Question

In the planning stage of an audit, auditors frequently consider certain financial ratios. For either of the following two ratios, which are at unusual levels, please state one kind of error or fraud which would explain why the ratio is at an unusual level this year.

Ratio #1   The number of days of sales in accounts receivable has increased from 35 to 60. The industry average is 34.       [Days of sales in accounts receivable = {ending accounts receivable /sales}*365]

OR      Ratio # 2   Salesmen’s commission expense = 4% of sales. Last year it equaled 7%.

Refer to the same two ratios as in the previous question. For the same ratio you discussed in the previous question, State one reason, that is not an error or fraud, which would explain why the ratio is at an unusual level this year. (This might be a business reason.)

Answer 1

PART A : FRAUD POSITION IN UNUSAL POSITION OF DEBTORS TURNOVER RATIO:

Money received from Debtors is not accounted in books and hence debtors balances as at end of the year is high. This is a clear fraud.

Salesmen commission depends on amounts collected and deposited into companys bank accounts. Last year entire amount collected was deposited without siphoning off amounts(7%) . Hence commissio percentage is high. This year amounts collected fully not deposited into bank accounts of company. Hence percentage is low (4%)

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PART B : REASON FOR NO FRAUD BUT BUSINESS REASONS:

1. mONEY MARKET IS TIGHT AND THE COMPANY HENCE HAS INCREASED CREDIT TERMS FROM 30 DAYS TO 60 DAYS AND HENCE THE DEBTORS DAYS ALSO INCREASED FROM 35 DAYS (LAST YEAR) TO 60 DAYS (THIS YEAR)

2. lAST YEAR BAD DEBTS ARE LESS (MONIES UNCOLLECTIBLE ARE LESS) : hENCE actual collections more hence percent is 7%. This year bad debts are more, collections are less hence 4%