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Audit approach - Overstated Sales and Accounts Receivable

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Write the "audit approach" portion of the case, organized around these sections: Objective: Express the objective in terms of the facts supposedly asserted in financial records, accounts, and statements.

Control: Write a brief explanation of desirable controls, missing controls, and
especially the kinds of "deviations" that might arise from the situation described in
the case.
Test of controls: Write some procedures for getting evidence about existing controls,
especially procedures that could discover deviations from controls. If there are no
controls to test, then there are no procedures to perform; go then to the next section.
A "procedure" should instruct someone about the source(s) of evidence to tap and the
work to do.
Audit of balance: Write some procedures for getting evidence about the existence,
completeness, valuation, ownership, or disclosure assertions identified in your
objective section above.
Discovery summary: Write a short statement about the discovery you expect to
accomplish with your procedures.
Ring around the Revenue
Problem: Sales were recorded early, sometimes at fictitiously high prices, overstating
sales revenue, accounts receivable, and income.

Method: Mattox Toy Manufacturing Company had experienced several years of good
business. Income had increased steadily, and the common stock was a favorite among
investors. Management had confidently predicted continued growth and prosperity.
However, business turned worse instead of better. Competition became fierce.
In earlier years, Mattox had accommodated a few large retail customers with the
practice of field warehousing coupled with a "bill and hold" accounting procedure.
These large retail customers executed noncancelable written agreements, asserting
their purchase of toys and their obligation to pay. The toys were not actually shipped
because the customers did not have available warehouse space. They were set aside in
segregated areas on the Mattox premises and identified as the customers' property.
Mattox would later ship the toys to various retail locations upon instructions from the
customers. The "field warehousing" was explained as Mattox's serving as a temporary
warehouse and storage location for the customers' toys. In the related bill and hold
accounting procedure, Mattox prepared invoices billing the customers, mailed the
invoices to the customers, and recorded the sales and accounts receivable.
When business took the recent downturn, Mattox expanded its field warehousing
and its bill and hold accounting practices. Invoices were recorded for customers who
did not execute the written agreements used in previous arrangements. Some
customers signed the noncancelable written agreements with clauses permitting
subsequent inspection, acceptance, and determination of discounted prices. The toys
were not always set aside in separate areas, and this failure later gave shipping
employees problems with identifying shipments of toys that had been "sold" earlier
and those that had not.

Mattox also engaged in overbilling. Customers who ordered closeout toys at
discounted prices were billed at regular prices, even though the customers' orders
showed the discounted prices agreed to by Mattox sales representatives.
In a few cases, the bill and hold invoices and the closeout sales were billed and
recorded in duplicate. In most cases, the customers' invoices were addressed and
mailed to specific individuals in the customers' management instead of the routine
mailing to the customers' accounts payable departments.

Audit trail: The field warehousing arrangements were well known and acknowledged
in the Mattox accounting manual. Related invoices were stamped "bill and hold."
Customer orders and agreements were attached in a document file. Sales of closeout
toys also were stamped "closeout," indicating the regular prices (basis for
salespersons' commissions) and the invoice prices. Otherwise, the accounting for sales
and accounts receivable was unexceptional. Efforts to record these sales in January
(last month of the fiscal year) caused the month's sales revenue to be 35 percent
higher than the January of the previous year.

In the early years of the practice, inventory sold under the field warehousing
arrangements (both regular and closeout toys) was segregated and identified. The
shipping orders for these toys left the "carrier name" and "shipping date" blank, even
though they were signed and dated by a company employee in the spaces for the
company representative and the carrier representative signatures.
The lack of inventory segregation caused problems for the company. After the
fiscal year-end, Mattox solved the problem by reversing $6.9 million of the $14
million bill and hold sales. This caused another problem because the reversal was
larger than the month's sales, causing the sales revenue for first month of the next year
to be a negative number!

Amount: Company officials' reasons for the validity of recognizing sales revenue and
receivables on the bill and hold procedure and field warehousing were persuasive.
After due consideration of the facts and circumstances, the company's own
accountants agreed that the accounting practices appropriately accounted for revenue
and receivables.

Mattox's abuse of the practices caused financial statements to be materially
misstated. In January of the year in question, the company overstated sales by about
$14 million, or 5 percent of the sales that should have been recorded. The gross profit
of $7 million on these sales caused the income to be overstated by about 40 percent.

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Solution Preview

About Mattox Toy manufacturing company
The company is into toy manufacturing and previous it was doing well. But now it is facing downturn due to competition and it's struggling to match the previous growth. Moreover in order to match the earlier growth they are artificially showing greater sales and there are other irregularities in the accounting and control system of the organization.

Suggestions for Control Mechanisms
Control mechanisms assist in increasing communication, empowering the workforce, and attaining the goals set forth by helping management in the company evaluate and compare the performance of the company and/or employee over a specified time period to standards established. An Accounting control system consists of financial records and procedures dealing with cash disbursements, cash receipts, purchase of goods and services, employee payroll, and sales or other rendering of goods and services. Functional responsibilities should be performed by separate people ...

Solution Summary

Write the "audit approach" portion of the case, organized around these sections: Objective: Express the objective in terms of the facts supposedly asserted in financial records, accounts, and statements.