5. Appendix I: Financial Ratios

Question 1

To measure how effectively an entity employs its resources, an auditor calculates inventory turnover by dividing average inventory into:

a. Gross sales.
b. Net sales.
c. Operating income.
d. Cost of goods sold.

Answer 1

Choice “d” is correct. The appropriate numerator for calculating inventory turnover is cost of goods sold. Cost of goods sold is the expense most clearly associated with the sale (turnover) of inventory, which is priced at acquisition cost, not selling price.

Question 2

Return on total assets ratios?

Answer 2

= Net Income / Average total assets

Question 3

Accounts receivable turnover?

Answer 3

= Net credit sales divided by average accounts receivable

Question 4

Average number of days sales in inventory is defined as

Answer 4

365 days per year divided by the inventory

turnover.

Question 5

The average days sales in inventory

Answer 5

First, determine inventory turnover in days:
Average inventory / (CGS/365)
Then
365/inventory turnover

Question 6

Acid-test ratio?

Answer 6

The acid-test ratio is calculated by taking the current assets excluding inventory and prepaid expenses and dividing by current liabilities.

Question 7

Average number of days to collect accounts receivable is calculated by

Answer 7

Dividing 365 days by the
accounts receivable turnover (A/R Turnover)
&
A/R Turnover = Credit Sale / Average A/R

Question 8

Gross Profit Ratio

Answer 8

(Sales - Cost of Sales) / Sales