Question

1. What is meant by the term “proper cutoff”; and (B) what specifically would an auditor compare to determine that the client entity achieved a proper cutoff with respect to its sales transactions?

Answer 1

A. The term proper cutoff means that the transactions are recorded in the correct period, i.e., expenses belonging to a particular financial year are recorded in that financial year and the revenues pertaining to one financial year are recorded in that financial year.

For example: XYZ company follows the calender year and prepares financial statements as on December 31. XYZ company enters into a sales transaction with ABC company for sale of goods on December 28 with shipping terms "FOB shipping point". These goods were shipped on December 30, however they were delivered on 5th January next year. Now in this case XYZ company should record the revenue in the current year itself since the risk and rewards have been transferred to ABC company on December 30 only as per the shipping terms.

B. An auditor would compare the date on which entry is recorded in the sales register with the shipping documents and shipping terms. Following the example mentioned above XYZ company's shipping terms are FOB shipping point and the goods were dispatched on December 28. This means that the revenue should have been recorded in the current year only. If the shipping terms are FOB destination, the revenue would be recorded next year on January 5 when the goods have been delivered.