Question

An auditor is reviewing sales cutoff as of March 31, 2019. All sales are shipped FOB destination and the company records sales three days after shipment. The auditor notes the following transactions:

Date Shipped Month Recorded Selling Price (000s) Cost (000s)
March 28 March $ 192 $ 200
March 29 March 44 40
March 30 April 77 81
April 2 March 208 220
April 5 April 92 84
If the entity records the required adjustments, the net effect on income (in thousands of dollars) for the period ended March 31, 2019 is
A) an increase of 12.
B) an increase of 8.
C) a decrease of 12.
D) a decrease of 8.

Answer 1

The auditor must adjust sales revenue and corresponding costs to the correct time period based on FOB destination policy. After making the necessary adjustments, the net effect is B)an increase of $8,000 in net income.

Step-by-step explanation:

The student has asked about the net effect on income when an auditor is reviewing sales cutoff dates with respect to generally accepted accounting principles (GAAP). To answer this, we should first recognize that the company records sales three days after shipment and uses FOB destination. This means that the revenue should be recognized when the goods arrive at the destination, not when they are shipped. To determine the effect on net income as of March 31, 2019:

• The sale shipped on March 30, for which revenue was recorded in April (selling price $77,000) should be included in March's financial records because it would likely arrive and, by their policy, be recorded within the three days.
• The sale shipped on April 2, for which revenue was recorded in March (selling price $208,000), should not be included in March's financial records because it would not arrive and be recorded until after March 31.

By adjusting these, we decrease March's income for the $208,000 sale that was prematurely recorded and increase it for the $77,000 sale that should have been recorded in March. The net effect is a decrease of $208,000 and an increase of $77,000, totaling a net decrease of $131,000 in income before considering costs. However, we must also adjust for the costs of the goods: a decrease in cost of goods sold of $220,000 that was prematurely recorded and an increase of $81,000 that should have been recorded, resulting in a net decrease of costs by $139,000.

Thus, the net effect on income after considering both selling price and cost of goods will be a decrease of $131,000 in revenue and a decrease of $139,000 in costs. Since the decrease in costs is greater than the decrease in revenue, the net income will increase. The calculation is thus $139,000 (decrease in costs) - $131,000 (decrease in revenue) = increase in net income by $8,000. Therefore, the correct answer is B) an increase of 8.