One of the partners of the CPA firm you work for has engaged a new audit client, Pinnacle Manufacturing, for the year ended December 31, 2009. Pinnacle is a medium-sized corporation, with its headquarters located in Detroit, Michigan. The company is made up of three divisions. The first division, Welburn, has been in existence for 35 years and creates powerful diesel engines for boats, trucks, and commercial farming equipment. The second division, Solar-Electro, was recently acquired from a high-tech manufacturing firm based out of Dallas, Texas. Solar-Electro produces state-of-the-art, solar-powered engines.
The solar-powered engine market is relatively new, and Pinnacle's top management believes that the Solar-Electro division will be extremely profitable in the future as the focus on global climate change continues and when highly anticipated EPA regulations make solar-powered engines mandatory for certain public transportation vehicles. Finally, the third division, Machine-Tech, engages in a wide variety of machine service and repair operations. This division, also new to Pinnacle, is currently in its second year of operations. Pinnacle's board of directors has recently considered selling the Machine-Tech division in order to focus more on core operations-engine manufacturing. However, before any sale will be made, the board has agreed to evaluate this year's operating results.
Excellent operating results may have the effect of keeping the division a part of Pinnacle for the next few years. The vice president for Machine-Tech is committed to making it profitable.
a. Calculate at least five ratios that are useful to assess going concern using Pinnacle's financial statements, which are included in Figure 8-9. Document the ratios in a format similar to the following:
Current ratio
b. Based on your calculations, assess the likelihood (high, medium, or low) that Pinnacle is likely to fail financially in the next 12 months. c. Go to the Pinnacle link on the textbook Web site (www.prenhall.com/arens) and open the Pinnacle income statement, which is located in the Pinnacle Income Statement worksheet of the Pinnacle_Financials Excel file. Use the income statement information to prepare a common-size income statement for all three years. See Figure 8-7 (p. 229) for an example. Use the information to identify accounts for which you believe there is a concern about material misstatements. Use a format similar to the following:
Account Balance
Estimate of $ Amount of Potential Misstatement
d. Use the three divisional income statements in the Pinnacle_Financials Excel file on the Web site to prepare a common-size income statement for each of the three divisions for all three years. Each division's income statement is in a separate worksheet in the Excel file. Use the information to identify accounts for which you believe there is a concern about material misstatements. Use a format similar to the one in requirement c.
e. Explain whether you believe the information in requirement c or d provides the most useful data for evaluating the potential for misstatements. Explain why.
f. Your aging analysis of accounts receivable and discussions with management indicate that collections of accounts receivable have been somewhat slower than in the previous year. Evaluate whether or not you believe the allowance for uncollectible accounts is fairly valued. If you believe the account is misstated, calculate the potential misstatement.