risk in revenue cycle, audit concerns, and procedures
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ABC Tech Company has been growing rapidly and has recently engaged a firm as its auditor. it is actively traded over the counter (OTC) and believes it has outgrown the service capabilities of its previous auditor. However, on contacting the previous auditor it was learned that a dispute led to the firms dismissal. The client wanted to recognize income on contracts for its produced but not shipped. The client believed the contract were firm, and that all the principal revenue-producing activities had been performed. The change in accounting principle would have increased net income 35 per cent during the last year.
ABC Tech Company is 30 per cent owned by John Q, who has a reputation as a turn around artist. John Q brought out the previous owner of ABC Tech (formerly XYZ Industries) three years ago. The company's primary products are in the materials handling business, such as automated conveyors for warehouses and production lines. John Q has increased profits by slashing operating expenses most notably personnel and research and development. In addition, he has outsourced a significant potion of component part production. Approximately 12% of the company product is now obtained from MY Ltd, a privately held company 50% owned by John Q and his brother.
A brief analysis of previous financial statement shows that the sales have been increasing by 20% per year since John Q assumed control. Profitability has increased even more. However, a tour of the plan gives the impression that it is somewhat old and not kept up-to-date. Additionally, a large amount of inventory is sitting near the receiving dock awaiting final disposition.
1. Identify the elements of inherent risk associated with the revenue cycle that the auditor should consider.
2. For each element of inherent risk identified, briefly indicate the audit concern and suggest audit procedures to address the risk.
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1. Identify the elements of inherent risk associated with the revenue cycle that the auditor should consider.
The elements of inherent risk associated with the revenue cycle that the auditor should consider are if the client wants to recognize income on contracts not shipped. Further, if the components that are received from MY Ltd are actually sold at a profit. The next element of inherent risk is the increase in sales by 20% since John Q took over the company. Finally, there is inherent risk associated with the large amount of inventory sitting near the receiving dock awaiting final disposition.
The elements of inherent risk associated with the revenue cycle that the auditor should consider are revenue recognition on contracts. The reason for this is that Mr. John will be under pressure to overstate revenues to achieve the announced revenue or profitability targets. The point is that the firm's shares are actively traded over the counter. Further there is an inherent risk to show that components are actually sold at a profit. The reason for this is that that there are pressures to overstate cash and gross receivables or understate allowance for doubtful accounts. Recognizing income on contracts not shipped: The past auditor has already alerted the current auditor that change of principles of revenue recognition was the cause of dispute with the previous auditor. The inherent risk is that unacceptable standards may be in use now for revenue recognition at ABC Tech Co. There is an inherent risk that the increase in sales by 20% could have receivable that are factored with recourse. For instance, some money could have been borrowed by MY Ltd or its partners and this could have been shown as accounts receivable. The large amount of inventory sitting new the receiving dock awaiting final ...
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