Trend and Jones, CPAs, were planning their initial audit of Kargo Corporation, whose stock traded on the New York Stock Exchange. Although the partners had consulted with the predecessor auditor and had reviewed prior-year working papers, they still had a number of questions about the areas that should be given special attention in the audit. To provide them with more insight, Ms. Trend and Mr. Jones decided to take the published financial statements of Kargo Corporation for the last two years and the statements for the first quarter of this year and develop some ratios. They calculated the following amounts.

In addition to these ratios, the following information is available.
1. Kargo's credit terms are 30 days net.
2. The Kargo Corporation has a loan restriction that requires it to maintain at least a 2 to 1 current ratio.
3. The "normal" inventory turnover for the industry in which Kargo Corporation operates is 10.

Required:

a. Indicate the areas in which the auditors should concentrate special effort. Consider only the areas revealed by the ratio analysis. Do not name specific audit procedures.

b. Discuss actions that the management of Kargo might be inclined to take to cover up any possible adverse effects of these listed ratios. What could the auditors do to provide reasonable assurance that they found these actions?

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1st Quarter 19X6 19X7 19X8 Current ratio 2.1 to 1 2.0 to 1 1.8 to 1 Accounts receivable turnover 8.3 8.4 8.6" Inventory turnover 7.4 9.2 10.8" Times interest carned 1.7 1.6 1.4 Earnings per share 10.50 11.62 3.45 Debt/equity ratio .95 1.20 1.24 Dividends per share 2.50 3.00 .90 "Annualized.