Question

ABC Ltd. is a distributor of ski equipment. The company’s records includes sales and purchase orders, purchasing invoices, a sales journal, a purchases journal, and sub ledgers for both payables and receivables. There is a Canadian and a U.S. bank account.

All customers have a pre-determined credit limit that is noted in their files. If a customer’s order exceeds the authorized credit limit, the credit manager must approve the sale; otherwise, the sales clerk enters and approves the order for processing.

The allowance for doubtful accounts shows that $75,000 worth of receivables are greater than 90 days past due. There are no past due accounts payable. ABC has 4 U.S. suppliers. An allowance for doubtful accounts is prepared by management and done on a case by case basis based on past payment history and management judgment.

The accounting department receives a report each day of goods shipped and purchased goods received. All shipments are invoiced within one day of shipment.

All liabilities are paid within 30 days. An accrual listing is prepared from unmatched receiving reports each month.

Required

Write 4 complete substantive procedures for ABC. For each audit procedure, be clear in the type of procedure e.g. tracing, vouching, observing, scanning, and so on and state the related key management assertion.

Answer 1

Substantive procedure for ABC are as follows:-

• Cut-off Analysis:- This is when you pause operations such as receiving and shipping at the time of the physical count to ensure nothing is being handled and goes unaccounted for. Physical inventory count can also be done. This is to make sure that the system’s numbers match up with your physical stock, counting each unit. Devices like barcode scanners can help keep track electronically. Compare gross margins, inventory turnover ratio, and/or unit costs of inventory with previous years.

• Match invoices to shipping log:- Verify that invoices match the amount of items and cost of Ski equipment shipped from your warehouse. This may be done at random by an auditor to verify that the right amount was charged to the right customer at the right time

• Overhead analysis:- Knowing your indirect costs of doing business will help with budgeting. Outside of direct materials and labor, this looks at “hidden” expenses such as rent, utilities, and other costs of doing business — if you record overhead as part of your inventory costs.

• Freight cost analysis:- This determines the costs of getting things from one place to another, such as freight shipping costs and tracking the time between the date of shipment and the date of receipt. This documentation accounts for any units that are in transit and also in case anything is lost or damaged in transit.

Ralated Management Assertions are as follows:-

• Occurrence:- Occurrence tests if the inventory transactions actually took place. To test occurrence, you should take a sample of additions to ski equipment (purchases) and vouch them to purchase requisitions and receiving reports. Vouching means you take a recorded amount and trace it back to the supporting document.

• Completeness:- Completeness evaluates the management assertion opposite of occurrence. In the inventory management process, understatement (lack of completeness) is your highest risk. In other words, the company buys ski equipment but the purchase isn’t recorded in the ski equipment account.

• The one big reason this problem may occur is poor inventory controls. For example, employees act together to steal ski equipment. First, they team up to order ski equipment. Then, after the ski equipment is received, it doesn’t hit the books — the employees misappropriate the ski equipment (taking it home for personal use or to resell).

  To check for completeness, you sample and then trace the inventory receiving reports to the inventory records to make sure the two reports match.

Remember : When it comes to inventory, the physical inventory at the period end is another measure of completeness. You measure completeness by comparing your client’s inventory compilations to the general ledger listing for inventory.

• Authorization:- This step addresses whether your client’s management and staff follow proper internal control or other company authorization procedures when handling inventory transactions. Disbursements of stored merchandise or raw material inventory should also be made only when approved by appropriate levels of management. To test this assertion, select a sample of material or inventory requisitions and bills of lading to check that all have proper authorization.
• Accuracy:- Testing accuracy addresses whether transactions are free from error. Your two big issues with accuracy are making sure that your client’s mathematical physical ski equipment(Inventory) figures are correct and that the correct amount of ski equipment(Inventory) flows from the balance sheet to the income statement as cost of goods sold.
• Cut-off:- This step involves making sure all transactions have been reported in the proper financial period. You do so by testing receiving and shipping documents to prove that the client has correctly recorded movement into inventory (receiving) and out of inventory (shipping). For example, a client on a calendar year-end can’t record merchandise received on January 2 as December inventory.