a) (1) gross margin ratio = gross margin / revenue

(2) inventory turnover = average inventory / cogs

2008 2007 2006

Gross margin 52% 51% 51%
Inventory turnover 5,6 5,89 5,9

b) The gross margin represents the percent of total sales revenue that the company retains
after incurring the direct costs associated with producing the goods and services it sells. The
higher the percentage, the more the company retains on each dollar of sales, to service its
other costs and debt obligations.
Logical causes of the changes in the gross margin as a percent of sales include:
1. Selling prices were raised without a corresponding increase in cost of sales.
2. The method of accounting for inventory was changed, causing a higher ending
inventory (moreexpenses absorbed into inventory) and lower cost of sales.
3. Inventory cutoff was improper, causing sales to be recorded without the
corresponding entry tocost of sales.

4. The product mix of the company changed. More high markup items were sold
than in previousyears.

5. An improper journal entry was recorded which adjusted the gross margin upward.

c) Inventory turnover measures how fast a company is selling inventory and is generally
compared against industry averages. A low turnover implies weak sales and, therefore, excess
inventory. A high ratio implies either strong sales and/or large discounts.
Logical causes of the changes in the inventory turnover include:

1. The increased selling prices, which caused the gross margin percent to increase,
reduceddemand for the product, and decreased the inventory turnover.

2. The company is building its inventory supply in anticipation of increased

sales in thefuture.

3. The company's inventory contains obsolete or unsalable merchandise, which is

affectingthe turnover rate.

d) The auditor should discuss the two changes with the client and obtain a reasonable
explanation for them. He or she should then perform appropriate procedures to verify
the validity of theexplanation. Ultimately, the auditor must be confident the
change does not result from amisstatement in the financial statements.
e) gross margin
Results Industry Substantive
calculated averages testing
2008 52% > 49% Decrease
2007 51% > 49% Decrease
2006 51% > 48% Decrease

Inventory Results Industry Substantive

turnover calculated averages testing
2008 5,6 < 5,7 Increase
2007 5,89 > 5,8 Decrease
2006 5,9 = 5,9 Originally