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berry0331
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Joined: 04 Sep 2011
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Posts: 49

Posted: 08 Aug 2012 at 07:50 \| IP Logged

1. This is the 1st question for Chapter 4 SIM part 2. I don't understand the
given explanation below. Why the answer is decrease instead of increase?
Can anyone help me out on this?

Gross profit percentage
Year2 38%
Year1 41%

Explanation:
Manufacturing cost decreased less than sales decreased during the
year
Gross profit percentage is calculated as (net sales - cost of goods sold) /
net sales. Based on the figures provided in the financial statements,
manufacturing cost (i.e., cost of goods sold) decreased less than sales
decreased. Since both the numerator and the denominator are affected,
the effect on this ratio will depend on the percentage change in the
numerator vs. the percentage change in the denominator. In this case,
given the specific financial statement amounts provided, these changes
resulted in a greater percentage reduction in the numerator than in the
denominator, causing a decline in the gross profit percentage.

2. I have a general question about ratio for analytical procedures. If both
the numerator and denominator are affected by an increase/decrease,
how would I know the combined result of the increase/decrease? Is there
a particular pattern for it?

Here's the question(chapter4 SIM3 question 1) that deals with the ratio.

Inventory stored at the distribution center on December 31, Year2, was
inadvertently omitted during the Year2 physical inventory count, to which
the general ledger was adjusted.

Explanation:
Inventory turnover = Cost of goods sold / Average inventory Return on
equity = (Net income - Preferred dividends) / Average common equity
1. Decreases | Increases
If inventory is omitted but all other items are correctly stated, ending
inventory will be understated while cost of goods sold will be overstated
by the same amount.
An increase in inventory (denominator) and a decrease in cost of goods
sold (numerator) will both cause the inventory turnover ratio to decrease.
The decrease in cost of goods sold will result in an increase to net
income, which in turn also causes an increase in equity. Generally,
however, the effect on the numerator will be proportionally greater than
the effect on the denominator (since income is just a portion of equity),
and therefore return on equity will increase.

3. What exactly is a canceled check in auditing?

Any input is welcome. Thank you!!!

afroz
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Joined: 22 Sep 2011
Location: United States
Online Status: Offline
Posts: 76

Posted: 08 Aug 2012 at 21:14 \| IP Logged

for your first question - its given that Decrease in Manufacturing cost is less than the Decrease in Sales for that period.
Following is my understanding-

In year 1, Sales is $100 and COGS is $80 so the Gross profit is $ 20 and Gross profit margin is 20/100 =20% now,
In year 2, it says Both Manufacturing cost and Sale are decreased but Decrease in Manufacturing cost is LESS than the Decrease in Sale so , if

Sale is decrease by $30 than the percentage decrease in sale would be (30*100)/100 = 30% and if Manufacturing cost decrease by $20 (which is less decrease compare to decease in sale) than the percentage decrease in COGS would be (20*100)/80=25%

For the above explanation year 2 Gross profit margin would be
(70-60)/70=14%
So have to remember if the percentage decrease in denominator is MORE that the percentage decrease in Numerator than the overall ratio will be decreased.

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sharmin afroz

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