The Cut-Off That Wasn't
You are the audit senior on Meridian Components Ltd, a manufacturer with a 31 December year end and a materiality of $180,000. During the December cut-off test you select goods despatch note (GDN) 8841, dated 29 December, with a sales invoice dated 31 December for $240,000. The despatch warehouse log shows the goods left the premises on 4 January. The finance director explains that the customer requested the goods be held at Meridian's warehouse, signed a 'bill and hold' agreement on 22 December, and that revenue recognition is therefore correct. You locate the agreement: it is signed by the customer, states the goods are identified and ready for delivery, and that title and risk pass to the customer on 22 December. However, the goods are still physically commingled in the general finished-goods area, not segregated, and the customer has paid nothing. Prior-year working papers show a similar $210,000 bill-and-hold adjustment was proposed and accepted.
1. Evaluate whether the $240,000 may be recognised as revenue at 31 December, and state the audit response you would document.
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Framework: Revenue is recognised when control transfers (IFRS 15). Bill-and-hold is only acceptable if, cumulatively: (a) the arrangement is substantive (commercial reason), (b) the product is separately identified as belonging to the customer, (c) it is ready for delivery, and (d) the seller cannot use it or direct it to another customer.
Apply:
- (a) Substantive reason: customer request documented - plausible, but no commercial rationale is recorded (why hold? storage capacity?). Weak.
- (b) Separately identified: fails - goods are commingled in general stock and not segregated or labelled for this customer.
- (c) Ready for delivery: apparently yes.
- (d) Cannot redirect: fails - commingled goods can be sold to anyone; Meridian retains practical ability to redirect.
Conclusion: Recognition is not appropriate; the $240,000 (1.3x materiality) is overstated revenue and receivables, with a matching inventory understatement. Propose an adjustment.
Audit response: (1) Extend cut-off testing around year end to all bill-and-hold transactions; (2) obtain the full population of bill-and-hold agreements from management and test each against the four criteria; (3) inspect physical segregation at the count; (4) consider whether the prior-year $210,000 item was similarly unsupported - this becomes a prior-period error and a possible indicator of management bias under ISA 240; (5) document the challenge and escalate to the engagement partner; (6) if uncorrected, treat as a misstatement and evaluate the effect on the audit opinion.
2. The finance director argues the prior-year treatment was accepted without adjustment. How does that affect your judgement and your documentation?
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Prior acceptance is not audit evidence and does not create a precedent that binds the current audit. Each period is assessed on its own facts (ISA 500; comparability is not a substitute for sufficient appropriate evidence).
However, the prior-year file is highly relevant in two ways:
- Consistency and bias: a repeated pattern of aggressive bill-and-hold recognition near year end is a fraud risk indicator (ISA 240 - revenue recognition presumed risk). It raises the assessed risk of material misstatement for the revenue cut-off assertion from 'normal' to 'significant'.
- Prior-period misstatement: if last year's item also failed the criteria, the comparative figures contain an error. Under ISA 560/ISA 450, you must consider whether the comparative is materially misstated and whether the prior-year opinion is affected.
Documentation: record the facts, the criteria applied, the conclusion, the discussion with the FD, and why prior acceptance did not change your view. A reviewer must be able to see that you exercised professional scepticism rather than deferring to management. If the FD maintains the position, escalate to those charged with governance and record the response.