An auditor discovered that a client's accounts receivable turnover is substantially lower for the current year than for the prior year. This may indicate that:

Question

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Choice "A" is correct. Recording fictitious sales generally has the same impact on revenues and receivables: both would be overstated by the same dollar amount. However, this will cause the accounts receivable turnover ratio to decrease, because the sales figure for the year is generally much larger than the average receivables amount. Since the numerator (sales) is being increased far less proportionately than is the denominator (receivables), overall the ratio will decline. (Try using actual numbers if you want to see how this works: Assume sales of $2,000,000 and average receivables of $300,000. What will happen to the ratio if you increase both of these numbers by $50,000? It will go from 6.7% to 5.9%--a decline.) Choice "B" is incorrect. Inventory stolen by employees just before year-end would not affect the accounts receivable turnover ratio, which is calculated as net credit sales divided by average gross receivables. Choice "C" is incorrect. A substantially lower accounts receivable turnover ratio may indicate collectability issues. This might be the result of the client loosening (not tightening) its credit-granting policies. Choice "D" is incorrect. If an employee has been lapping receivables in both years, the accounts receivable turnover ratio would not be substantially lower in one year compared to the other.

An Auditor Discovered That a Client's Accounts Receivable Turnover Is