Question

Question 3

Specialized Construction Equipment, Inc. is an audit client. The company booked a one-hundred-million-dollar credit sale close to the end of the fiscal year. The sale is material to annual sales, year-end accounts receivable, and annual profits.

This particular sale / receivable is being disputed by the customer. The customer's version of events, which you have been able to verify, is that the customer came to the audit client's place of business to try to buy a hundred million dollars' worth of specialized construction equipment, but the client's salesperson was a sarcastic little twit who would not answer any of the customer's questions about the specifications of the equipment. Finally, the customer asked, "Can I get some consideration here?" The client's salesperson answered that, no, the customer would not receive any consideration, not before, not during, and not after the sale. Then the salesperson called over a menacing-looking 275-pound person who told the customer to "put your John Hancock" on the order form. The customer said, "In that case, you can bill it to John Hancock and send it to John Hancock." The customer then crossed out the contents of both the "bill to" and "ship to" blocks and hand-printed "John Hancock" in both. He then signed "John Hancock" at the bottom of the form, rather than his own name or his company's name.

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The client's lawyer has represented to your audit firm that there is not any question that the customer signed the order; in fact, the customer admits that he wrote "John Hancock" in the space designated for a signature. However, later that same day, the customer placed an order with a different company, and that different company has already delivered the equipment.

Required:

a. In general, excluding the situation regarding this particular sale, what internal controls over sales and collections should the client have in order to be sufficient for you to rely upon in your performance of the total audit?

b. In general, excluding the situation regarding this particular sale, what audit steps should you perform to test whether the controls over sales and collections do exist and are working?

c. In general, excluding the situation regarding this particular sale, what audit steps should you perform to test whether the balances of the sales, accounts receivable, bad debts expense, and allowance for bad debts accounts are fairly presented?

Answer 1

Answer for question no.a:

Internal controls over sales and collections that should be present:

• Every sales invoice shoule be based on the order form received from the customer.
• The order form received should have details like description or specification of the items ordered.
• Details like to where the equipment should be sent and details like freight, whether it is FOB shipping point or whether FOB destination point etc.,
• Any advance payment received, if so whether the same has been adjusted in the invoice generated.
• The purchase order received is properly signed by a person authorized to do so.

Internal controls for collections:

• Once the stock is delivered whether acknowledgement is received from the receiving company.
• The amount to be collected is received with in credit period, then discount to be given is to be given to the customer.
• In case the customer is not paying in time, the customer has to be contacted for the same for recovery.
• In case the amount seems uncollectible, legal action if required is initiated.
• A policy that defines the procedure for creation of uncollectibles is created and is applied to all receivables.

Answer for question no.b:

Controls to be tested for sales:

• Whether the sales that are booked are real and not fake sales to inflate sales at year end
• Whether each sales order is supported by the order form received with all the required details like description or specifications and where to be sent
• Whether the order form received is properly signed, in case it is a hard copy, if the order is in electronic form whether the medium through which the order is received is valid.
• Whether the goods shipped to the customer are according to the specification present in the order form.

Collectibles:

• Whether the debtors paying in time are allowed disount.
• Whether the customers not paying in time are being followed up for collection.
• In case there is any dispute, whether proper action has been initiated or taken.
• Whether there is a policy present in place for creating provision for uncollectibles, if yes, whether the provision is created in accordance with the same.
• Whether the policy being followed for creation of provision is acceptable and reflects the actual position basing on the history of uncollectibles.

Answer for question no.c:

Sales:

• Compare the sales of the current year with the previous year and verify whether the growth is supported by the proportionate increas in cost of sales, atleast approximately.
• Verify the last month sales to identify any fake invoices are booked to inflate sales. This can be substantiated from any sales returns received in the next year starting months.

Accounts receivables:

• Accounts receivables balance is taken from the books, it is to be verified whether any amount received from debtors is properly recroded and also whether the cheque collected and returned due to insufficient balance in the customer accounts are properly reversed to increase the receivables balance.
• Whether any discount allowable to debtors for payment with in trade terms is deducted from the accounts receivable or not

Bad debts:

Bad debts written off should be verified with the colletions teams confirmation like, which customers have paid the sales and which company has made a part payment, and which companies have payment.

Whether any legal proceedings are filed against debtors for recovery and whether any court orders received settlling the dues are properly accounted.

Allowance for bad debts account:

• Whether allowance is created according to the policy for creation of bad and doubtful debts.
• Analyzing the bad debts of previous years and provision for bad and debts is reflecting a correct or approximately correct position of bad debts.