RJ company is a long-term client of Mike's firm. RJ had been experiencing profit pressures for two years now. A recessionary economy reduced profits, but the company reported net income decreases that were not as severe as other companies in its industry. In the audit, it was discovered that employees were recording sales too early and failing to account for customer discounts taken resulting in overstated sales and receivables, understated discounts expense, overstated net income.

As misstatements go, some of these were on the materiality borderline. Sales were overstated 0.3% and 0.5% in the prior and the current year, respectively. Accounts receivables were overstatedby 4% and 8% for the same years. But the combined effect was to overstate the division's net income by 6% and 17% respectively. Selected data were provided as follows:

Prior Year Current Year

Reported Actual Reported Actual

Sales $330 $329 $350 $348

Discount expense 1.7 1.8 1.8 2.0

Net income 6.7 6.3 5.4 4.6

In RJ 's grocery products division, sales had been recorded for orders prepared for shipment but not actually shipped until later. Employees backdated the shipping documents. Gross profit on these "sales" was about 30%. Customers took discounts on payments, but company did not record them, leaving debt balances in the customers' account receivable instead of charging them to discounts and allowances expense. Company accountants were instructed to wait 60 days before recording discounts taken.

The divisionvice-president and general manager knew about these accounting practices, as did a significant number of 2500 employees in the division. The division managers were under orders to achieve profit objectives they considered unrealistic, thus creating pressure on them to misstate the financial results.

Audit Trail

The customers' accounts receivable balances contained amounts due for discountsthe customers already had taken. The cash receipts records showed payments received without credit for discounts. Discounts were entered monthly as a special journal entry. The unshipped goods were on the shipping dock at year-end, with papers showing earlier shipping dates.

REQUIREMENT

1. 1. Audit objective
2. 2. Relevant controls that should be there.
3. 3. Tests of controls
4. 4. Tests of details of balances