No Defense for These Charges. Follow the instructions preceding Problem 9.57. Write the audit approach section following the case in the chapter.

SueCan Corporation manufactured electronic and other equipment for private customers and government defense contracts. It deferred costs under the heading of defense contract claims for reimbursement and deferred tooling labor costs, thus overstating assets, under-stating cost of goods sold, and overstating income.

Near the end of the year, the company used a journal entry to remove $ 110,000 from cost of goods sold and defer it as deferred tooling cost. This $ 110,000 was purported to be labor cost associated with preparing tools and dies for large production runs.

The company opened a receivables account for “cost overrun reimbursement receivable” as a claim for reimbursement on defense contracts ($ 378,000).

The company altered the labor time records for the tooling costs in an effort to provide substantiating documentation. Company employees prepared new work orders numbered in the series used late in the fiscal year and attached labor time records dated much earlier in the year. The production orders originally charged with the labor cost were left completed but with no labor charges!

The claim for reimbursement on defense contracts did not have documentation specifically identifying the labor costs as being related to the contract. There were no work orders. (Auditors know that Defense Department auditors insist on documentation and justification before approving such a claim.)

SueCan reported net income of about $ 442,000 for the year, an overstatement of approximately 60 percent.