Gustav Humphreys (chair of the board) and Ingrid VanEns (vice president, finance) prepared the draft of the financial review section of the annual report. You are reviewing it for consistency with the audited financial statements. The draft contains the following explanation about income coverage of interest expense: Last year, operating income before interest and income taxes covered interest expense by a ratio of 6: 1. This year, on an incremental basis, the coverage of interest expense increased to a ratio of 6.59: 1. The relevant portion of the audited financial statements showed the following:

Required:

a. Determine whether the financial review section statement about coverage of interest is or is not consistent with the audited financial statements. Be able to show your conclusion with calculations.

b. Assume that you find an inconsistency and the officers disagree with your conclusions. Draft the other- matter paragraph you should include in your auditors’ report.

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Prior Year Current Year Operating income Extraordinary gain from realization of tax benefits Interest expense Income taxes Net income $400,000 $360,000 (60,000) (120,000) (81 250) (127,500) SZ91 250 S180,000