Question

An auditor who performed analytical procedures that compared current-year financial information to the comparable prior period noted a significant increase in net income. Given this result, which of the following expectations of recorded amounts would be unreasonable?

A)Revenue should be consistent with the industry norm.
B)Operating expenses should vary in proportion to sales.
C)Cost of goods sold should vary in proportion to sales.
D)Income tax expense should decrease in proportion to the increase in net income.

Answer 1

It would be unreasonable to expect that income tax expense decreases in proportion to an increase in net income because tax expense is typically progressive. A company's financial trends should align with industry norms and expenses should vary in proportion to sales, except for taxes which generally increase as income increases.

Step-by-step explanation:

An auditor who performed analytical procedures and noted a significant increase in net income would expect certain trends in the financial statements. It would be reasonable for revenue to be consistent with industry norms, for operating expenses to vary in proportion to sales, and for the cost of goods sold to vary in proportion to sales. However, it would be unreasonable to expect that income tax expense should decrease in proportion to the increase in net income. While net income rises, income tax expense typically increases as well, as the tax is often a progressive percentage of the net income before taxes.

Regarding the self-check questions, using the provided data, the firm's accounting profit would be the total revenues minus the explicit costs, which equals $1,000,000 - ($600,000 + $150,000 + $200,000) = $50,000.