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Material misstatement for revenue and inventory

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5-34 (Risk of material misstatement) Your client, a manufacturer of computer components, has experienced slowing demand for its product. Recently, it cut back from three shifts a day to two shifts a day, and the company has eliminated the backlog of orders that existed in prior years by providing financing to customers. Newspaper reports indicate that competition has taken significant business away from the client because a large investment in R&D has not resulted in improved products.

Furthermore, a small handful of your client's customers are experiencing financial difficulties because of slowing demand for your client's products.

Required

a. Consider the implications of the above information for revenues. What assertions, if any, are likely to be misstated? As a result, what accounts are likely to be overstated or understated? Explain your reasoning.

b. Consider the implications of the above information for inventory. What assertions, if any, are likely to be misstated? As a result, what accounts are likely to be overstated or understated? Explain your reasoning.

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Solution Summary

The 317 word solution presents lists of possible misstatements for revenue and inventory in terms of audit assertions. Each item gives an explanation or example that relates to the audit assertion. Also provided is a link to an excellent and understandable source.

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Part a: possible misstatement of assertions with respect to revenues:

Existence or occurrence: validity and cutoff
Completeness: cutoff
Valuation or allocation: measurement
Presentation and disclosure: consistency

What accounts may be over or understated:
1. Accounts receivable may be overstated because the allowance for bad debts is insufficient and/or sales were not properly reported.
2. Notes receivable from customers may be overstated because of collection problems in a down economy.
3. There may be disputed sales (and therefore receivables) for unrecorded ...

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