What is the most likely effect of High Plains’ revenue recognition policy on net income and inventory turnover?

High Plains’ average net operating assets at the end of 2008 and 2007 was $977.89 million and $642.83 million, respectively.

What is the most likely effect of High Plains’ revenue recognition policy on net income and inventory turnover?
A . Net income and inventory turnover are overstated.
B . Only net income is overstated.
C . Only inventory turnover is overstated.

View Answer

Answer: A

Explanation:

Revenue should be recognized when earned and payment is assured. High Plains is recognizing revenue as orders are received. Since High Plains still has an obligation to deliver the goods, revenue is not yet earned. By recognizing revenue too soon, net income is overstated and ending inventory is understated. Understated ending inventory would result in an overstated inventory turnover ratio. (Study Session 7, LOS