Analytical Review and Planning the Audit

4-56 (Analytical Review and Planning the Audit) The following table
contains calculations of several key ratios for Indianola Pharmaceutical
Company, a maker of proprietary and prescription drugs. The company is
publicly held and is considered a small-to medium-size pharmaceutical
company. Approximately 80% of its sales have been in prescription drugs;
the remaining 20% are in medical supplies normally found in a
drugstore. The primary purpose of the auditor’s calculations is to
identify potential risk areas for the upcoming audit. The auditor
recognizes that some of the data may signal the need to gather other
industry- or company-specific data.
A number of the company’s
drugs are patented. Its number-one selling drug, Anecillin, which will
come off of patent in two years, has accounted for approximately 20% of
the company’s sales ‘during the past five years.
Ratio Current One Year Two Years Three Years Current
Year Previous Previous Previous Industry
Current ratio —–1.85 1.89 2.28 2.51 2.13
Quick ratio ——————————- 0.85 0.93 1.32 1.76 1.40
Interest coverage:
Times Interest earned——————- 1.30 1.45 5.89 6.3 4.50
Days’ sales in receivables————– 109 96 100 72 69
Inventory turnover———————- 2.40 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 year—- 3% 15% 2% 4% 6%
What major conclusions regarding financial reporting risk can be drawn
from the information show in the table? Be specific in identifying
specific account balances that have a high risk of misstatement. State
how that risk analysis will be used in planning the audit. Be very
specific in your answer. You should identify a minimum of four financial
reporting risks that should be addressed during the audit and how they
should be addressed.
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 information, what major actions did the company take during the immediately preceding year? Explain.


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