Question

This research assignment is an actual simulation directly taken from the audit section of a CPA exam. Please research the questions and provide the correct answer along with a short explanation as to why you chose that answer. Each question is worth ten points.

Gloria CPA, an auditor for Smart Move Inc., observed changes in certain Year 2 financial ratios or amounts from the Year 1 ratios or amount. For each observed change, answer the following questions regarding possible explanations. (Assume that the turnover ratios were calculated using year-end balances.)

Inventory turnover decreased substantially from the prior year. Which of the following is a possible explanation for this finding?

A. Items shipped FOB shipping point during December, Year 2, were included in Year 3 sales.

B. Items shipped on consignment during the last month of the year were recorded as sales.

C. A significant number of credit memos for returned merchandise that were issued during the last month of the year were not recorded.

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

Accounts receivable turnover decreased substantially from the prior year. Which of the following is not a possible explanation for this finding?

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. A larger percentage of sales occurred during the last month of the year, as compared to the prior year.

D. Sales increased at a lower percentage than cost of goods sold increased, as compared to the prior year.

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. Which of the following is not a possible explanation for this finding?

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. A larger percentage of sales occurred during the last month of the year, as compared to the prior year.

D. Sales increased at a lower percentage than cost of goods sold increased, as compared to the prior year.

Long-term debt increased from the prior year, but interest expense increased a larger-than-proportionate amount than long-term debt. Which of the following is a possible explanation for this finding?

A. A significant amount of long-term debt was paid off during the current year.

B. Long-term borrowing was refinanced on a short-term basis at lower interest rates.

C. Short-term borrowing was refinanced on a long-term basis at lower interest rates.

D. Short-term borrowing was refinanced on a long-term basis at higher interest rates.

Answer 1

Inventory turnover decreased substantially from the prior year. Which of the following is a possible explanation for this finding?

A. Items shipped FOB shipping point during December, Year 2, were included in Year 3 sales.

Explanation: The equation for inventory turnover ratio is the cost of goods sold or COGS divided by average inventory. If the inventory turnover ratio decreased, it means that the average inventory was increased COGS was reduced as compared to prior year.

Thereby decreasing the sales amount for year 2. And inventory turnover ratio decreased.

Accounts receivable turnover decreased substantially from the prior year. Which of the following is not a possible explanation for this finding?

D. Sales increased at a lower percentage than cost of goods sold increased, as compared to the prior year.

Explanation: receivables turnover ratio can be calculated by dividing the credit sales during a given period by the average accounts receivable during the same period. Decreased ratio means either decrease in net value of credit sale or increase in average accounts receivable.

Since sales increased in this case, the ratio should increase in this case.

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. Which of the following is not a possible explanation for this finding?

D. Sales increased at a lower percentage than cost of goods sold increased, as compared to the prior year.

Long-term debt increased from the prior year, but interest expense increased a larger-than-proportionate amount than long-term debt. Which of the following is a possible explanation for this finding?

D. Short-term borrowing was refinanced on a long-term basis at higher interest rates.

Explanation: this explains the increased debt and interest expenses.