Question

Several years ago, a medical device company was charged with improperly recognizing approximately $1.5 million in revenue from bill-and hold transactions. One distributor placed orders with the medical device company for approximately 15,000 units of a particular product in April and July. As part of the agreement with the distributor, the medical device company invoiced the distributor in September for the total 15,000 units for more than $500,000 in September, but held the product at its refrigerated facility until the distributor requested the product, which did not occur until March the following year. Yet, the company still recorded the revenue in the previous year.

#1. What accounts would this fraudulent transaction affect?

#2. What could an auditor do to discover the nature of the relationship between the company and its distributor regarding these products?

Answer 1

1. The fraudulent transaction will primarily effect the following accounts:

- Revenue and cost of goods sold: Revenue and cost of goods sold, both would be overstated, considering that the revenue from sale and associated costs are wrongly recognised, resulting in erronous and overstated profit too.

- Accounts receivable: Accounts receivable would be overstated to the extent of additional revenue recognised.

- Inventory-Inventory would be understated to the extent of costs of fraudulent sales booked

2. Few ways in which auditor can discover the nature of relationship betweencompany and distributor:

- Review the contract and history of transactions with the distributor

- Review the nature of differences in the physical count of inventory v/s book inventory. The inventory would not appear in book, but would be physically present.

- Call for direct balance confirmation from the customer