Question

34

What are the TWO most likely explanations of the auditor’s observation of the following change in the financial statement ratio from the prior year’s ratio “inventory turnover decreased substantially from the prior year”?

Possible explanations:

(1) A larger percentage of sales occurred during the last month of the year, as compared with the prior year.

(2) A fewer percentage of sales occurred during the last month of the year, as compared with the prior year.

(3) Year-end purchases of inventory were understated by incorrectly excluding items received before year end.

(4) Year-end purchases of inventory were overstated by incorrectly including items received in the first month of the subsequent year.

(5) Items shipped on consignment during the last month of the year were recorded as sales

(6) A significant number of items shipped to and received by customers during the last month of the year were not recorded until the first month of the subsequent year

Group of answer choices

1 and 4

4 and 6

5 and 6

2 and 6

4 and 5

Answer 1

2 and 6

Inventory turnover indicates the rate at which the company can sell its goods or in other words it indicates how many days the stock is lying in the company before getting sold.

Lower inventory Ratio means the stock is lying with the company for a longer period of time, it can happen when the sales are low , stocks lie in the company for a longer period thus decreasing the inventory Turnover

In the above cases

in 2 sales are comparatively less than the prior year thus reducing the inventory turnover

and in 6th point , sales are not recorded in the last month of the current year, which understates the sales which in turn decreases the inventory turnover

The situations in all the other points will increase the sales(overstate), thus increasing the turnover than the prior year, which is not the current observation by the auditor.

Only sales is considered for inventory turnover and not year end purchase of inventory

Therefore 2 and 6 are most likely observations for decrease in inventory turnover