Question

11.30 SUBSTANTIVE TESTING OF SALES COLO2 James is seeking your advice on the selection of substantive procedures for the audit of his client, Rock Ltd. Rock Ltd is a specialist outdoor clothing and equipment retailer and has experienced reasonable growth over the past three years, although this growth has come substantially from the clothing section. Sales of camping and climbing equipment are down significantly so far this year in all stores except Melbourne. Early results from audit testing show that controls over the sales process are reasonably effective, resulting in a low to moderate control risk. James believes he will need to do some substantive testing of sales, but is unsure about which procedures would be most useful. He has access to Rock Ltd's monthly sales budgets for the period and results for the eight months of the year to date. Required Write a memo to James explaining the substantive procedures for sales that he could choose from and which would be most useful in these circumstances.

Answer 1

11.30 :-

Memo to James:

The key assertions at risk for sales are occurrence, accuracy, and cut-off. In this case, clothing sales are growing, but sales from camping and climbing equipment are down in most stores. Because your risk assessment shows that controls are reasonably effective, I suggest you use monthly sales budgets and actual results to perform analytical procedures for the 8 months to date, then roll-forward results for the remainder of the year.

You should compare budgeted sales with actual sales for the past eight months and test for management review of the results and follow-up of variances. This means that where management has indicated on the report that specific action should be taken; gather evidence to show that such action was taken. Also, you should consider the reasonableness of the action that was recommended. If management have indicated that certain events have occurred which would explain the results, gather evidence that those events did occur and test the reasonableness of the explanation.

In addition, you should obtain industry data for the same period to ascertain if the patterns shown in Rocks results are similar to those experienced by other firms in the industry, and whether the same events and conditions that affected sales also affected sales for those businesses.

Your primary concern with the analytical review is to test the reasonableness of the actual sales data. Therefore, you should form expectations for the actual results based on all the available information and review the results for departures from those expectations. In some cases, no change in actual results would be unusual because you believe that there should be some fluctuation. Use the expense data to help form your expectations. For example, if sales are down, cost of sales should also be down. Compare ratios such as gross profit ratio with the previous period, and correlate the financial data (e.g., sales) with the physical data (e.g., units shipped). In times of uncertainty, such as falling demand for camping equipment, pay careful attention to sales returns and allowances. Substantiate a sample of sales returns, particularly after the year-end.

To test cut-off, I suggest you inspect the journals, ledgers and relevant documents for the period immediately before and after the cut-off date (i.e., this will be done at the year-end not during the interim period), and determine that transactions were recorded in the proper period. Compare revenue cut-off with cut-off for inventory and accounts receivable.

11.32 :-

(a) Accounts:

Payroll expense

Liability accounts Accrued wages, leave provisions (annual, sick, long-service leave all depend on accurate records)

Assertions:

Occurrence, accuracy, cut-off, completeness of payroll expense expense is most likely to be understated (completeness) but could also be overstated (occurrence) because of delay in removing employees from payroll. In addition, accuracy is likely to be violated due to poor records and miscalculations. Cut-off is at risk because of timing of adding and removing employees from payroll.

Completeness, valuation and allocation of liability accounts because accrued wages are not included.

(b) To search for overpayment - All payments made for a week should be tested against underlying record of hours worked, and back to file in human resources to ensure that the employee was employed, and the rate of pay that should be used, for that week.

The amounts for the weekly wages expense should be recalculated.

Additional supporting evidence should be sought to verify the employees right to claim pay.

To search for underpayments details of employee held on file in human resources should be traced to payroll and payment.

All payments and human resource file changes on both sides of year-end should be tested for cut-off.

To verify liabilities search for employees that have not been paid, search for vacation pay entitlements that have not been accrued review files, payments made in previous periods, list of employees added or removed during year, analytical review of payroll expense compared to previous periods, against non-financial data, such as truck movements (i.e., who was driving the truck?, how many drivers have been paid for each truck movement?)

Review payment amounts to ensure that overtime has been paid correctly.