Revenue Cut-Off at Year-End for a Custom Fabricator
Ridgeway Fabrication Ltd (RFL) builds bespoke steel structures. Its year end is 31 December 2025. On 20 December 2025 RFL shipped a completed mezzanine to a client and issued an invoice for Tk 4.8 million, recording revenue and a receivable on 20 December. The contract states title passes on installation sign-off, which occurred on 8 January 2026. The client had a contractual right to cancel before sign-off if site readiness failed, and RFL's engineers were still on site adjusting tolerances on 31 December. Cost of goods sold for the job was Tk 3.6 million, already expensed. RFL's draft profit before tax is Tk 9.2 million; the bank covenant requires a minimum current ratio of 1.4 and RFL's draft current ratio is 1.42. The finance director argues the goods were physically delivered, so revenue recognition is defensible and the covenant should not be jeopardised. The audit partner has flagged cut-off as a significant risk.
1. Assess whether the Tk 4.8 million should be recognised in 2025. Identify the specific recognition criteria at issue and quantify the effect on profit and the covenant.
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Revenue should not be recognised in 2025. Under IFRS 15, revenue is recognised when control transfers. Control indicators include physical possession, legal title, significant risks and rewards, and acceptance. Here title passes only on installation sign-off (8 January 2026), the client retains a cancellation right tied to site readiness, and RFL's engineers were still adjusting the structure at year end, meaning RFL retained significant risks of non-acceptance. Physical delivery alone is not determinative.
The correction removes Tk 4.8 million of revenue and the related receivable, and reverses Tk 3.6 million of cost of sales into inventory or contract asset, reducing profit before tax by Tk 1.2 million to Tk 8.0 million. The receivable reduction lowers current assets, so the current ratio falls below 1.4 and breaches the covenant. The covenant breach is a genuine commercial consequence, not a reason to misstate; it must be disclosed and the bank engaged. The FD's argument is pressure to override an accounting judgement, which is a fraud risk factor under ISA 240.
2. Design the audit procedures you would perform to conclude on cut-off, and explain how you would respond to the FD's stated motive.
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Procedures: obtain the contract and confirm the title-transfer and acceptance terms; inspect installation sign-off dated 8 January 2026; review engineers' site logs and timesheets for late-December work; test a sample of December and January shipments against signed acceptance documents; review credit notes and returns after year end for evidence goods were not accepted; confirm the balance and terms directly with the client; and review the general ledger for manual journals around year end crediting revenue.
Response to the FD's motive: the FD has an explicit incentive to keep the covenant, so this is a fraud risk under ISA 240 and the matter is significant. Escalate to the engagement partner, document the discussion contemporaneously, and do not accept oral assurances without corroboration. If management refuses to adjust, the misstatement of Tk 1.2 million is material relative to profit and affects a covenant, so consider a qualified opinion and communicate with those charged with governance. Independence and objectivity require resisting the pressure regardless of the client relationship.