Question

1.) If a client experienced the below during the fiscal year, what effect would the auditor expect to see on the inventory turnover ratio?

* Items shipped on consignment during the last month of the years were recorded as sales.

* Year-end purchases of inventory were understated by incorrectly excluding items received before the year end.

a.) Inventory turnover would increase

b.) Inventory turnover would not change

c.) Inventory turnover would decrease

2.) You note that your client's ROE has increased significantly from the previous year. This could be the result of

a.) Decrease in profit margin

b.) A two-for-one stock split

c.) Buying back treasury shares near year end

d.) Distributing stock dividends

e.) None of the Above

Answer 1

1.) In both the scenario inventory turnover ratio will increase, since the formula is (COGS/Sales)/Inventory. thus, Increase in sales or not recording inventory will decrease the denominator and thereby increasing turnover ratio. so correct answer is option (a.).

2.) Return on equity= (Net Income)/(Shareholder's equity), whereby shareholder's equity is equal to paid up share capital+Free reserves+Specific reserve. dividends are paid out of free reserves and thus are decreased when dividends are paid. therefore. in the current case, distribution of dividend will lead to a lower denominator in the above formula and thus a return on equity, so correct answer is option (d.)