Q13. Frank Brill, CFA, is concerned that Moses Aviation is overstating its profits. The best indicator of such action would be Moses

     Aviation’s:

A)   sales-growth rate of nearly twice the industry average.

B)   recognition of revenue from barter transactions.

C)   rising inventory.

Q14. With regards to specific measures to analyze in detecting manipulation in the financial reporting process, which of the following

     statements is the least accurate?

A)   A decreasing days’ sales outstanding (DSO) measure may be an indication of lower quality revenue.

B)   An increasing days’ inventory on hand (DOH) measure may be indicative of obsolete inventory.

C)   Negative nonrecurring or non-operating items may be indicative of misclassifying an operating expense.

Q15. Marcel Schulte is analyzing various retailing firms. Which of the following items is least indicative of a potential problem with

     revenue recognition and earnings quality?

A)   Use of barter transactions.

B)   Disproportionate revenues in the last quarter of the calendar year.

C)   Implementing a “bill and hold” arrangement.

Q13. Frank Brill, CFA, is concerned that Moses Aviation is overstating its profits. The best indicator of such action would be Moses fficeffice" />

     Aviation’s:

A)   sales-growth rate of nearly twice the industry average.

B)   recognition of revenue from barter transactions.

C)   rising inventory.

Correct answer is B)

While an unusually high sales-growth rate may indicate fraud, it could also indicate good management. It’s a yellow flag, but not the best indicator of accounting shenanigans. Rising inventory is also a dual signal. It could be meant to overstate profits, or it could simply reflect an actual buildup of inventory in response to market forces or corporate operations. However, companies should not recognize revenue from barter transactions. The additional revenue is likely to improperly boost profits.

Q14. With regards to specific measures to analyze in detecting manipulation in the financial reporting process, which of the following

     statements is the least accurate?

A)   A decreasing days’ sales outstanding (DSO) measure may be an indication of lower quality revenue.

B)   An increasing days’ inventory on hand (DOH) measure may be indicative of obsolete inventory.

C)   Negative nonrecurring or non-operating items may be indicative of misclassifying an operating expense.

Correct answer is A)

Days’ sales outstanding (DSO) measures the number of days it takes to convert receivables into cash and is calculated by dividing the number of days in the period by the accounts receivable turnover ratio. An increasing DSO (decreasing receivables turnover) may be an indication of lower quality revenue; that is, the longer it takes to collect from customers, the more likely the receivables will turn into bad debt.

Days’ inventory on hand (DOH) is equal to the number of days in the period divided by inventory turnover ratio and it measures the number of days it takes to sell inventory. An increasing DOH may be indicative of obsolete inventory.

Analysts should compare changes in the core operating margin over time and look for negative nonrecurring (e.g., restructuring charges, asset impairments, and write-downs) or non-operating items that occurred when the ratio increased. This may be the result of misclassifying an operating expense.

Q15. Marcel Schulte is analyzing various retailing firms. Which of the following items is least indicative of a potential problem with

     revenue recognition and earnings quality?

A)   Use of barter transactions.

B)   Disproportionate revenues in the last quarter of the calendar year.

C)   Implementing a “bill and hold” arrangement.

Correct answer is B)

Disproportionate revenues in the last quarter may be an indication of aggressive revenue recognition to meet analyst forecasts but it is much more likely if the firm is a non-seasonal one. A retailing firm presumably has a disproportionate amount of sales during the busy Christmas season in the last quarter of the calendar year so this point alone would not be indicative of a potential problem.

In a barter transaction, two parties exchange goods or services. The main issue is whether: (a) a sale transaction has actually occurred in substance; (b) it is not a “sham” transaction; and (c) the transaction amount is overstated.

Bill and hold occurs when the retailer (seller) invoices the customer but does not ship the goods until a later date. Alternatively, the seller may ship the goods to a location other than the customer’s. In either case, the seller may be recognizing revenue prematurely.