3
EarthWear Hands-on Mini-case
Chapter 3 - Audit Planning Memo
AUDITING & ASSURANCE SERVICES 11e © The McGraw-Hill Companies, Inc., 2019
In this case you will complete the audit planning memo for the EarthWear engagement. Additional
information to help you prepare this memo can be obtained from the EarthWear and Willis & Adams
websites.
A planning memo is typically used to summarize the considerations and conclusions involved in several of
the audit planning phases you’ve read about in Chapter 3.
INSTRUCTIONS:
Willis and Adams, CPAs uses the template shown in the "Audit Planning Memorandum" worksheet tab to
prepare the planning memo. Some portions have already been completed or begun. These portions are
indicated in plain text. Portions highlighted in green will be completed by other auditors; however, brief
descriptions of what will be included in these sections of the planning memo are included in the template
for instructional purposes. For each of the memo topics that remain to be completed (areas highlighted in
yellow), you should address at least two key points about EarthWear Clothiers or the mail order clothing
industry. Keep in mind that the points you identify should have important implications for the audit.
Address each topic using information from the EarthWear and Willis & Adams websites, the textbook, the
work papers provided in this workbook, and prior mini-cases.
Fields you are to complete on the form are colored yellow. The color will disappear as the field is completed.
In addition to the analytical procedures already listed in the memo, analyze an additional four that are
useful in the planning process for the EarthWear audit (see area highlighted in yellow in "Audit Planning
Memorandum" tab). Discuss the meaning of the analytical procedures included and how they may affect
your audit plan/procedures. Work Paper 3-6 and the Common Size Balance Sheet and Income Statement
for EarthWear have been provided to assist you.
Please input your answers into Connect or print a copy of the Print Out to submit unless your instructor
requests an electronic submission. The Print Out is formatted to fit on one page.
EARTHWEAR CLOTHIERS Prepared by:
Audit Planning Memorandum Reviewed by:
December 31, 2019 Date:
BACKGROUND INFORMATION
· Business Strategy and Target Customers
EarthWear Clothiers generates revenue mainly through the sale of high quality clothing for outdoor sports, such as
hiking, skiing, fly-fishing, and white-water kayaking. The company’s product lines also include casual clothes,
accessories, shoes, and soft luggage. The company’s key customers are the 18.8 million persons on its mailing list,
approximately 6.8 million of whom are viewed as “current customers” because they have purchased from the company
in the last 24 months. Market research as of January 2018 indicates that approximately 50 percent of customers are in
the 35-54 age group and had a median income of $62,000. Almost two-thirds are in professional or managerial
positions.
· Suppliers
Address at least two key points about issues relating to EarthWear Clothiers' suppliers. Keep in mind that
the points you identify should have important implications for understanding EarthWear as an audit client.
· Competition
Address at least two key points about EarthWear Clothiers' competitors or the mail order clothing industry.
Keep in mind that the points you identify should have important implications for understanding EarthWear
as an audit client.
· Social Factors
The company’s results can be affected by changing fashion trends .
· Analytical Procedures
*Days Outstanding in Accounts Receivable is 3.09 and the industry average is 14.10. This ratio indicates that
EarthWear collects on sales much more quickly than the rest of the industry. It also represents a significant
improvement relative to prior years for EarthWear and is better than expected for this year. This ratio is consistent with
a relatively low allowance for doubtful accounts. Controller explains that fast collection rate is a result of increased
focus on collection activities and newly implemented incentives for early payment. We will corroborate the client's
explanation as a part of our testing in the sales & collection cycle.
Analyze 4 additional analytical procedures that were completed in the planning process.
EarthWear's Gross Profit Percentage is 43.90% and the industry average is 38.80%
Discuss the meaning of the analytical procedure and how it may affect risks relating to the EarthWear audit
or your planned audit procedures.
EarthWear's Debt to Equity ratio is 0.50 and the industry average is 0.84
Discuss the meaning of the analytical procedure and how it may affect risks relating to the EarthWear audit
or your planned audit procedures.
· Materiality
Materiality for the 2019 audit is calculated on work paper 3-7.
Class:
EARTHWEAR CLOTHIERS Prepared by:
Audit Planning Memorandum Reviewed by:
December 31, 2019 Date: 2/16/2020
PRINT OUT
· Suppliers
Enter your answer on the Audit Planning Memorandum.
· Competition
Enter your answer on the Audit Planning Memorandum.
· Analytical Procedures
Enter your answer on the Audit Planning Memorandum.
ACTIVITY RATIOS:
Receivables Turnover 71.18 77.25 74.34 73.82 75.41 118.00 42.60 N/A N/A
net sales / net ending receivables
Days Outstanding in Accounts Receivable 5.13 4.73 4.91 4.94 4.84 3.09 -1.74 14.10 -11.01
365 days / receivables turnover
Inventory Turnover 3.43 4.27 4.48 4.47 4.99 3.87 -1.12 6.20 -2.33
cost of sales / inventory
Days of Inventory on Hand 106.41 85.51 81.40 81.72 69.22 94.99 25.78 58.70 36.29
365 / (cost of sales / inventory)
COVERAGE RATIOS:
Debt to Equity 0.79 0.88 0.58 0.61 0.51 0.50 -0.01 0.84 -0.34
total liabilities / shareholders' investment
Times Interest Earned 53.88 26.31 26.41 23.92 10.19 50.57 40.38 N/A N/A
(net income + interest expense) / interest expense
* Expected values are obtained by using the forecast function in Excel (using the row of data from 2017 and 2018 to obtain the expected value for 2019).
† Industry Source: Dun & Bradstreet (D&B). The median values of the industry ratios are used for comparison purposes. For ratios not specifically included on D&B, ratios
were calculated from average financial statement data provided.
December 31
2019
2017 2018 Expected* Actual Difference
Dollar Value % of Total Dollar Value % of Total Dollar Value % of Total Dollar Value % of Total Dollar Value % of Total
Assets Assets Assets Assets Assets Assets
Current Assets:
Cash and cash equivalents $49,668 16.75% $48,978 14.84% $48,288 13.29% $79,359 20.38% $31,071 7.09%
Receivables, net $11,539 3.89% $12,875 3.90% $14,211 3.91% $8,643 2.22% ($5,568) -1.69%
Inventory $105,425 35.55% $122,337 37.08% $139,249 38.32% $147,693 37.93% $8,444 -0.39%
Prepaid advertising $10,772 3.63% $11,458 3.47% $12,143 3.34% $10,212 2.62% ($1,932) -0.72%
Other prepaid expenses $3,780 1.27% $6,315 1.91% $8,849 2.44% $5,435 1.40% ($3,414) -1.04%
Deferred income tax benefits $6,930 2.34% $7,132 2.16% $7,335 2.02% $10,338 2.65% $3,003 0.64%
Total current assets $188,115 63.44% $209,095 63.37% $230,075 63.31% $261,680 67.20% $31,604 3.88%
Property, plant and equipment, at cost 0.00%
Land and buildings $66,804 22.53% $70,918 21.49% $75,031 20.65% $76,560 19.66% $1,529 -0.99%
Fixtures and equipment $66,876 22.55% $67,513 20.46% $68,150 18.75% $68,632 17.62% $482 -1.13%
Computer hardware and software $47,466 16.01% $64,986 19.70% $82,507 22.70% $75,400 19.36% ($7,107) -3.34%
Leasehold improvements $2,894 0.98% $3,010 0.91% $3,125 0.86% $3,144 0.81% $20 -0.05%
Total property, plant and equipment $184,040 62.07% $206,426 62.56% $228,812 62.97% $223,737 57.45% ($5,076) -5.51%
Less - accumulated depreciation and amortization $76,256 25.72% $85,986 26.06% $95,716 26.34% $97,722 25.09% $2,007 -1.25%
Property, plant and equipment, net $107,784 36.35% $120,440 36.50% $133,097 36.63% $126,014 32.36% ($7,082) -4.27%
Intangibles, net $628 0.21% $423 0.13% $218 0.06% $1,734 0.45% $1,516 0.39%
Total assets $296,527 100.00% $329,959 100.00% $363,390 100.00% $389,428 100.00% $26,038 0.00%
* Expected values are obtained by using the forecast function in Excel (using the row of data from 2017 and 2018 to obtain the expected value for 2019).
* Expected values are obtained by using the forecast function in Excel (using the row of data from 2017 and 2018 to obtain the expected value for 2019).