Use ratios to test reasonableness data.
You are a new staff accountant with a large regional CPA firm, participating in your first audit. You recall from your auditing class that CPAs often use ratios to test the reasonableness of accounting number provided by the client. Since the ratio reflect the relationship among various accounts balances, if it is assumed that prior relationship still hold, prior years' ratios can be use to estimate what current balances should approximate. However, you never actually performed this kind of analysis until now. The CPA in charge of the audit of Covin Corp bring you the list of ratios show below and tells you these reflect the relationships maintained by Covington Pike in recent years.
Profit margin on sales = 5%
Return on assets = 7.5%
Gross profit margin = 40%
Inventory turnover ratio = 6 times
Receivable turnover ratio = 25
Acid test ratio = 9
Current ratio =2 to 1
Return on shareholders' equity = 10%
Debt to equity ratio = 1/3
Times interest earned ratio =12 times
Jotted in the margin are the following notes:
• Net income $ 15,000
• Only one short-term note(5,000); all other current liabilities are trade accounts
• Property, plant, and equipment are the only noncurrent assets
• Bonds payable are the only noncurrent liabilities
• The effective interest rate on short-term notes and bonds is 8%
• No investment securities
• Cash balance totals $15,000
Required:
Please approximate the current year's balance in the form of a balance sheet and income statement, to the extent the information allows. Accompany those financial statements with the calculation you use to estimate each amount reported.