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Dear tutor,
can you please explain why the answer to the following question is the first option for both inventory and receivables? i.e Extend cut-off testing
Thank you!
“As of 1 July 20X5, you are working as an audit manager at Wood & Co and are preparing the audit for Glass Co, which is a new client of the firm with a financial year ending 30 June 20X5. Glass Co is a large mobile phone retailer operating a chain of stores across several European countries.
You have received planning notes from the audit engagement partner following a meeting with the finance director.
During the year, the company introduced a sales-based bonus scheme for its sales staff. The bonus was linked to increasing the number of customers signing 24-month mobile contracts. This initiative proved successful, with revenue rising by 15% compared to 20X4. Notably, sales increased significantly in May and June 20X5.
Suppliers of mobile phones typically launch new models with enhanced features every year. When these new models are released, Glass Co offers substantial discounts on older phone versions.
You have been asked to carry out an initial analytical review of the draft financial statements and have been given the following information:
$ 20X5 – 20X4
Revenue 1,267,000 – 1,205,000
Cost of sales 1,013,000 – 965,000
Receivables 121,000 – 100,000
Payables 87,500 -85,000
Inventory 160,000 – 125,000
Cash 123,000 – 140,000Question: Which of the following does not represent a suitable audit response to the significant risks associated with inventory and receivables?
Inventory
Extend cut-off testing
Evaluate controls over inventory management
Discuss slow-moving inventory with the finance director
Carry out testing of sales invoices after the year end
Receivables
Extend cut-off testing
Review controls related to debt collection
Discuss overdue receivables with the finance director
Perform testing of cash received after the year end”
First let me say that for lots of reasons I can see this is NOT a real past OT case question. Presumably you have an answer justification, so what is it about that justification that is not clear?
The Q ask which of the following is NOT a suitable response. “Extend cut-off testing” is a suitable response to the risk that that transactions (in this case sales) may be recorded in the incorrect accounting period.
I see nothing in the narrative that identifies cut-off as a risk – so even without looking at the other options, extending cut-off cannot be a response to an ASSESSED risk.
The assessed risk for receivable arises from “The bonus was linked to increasing the number of customers signing 24-month mobile contracts.” The risk usually associated with incentivising sales staff to make more sales is that less attention is paid to credit risk – if customers are not sufficiently credit worthy, there is a risk that receivables may be overstated. All the suggested responses other than “extend cut-off testing” are relevant to this risk.
The assess risk for inventory arises from “Inventory 160,000 – 125,000” – if you’re selling your stock like hot cakes, you’d expect inventory holding to fall. So the assessed risk is inventory overstatement.
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