During the audit of Xtra Technology Inc. (XTI), Andrea found the following journal entry occurring at the end of each month:
Inventory ……… DR $20,000.00
Cost Variance ………………. CR $20,000.00
The accounting manager told Andrea that this was a regular entry made every month to account for the deviation from actual cost to standard costing for inventory. Andrea was skeptical of this explanation as it was the same every month, and there were other journal entries that appeared to deal with the cost variances adequately, so she asked for the supporting documents for the entries. The accounting manager told her that there were no supporting documents as this was an automatic entry made every month, authorized by the controller. He had never considered checking it before. When Andrea asked the controller about the entries, she discovered that the company purchased inventory from a company controlled by the same company that owned a controlling interest in XTI. The $20,000 was actually a purchase, but they preferred to record it as a cost variance. The controller told Andrea not to be concerned about it and that the parent company’s auditors would take case of all transactions between the two companies in its consolidated accounting.
REQUIRED
Assume that you are a manager with the audit firm and Andrea reports to you. Explain your concerns, if any, over the information that Andrea has learned.