Question

Evaluating substantive testing results

The following items are documented in the working papers:

1. Sales transaction included in the year ended December 2022, but evidence from the cut-off procedure suggets the sale should be dated January 1, 2023 ($1,250,000).

2. Warranty expenses in the trial balance for the year ended December 2022 total $150,000. The provision (liability) for warranty claims as of December 31, 2021, was $100,000. Inspection of correspondence suggests that an additional $200,000 in warranty claims could results from ongoing disputes with customers. No provision for these claims has been made. Management has booked a warranty provision for 2022 of $120,000.

3. Restructuring expenses related to reorganization of head office administration incorrectly charged to rental expenses ($578,920).

4. No expense for impairment of assets has been made by management. A drought-induced recession has adversely impacted property values in regional cities where seven branch offices are located (head office and two branch offices are located in the capital city). Total land and buildings in the trial balance is $5,500,000.

Required:

a. Evaluate each item and explain whether it is a factual misstatement or a judgement misstatement. What action do you recommend for each?

b. Which accounts would be affected, and how, if an adjustment is made for each item?

Answer 1

Factual misstatement refers to the misstatement when there is no doubts and all the correct supporting documents are available.

Judgement Misstatement refers to the misstatment that happens due to judgemental issues which the reviewing officer may consider as incorrect.

Answer to question No.a

1. Sales transaction included in the year Dec' 2022 is a factual misstament since the cut off supportings are available and the same indicates that the sales are related to Jan' 2023.

The company should reduce sales of Dec'2022 by $ 1,250,000 and the should be shown as sales in Jan' 2023

2. Inspection of correspondence indicates that an addittional claim of $ 200,000 could results from ongoing disputes with customers but no provision for these claims has been made. Non recording of provision indicates factual misstatement since correspondence are available in supporting of additional claim which may arise as results from ongoing disputes with customers

Since the company has recorded provision at a lower amount, the company should book additional provision of $ 120,000

3. Charging of restructuring expenses to rental expense is a factual misstatement since clear indication to show the expense as restructuring expense is available and there is no judgemental activities involved.

The expense has been booked under incorrect head. Thus, same should be rectified by reducing the rental expenses by $578,920 and charging the same to restructuring expense.

Note : The above expense has not been capitalized because the same has been incurred for administration

4. Non recording of expenses for impairment is a judgemental misstatement since their are no documents available and creating of provision for impairment of assets is a judgemental decision.

The company should create provision for impairment of assets.

Answer to Question b

1. Treatment for incorrect recording of sales :

Sales Account will be debited and Sundry Debtors account will be credited in the month of Dec'22 by

$ 1,250,000

Sundry Debtors account will be debited and Sales account will be credited in Jan'23 by $ 1,250,000

2. Treatment for non-recording of provision for warranty claims

Warranty Expense will be debited and Provision for warranty claim account will be credited by $2,00,000

3. Treatment for incorrect recording of expense

Restructuring expense will be debited and rental expense will be credited by $ 578,920

4. Treatment for recording of provision of impairment of assets

Impairment Expense account will be debited and provision for impairment of assets accounts will be credited by $5,500,000