This
subject has been mentioned already and it is extremely important.
Consider
a trading account:
a trading account:
|
|
£’000s
|
£’000s
|
|
Sales
|
|
1000
|
|
Opening Stock
|
100
|
|
|
Purchases
|
750
|
|
|
Closing Stock
Cost of Sales
Gross Profit
|
850
150
|
700
300
|
Two
scenarios:
scenarios:
1.
Supposing goods valued at £50,000 were:
Supposing goods valued at £50,000 were:
a.
Dispatched and involved by the supplier before balance sheet date; and
Dispatched and involved by the supplier before balance sheet date; and
b.
Receive after balance sheet date owing to delays in transit,
Receive after balance sheet date owing to delays in transit,
They
would be included in purchases, as a consequence of (a) and they would be
excluded from closing stock as a consequence of (b).
would be included in purchases, as a consequence of (a) and they would be
excluded from closing stock as a consequence of (b).
In
this case either the stock has to be included as stock in transit (and the
auditors would have to verify the existence, ownership and value of that heat
stock) or the invoice should be deleted from creditors and purchases and the
whole transaction included in the next accounting period. This is a ,matter for
judgement by the auditors.
this case either the stock has to be included as stock in transit (and the
auditors would have to verify the existence, ownership and value of that heat
stock) or the invoice should be deleted from creditors and purchases and the
whole transaction included in the next accounting period. This is a ,matter for
judgement by the auditors.
2.
Suppose goods is in the stores value at
50000were ivolved as a sale the day before the
stock count but not actually despatched to the customer until the day after.
Suppose goods is in the stores value at
50000were ivolved as a sale the day before thestock count but not actually despatched to the customer until the day after.
In
the case the goods would be included in both stock and debtors (and sales) so
the profit would, again, be distorted. Again the auditor has to ensure that
only goods actually despatched to customers are included in sales.
the case the goods would be included in both stock and debtors (and sales) so
the profit would, again, be distorted. Again the auditor has to ensure that
only goods actually despatched to customers are included in sales.
Avoiding
this possibility is a vital part of the system of internal control as applied
to stock and consequently of prime concern to the auditor.
this possibility is a vital part of the system of internal control as applied
to stock and consequently of prime concern to the auditor.
A
famous case on the subject of cut-off was Re, Thomas Gerrard & Son Ltd
(1967). This was a cotton spinning and manufacturing company. The manager and
principal shareholder:
famous case on the subject of cut-off was Re, Thomas Gerrard & Son Ltd
(1967). This was a cotton spinning and manufacturing company. The manager and
principal shareholder:
a.
Post-dated purchase invoices received before the year end;
Post-dated purchase invoices received before the year end;
b.
Ante-dated sales invoice copies in the New Year to dates prior to the
year end.
Ante-dated sales invoice copies in the New Year to dates prior to the
year end.
He
did this quite openly for five half-year periods for bigger sums each time,
thus turning losses into profits and causing the company to pay tax and
dividends. The auditors discovered the alteration, asked questions and were put
off by answers such as ‘these were year end adjustment’ or ‘it is more
convenient’.
did this quite openly for five half-year periods for bigger sums each time,
thus turning losses into profits and causing the company to pay tax and
dividends. The auditors discovered the alteration, asked questions and were put
off by answers such as ‘these were year end adjustment’ or ‘it is more
convenient’.
The
judge awarded damages against the auditors on the grounds that once their
suspicious were arouse they had a duty to probe the matter to the bottom.
judge awarded damages against the auditors on the grounds that once their
suspicious were arouse they had a duty to probe the matter to the bottom.
Auditors
have a duty to satisfy themselves as to the validity of stock and work in
progress and this cannot arise solely out of the assurance from management,
however, trust-worthy in appearance.
have a duty to satisfy themselves as to the validity of stock and work in
progress and this cannot arise solely out of the assurance from management,
however, trust-worthy in appearance.
Independent Stock-takers
In
some trades it found that the stock is counted and valued by an independent
firm of stock-takers. Examples include the jewellery, licensed and retail
pharmacy trades.
some trades it found that the stock is counted and valued by an independent
firm of stock-takers. Examples include the jewellery, licensed and retail
pharmacy trades.
The
question arises as to whether this influences the extent of the auditors’
examination. The answer is that the auditors have a duty to form an opinion on
the amount at which stock is stated.
question arises as to whether this influences the extent of the auditors’
examination. The answer is that the auditors have a duty to form an opinion on
the amount at which stock is stated.
They
cannot simply accept an outside stock-takers valuation but it is usual to do so
if:
cannot simply accept an outside stock-takers valuation but it is usual to do so
if:
·
They are satisfied of the sock-takers independence.
They are satisfied of the sock-takers independence.
·
The stock-taker is suitable qualified.
The stock-taker is suitable qualified.
·
The stock-taker has a suitable level of experience in the trade carried
on by the company.
The stock-taker has a suitable level of experience in the trade carried
on by the company.
·
The auditor is satisfied:
The auditor is satisfied:
·
That the basis of valuation used is appropriate; and
That the basis of valuation used is appropriate; and
·
Proper cut-off procedures were employed.
Proper cut-off procedures were employed.
Remember that the auditors have final responsibility for their audit
opinion and cannot blame the stock-taker if things go wrong.
opinion and cannot blame the stock-taker if things go wrong.
Historical Note
There
are some lessons for auditors to learn from past cases and these are three of
the most famous:
are some lessons for auditors to learn from past cases and these are three of
the most famous:
Re, the Kingston Cotton Mill Co. Ltd (1896)
The auditors
failed to detect overstatement of the amount of stock. They accepted a
certificate from the manager on the amount of stock after comparing it with the
stock journal which contained accounts for each item or class of items
purporting to be in stock and a summary. The summary was agreed by the auditors
to be in agreement with the detailed accounts. In fact the entries were
falsified to show more stock than was actually in existence. The auditors were
exonerated on the grounds that it is no part of the auditors duty to take stock
and that they were entitled to rely upon other people for the detailed of stock
in trade.
failed to detect overstatement of the amount of stock. They accepted a
certificate from the manager on the amount of stock after comparing it with the
stock journal which contained accounts for each item or class of items
purporting to be in stock and a summary. The summary was agreed by the auditors
to be in agreement with the detailed accounts. In fact the entries were
falsified to show more stock than was actually in existence. The auditors were
exonerated on the grounds that it is no part of the auditors duty to take stock
and that they were entitled to rely upon other people for the detailed of stock
in trade.
The
judge’s remarks contained the famous phrase ‘He is a watchdog, not a
bloodhound’. This means that if the auditors discover something which is
suspicious they should probe it to the bottom but in the absence of suspicious
circumstances they are only bound to be reasonably cautious and careful.
judge’s remarks contained the famous phrase ‘He is a watchdog, not a
bloodhound’. This means that if the auditors discover something which is
suspicious they should probe it to the bottom but in the absence of suspicious
circumstances they are only bound to be reasonably cautious and careful.
Today,
the judgement in this case would undoubtedly be against the auditor, but the
comfortable words of the judge have been used by auditors as a defence against
charges of negligence in relation to frauds-a subject we look at more closely
in Chapter 31.
the judgement in this case would undoubtedly be against the auditor, but the
comfortable words of the judge have been used by auditors as a defence against
charges of negligence in relation to frauds-a subject we look at more closely
in Chapter 31.
McKesson and Robbins Inc, USA (1939)
In
this, almost unbelievable (expect perhaps in America) case, the directors of
the company created fictitious records of trading, sales, purchases, bank
accounts, debtors, and stock so that the assets were overstated by over $20m.
This extraordinary state of affairs was not detected by the auditors. In
particular they did not attend the stock-take. Had they done so they would
rapidly realised that no stock existed.
this, almost unbelievable (expect perhaps in America) case, the directors of
the company created fictitious records of trading, sales, purchases, bank
accounts, debtors, and stock so that the assets were overstated by over $20m.
This extraordinary state of affairs was not detected by the auditors. In
particular they did not attend the stock-take. Had they done so they would
rapidly realised that no stock existed.
Allied Crude Vegetable Oil Refining Corporation of
New Jersey (1963)
New Jersey (1963)
In
this scandal, methods were used to fool auditors who were present at the
stock-taking.
this scandal, methods were used to fool auditors who were present at the
stock-taking.
Three
methods, at least, were used:
methods, at least, were used:
·
The quality of vegetable oil in a tank was checked and before the
quality was checked in the second tank, the contents of the first tank were
pumped through to the second tank.
The quality of vegetable oil in a tank was checked and before the
quality was checked in the second tank, the contents of the first tank were
pumped through to the second tank.
·
Using a dip stick to measure the quantity of oil in a tank. In reality
the tank was empty and oil was contained only in a thin drainpipe down which
the dipstick was dropped.
Using a dip stick to measure the quantity of oil in a tank. In reality
the tank was empty and oil was contained only in a thin drainpipe down which
the dipstick was dropped.
·
Filling the tank with mostly water and a small quantity of oil-the oil
floated on the top and it looked like a full tank.
Filling the tank with mostly water and a small quantity of oil-the oil
floated on the top and it looked like a full tank.
The
oil ‘stocks’ were certified by the auditors and were used as collateral for
millions of dollars worth of loans which were used fraudulently. The auditors’
procedures were found to be totally inadequate and they had signed the
certificate of value on the basis of very flimsy audits evidence.
oil ‘stocks’ were certified by the auditors and were used as collateral for
millions of dollars worth of loans which were used fraudulently. The auditors’
procedures were found to be totally inadequate and they had signed the
certificate of value on the basis of very flimsy audits evidence.
