Total Assets 207,339 119,103 70,520Liabilities 1981 %Liability/ 1980 %Liability 1979 %LiabilityStock.Eq. Stock. Eq. Stock. Eq.Accounts Payable 12,278 5.9 6,951 5.8 6,271 8.9Notes Payable 1,596 2.3 Income Taxes Payable 1,685 1.4 Current L-T Debt 724 .35 666 .56 401 .57 Accrued Expenses 5 ,673 2.7 5,130 4.3 5,145 7.3 Long-Term Debt 80,642 38.9 47,569 39.9 33,497 47.5Deferred Income Tax 7,466 3.6 2,956 2.5 1,384 2.0Liabilities 1981 %Liability/ 1980 %Liability 1979 %LiabilityStock.Eq. Stock. Eq. Stock. Eq.Stockholders EquityCommon Stock 1,081 .52 930 .78 379 .54Add. Paid-in Capital 72,594 35.0 34,932 29.3 10,736 15.2Retained Earnings 32,665 15.8 20,881 17.5 13,189 18.7Translation Allowance (1,086)Deferred Compensation- make do Restricted Stock (4,698) (2,597) (2,078)Total Stock. Equity 100,556 48.5 54,146 45.5 22,226 31.5Total Liabilities/Stockholders Equity 207,339 119,103 70,520Financial Ratios for U.S. Surgical Corporation1981 1980Cash Ratio .0228 .0861Current Ratio 5.37 4.48Accounts Receivable derangement 3.33 2.57Inventory Turnover 1.11 .75Gross Profit Percent 57% 62%Profit Margin 11.5 14.1Return on Assets 7.9 7.4The common sized income statement was alert to display all items as a percentage of sales. On the income statement we can see that there was a strike in cost of goods change from 1979 to 1980. Cost of goods sold went from 42.1% of sales to 37.5% of sales even though net sales change magnitude. This information along with the increase in the current asset roll account on the balance sheet indicates a satisfying increase in memorial held by USSC. Another high risk income statement item was the selling, general and administrative expenses. Included in this category of expenses are query and development cost. The amounts of research and development costs reported dropped significantly. In 1980 they were reported at $3,020,000 and dropped to $1,337,000 in 1981. Also the entire category of selling, general and administrative expenses which included these RD costs decreased as a percent of sales from the old year. The USSC openly admitted to undergoing a large research and development program to create new products and technology in 1981. The major decrease in costs reported for research and development in 1981 should have caused further investigation by the scrutinizeing team. The common sized balance sheet was prepared to display each asset as a percentage of total assets. The percentages for the cash and accounts receivable accounts in 1981 decreased significantly from the previous years while the inventory account increased. This indicates a decrease in liquidity of assets which is also supported by the change in the cash ratio from 1980 to 1981. Another high-risk item would have been the other assets account. fall in States Surgical Corporation included their patents in this other assets account. They were capitalizing costs associated with the legal defense of a patent that should not have been capitalized. There was a significant increase in this account, $3,842,000 in 1980 to $14,786,000 in 1981. Another red flag would be the significant increase in total long term assets. In 1979 long term assets accounted for 45% of total assets, in 1980 it was 45.7% of total assets and in 1981 long term assets accounted for 51.6% of total assets. USSC was capitalizing costs associated with patents that should not have been capitalized, charging inventoriable production to a long-term assets account molds and dies, and extending the useful lives of some assets and therefore understating depreciation. All of these actions would have caused a significant increase in total long-term assets. A more(prenominal) particular high-risk item was the long-term asset molds and dies. This account doubled in 1981 from the previous year from $15,963,000 to $32,082,000. The SEC investigation later revealed that USSC was in fact capitalizing production costs and charging them to the molds and dies asset account.Financial ratios were also calculated to determine high-risk items. The current ratio for USSC in 1981 is a little high and has increased from the previous year. In 1981 the current ratio indicated that USSC had $5.37 in current assets for every dollar of current liabilities. This high ratio may indicate that United States Surgical Corporation was overstating their assets. The inventory turnover is low at .75 in 1980 and 1.11 in 1981. The auditing team would have wanted to investigate to find out why inventory was accumulating and not turning over as these numbers indicated. By preparing the common size financial statements and ratios we can identify the high-risk items when performing an audit. The major items for United States Surgical Corporation were the reduced research and development costs recognized despite the increase in research for new products, the major increase in the long-term asset account molds and dies and the other assets account.Q5. Regarding the costs incurred for USSC by Barden, identify (a) the demonstration Hope collected that supported USSCs claim that the costs involved tooling modifications and (b) the audit evidence that supported the position that the costs were generic production expenses. What do generally accepted auditing standards sugges t are the key evaluative criteria that auditors should consider when assessing audit evidence? Given these criteria, do you believe Hope was justified in deciding that the costs in question were for tooling modifications? Why or why not? The evidence that hope collected that supports USSCs claim that the charges in question were in fact for tooling modifications was the General Manager of Lacey Corporation (A division of Barden Corporation) goes back on his previous statement and confirms that the purchase orders and invoices were in fact for tooling modifications. USSC explained their position and said that they had instructed Lacey to make certain tooling changes that would result in improved efficiency in production of USSC products. When the audit team asked to take a tour of the Lacey plant to examine the actual production process the Lacey General Manger informed the audit team that power often mistakenly charge tooling jobs to production. There was more evidence that support ed the position that the costs in question were just generic production expenses. ab initio the audit team did not notice that the assets were being overstated and there was an issue with the classification. It was the company who does work for USSC that admitted that there were issues with some of the purchase orders and invoices. The Lacey general coach informed the auditors that invoices and purchase orders were being reviewed and that they were for general production work and not tooling modifications as USSC had previously stated. The chairman of the board of directors for Barden Corp. reported that an independent investigation by an outside law firm has concluded that the purchase orders and invoices were in fact for general production work and not for tooling modifications. Finally the Senior Vice death chair and Treasurer for Barden Corporation refused to sign confirmation that $1 million in charges were for tooling modifications on two occasions. The key criteria for eva luating audit evidence are relevance, reliability and sufficiency. The evidence must be relevant to audit objective. The auditors must use procedures and documents that are relative to the audit objective. The evidence must be reliable, or must be believable and trust worthy. The sufficiency of evidence has to deal with the quantity of evidence obtained. In my opinion Hope was not justified in deciding that the costs were for tooling modifications. There was not sufficient evidence to come to this conclusion, just some complicated explanations from USSC and inaccurate purchase orders and invoices. The evidence was not relevant to the audit objective. The specific products with modifications should have been traced back to their purchase orders. Instead the auditors just took the explanation of these orders from management. Finally the reliability of the evidence was not high, USSC had a lot to lose if it was concluded that they were indeed general production and the General Manger for Lacey had changed his position numerous times. The only reliable evidence was that of the independent law firm that concluded the purchase orders and invoices were not for tooling modifications. ReferencesKnapp, Michael C., United States Surgical Corporation Contemporary Auditing. Real Issues Cases. Sixth Edition (2006), 137-146.Arens, R. Randal, M. Beasley, Auditing and Assurance Services. An Integrated Approach. (2008) 175-176.