OVERSTATED SALES AND ACCOUNTS RECEIVABLE

Overstated Sales and Accounts Receivable

Overstated Sales and Accounts Receivable

Problem 7.50

Introduction

The facts of this case show that Mattox Toy Manufacturing Company had experienced several years of good business. When competition became worse, the company's business began to deteriorate. As a result of this, the company adopted some procedures to show more revenue in the books such as 'bill and hold' and field warehousing. Sales were made to large retailers with a non concealable agreement asserting their purchase and payment. Merchandise was held in the company's warehouse on behalf of customers until they were shipped to customers' location. The main problem in this case is lack of proper controls in the warehouse that caused mix up of company merchandise and merchandise belonging to the customer. Proper accounting procedures were not followed with respect to 'bill and hold' and close out sales during the last month of the fiscal year. Weak internal controls, lack of documentation and an improper accounting system are some of the main reasons that caused the revenue of Mattox to be misstated in financial accounts.

Process and Benefits of Audit Sampling

Audit sampling is defined by SAS 39 as “the application of an audit procedure to less than 100 percent of the items within an account balance or class of transactions for the purpose of evaluating some characteristic of the account balance or class of transactions.” This technique begins with examination of less than 100 percent of items in a population and extending the results to the whole population. Sampling can be used in situations where transaction processing is similar for the entire transaction. For example, in checking the correctness of accounts payable invoices, audit can be done by testing a sample of say 10% of the total invoices. Similarly for sales cycle, sampling can be used to check a few sales invoices and related documents to make sure sales are recorded correctly. In the case of Mattox Toy Manufacturing Company, sampling can be used to verify a few sales invoices, customer agreements for 'bill and hold' sales, shipping documents and cash received for invoices. The advantages of sampling include speedy completion of audit, cost savings and less effort. An auditor can draw conclusions based on results of sampling.

Assessment of Inherent Risks

SAS-47 (AU 312.20) describes assurance risk at the class-of-transactions level in terms of three component risks:

Inherent risk: Risk that material misstatements are not detected assuming there are no internal controls.

Control risk: Risk that material misstatements are not detected by company's internal controls.

Detection risk: Risk that the assurer will not detect omissions or misstatements.

In the case of Mattox Toy Manufacturing Company, the inherent risk is very high because of the company's improper accounting procedure for close out sales, fierce competition resulting in low sales, lack of proper documentation for field warehousing, lack of procedures for segregating merchandise of customer in 'bill and hold' sales and persuasive ways of selling to retailers in absence of valid agreements. Considering the overall picture in the toy manufacturing ...