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Homework answers / question archive / Extech Ltd's sales revenue budget for 2018 is $350,000

Extech Ltd's sales revenue budget for 2018 is $350,000

Accounting

Extech Ltd's sales revenue budget for 2018 is $350,000. Extech Ltd manufactures tables and its production costs as a percentage of sales revenue are:

Raw materials 25%

Direct Labour 25%

Overheads 10%

Raw materials, which are added at the start of production, are carried in inventory for ten days and finished goods are held in inventory before sale for twenty days.

Work in progress is held at levels where products are assumed to be 50% complete in terms of labor and overheads.

The production cycle is five days and production takes place evenly through the year.

Extech Ltd receives 60 days credit from suppliers and grants 30 days credit to its customers.

Overheads are incurred evenly throughout the year.

(a) Determine Extech Ltd’s total working capital requirement

(b) Extech Ltd are owed $10,000 by a supplier who has just been declared bankrupt. The owner of Extech wants to sue the supplier’s auditors for the $10,000 as she had reviewed their audited accounts and understood that the business would continue for the foreseeable future. Discuss, with reference to the “performance gap” and the “expectations gap” what an auditor does and does not do, and whether the owner of Extech is correct in their understanding.

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(a) Working Capital = Current Assets - Current Liabilities
  % of Sales Value  
Sales   $350,000
Raw Materials 25% $87,500
Direct Labor 25% $87,500
Overheads 10% $35,000
 
Raw Material Inventory is quantity for ten days of production
Given that production is even throughout the year
Computation of Raw Materials Inventory
Total value of Raw Materials consumed during the year $87,500
Value of Raw materials consumed per day $240
Value of Raw materials consumed in ten days $2,400
Raw materials inventory levels $2,400
 
Computation of Finished Goods Inventory
Total value of Finished Goods sold during the year $350,000
Value of Finished goods sold per day $959
Value of Finished goods sold for twenty days $19,180
Finished goods inventory levels $19,180
 
Computation of Work-in-progress Inventory
Since,production cycle is for five days, Work in progress includes
a. Five days of raw materials inventory
b. 50% of five days of direct labor cost
c. 50% of five days of overheads cost
  Daily Cost Days % of Completion Value
Inventory $240                5 100% $1,200
Direct Labor $240                5 50% $600
Overhead $96                5 50% $240
Work-in-progress inventory levels       $2,040
 
Computation of Accounts Receivables
Credit period allowed to customer(in days) 30
Average daily sales $959
Sales value for 30 days $28,770
Average Accounts Receivables $28,770
 
Computation of Accounts Payable
Credit period allowed by suppliers(in days) 60
Average daily purchases $246
Purchase value for 60 days $14,760
Average Creditors $14,760
 
Note - Purchase = Raw Materials Consumed + Raw Material Inventory
= $ 87,500 + $ 2,400
= $ 89,900
Average daily purchase = $ 89,900/365
= $ 246
 
Current Assets
Raw Material Inventory $2,400  
Work-in-progress Inventory $2,040
Finished Goods Inventory $19,180
Accounts Receivable $28,770
Total Current Assets $52,390
 
Current Liabilities
Accounts Payable $14,760  
Total Current Liabilities $14,760
 
Working Capital = Current Assets - Current Liabilities
= $ 52,390 - $ 14,760
Working capital requirement = $ 37,630
(b)
Expectation gap is the difference between the public perception of an auditor's
role and responsibilities regarding audits of financial statements and what the
auditor's legal responsibilities actually are.
Expectation gap may be categorized into
(i) Performance gap which signifies the difference between the level of work an
auditor is required to do by the auditing standards and what public believes they
ought to do.
(ii) Liability gap which signifies the mis-perception regarding the legal liability of the
auditor.
 
The auditing process has certain limitations.The auditor has to express his
opinion on the financial statements of the auditee on basis of the information he
gathers on the basis of the data made available to him.This data is collected in
form of samples ans these samples are a subset of transactions during the
financial year.The auditor does not tests the whole records and it is possible that
the sample tested does not truly represent the total financial data for the year.
Also,the evidences available to the auditor may not always be conclusive.The
auditor relies on his judgement if the evidence is persuasive.
It is for these reasons that the auditor expresses his opinions on the financial
statements and does not certify it.
Hence,the auditor would not be legally liable if the supplier is declared bankrupt
where he had expressed his opinion that the business of the supplier would
continue for forseable future,if he was satisfied with the evidence made available
to him and performed his audit tests with due diligence.This is irrespective of the
opinion of Extech Limited that it was the duty of the auditor to predict that the
said supplier would become bankrupt because the audit engagement does not
create any liability on the auditor to certify that the financial statements show the
exact and precise conditions of the company.

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