ACCT7103 Auditing Case Study: Sales Revenue and Inventory Analysis

This case study analyzes the audit of Quartet Ltd, focusing on the sales revenue and inventory accounts for the year ending December 31, 2018. The assignment requires an assessment of inherent risk, including factors like pricing markdowns and changing sales trends, and the performance of analytical procedures to assess the likelihood of misstatements. The solution identifies weaknesses in internal controls, such as the lack of verification for online sales invoices and the absence of inventory inspections. The document outlines tests of control, including physical inventory counts and the examination of sales invoice samples. Finally, it details substantive procedures, such as matching sales invoices to delivery documents and verifying inventory records. The analysis adheres to Australian Auditing Standards, providing a comprehensive approach to the audit process.

Running head: AUDITING THEORY AND PRACTICE
Auditing theory and practice
Name of the Student
Name of the University
Author Note

AUDITING THEORY AND PRACTICE
Table of Contents
Answer to question 1:.................................................................................................................2
Performing analytical procedures to assess the likelihood of misstatements of each of the
general objectives of accounts:..................................................................................................3
Answer to question 2:.................................................................................................................4
Identification of internal control to the audit objectives of sales revenue and inventory
account:......................................................................................................................................4
Explanation of internal controls in detecting the material misstatement of accounts:...............5
Answer to question 3:.................................................................................................................5
Answer to question 4:.................................................................................................................6
References list:...........................................................................................................................8
Anderson, J. and Fleming, D., 2016. Analytical procedures decision aids for generating
explanations: Current state of theoretical development and implications of their use. Journal
of Accounting and Taxation, 8(5), pp.51-58..............................................................................8

AUDITING THEORY AND PRACTICE
Answer to question 1:
The overall objective of sales revenue account is to evaluate whether there is a fair
presentation of the balances, disclosures and account transactions according to the applicable
accounting standards. In achieving the occurrence general objective of sales revenue account,
the objective of auditor is to obtain an assurance that all the transactions related to revenue
are recorded properly. Inherent risk is the susceptibility of a relevant assertion to a material
misstatement by assuming that there are no other related controls. For some assertions and
related class of transactions, account balances and disclosures, the risk of material
misstatement is greater. Inherited risk is also influenced because of rising business risk that is
associated with the external circumstances (Appelbaum et al. 2017).
The inherent risk related to particular specific relevant assertion is also influenced by
factors of the entity that are related to various of all the accounts balances, classes of
transaction and disclosures (accaglobal.com 2019). In the given case, Quarter limited is
facing inherent risk indicated by marking down of the selling price of the items that is aims at
making sales revenue account more susceptible to understatement. In addition to this, the
trend of sales in the previous years has made the products less popular with customers.
Some of the inherent risk that is associated with the sales revenue account includes
the timing of recognizing revenue, proper treatment of sales transactions done and customers
right to return the product (Byrnes et al. 2018). From the analysis of the case study of Quarter
limited, it has been found that the inherent risk associated with inventory account is the
complexities of inventory procedure and prior period misstatement. The financial statement
of Quarter ltd for year 2018 do not record allowance and expense related to obsolescence
account which would mislead investors about the valuation of inventory. In addition to this,
the signed delivery documents in the sale transaction of inventory management system are

AUDITING THEORY AND PRACTICE
not verified and the accountant might miss out on the invoice which would mislead the
prepared inventory report.
Performing analytical procedures to assess the likelihood of misstatements of each of the
general objectives of accounts:
The analytical procedures of inventory account can be assessed by developing an
independent expectation which require predicting the recorded ratio concerning that
particular account. Next step requires defining the observed significant difference and then
computing the difference along with reason for such difference and drawing the conclusion
(Lakis and Masiulevičius 2017).
From the given information on the figures of sales revenue account, it is observed that
the growth of profit has improved year on year with the current figure recorded at 1.06. It is
expected that the profit growth would be accelerated further because of introduction of online
stores and refreshment of existing stores to catch up with competitors and to increase the
profits generated (Appelbaum et al. 2018).
It can be observed from the given case study that the inventory turnover ratio is
recorded at 5.88 in the first 10 months of 2018 which is less that the ratio recorded in the
previous year’s indicating that the ratio has fallen. This has been because of changing trend
and increased competition. Moreover, the company has not made any clearance sale for the
old inventories. Furthermore, the inspection of inventories is not done because the staffs have
been busy with the disruptions in delivery.

AUDITING THEORY AND PRACTICE
Answer to question 2:
Identification of internal control to the audit objectives of sales revenue and inventory
account:
Internal controls are the set of procedures and policies that are implemented by
organization for safeguarding their assets and the materiality of the accounts are considerably
influenced by the effectiveness of internal control procedures. The process of managing
inventory has control risk and therefore, the control risk can be identified by assessing the
internal control (Byrnes et al. 2018).
The internal control process of sales revenue account of Quarter Limited include the
details of the sales invoices, preparation of delivery documents using such invoices, serially
numbering the invoices and delivery documents, authorization of such documents and
preparation of monthly inventory reports. However, these internal controls of Quarter
Limited has some weakness as the online sales invoices are not verified against the delivery
documents which make chance of producing duplicate invoices or the invoices can be
missing.
Quarter Limited has integrated inventory management and sales system and the sales
computer system can be accessed by the sales staff because the system is protected by the
individual password. Moreover, in order to process the transaction in the inventory
management system, the authorization is given by warehouse manager which results in strict
scrutiny of the accounts. In addition to this, the unrealized inventory loss is not recorded
because such amount is uncertain and recording it in the book of account would mislead the
users of financial report.

AUDITING THEORY AND PRACTICE
Explanation of internal controls in detecting the material misstatement of accounts:
The password control inventory management system would help in preventing the
occurrence of any fraud activities as there would not be omission of any items related to the
inventory account. The authorization of inventory management system would help in
preventing the misstatement of financial statements by ensuring that different accounts
presents the figures that are free from error and are rightly recorded (Appelbaum et al. 2018).
Since the accounting department has the original copy of document, it is not possible to
wrongly record the item when make the duplication of document. Therefore, the financial
statements concerning the accounts would not present material information.
However, the existing internal control of Quarter limited is not designed appropriately
and comes with limitation that carries a risk that there exist of possibility of material
misstatement when preparing the financial statements. This is so because the organization
currently no inspection of inventory is conducted and no verification of signed delivery
document is conduced against the online sales invoices. Therefore, it can be inferred that the
internal control system of Quarter limited has some weakness as there is the possibility of
material misstatement due to the associated deficiencies in the system.
Answer to question 3:
Test of control is the procedure that is used to test the effectiveness of the internal
control system. From the analysis of the given case, it has been ascertained that Quarter
limited has adopted perpetual inventory system and the test of control in event of maintaining
such inventory system would be either to make the physical count of inventories or the
quantity information of entity can be ascertained by properly recording the items. The
quantity of inventories can be determined by statistical sampling method which is considered
to be highly effective in determining the quantity of inventories (Pcaobus.org 2019).

AUDITING THEORY AND PRACTICE
Regarding the test of control for sales revenue account, the auditor would select
sample of sales invoices and examine the evidences which the company compared the details
to purchase orders, shipping documents and sales order. Using this test of control would
enable the company to verify the recording of the documents and data contained in the
account such as sales account and inventory account (accaglobal.com 2019).
Such test of control is designed to detect, correctly record and prevent the occurrence
of any material misstatement by way of examining the internal control associated with
respective accounts. The substantive testing can be reduced by the organization if it is found
that the internal controls are strong. If the test of controls is designed effectively, it helps in
obtaining the sufficient evidence for supporting the opinion on the internal control system of
the financial reporting (Lakis and Masiulevičius 2017). Such testing of control helps in
concluding on the effectiveness of internal control of the accounts and classes of transactions
related to inventory account and net sales revenue account.
Answer to question 4:
Substantive procedures are used by auditors to detect the information that result in
material misstatement or detecting the fraud. The substantive procedure that can be adopted
for producing reliable evidence to meet the general objective of sales revenue account is
matching of the sales invoices to delivery document. This would facilitate the verification of
the signed delivery documents to the data that is fetched online and thereby help in
preventing the occurrence of error. The evidence that would be produced by substantive
procedure would depend upon the mix of timing, nature and the extent of such procedures. In
order to meet the objective of account while conducting the audit procedure, it is required to
determine the mean of selected items in the account for testing and this would help in
meeting the objective (Bemelmans 2017). However, the risk concerning the material

AUDITING THEORY AND PRACTICE
misstatement when appropriate considers the reliance on control and testing the relevant
assertion.
Regarding the inventory account, the substantive test of control that can be adopted is
to inquire about the procedures of perpetual inventory and testing all the records regarding
inventory by referring to the purchase invoices, requisitions, writing down of inventory
expense and any allowance of obsolescence account of inventory. The substantive procedures
for testing revenue involve a combination of substantive analytical procedure and test of
revenue transactions (Anderson and Fleming 2016).

AUDITING THEORY AND PRACTICE
References list:
Anderson, J. and Fleming, D., 2016. Analytical procedures decision aids for generating
explanations: Current state of theoretical development and implications of their use. Journal
of Accounting and Taxation, 8(5), pp.51-58.
Appelbaum, D.A., Kogan, A. and Vasarhelyi, M.A., 2018. Analytical procedures in external
auditing: A comprehensive literature survey and framework for external audit
analytics. Journal of Accounting Literature, 40, pp.83-101.
Bemelmans-Videc, M.L., 2017. Accountability, a classic concept in modern contexts:
Implications for evaluation and for auditing roles. In Making Accountability Work (pp. 39-
58). Routledge.
Byrnes, P.E., Al-Awadhi, A., Gullvist, B., Brown-Liburd, H., Teeter, R., Warren Jr, J.D. and
Vasarhelyi, M., 2018. Evolution of Auditing: From the Traditional Approach to the Future
Audit 1. In Continuous Auditing: Theory and Application (pp. 285-297). Emerald Publishing
Limited.
Eilifsen, A., Hamilton, E.L. and Messier Jr, W.F., 2017. The Importance of Quantifying
Uncertainty: Examining the Effect of Audit Materiality and Sensitivity Analysis Disclosures
on Investors’ Judgments and Decisions.

AUDITING THEORY AND PRACTICE
https://www.accaglobal.com, A. 2019. Audit evidence and specific considerations for certain
items | ACCA Global. [online] Accaglobal.com. Available at:
https://www.accaglobal.com/in/en/member/discover/cpd-articles/audit-assurance/specific-
considerations.html [Accessed 3 May 2019].
Lakis, V. and Masiulevičius, A., 2017. ACCEPTABLE AUDIT MATERIALITY FOR
USERS OF FINANCIAL STATEMENTS. Journal of Management, 2(31).
Pcaobus.org., 2019. Auditing Standard No. 13. [online] Available at:
https://pcaobus.org/Standards/Archived/PreReorgStandards/Pages/Auditing_Standard_13.as
px [Accessed 3 May 2019].

AUDITING THEORY AND PRACTICE