The Journal Entry That Arrived Late
You are completing the audit of Marlowe Retail Ltd, year-end 31 December, with profit before tax of £1.2m and materiality of £60k. During the final review, you identify a manual journal posted on 30 December: Dr revenue £95k, Cr accrued income £95k, posted by the financial controller with the description 'reclass'. The controller says it corrects a prior-period error and is not material. You also find that the same controller posted 14 similar journals in the year totalling £310k, all with generic descriptions, and that the audit committee was not told. The draft audit report is unmodified. The partner asks whether the report can be issued and what should be communicated.
1. Assess the materiality and reporting implications of the journal entries.
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The single journal is £95k, above materiality of £60k, and the aggregate of £310k is 26% of profit before tax, so the amounts are material. The description 'reclass' is not adequate documentation, and the controller's assertion that it is a prior-period error is unverified. If it is a prior-period error, it should have been corrected by restating comparatives or disclosed, not buried in a December journal.
The journals are a fraud risk indicator (management override). The auditor must:
- Obtain the supporting documentation for each journal and test whether the accounting treatment is correct.
- Consider whether the correction is an error or a deliberate misstatement.
- Evaluate the cumulative effect on the financial statements and whether the audit report can be unmodified.
If the entries are unsupported or incorrect and the effect is material, the financial statements are misstated and the opinion should be qualified or adverse depending on pervasiveness. Even if the amounts are corrected, the override risk must be reported to those charged with governance, and the audit committee should be informed of the control failure.
2. Draft the key matters you would communicate to those charged with governance and explain the auditor's responsibilities.
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Communication should cover:
- The nature, number and value of the manual journals (£310k across 14 entries) and the lack of adequate descriptions and supporting documentation.
- The specific £95k entry, its stated purpose and the evidence obtained or not obtained.
- The control deficiency: no independent review of manual journals and no audit committee visibility.
- The fraud risk implications of management override and the auditor's procedures in response.
- Any uncorrected misstatements and their effect on the opinion.
- Recommendations: journal approval workflow, mandatory descriptions, review by someone other than the poster, and reporting to the audit committee.
The auditor's responsibilities under ISA 240 include maintaining professional scepticism, evaluating journal entries and other adjustments, and communicating fraud risks to those charged with governance. The auditor should document the communication and any management response. If management is uncooperative, the auditor should consider the effect on the reliability of representations and whether the engagement can continue.