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11. The ratio of operating cash flow to net income (the cash flow earnings index) would least likely be an “accounting red flag” when it is: A. less than one. B. declining over time. C. highly variable.

Ans: C. Operating cash flow that is less than net income (ratio less than one) or declining over time may indicate low quality earnings from aggressive accounting or accounting irregularities. A ratio that is consistently above one, but highly variable, is not necessarily indicative of accounting irregularities.

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12. A manager whose compensation is tired to improving the firm’s inventory turnover most likely has an incentive to: A. overstate assets. B. understate earnings. C. overstate working capital.

Ans: B. Inventory turnover = . A manager who wishes to manipulate earnings or the balance sheet to show improvement in this ratio can either understate inventories, which would understate working capital and total assets, or overstate COGS, which would understate earnings.