Question

In your 2013 audit of B. Industries, you found several issues that you think may indicate possible to the company's books. These issues are listed below. Management does not want to make any adjustment to the books, as they prefer not to revisits old records once a fiscal year has ended. Planning materiality for the company's audit was $100,000, determined by computing 5% of expected income before taxes. Prior to any adjustments, actual income before taxes on B Industrial financial statement is $1,652,867. Possible Adjustments : 1. Several credit memos that were processed and recorded after year-end relate to sales and Account Receivable for 2013. These total $ 23,529. 2. Inventory cutoff test indicate that $22,357 of inventory received on December30, 2013, was recorded as purchase and Account Payable 2014. These items were included in the inventory count at year end and were therefore included in ending inventory. 3. Inventory cutoff test also indicate that several sales invoices were recorded in 2013 for goods that were shipped in early 2014. The goods were not included in inventory, but were set aside in a separate shipping area. The total amount of these shipment was $ 36.022. (Ignore COGS for this item). The company wrote several checks at the end of 2013 for Account Payable that were held and not mailed until January 15, 2014. These total $48.336. Recorded cash and Account Payable at December 31, 2,356,553 and $ 2,666,290 respectively. 5. The company has not established an allowance for obsolescence of inventories. Your tests indicate that such an allowance is appropriate in an amount somewhere between $20,000 and $ 40,000. Required: a. Determine the adjustment that you believe must be made for B Industrie's financial statement to be fairly presented. Include the amounts and accounts affected by cash adjustment. b. Why may B Industries' management resist making these adjustment?. C. Explain what you consider the most positive way of approaching management personnel to convince them to make your proposed changes. d. Describe tour responsibilities related to unadjusted misstatements that management has determined are immaterial individually and in the aggregate. e. Assuming B Industries is a publicly listed company, describe how the noted adjustment might impact your audit report on internal control over financial reporting. 4.

Answer 1

a) The following adjustments entries required to booked in B Industries' books.

1) Sales A/c Dr. $23,529

Accounts Receivable Cr. $23,529

(Being the value of credit memos issued subsequent to the book closure but related to financial year 2013)

2) Purchases A/c Dr. $22,357

Accounts Payable A/c Cr.$22,357

(Being the cost of purchases that were included in physical inventory and already accounted but not shown as purchase resulting in mis-match between physical inventory vs the book inventory)

3) Sales A/c Dr. $36,022

Goods in Transit Cr. $36,022

(Being the goods kept aside and recorded as sales but actually dispatched post year end)

As per FASB’s Statement of Financial Accounting Concept (SFAC) No. 5 “revenue is to be recognized when it is realized or realizable and when it is earned”.

There are 5 key criteria' to be reviewed before revenue can be considered as earned and recorded in the books. They are

A) Collection is reasonably assured

B) Evident of the delivery of the goods/services (either physical or electronic)

C) There is a persuasive evidence of arrangement in the form of Purchase Order / Contract

D) There is pre-determined or fixed price for the goods & services

E) There is a fair value for all undelivered items to recognize the revenue separately.

In the event of failure to comply with any one of the criteria' the revenue cannot be recognized. In this case the goods were kept aside but was never delivered hence the revenue cannot be recognized and must be reversed.  This is a classic example of Overstaing revenue and may be construed as fraud to showcase higher revenue in order to attract more investment.

4) There is no need to record journal entry for the cheques prepared but not mailed to vendor as it does not impact the revenue or the profit of the organization. Besides, this would anyway come out of Bank reconciliation Statement.

5) Allowance for Obsolete Inventory Dr. 20,000

Cost of goods sold (COGS) Cr. 20,000

(Being allowance for Obsolete inventory created as per Principle of Conservatism) Though there is no policy in place, considering the market practices it is advisable to provide for a min amount in books.

b) The bottom line of any business’ income statement is considered one of the most critical indicators of corporate wealth. While net income is paramount for current and prospective shareholders and creditors to make rational investment decisions, profits would be nonexistent without the presence of revenue. Revenue, which enhances the equity of any business, hence the Management does not want to alter the revenue numbers even though the it results in decline in net earnings and net Tax outflow.  

c) Explain the observations, the impact of value and also share with legal case studies or the rulings of SEC in  such cases to substantiate the findings and why the adjustments need to be carried.

d) The adjustments must be made in the books. However, if the management does not agree with the findings and consider it immaterial to record the transactions it will be qualified in the audit report.

e) The auditor's objective in an audit of internal control over financial reporting is to express an opinion on the effectiveness of the company's internal control over financial reporting. Hence the audit report would show that the internal control is ineffective and material weaknesses exist as of the date specified in management's assessment. (A material weakness in internal control over financial reporting may exist even when financial statements are not materially misstated.)