Question

1. In the planning stage of an audit, auditors frequently consider certain financial ratios. For either of the following two ratios, which are at unusual levels, please state one kind of error or fraud which would explain why the ratio is at an unusual level this year. Ratio #1 The number of days of sales in accounts receivable has increased from 35 to 60. The industry average is 34. [Days of sales in accounts receivable = {ending accounts receivable /sales}*365] OR Ratio # 2 Salesmen’s commission expense = 4% of sales. Last year it equaled 7%.

2. Refer to the same two ratios as in the previous question. For the same ratio you discussed in the previous question, State one reason, that is not an error or fraud, which would explain why the ratio is at an unusual level this year. (This might be a business reason.)

Answer 1

1. Frauds or errors.

Ratio #1. The increase in this ratio might be because, suppression of cash receipts which is a fraud. Even if the cash is received from the receivables, they are not shown and the cash is mislead.

2. Not a fraud or error.

Ratio #1. Their might happen that the receivables are not making good the payments even after consistent efforts to collect the cash. Because non availability of cash with the receivables parties. This is not a fraud or an error but this is because of some other reasons outside the hands of the company.