Week 2 integrating case 5-23 p. 296


Week 2 Integrating Case 5-23 p. 296

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 numbers provided by the client. Since ratios reflect the relationships among various account balances, if it is assumed that prior relation- ships still hold, prior years’ ratios can be used 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 Covington Pike Corporation brings you the list of ratios shown 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 

Receivables 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 margins 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


You are requested to approximate the current year’s balances in the form of a balance sheet and income statement, to the extent the information allows. Accompany those financial statements with the calculations you use to estimate each amount reported.

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