74 Walters
Audit risk
Walter’s management were disappointed with
the 20x3 result and are under high pressure to
improve trading results. Therefore, this will
leading to a risk that management trying to
manipulate the revenue and profit.
The receivables collection period have increased
from 61 days to 71 days which can be explained
by the extension of credit period to their
customers.
There is a risk of increasing unrecoverable debt
which will leading to an overstatement in
revenue.
The Revenue have increased significantly but Cos
has only increased 10%. This can be explained by
the generous sales-related bonus scheme and
advertising campaign, but there may have a risk
that the management have been manipulate the
revenue.
A generous sales-related bonus scheme has been
introduced for the company’s salespeople. This
increases the risk of misstatements arising from
sales cut-off as the sales staff seek to maximize
their bonus.
The inventory valuation policy has been changed,
with additional overheads to be included within
inventory.
The inventory holding period has increased from
58 to 70 days.
There is a risk that inventory is overvalued.
Although the gross margin has increased from
44.4% to 52.2%, the operating margn has
decreased from 22.2% to 19.6%. This trend is
unusual. While the bonus scheme and advertising
campaign could account for some of the increase
in operating expense, there is a possibility that
costs may have been misclassified from costs of
sales to operating expense.
Response
The audit team need to remain alert to the risk of
creative accounting throughout the audit.
It is important that they exercise professional
skepticism and evaluate any assumptions made
by management in auditing accounting estimates.
Current year balance should be compared with
prior year to highlight any unusual trends.
Reviewed the credit policy to ensure only
customer which have good credit rating is
extended credit period.
Obtain a detailed breakdown of revenue and cost
of sales to ensure only related expenditures are
recognized.
Inquiries should be made of management
regarding the reason why cost of sales are not
increased in line with sales.
Increasing sales cut-off testing will be required.
Post year end sales returns should be reviewed,
as they may provide evidence of incorrect cut off.
The change in the inventory valuation policy
should be discussed with management. The
additional overheads should be reviewed to
ensure, to confirm that they are related to
production.
Detailed cost and NRV testing should be
performed and the aged inventory report should
be reviewed to assess whether a write down is
required.
The classification between COS and operating
expenses will be compared with prior year to
ensure consistency.
A detailed breakdown of operating expenses and
cos should be reviewed for evidence of
misclassification.