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Audit Chapter 8 Essay

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When analyzing the Pinnacle Manufacturing Financial Statements there multiple concerns that should be further investigated that I will explain in this memo. When identifying the year to year change and using financial ratios found on A6, there are a couple of concerns that need to be identified. The fact that the operating expense from fluctuated from an increase $892,861 from 2009 to 2010 and then decreased by $956,231 from 2010 to 2011 should be raised in question. At the same time Operating expenses income from operations decreased from 2009-2010 by $1,260,571 and increased from 2010-2011 by $78,541.

The -23. 10% from 2009-2010 is concerning in their ability realized from profit on their business operation. On the balance sheet there was a substantial increase by $6,698,823 from 2010-2011. When examining this with the inventory turnover ratio from 2010 to 2011 there was a decrease in inventory. This is very concerning from Pinnacle, in respects to their industry, that there is excess inventory and that the inventory is at the end of its product life cycle and has not seen any sales. The account receivable turnover ratio measures how efficiently a company uses it assets.

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In this case Pinnacle has a declining at turnover ratio that indicates that Pinnacle should re-evaluate its credit policies to ensure timely receivable collection. The high debt/equity ratio means that Pinnacle has been aggressive in financing it growth with debt. Usually if a lot of debt is used to finance increased operations could lead to bankruptcy, however given the industry in which Pinnacle operates is capital – intensive (manufacturing) tends to have a debt/equity ratio around 2. (A6) The gross profit percent shows the portion of sales available to cover all expenses and profit after deducting the cost of the product.

From the results from parts a and b, we can see that Pinnacle has the ability to generate cash for payment of obligations, expansions and dividends, however the gross profit percentage is lower, this concerns me because the higher gross profit margin it indicates that the company can make a reasonable profit on sales. (A11) On A7 is the computation of the common sized income statement of all division. Some concerns that where acquired when analyzing the common sized income statements there is a concerning issue with the increase in the net eceivable however there is a $192,361 decrease from 2010 to 2011. This is revealed in the decreasing amounts in the accounts receivable turnover ratio and the inventory turnover. The ratio computation that supports the common sized income percentages are shown on A6. This is concerning because bad debt is also in question because this account is decreasing, yet account receivable is increasing. Other concerns on the common sized income statement are the legal service account. There is a $205,476 increase from 2010 to 2011. As a sudden increase this can be a result from a lawsuit or a current litigation.

This should be researched more, and should be discussed with the legal department to explain the discrepancy (A7). Another concern is miscellaneous expense account. This account increased from $194,257 from 2010 to 2011. There was also a minor increase in this account from 2009 to 2010, however from 2010 to 2011 should be further investigated. Property tax should also be a concern. On A7 we see the property tax decreases $155,424 from 2010 to 2011. This is a major issue because on the balance sheet (A11) the Land account from 2010 to 2011 stays the same at $11,490,036.

Bottom line is that net income continuing to decrease each year which correlates with decrease in profit. On pages A7 – A9 show that common sized income statement of all three divisions. The net sales are inconsistence in accordance with the cost of sales for all three divisions. This is a concern because gross profit it decreasing while cost of sales has continued to increase from the past years for the Welburn division (A8). For the Solar-Electro Division (A9) is where we can identify the legal service concern. From 2010 to 2011 there was a $223,004 increase in this account that has yet to be disclosed.

As discussed above this can just be further investigated with the legal department for clarification of what occurred during that year. Another concern for Solar –Electro division is their miscellaneous expense. There should just be a further explanation of how they get an increase of $191,910 from 2010 to 2011. Finally for Solar – Electro the operating income brings up concern on their steady decrease, and their continuing to report operating loss. Machine-Tech (A9) is doing the best out of each division profit wise. There are not too many concerns for this division.

I think that the information from all divisions is helpful because we can see the variance as a whole and how future predictions can affect the company and identifying any concerns. When comparing both the “all divisions” and each of the “individual division”, they are both useful for evaluating data for potential misstatements. Using both helps understanding the variance or potential misstatements in “all divisions” and identifying which division is causing the concern and further research will be done with in the individual division. (A7-A10) The account receivable turnover ratio (A6) measures how efficiently a company uses it assets.

In this case Pinnacle has a declining turnover ratio that indicates that Pinnacle should re-evaluate its credit policies to ensure timely receivable collection. Looking at the continual increase in days to collect receivable, especially the big jump in 2011 is a not positive. This could be a result from the new addition of Machine – Tech and Solar -Electro division in the last two years. However, analyzing the days to collect receivable indicated Pinnacle in not as efficient as it has been in the past by quickly turning sales into cash that allows the company to put the cash to use again (or reinvest it).

Examining their current ratio, there is a constant decrease which means that Pinnacle is inefficient in their ability to pay back its short term liabilities with their short term assets. The days to sell inventory (A6) is used to identify the financial measure of a company’s performance that gives investors an idea of how long it takes a company to turn its inventory into sales. The increase can be due to the recent acquirement of division. The efficiency in days to sell inventory has decreased and it is taking longer to receive perceive payment on AR while it is talking long for the Pinnacle to pay off its AP.

According to my calculations and concerns on the company as a whole and each division that supports the company, I believe that Pinnacle is in the medium range in likely to fail financially in the next 12 months. I gave them a medium status because Pinnacle can survive a year or two more however they are not looking confident for financial security given their constant decrease in sales and their Solar-Electro Division is continuing to report an operating income loss. Given the debt/equity ratio (A6), it indicates what proportions of equity debt Pinnacle is using to finance its assets.

Pinnacle is lower their debt/equity ratio which indicates conservative financing and lowing their risk. However, the continue decrease in gross profit indicates the decrease in financial health and the decrease on gross profit on every dollar of revenue Pinnacle is earing. Given the continue decrease in current ratio, debt/equity and gross profit and given the obsoleteness of inventory Pinnacle is in the medium range for likelihood that pinnacle is likely to fail financially in the next 12 months because their financial health is very concerning.