Substantive testing and assertions
Required:
(a) Identify the key account balance at risk because of the sales team remuneration at Shady Oaks. Also identify and explain the key assertion at risk.
(b) Identify the key account balance and key assertion being tested with the substantive procedure. Given the bonus structure in place for the sales team, justify your answer.
(a) The sales team are remunerated in two ways; a base salary plus a bonus based on the dollar values of sales. The bonus payment increases if the sales person increases recorded sales. An inappropriate way of increasing sales is to record sales during the year for samples given to customers. When the sample is returned following the year-end the sale is reversed or adjusted with a sales return or allowance. Another way of increasing sales is to falsify sales by recording a sale to a fictitious customer. The account balance is eventually written off for non-payment of the account. The sales and accounts receivable account balances are at risk because of these practices. The assertions at risk are occurrence and existence for the sales transaction and accounts receivable balance. In addition, the valuation and allocation assertion for accounts receivable is at risk because the balance does not represent the amount that is reasonably expected to be received from customers.
(b) The substantive test described in the question is to take a sample of payments received by the hospital (i.e. cash receipts) and trace back to the general ledger and customer account balance. Performing this test will provide evidence about the existence/occurrence assertion for the accounts receivable and sales balances, and the valuation and allocation assertion for accounts receivable. If the client receives cash for the credit of an accounts receivable this is reliable evidence that the recorded sale did occur and that the balance of accounts receivable was fairly stated at the year-end. The reference to the bonus structure is to reinforce the risk to the occurrence assertion for sales and the valuation and allocation assertion for accounts receivable.