Determine Proper Account Values And Evaluate Sample Results

Determine Proper Account Values & Evaluate Sample Results for KCN

The case of Keystone Computers & Networks, Inc. (KCN), presents a scenario involving the verification of accounts receivable through sampling and subsequent adjustments based on confirmation responses and follow-up procedures. The primary task involves analyzing five exceptions identified during confirmation and determining the proper audited value for each account. Additionally, the application of the probability-proportional-to-size (PPS) sampling method is essential to evaluating the reliability of the sample results, with a concern for maintaining a 5% risk of incorrect acceptance. This essay discusses the process of evaluating each exception, calculating the adjusted account balances, and assessing if the variances fall within acceptable tolerances, aligned with auditing standards and statistical methods.

Background and Context

Keystone Computers & Networks, Inc., had a total accounts receivable balance of $10,235,457, with a sample size of 260 accounts (142 unique accounts) selected for confirmation. Out of these, 10 accounts did not respond directly, but alternative procedures confirmed their balances, revealing five exceptions. The responses and follow-up analyses provided specific details that could impact the reported balances, necessitating adjustments to reflect accurate, audited financial figures. The overall goal is to evaluate whether the identified variances warrant adjustments to the receivable balance and how these adjustments are reflected in the general ledger.

Analysis of Exceptions and Determination of Corrected Balances

Exception 1: Overpayment of $120,000

The customer indicated they paid the balance in full on December 31, 20X5, but the check was actually received on January 9, 20X6. Since the payment was received after the balance sheet date, the receivable balance as of December 31, 20X5, should be reduced by $120,000. The proper audited value for this account, therefore, is the original balance minus this payment—assuming no other factors impacting the balance—resulting in an adjustment that decreases the receivable by $120,000.

Exception 2: Return of Printer Valued at $330

The account initially reflected $30,000, but the customer returned a printer valued at $330, received on December 31, 20X5, with the return processed on January 2, 20X6. Since the return occurred within the fiscal year, the account balance should be decreased by $330 to reflect the actual net receivable. The adjusted value is, therefore, $30,000 - $330 = $29,670.

Exception 3: Payment Made After Year-End

The customer paid $214,000 on January 5, 20X6, but the invoice date was December 31, 20X5. The receipt date indicates the payment pertained to the subsequent accounting period. As per accounting principles, the receivable should not include this payment in the year-end balance, thus, the balance should be decreased by $214,000 for accurate period valuation.

Exception 4: Goods Not Received Until After Year-End

Goods valued at $130,000 were shipped on January 3, 20X6, with the customer receiving them on January 5, 20X6. Since these goods were shipped after the fiscal year-end, the corresponding receivable should not be included in the December 31, 20X5, balance. Consequently, the account should be reduced by $130,000, ensuring only receivables for goods shipped before year-end are included.

Exception 5: Unauthorized Discount Granted

The customer’s unpaid balance of $540, representing 3% of $18,000, was initially recorded. However, the sales agreement did not authorize a special discount, and the salesperson improperly granted it. After investigation, it was confirmed that the discount was processed on January 15, 20X6. As this adjustment pertains to a post-year transaction, the proper audited balance should reflect the original $18,000 less any legitimate discounts, excluding this unauthorized discount. Therefore, the $540 should be reversed or excluded, restoring the receivable to $18,000.

Application of the Probability-Proportional-to-Size (PPS) Sampling Method

The PPS sampling approach prioritizes larger accounts, aligning with risk assessment practices to mitigate the likelihood of missing material misstatements. Given the total receivable balance and the sample size, the sample results need to be scaled appropriately to estimate the total adjustments needed. The 5% risk of incorrect acceptance indicates a high confidence level that any material misstatement exceeding a specific threshold would be detected. Using the sample data, ratio estimation allows projecting the observed variances onto the entire population, considering the size of the accounts involved.

For each exception, the audit team estimated the adjusted receivable balances based on the actual identified variances and the proportion of total receivables they represent. These estimates involve calculating the ratio of the exception amount to the sample account size, then extrapolating to the entire population using the PPS weighting. Significant discrepancies that exceed the tolerable misstatement threshold based on the risk model require adjustments to the total accounts receivable figure, potentially decreasing it by the aggregate sum of the adjusted exceptions.

Evaluation of Variances and Acceptability of Adjustments

After adjusting each account as per the identified exceptions, the total impact on the accounts receivable balance can be calculated. The acceptability of these variances hinges on whether the total projected misstatement remains within the tolerable limit established by the audit plan, considering the 5% risk threshold. If the projected misstatement exceeds this limit, further substantive procedures would be warranted, and the account balance would need to be revised accordingly.

Based on the analyses, the combined effect of the five exceptions leads to a reduction in the accounts receivable balance. The projected total adjustment, calculated via ratio estimation, confirms whether the remaining error is within acceptable levels. If it is, the auditor can conclude that the receivables are fairly presented, with the necessary adjustments made. If not, additional sampling or inquiry might be necessary. Ultimately, the adjustment process aligns with auditing standards for materiality and risk mitigation, ensuring accurate financial reporting.

Conclusion

The thorough evaluation of the five identified exceptions demonstrates the importance of adjusting the accounts receivable balance to reflect accurate year-end figures. The application of the PPS sampling method enables auditors to project the impact of these variances across the entire population, ensuring that the risk of incorrect acceptance remains within the permissible threshold of 5%. Proper adjustments decrease the reported receivables by approximately the sum of the exceptions, ensuring compliance with accounting and auditing standards. This process illustrates the critical role of audit procedures in verifying the integrity of financial statements and providing reasonable assurance of their fairness.

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