Module C (September 2004 Session) 1SECTION A: CASE QUESTIONS Answer 1(a) Assertions relevant to sales There are five assertions relevant to ABCs sales for the year ending 31 December 2004. They are: Occurrence: that all sale transactions that have been recorded have occurred and pertain to ABC; Completeness: that all sale transactions that should have been recorded have been recorded by ABC; Accuracy: that amounts and other data relating to recorded sale transactions have been recorded appropriately; Cut-off: that sale transactions have been recorded in the correct accounting period; and Classification: that transactions and events have been recorded in the proper accounts. Assertions that have higher risks of material misstatement The principal change in ABCs operations during the year that affected assertions relevant to sale transactions during the year was the introduction of the special trial sales scheme in January 2004. The key issue is when these special trial sales should be recognised in ABCs financial statements. ABC recognised these sales on delivery. However, it is arguable that, in accordance with HKAS 18, sales should not be recognised until the expiry of the 30 day trial period for goods retained by customers. This issue was not sufficiently dealt with by simply making a 2% provision for expected returns. The principal assertion affected by these uncertainties or controversy is the cut-off assertion. For goods that were returned during the 30-day trial period, it is arguable whether sales should be recognised in the first place. The principal assertion affected by these uncertainties or controversy is the occurrence assertion. Assertions that have low risks of material misstatement Since there have been no other material changes in ABCs operations that affect sale transactions, it is reasonable for ABC to consider that the risks of material misstatement of the assertions of completeness, accuracy and classification would be the same as last year.That is, the risks of material misstatement for these assertions are assessed as low on the expectation that relevant internal controls on sale transactions during the year had been operating effectively. Module C (September 2004 Session) 2Assertions relevant to trade receivables There are four assertions relevant to ABCs balance of trade receivables as at 31 December 2004. They are: Existence: that the trade receivables exist; Completeness: that all trade receivables that should have been recorded have been recorded by ABC; Valuation and allocation: that trade receivables are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded; and Rights and obligation: that ABC holds or controls the rights to the trade receivables. Assertions that have higher risks of material misstatement During the year ending 31 December 2004, the principal change in ABCs operations that affected the assertions relevant to trade receivables was the extension of the credit period for customers. The new credit term might reflect the existing pattern of bill settlement, or in the more likely case, that customers would take advantage of the longer credit term and further delay settlement. In particular, the management explained that the extension was made in response to a poorer economic environment. There would be a higher risk of material misstatement if ABC had not evaluated or changed its policy on the valuation of trade receivables in response to the changes in the business environment. The key issue is whether ABCs existing policy or practice in estimating the amount of the provision for doubtful debts continued to be appropriate in the new situation. The principal assertion affected by these uncertainties or controversy is the valuation and allocation assertion. Assertions that have low risks of material misstatement The special trial sales scheme also affects the existence and rights and obligation assertions of ABCs trade receivables, since if such sales should not be recognised in the year, the corresponding trade receivables should not be recognised either. However, risks of material misstatement caused by special trial sales on the existence and rights and obligation assertions are considered to be less acute than the risks of material misstatement in the valuation and allocation assertion. This is because, amongst other reasons, the longer period involved makes it difficult to review subsequent events to give a better accounting estimate of the provision for doubtful debts. It is reasonable for ABC to consider that the risks of material misstatement of the completeness would be the same as that of the last year since there had been no other material changes in ABCs operation that affect this assertion. That is, the risks of material misstatement for the completeness assertion are assessed as low on the expectation that