Question

Following are examples of control deficiencies that may represent significant deficiencies or material weaknesses. For each control deficiency, indicate whether it is a significant deficiency or material weakness. Justify your decision.

a.
The entity uses a standard sales contract for most transactions. Individual sales transactions are not material to the entity. Sales personnel are allowed to modify sales contract terms. The entity’s accounting function reviews significant or unusual modifications to the sales contract terms but does not review changes in the standard shipping terms. The changes in the standard shipping terms could require a delay in the timing of revenue recognition. Management reviews gross margins on a monthly basis and investigates any significant or unusual relationships. In addition, management reviews the reasonableness of inventory levels at the end of each accounting period. The entity has experienced limited situations in which revenue has been inappropriately recorded in advance of shipment, but amounts have not been material.

b.
The entity has a standard sales contract, but sales personnel frequently modify the terms of the contract. The nature of the modifications can affect the timing and amount of revenue recognized. Individual sales transactions are frequently material to the entity, and the gross margin can vary significantly for each transaction. The entity does not have procedures in place for the accounting function to regularly review modifications to sales contract terms. Although management reviews gross margins on a monthly basis, the significant differences in gross margins on individual transactions make it difficult for management to identify potential misstatements. Improper revenue recognition has occurred, and the amounts have been material.

c.
The entity has a standard sales contract, but sales personnel frequently modify the terms of the contract. Sales personnel frequently grant unauthorized and unrecorded sales discounts to customers without the knowledge of the accounting department. These amounts are deducted by customers in paying their invoices and are recorded as outstanding balances on the accounts receivable–aging. Although these amounts are individually insignificant, when added up they are material and have occurred regularly over the past few years.

Answer 1

The Control deficiencies identified in each option is as follows

A) Significant Deficiency

B) Material Weakness

C) Material Weakness

Step-by-step explanation:

A material weakness is a one or more deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.

A significant deficiency is an error in internal control over financial reporting, that is less severe than a material weakness yet important enough to merit attention by those responsible for oversight of the company's financial reporting.

A) For Individual sales transactions where Sales personnel are allowed to modify sales contract terms and entity’s accounting function reviews significant or unusual modifications to the sales contract terms and In addition, management reviews the reasonableness of inventory levels at the end of each accounting period, significant deficiency applies.

B) For standard sales contract where nature of the modifications can affect the timing and amount of revenue recognized, material weakness applies.

C) Material weakness also applies here

Answer 2

a. Significant deficiency.

b. Material weakness.

c. Material weakness.

Step-by-step explanation:

a. Individual sales transactions are not material and the compensating detective controls operating monthly and at the end of each financial reporting period should be able to decrease the possibility of a material misstatement going undetected.

b. Individual sales transactions are frequently material, and gross margin can vary significantly with each transaction.

c. The frequency of occurrence allows unmeaningful amounts to return and be a part of material in the aggregate.