Horizontal and Vertical Analysis

Name

ACC 614: Auditing & Fraud Detection

26^th November 2022

Horizontal and Vertical Analysis

“Horizontal analysis” describes comparing data and ratios from two or more years of financial statements. Annual quantities in the income statement and balance sheet are reported as percentages of some base, such as sales or total assets, respectively, for vertical analysis. The financial accounts of the Retail Company, both for the preceding year (audited) and the current year (unaudited), as well as the quantities and percentage changes from one year to the subsequent (horizontal analysis) and the common­size percentages, are included in Exhibit 4.55.1. (Vertical analysis). Selected financial ratios derived from these financial statements are shown in Exhibit 4.55.2. Examining these data sets may help auditors spot connections that cause concern regarding potentially deceptive financial statements.

Check to see Exhibits 4.55.1 and 4.55.2 for further information. Generate a note detailing any areas of concern that might lead to misrepresentations in the current year’s financial accounts. Here’s some more data about the Retail Company: The current ratio must remain at 2:1 to keep the new loan from a bank received on July 1 of this year**.** The corporation has a 10­year note with a $800,000 principle and annual interest payments due every January 1. The company has no plans to ever provide dividends to ordinary shareholders.

When a company’s management knowingly and willfully includes misleading or incorrect information in the company’s annual report or omits material facts that might affect the company’s financial position, this is called financial misrepresentation. Some of this information is meant to be obfuscated, for as by omitting expenses, contingent liabilities, or managerial incentives along with “actual” sales, profits, or other financial indicators. Management engages in these actions to boost the stock price, facilitate a takeover, or improve the company’s credit standing. The following are some possible places where mistakes, fraud, or other audit concerns may arise. These considerations should be included in the audit program’s earliest planning stages.

The historical high current ratio was 4.57, but now it’s just 2.0, which is far more manageable. Instead of improved management of short­term assets, this is attributable to more than twofold short­term liabilities. Short­term borrowings for the retail firm have increased from $500,000 to $1.4 million. Short­term borrowing has increased, as seen by a rise in Accounts Payable from $450,000 to $600,000. Substantial amounts of short­term bank loans up to $750,000 with interest have been taken out.

A current ratio of 2.0 may seem healthy, but it is unsupported by rising sales. A nine hundred thousand dollar drop in sales is a proven truth. This suggests that the corporation has not utilized the proceeds from the new loans to expand its operations. Funds available for immediate use have been diverted from short­term benefits to acquiring and settling long­term commitments and fixed assets. Short­term loans have been utilized to pay off long­term obligations. The 11% APR on the short­term loan was used to pay off the 10% APR on the long­term loan.

In addition, the amount of unsold inventory has increased to $1.94 million, from $1.5 million a year ago. The result is an increase from 86 days to 132 days in the sales­to­inventory days ratio, suggesting that goods often go unused for more than four months. The company is in serious jeopardy if it is unable to fulfill its immediate and extended obligations. Despite this, the net earnings have grown from $186,000 ­ $294,000. This is the result of cost­cutting rather than an increase in revenue. There is, however, no reason for a $750,000 short­term loan. The debtcollecting process has been streamlined: The average number of days it takes to collect invoices has dropped from 18.40 to 16.44. But this is mainly because it has decreased sales. There is no increase in sales or other indicators of increased productive activity due to the fixed assets.

References

Louwers, T., Ramsay, R., Sinason, D., Strawser, J., Thibodeau, J. (2015). Auditing & assurance services (6th Ed.). New York: McGraw Hill Education.