Question;7.50 Overstated Sales and Accounts Receivable. This case is designed like the ones in the chapter. Your assignment is to 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 RevenueMattel 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, Mattel 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 Mattel premises and identified as the customers' property. Mattox would later ship the toys to various retail locations upon instructions from thecustomers. The "field warehousing" was explained as Mattel'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 warehousingand 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 shippingemployees problems with identifying shipments of toys that had been "sold" earlier and those that had not.Mattel 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 andrecorded 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 Mattel 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 percenthigher 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.Mattel'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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