Preliminary Analytical

Procedures
Lone Star Western Apparel Co PL/1

Percentage Analysis – Planning

December 31, 19X2

Income Statement

19X1 19X0

Sales 100% 100%

Cost of Sales 72 75

Gross Margin 28% 25%

Selling,general,and administrative 20 17
expenses

Income before income taxes 8% 8%

Income taxes 2 3

Net income 6% 5%

Balance Sheet Dec. 31, 19X1 Dec. 31, 19X0

Current Asset:

Cash 12% 20%

Accounts Receivable 36 34

Inventories 14 7

Other Current Assets 5 10

Total Current Assets 67% 71%

Equipment and Leasehold
Improvements:

Machinery and Equipment 50% 47%

Motor Vehicles 1 1

Office equipment 4 5

Leasehold Improvements 56% 54%

Less: Accumulated Depreciation and (25) (27)

Amortization

Net value 31% 27%

Other Asset 2% 2%

Total Asset 100% 100%

Current Liabilities:

Accounts Payable 26% 6%

Accrued salaries and wages 23 30

Other current liabilities 1 3

Total current liabilities 50% 39%

Stockholder’s Equity:

Common Stock 7% 11%

Retained Earnings 43% 50%

Total Equity 50% 61%

Total liabilities and equity 100% 100%

Lone Star Western Apparel Co PL/2

Ratio Analysis – Planning

December 31, 19X2

Industry

Average 19X1 19X0

19X1

1. Current Assets to Current Debt (times) 1.9 1.33 1.8

2. Net Profits on Net Sales
(percent) 7.2% 6.09% 4.9%
3. Net Profits on Tangible Net Worth
4. Net Profits on Net Working Capital (percent) 22.3% 20.8% 20.1%
5. Net Sales to Tangible Net Worth
(percent) 45.1% 63.3% 38.0%
6. Net Sales to Net Working Capital
7. Collection Period (times) 6.5 3.42 4.1
8. Net Sales to Inventory
(times) 9.8 10.38 7.8
9. Fixed Assets to Tangible Net Worth
10. Current Debt to Tangible Net Worth (days) 42.5 61.8 49.3
11. Total Debt to Tangible Net Worth
(times) 15.8 12.15 36.1
12. Inventory to Net Working Capital
13. Current Debt to Inventory (percent) 75.0% 62.7% 44.4%
14. Funded Debt to Net Working Capital
(percent) 55.0% 100.65% 63.3%

(percent) 80.0% 100.65% 63.3%

(percent) 60.0% 85.50% 21.5%

(percent) 450.0% 357.61% 556.8%

(percent)
30.0% -0- -0-
Lone Star Western Apparel Co PL/3

Analytical Review– Planning

December 31, 19X2

Audit Conclusions

Analytical reviews are used in planning to understand the client’s business industry and
throughout the audit identify possible misstatements, reduce detailed tests, and to assess going-
concern issues. The use of analytical procedures has increased because of their effectiveness at
identifying possible misstatement at a low cost, and they are required in the planning and
completion phases of the audit.

In the common-size financial statements analysis, the following interpretations are obtained:

Income Statement

The cost of goods sold decreased from 75% to 72% of net sales, thus, increasing the gross profit
by 3%. However, the selling, general, and administrative expense increased by 3% also;
therefore the income before income taxes equals to the last year’s balance. On the other hand,
income taxes decreased from 3% to 2%, so the net income increased by 1%.

Balance sheet

Cash decreased from 20% to 12% of the total assets. Accounts receivable and inventories
increased by 2% and 7%, and the remaining other current assets decreased by 5. The machinery
and equipment increased slightly, while the leasehold improvements decreased by 1%. However,
the motor vehicles, office equipment, and other assets remain the same.

Accounts payable increased by 20%, while the accrued salaries and wages decreased along with
other current liabilities. In the Shareholder’s Equity, Common Stock and retained earnings both
decreased by 4% and 7%, respectively.

In the financial ratios analysis, the following are obtained:

1. Current Assets to Current Debt - current ratio decreased compared to last year's ratio. This is
because of the large increase in the accounts payable which affects the liquidity of the company.
Suppliers may be discouraged in providing them inventories due to the fact of the company's
decreasing current ratio which is far under the average of the industry. Current ratio of greater
than one provides additional cushion against unforeseeable contingencies or expenses that may
arise in the short term. However, current ratio that is under the average ratio of the industry may
be risky strategy that could entail liquidity problems for the company.

2. Net Profits on Net Sales - the ratio increased and is near the average of the industry. This
means that the company is competing in the industry standard.

3. Net Profits on Tangible Net Worth - net profits increased but tangible net worth increased
more making the ratio increase only a little bit, thus, only nearing to the industry’s average.

4. Net Profits on Net Working Capital - there is a large increase in the ratio which may indicate
that there is a large increase in the profit but through further analysis, the large increase was
because of the decrease in the net working capital brought by the increase in current liabilities.

5. Net Sales to Tangible Net Worth - it decreased because the increase in tangible net worth is
higher than the increase in net sales.

6. Net Sales to Net Working Capital - there is an increase above the average of the industry
because net working capital decreased. It may indicate an efficient use in working capital and it
shows that the business relies extensively upon credit granted by the suppliers as substitute for
adequate margin of operating funds.

7. Collection Period - collection period increased, therefore, accounts receivable are not
converted into cash for reinvestment. Lone Star Western Apparel Co. should inform their debtors
to pay quickly to ensure shorter collection period, otherwise they may face the problem of
collection.

8. Net Sales to Inventory - decreased due to the sudden increase in inventory.

9. Fixed Assets to Tangible Net Worth - it increased but still far from the average.

10. Current Debt to Tangible Net Worth - increased due to the increase in current liabilities, it
may indicate a less protection for the creditors.
11. Total Debt to Tangible Net Worth - same with the previous ratio, since there is no non-current
liability.

12. Inventory to Net Working Capital - it increased because the inventory increased and the net
working capital decreased.

13. Current Debt to Inventory - though both account increased, the current debt’s increase is
higher than that of the inventory resulting to a higher ratio.

14. Funded Debt to Net Working Capital - there is no ratio for this since there is no long-term
obligation.

One of the sign that one company is performing well is when the ratio exceeds the average
industry norm, however, ratios may be above or below the industry norm for both positive and
negative reasons, and it is necessary to determine why a firm’s performance differs from its
industry norms.

Overall, the sudden increase and decrease in the financial ratios above are mainly caused by big
changes in the inventories balance, accounts receivable, equipment and leasehold improvement,
and accounts payable which may indicate a potential audit risk.These increase or decline of
financial statements ratios will lead to a direction of the emphasis of audit testing in order to
investigate these abnormalities.