The auditor for ABC Wholesaling Company has just begun to perform analytical procedures as part of planning the audit for
The auditor for ABC Wholesaling Company has just begun to perform analytical procedures as part of planning the audit for the coming year.ABC Wholesaling is in a competitive industry, selling products such as STP Brand products and Ortho Grow products to companies such as Wal-Mart, Kmart, and regional retail discount chains. The company is privately owned and has experienced financial difficulty this past year. The difficulty could lead to its major line of credit being pulled if the company does not make a profit in the current year. In performing the analytical procedures, the auditor notes the following changes in accounts related to accounts receivable.
The auditor notes the large increase in receivables and decides to make inquiries of management. Management explains that the change is due to two things:
(1) A new computer system that has increased productivity; and
(2) A new policy of rebilling items previously sold to customers, thereby extending the due dates from October to April.
The rebilling is explained as follows: many of the clients' products are seasonal, for example, lawn care products. To provide better service to ABC's customers, management instituted a new policy whereby management negotiated with a customer to determine the approximate amount of seasonal goods on hand at the end of the selling season (October). If the customer would continue to purchase from the client, management would rebill the existing inventory, thereby extending the due date from October until the following April, essentially giving an interest-free loan to the customer. The customer, in turn, agreed to keep the existing goods and store them on their site for next year's retail sales.
The key to analytical procedures is to determine whether potential explanations satisfy all the changes that are observed in account balances. For example, does the explanation of a new computer system and the rebilling adequately explain all the changes? The auditor must be able to answer these questions to properly apply the risk-based approach to audit. There are several factors indicating that these explanations might not hold:
1. The company has a large increase in gross margin. This seems unlikely, because it is selling to large chains with considerable purchasing power. Further, other competitors are also likely to have effective computer systems.
2. If the rebilling items are properly accounted for, there should not be a large increase in sales for the last two months of this year when the total sales for the previous year is practically the same as that of the preceding year.
3. If the rebillings are for holding the inventory at customers' locations, the auditor should investigate to determine
(a) If the items were properly recorded as a sale in the first place, or if they should still be recorded as inventory;
(b) What is the client's motivation for extending credit to the customers indicated; and
(c) Whether it is a coincidence that all of the rebilled items were to large retailers who do not respond to accounts receivable confirmations received from auditors.
a. What potential hypotheses would likely explain the changes in the financial data given?
b. Which hypothesis would best explain all the changes in the ratios and financial account balances?
c. What is the most likely cause of the changes?
d. What risks are identified and what are the implications for audit procedures? What specific audit procedures do you recommend as highest priority?Why
A line of credit (LOC) is a preset borrowing limit that can be used at any time. The borrower can take money out as needed until the limit is reached, and as money is repaid, it can be borrowed again in the case of an open line of credit. A LOC is...
This problem has been solved!
Step by Step Answer: