ACC3603

Case 3
Sales & AR
Ahad Vakil
Michelle Tan
Ng Zheng Wei
Fang ChunChun
Tan Tse Jie
Janice Lai
Yang Yi Chao
Q1. (a) Based on the work performed, are there any
actual or possible material misstatement(s) to sales?
Quantify the misstatement(s) based on the
information provided
 Actual Misstatements at Assertion Level
1. Classification

INV/DEC12/665
The consignee PAPL does not own legal rights of the consignment
goods
Revenue from sale of consignment goods is not earned by PAPL and
thus its sales should not be included in the revenue
Overstatement of sales revenue in 2012 by $10,000

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 Actual Misstatements at Assertion Level
2. Cutoff

INV/DEC12/668
Delivery date of goods delivered to Santa Pte Ltd is 2-Jan-13, which is
after the financial year 2012
However, sales are recognized in Dec 2012 instead of Jan 2013
As sales are recognized at FOB shipping point basis, sales will be
overstated in FY 2012 by $30,000 and understated in FY 2013 by
$30,000

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 Possible Misstatements at Assertion Level
3. Completeness

INV/DEC12/666 missing from the sequential order of the last four

invoices
Need to verify the reasons for the invoice being missing.

No actual misstatements if the invoice is void, cancelled, or if the

goods have not been shipped yet.

If it is misplaced, there would be a possible understatement of sales

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 Possible Misstatements at Assertion Level
4. Occurrence
Occurrence of sales
Auditors have only selected the clients internal documents
Reliability of the audit evidence is low
There might be fictitious sales made
Possible overstatement of sales

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 Possible Misstatements at Assertion Level
5. Cutoff
According to the client, all the sales are made on FOB shipping point basis.
Audit evidence is obtained directly from the client
Level of reliability of the audit evidence is low
Client can choose to record the sales in the period that is more favorable to
them
Auditors failed to verify whether each of the transactions made are FOB
shipping point or FOB destination
May affect the cut-off of sales
Possible misstatements in sales

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 Q1(b) What would be the adjusting journal entry to the
sales account to correct the quantifiable
misstatement(s) in sales?
Dr Cr
Dr Sales $30,000
Cr Accounts Receivable $30,000
Reversal of sales INV/Dec12/668

Dr Sales $10,000
Cr Accounts Payable - Maryland $10,000
Reversal of sale of consignment
goods INV/Dec12/665

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 Q1(c) Are there other income statement account(s) that
would be affected by the misstatement(s) in sales?
1. Overstatement of COGS
INV/Dec12/668 COGS should be recorded in the next period

INV/Dec12/665 sale of consignment inventory should not be included

2. Commission revenue
From sale of consignment inventory

Dr Accounts Payable - Maryland

Cr Commission revenue

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 (d) Would your answer in (a) and (b) be different if
sales transaction Inv/Dec12/667 is on FOB destination
terms?
FOB destination terms: sale does not occur until the goods
reach the destination record sales only when goods
arrived at the destination and received by the client
For sales transaction Inv/Dec12/667, as the goods are only
sent out on 31 Dec 2012, it is unlikely that the customer in
Mexico can receive the good in year 2012 shouldnt
record the sale in 2012

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 The sale should be recorded in 2013 (when the goods are
received by the client) if transaction is on FOB destination
terms.
Adjusting Journal Entries for cutoff misstatement:
Reserve the journal entries for sales transaction
Inv/Dec12/667
Dr Cr
Dr Sales $30,000
Cr Accounts Receivable $30,000
Reversal of sales INV/Dec12/667

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(e) Explain whether you will propose any change(s)
to the sales cutoff procedures, based on results of
the testing performed so far (including taking
into consideration Inv/Dec12/667 as a FOB
destination sale)?
 Need for audit adjustment
Audit procedures to compare details in the invoice and the details in
the delivery notes (or other shipping documents showing delivery of
goods such as good receipt note), particularly the date when invoice is
recorded and the date of the delivery.
The current method of starting from Sale Day Book (Accounts) & trace
to the Source failed to detect possible misstatement for AR (i.e
completeness, FOB destination sales)
As the client might have misstated its sales and AR due to cut-off error,
there is a need for audit adjustment.

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 Current Method
Start from Sale Day Book (Accounts) & trace to the Source, test for occurrence,
accuracy and cutoff
Select the last few (4) sale invoices recorded in the sale day book before the financial
year end and trace details to delivery notes to see whether goods were delivered
before year end.
If goods were delivered before year end, no cutoff error. If goods were delivered
after year end, cut off error.
Select the first few (4) sale invoices recorded in the sale day book after the financial
year end and trace details to delivery notes to see whether goods were delivered
after year end.
If goods were delivered after year end, no cut off error. If the goods are delivered
before year end, cut off error.

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 New Method
Start from delivery notes (source) and trace to the accounts
Test for completeness

Accounts Receivable Testing

For sales on FOB destination

Select more samples for testing

Select a longer accounts period for testing

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 Select the last 6 weeks and at least 20 delivery notes before year end and
trace details to sale invoices and then to the receivable ledger and
general ledger to see whether the sale invoices are recorded in the
ledgers before year end
Select the last 6 weeks and at least 20 delivery notes after year end and
trace details to sale invoices and then to the receivable ledger and
general ledger to see whether the sale invoices are recorded in the
ledgers after year end
Furthermore, the company should inspect sales agreement/contract to
determine whether the sales is on FOB or FOB destination basis, which
may affect cut off.

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 Accounts Receivable Testing
Auditors should send confirmation letters to companys customers to
confirm the amount owed to the company as of balance sheet date
When customer replies that the balance wasnt owed as of balance sheet
date, it signals potential cutoff problem
However, this method does not provide adequate concern over cutoff on
its own and additional procedures are likely to be performed

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 FOB Destination Sales
For FOB destination sales, there is a need for auditors to check if there is
a copy of delivery note signed by the recipient to determine when goods
are received
Sales should only be recorded after a signed copy is received
There may be cutoff error if the company records sales according to the
delivery note sent by the company instead of the one received by the
client

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Q2: Comment on the appropriateness of the type of accounts
receivable confirmation that the auditors have sent to the
companys debtors, and under what circumstances are such
confirmations most effective.
 To determine the appropriateness of the type of accounts
receivable confirmation that the auditors have sent to
the companys debtors:
1. Determine the appropriateness of the number of confirmation letters sent out
Higher risk of overstatement than understatement select debtors with large balances
Confirmation was sent out to 30 trade debtors with the largest balances
Appropriate since 30 is a reasonable number to audit for >70% of OMLs overall AR (70%
contributed by 25 largest debtors)
There is high inherent risk for OML
High accounting risk because of impairment
High management risk because of pressure to show strong financial results
Moderate control risk despite OML being a major regional food manufacturer
Supposedly good but there is risk of human error, controls circumvented by collusion, management override
No test of controls by auditors could imply poor internal controls
Therefore there is high RMM, which calls for a substantial extent of audit work required, justifying
the audit of all the 30 largest debtors.

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 To determine the appropriateness of the type of accounts
receivable confirmation that the auditors have sent to
the companys debtors:
2. Method of confirmation: Negative confirmation
The debtors were told to confirm directly with the auditors only when they disagree with
the AR balances stated in the letters, and that there is no need to respond if they agree
with the correctness of the information.

3. Under what conditions are negative confirmation most effective:

There are many debtors with outstanding balances at year end
All individual debtor balances are small on their own
Clients internal control over debtor recording is good and thus the risk of misstatement in
receivable is considered low

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 To determine the appropriateness of the type of accounts
receivable confirmation that the auditors have sent to
the companys debtors:
4. OML meets the condition:
Individual debtor balances are small on their own (25 to account for 70%,
30 to account for more than 70% )
- But there are not many debtors with outstanding balances at year end and
clients internal control over debtor recording may not be good

5. However, negative confirmation may be less reliable since no reply could be

due to reasons other than debtors agreeing with the balances.

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 Limitations
6. Negative confirmation may be less reliable since no reply
could be due to reasons other than debtors agreeing with the
balances:
Did not receive confirmation letter
Sent out confirmation request letters personally
Did not understand confirmation letter and hence did not
reply
Cannot be bothered to reply

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 Blank Confirmation
The auditors may want to implement blank confirmation
because there exist a risk of understatement by the trade
debtor.
Should the accounts receivable balance in OMLs
statements be understated, there is a risk that debtors may
just confirmed whatever balances stated. In undertaking
bank confirmation, the confirmation request should leave
the balance to be confirmed as blank for the debtors to
fill in the balance according to the debtors accounting
record.

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 Additional Points
The audit procedures in vouching to source documents
for invoices-in-transit are appropriate. Also, signatures of
customers enhances the reliability of audit evidence.

The audit procedures for cash-in-transit are appropriate

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