We considered broad \"accounting systems\" involving the Sales Cycle AND Invento
ID: 2462512 • Letter: W
Question
We considered broad "accounting systems" involving the Sales Cycle AND Inventory Observation to illustrate the direction of testing involving testing for overstatement or understatement. Requirements: 1. Consider THREE ADJACENT pieces of the sales cycle and DISCUSS the proper direction of testing for Sales for UNDERstatement. 2. In an Inventory Observation, discuss the proper direction for taking test counts to test for UNDERstatement of inventory? 3. The double-entry accounting system conceptually can be used to gain audit efficiencies. Use "journal entries" and explain how by testing another account one can also test (A) Accounts Receivable for UNDERstatement; and how by testing another account one can test (B) a liability account (name the account) for OVERstatement. 4. Discuss briefly the type of audit evidence used to test sales for overstatement? 1. Sales for UNDERstatement 2. Physical Inventory testing for UNDERstatement 3A. JE & Discussion. Accounts receivable Understatement. 3B. JE & Discussion. Liability account for OVERstatement. 4. Type of evidence, Sales for overstatement.Explanation / Answer
1 :Sale for understatement
Audit procedures will best uncover an understatement of sales :
2 : Physical inventory testing for understatement
Inventory valuation procedures Raw materials and consumables · Ascertain what elements of cost are included e.g. carriage in, duties. Etc If standard costs are used, enquire into basis of standards, how theses compare with actual costs and how variances are treated. · Test check cost prices used with purchase invoices received in the month(s) prior to counting. · Follow up valuation of all damaged or obsolete inventories noted during observance of physical counting with a view to establishing a net realizable value. Work in progress
Ascertain how the various stages of process are measured and if estimates are made, on what basis they are made. Ascertain what elements of cost are included. If overheads are included, ascertain the basis on which they are included and review this basis with the available costing and financial information. ·
Ensure that any material costs exclude any abnormal wastage factors. Finished goods and goods for resale. · Enquire into what costs are included, how these have been established and ensure that the overhead included is based on normal costs and is reasonable in relation to the information disclosed by the draft FS. ·Test check prices on inventory lists with official sales price list, bearing in mind any trade discounts which are normally granted off the list prices. · Ensure that inventories are valued at net realizable value if this is less than cost. For any such items, also check back and see if the relevant partly processed inventories and raw materials have also been written down. Follow up any items which is obsolete, damaged, slow moving ascertain the possible realizable value of such items. · Follow up any inventories which at time of observance of physical counting were noted as being damaged or obsolete.
3 A : JE & Discussion . Account receivable understatement
Account receivable is documented through an invoice, which you are responsible for issuing to the customer through a billing procedure. The invoice describes the goods or services you have sold to the customer, the amount it owes you (including sales taxes and freight charges), and when it is supposed to pay you.
Operating under the cash basis of accounting, you only record transactions in your accounting records (which are then compiled into the financial statements) when cash is either paid or received. Since issuing an invoice does not involve any change in cash, there is no record of accounts receivable in your accounting records. Only when the customer pays you do you record a sale.
Operating under the more widely-used accrual basis of accounting, you record transactions irrespective of any changes in cash. This is the system under which you record an account receivable. In addition, there is a risk that the customer will not pay you. If so, you can either charge these losses to expense when they occur (known as the direct write-off method) or you can anticipate the amount of such losses and charge an estimated amount to expense (known as the allowance method). The later method is preferred, because you are matching revenues with bad debt expenses in the same period (known as the matching principle).
For example, ABC International billings a customer for $10,0000 in services, and records the following entry:
Debit
Credit
Accounts receivable
10,000
0
Sales
10,0000
3 B : JE & Discussion . Liability account for over statement
The cost has been recorded as assets or liabilities and but will be recognized as expenses or liabilities over time or through the normal operations of the business.
The expenses or revenues have not been recorded in the accounts but need to because a certain event has taken place which requires the accounts to be adjusted.
Examples: Accrual interest There are two major types of adjustments related to interest:
Interest due to you Dr. Interest Receivable
Cr. Interest Income
Interest Owed by you Dr. Interest Expense
Cr. Interest Payable
4 : Types of evidence . Sale for overstatement
Accounting system is made up of records and procedures.A company the nature of these records and procedures are governed by the law.
As a few the company records must include:
Debit
Credit
Accounts receivable
10,000
0
Sales
10,0000
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