Question

kpmg llp served as the external auditor

unter during rally being a auditor address "senior management. a. What audit evidence-related problems did DTT encounter du the audit of Longtop? b. Exhibit 6.8 describes external confirmations as generally beine reliable, high quality type of evidence. When would that ger ity not be accurate? What assumptions should the auditor ad concerning confirmations before concluding that using confirma tions will result in reliable audit evidence? c. Explain the role of professional skepticism in the context of eval ating evidence obtained from confirmations. 6-32 GATEWAY COMPUTERS (LO 1, 2, 4) The SEC took action against Gateway Computers in 2001 because it believed that Gateway systematically understated the allowance for doubtful accounts to meet sales and earnings targets. This is essentially the way the alleged fraud took place: • Gateway sold most of its computers over the Internet and had a strong credit department that approved sales. • When sales dropped, management decided to go back to customers who had been rejected because of poor credit approval.

Answer 1

a) The allowance is determined on the basis of the credit sales made to the customers. Allowance for doubtful debts is a certain percentage charged on the credit sales for the accounts receivable whose recovery is doubtful. It is based in the terms of the sales, past data etc. This is different from the recording of the transaction on cash basis. In case of cash transaction all the revenue is recognized at the time of sale. However in case of credit sales an estimation is provided for the debts which are doubtful. While determining the allowance for doubtful debts the entity should be more precise. It should observe the past data, the trends exists and the financial terms of the customer to whom credit is provided.

b) The company should should make the allowance for doubtful debts at an estimated percentage. This percentage is decided on the basis of the past records of the customers. The credit period allowed. The relationship with the customers. When the entity make credit sales to new customers it should be very precise while making the allowance for the doubtful debts. The rate for allowance should be estimated on the basis of the terms agreed between them. However the company has made credit sales to new customers but did not revise the allowance estimation.

c) The auditor while carrying out the audit of the entity should obtain all the reasonable audit evidences on the basis of which the entity has estimated the allowance. The auditor should check whether the estimation is based on the valid base. The auditor should analyze the past trends. The relationship of the customers and the financial feasibility of the customers.

d) The company has made the credit sales to the customers. While making the credit sales the risk for non payment also arises. The company should increase the estimated expenditure for allowance for doubtful debts. Because as the credit sales increase the bad debts also increases. And so the company's allowance for doubtful debts will be affected by it's expansion to new customers on credit.