Question

Marty has to audit the sales transactions of Okawa Inc. Okawa supplies tools to the mining industry and carries a large number of different makes and models of standard mining tools. Okawa also designs and manufactures tools for special purposes and for miners operating in difficult conditions. The custom-designed tools are made only on the signing of a contract and receipt of a deposit, whereas standard tools are supplied to regular customers on receipt of a phone or email order. Okawa’s sales transactions vary from a few dollars to millions of dollars depending on the number of items sold, whether the individual items are large or small tools, and whether the tools are standard items or custom designed.

-Marty is instructed to gather evidence about the sales transactions using sampling and vouching. This is explained in detail in the audit program-

-How could Marty use ADA as a substantive procedure? (You may want to refer to Illustration 7.8 to help formulate your response.)

Answer 1

1.) Based on the above scenario, it appears that Marty has the responsibility to conduct the audit of hte sales transactions of Okawa Inc. The business of Okawa inc includes supply of different makes and models of standard minding tools to the mining industry. The sale transactions of Okawa inc vary from few dollars to the millions of dollars depending on the items sold through various transactions.

a.) Marty can use the following ways to gather evidence about the sales transactions

Step 1:- Compare the sales per the ledger to the sales book and verify and perform reconciliaitons for differences, if any.

Step 2:- Investigate reconciling items, if any

Step 3:- Verify that the accounts receivable balance reported agrees to the general ledger balance as it directly affects the sales

Step 4:- Pick a sample of sales transactions recorded in the sales book to verify the accuracy and the authenticity of the transactions

Step 5:- For each such sample selected , obtain a list of supporting documents like invoices, purchase orders, receipts, goods delivery note, etc.

Step 6:- For any sales returns reported, assess the credit memos issued during the audit period to see if they were properly authorized, whether they were issued in the correct period, etc.

Step 7:- Perform analytical procedures year over year or period over year to verify that the sales have been in line in accordance to the previous years.

Step 8:- For amounts that are yet to be received, verify the accuracy of such accounts receivable by sending confirmations to the customers.

Step 9:- Perform a reverse audit by selecting samples from invoices, delivery notes, etc to verify if they were properly included as part of the Sales book/sales ledger.

b.) Marty can also make use of the Allowance for Doubtful Accounts(ADA) as a substantive procedure to verify the sales.

Allowance for doubtful accounts are allowances that are created by the company anticipating the fact that all the amounts reported as part of the sales would not be recoverable. It is reasonable for the company to anticipate the fact that not all amounts reported as sales would be recognizable in the books of accounts because few of the customers to which the company sells the goods are expected to default in their payments.

To protect the company from this, the company creates a reserve , based on a percentage of sales that is known as Allowance for Doubtful accounts. The Allowance for doubtful accounts is created as a percentage of sales based on a variety of factors like past sales, competitors trends, etc.

The Allowance for Doubtful Accounts(ADA) can be used as a substantive procedure in verifying the accuracy of the sales the company has reported in its books of accounts. Since the Allowance for Doubtful accounts are calculated as a percentage of sales, the auditor can use this balance to compare the allowance created over years and perform a trend analysis to ensure that the ADA has remained consisten. The auditors can also review the prcoess that the company follows to derive the Allowance for Doubtful accounts and whether the method is appropriate for the business environment