ADM 3350 Study Guide - Inventory Turnover, Net Present Value, Variable Cost

Prior Period 000 omitted

% of Sales

Current Period 000 omitted

% of Sales

% Change

Industry Average as % of Sales

Sales

$10,000

100

$11,000

100

10

100

Inventory

$2,000

20

$3,250

29.5

57.5

22.5

Cost of goods sold

$6,000

60

$6,050

55

0.83

59.5

Accounts payable

$1,200

12

$1,980

18

65

14.5

Sales commissions

$500

5

$550

5

10

N/A

Inventory turnover

6.3

—

4.2

—

(33)

5.85

Average number of days to collect

39

—

48

—

23

36

Employee turnover

5%

—

8%

—

60

4

Return on investment

14%

—

14.3%

—

2.1

13.8

Debt/Equity

35%

—

60%

—

71

30

Risk Analysis

Potential Risk Indicator

a.

Has decreased by 33 percent. This points to and confirms theproblems identified by the increase in inventory and decrease incost of goods sold. There are substantial obsolescence problems,material items are not correctly recorded. Or the inventory hasbeen intentionally increased in anticipation of some unusual eventearly next year as mentioned in the accounts payable increase.

b.

This ratio has increased substantially and is double theindustry average. The company has become highly leveraged. Theincreased leverage has three implications the auditor ought toaddress: the existence of new debt covenants that ought to beaddressed as part of the audit; a potential problem of remaining agoing concern should there be a downturn in operations or asignificant increase in interest rates; there may be concern withhow the debt proceeds have been utilized by the company.

c.

The increase could reflect credit problems or other financingproblems. Such problems could make it difficult for the company tocarry out its on-going activities. It may simply reflect thepurchase of an unusual amount of inventory just beforeyear-end.

d.

This ratio has increased by 23 percent over the previous yearand is 33 percent above the industry average. The increase in theratio could represent a number of problems: less stringent creditstandards; warranty problems; unrecorded returned items or asignificant lag in issuing credit memos associated with returneditems.

e.

There is a substantial increase both in dollar terms and as apercentage of sales, which could indicate potential problems withnew products, with obsolescence, or with competitiveness with otherproducts. It may indicate an increase of just before year-end inanticipation of rise in cost, a strike, or unusually heavy demand.Could be overstated due to misstatements of quantities or prices.This could also affect the COGS change.

f.

This ratio does not indicate a problem. In fact, the companyexceeds the industry average. An alert auditor should wonderhowever, how the company is able to maintain a superior return whenthere are problems with inventory and receivables.

g.

Has decreased to 55 percent of sales at the same time inventoryhas increased. One explanation is that costs have not been bookedfor some significant sales. There may also be a change in productmix.

h.

This is more difficult to interpret, but there is a 60 percentincrease over previous years to a rate that is double that of theindustry. This might indicate problems with morale, qualitycontrol, or other dissatisfaction with the manner in which thecompany is being run.