Items 1 through 6 represent an auditor’s observed changes in certain financial statement ratios or amounts from the prior-year ratios or amounts. For each observed change, select the most likely explanation or explanations from the list of explanations provided. Answers on the list may be selected once, more than once, or not at all.
Auditor’s observed changes (considered independent of each other):
1. Inventory turnover increased substantially from the prior year. (Select 3 explanations.)
2. Accounts receivable turnover decreased substantially from the prior year. (Select 3 explanations.)
3. Allowance for doubtful accounts increased from the prior year, but allowance for doubtful accounts as a percentage of accounts receivable decreased from the prior year. (Select 3 explanations.)
4. Long-term debt increased from the prior year, but interest expense increased a larger than proportionate amount than long-term debt. (Select 1 explanation.)
5. Operating income increased from the prior year although the entity was less profitable than in the prior year. (Select 2 explanations.)
6. Gross margin percentage was unchanged from the prior year although gross margin increased from the prior year. (Select 1 explanation.)
Explanations
A. Items shipped on consignment during the last month of the year were recorded as sales.
B. A significant number of credit memos for returned merchandise that were issued during the last month of the year were not recorded.
C. Year-end purchases of inventory were overstated by incorrectly including items received in the first month of the subsequent year.
D. Year-end purchases of inventory were understated by incorrectly excluding items received before the year-end.
E. A higher percentage of sales occurred during the last month of the year as compared to the prior year.
F. A smaller percentage of sales occurred during the last month of the year as compared to the prior year.
G. The same percentage of sales occurred during the last month of the year as compared to the prior year.
H. Sales increased at the same percentage as cost of goods sold as compared to the prior year.
I. Sales increased at a higher percentage than cost of goods sold increased as compared to the prior year.
J. Sales increased at a lower percentage than cost of goods sold increased as compared to the prior year.
K. Interest expense decreased as compared to the prior year.
L. The effective income tax rate increased as compared to the prior year.
M. The effective income tax rate decreased as compared to the prior year.
N. Short-term borrowing was refinanced on a long-term basis at the same interest rate.
O. Short-term borrowing was refinanced on a long-term basis at a lower interest rate.
P. Short-term borrowing was refinanced on a long-term basis at a higher interest rate.
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