What is the purpose of cutoff testing?
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Detailed below are some individual tests that can be applied in order to help satisfy the objectives noted in Audit objectives. It may not be appropriate to undertake all of the tests; in each case, the auditor should review this bank of tests and determine which are most appropriate for the circumstances of the particular client being dealt with.
The auditor should, however, ensure that each objective is satisfied. Where the balance includes accounting estimates, refer to the guidance in Auditing accounting estimates. To subscribe to this content, simply call 0800 231 5199 We can create a package that’s catered to your individual needs. Or
book a demo to see this product in action. Audit objectives for sales cutoff focus on ensuring that sales are recorded in the proper period. Small-business owners can count on the auditor gaining assurance over the cutoff of sales using multiple procedures. Understanding some of the more common sales cutoff procedures can eliminate some of the surprise in your company's audit. Policies and ProceduresAn understanding of the company's policies and procedures employed in the sales process is the most important tool the auditor has to assess sales cutoff. Because sales cutoff concerns whether sales are recorded in the proper period, it is important for the auditor to understand when title of goods passes from the seller to the buyer. Small-business owners should be prepared to describe and show documentation that supports a company's title transfer procedures. This is especially salient if the company does not simply transfer title upon the exchange of cash. Accounts Receivable TestingAuditors gain some assurance over sales cutoff through accounts receivable testing. When performing this audit procedure, auditors will send letters asking the company's customers to confirm the amount owed to the company as of the balance sheet date. If sales are recorded in an incorrect period, customers may reply that the balance wasn't owed as of balance sheet date, alerting auditors to a potential cutoff problem. Small-business owners should realize, however, that this method does not provide adequate concern over cutoff on its own and additional procedures are likely to be performed. Sequential InvoicingIf a company numbers invoices sequentially and has a standard procedure for transferring the title of goods sold, then examining the invoices that surround the year-end date can be a simple and effective method for testing sales cutoff. To perform this procedure, the auditor usually will ask for the invoices for the five days before and after year end. Depending on the number of invoices, the auditor will then ask for shipping information regarding either all of the invoices or a reasonable sub-selection. Small-business owners should be ready to supply the auditor with this evidence. In addition, small-business owners may wish to examine these transactions themselves before the audit begins. This give the company time to correct any errors, if they arise. Allowance CutoffFor companies that have material amounts of sales returns, generally accepted accounting principles require that sales returns are matched with the original sale and counted in the same period. Many companies operate on the assumption that if sales are consistently recorded in the period in which the item is returned, then over time, the sales mis-recorded in each period balance out and there is no material difference between recording the return upon receipt and matching the return to the proper period. Small-business owners who are experiencing rapid growth should take caution with this approach. If sales are increasing year over year, the amount of sales returns may be increasing as well. In this case, this assumption may not hold and the auditor may determine that there is a sales allowance cutoff error that needs to be corrected. References
Writer Bio John Freedman's articles specialize in management and financial responsibility. He is a certified public accountant, graduated summa cum laude with a Bachelor of Arts in business administration and has been writing since 1998. His career includes public company auditing and work with the campus recruiting team for his alma mater. The end of any accounting period is chaotic without the right procedures in place to ensure everyone has the right information and reports. Establishing set procedures for period-ending reporting gives the accounting department time to plan and sets the expectations of all departments to prepare. The accounting department needs to work with business leaders to be on the same page about the cutoff procedures for the company. Inventory Cut Off ProceduresA company's inventory is constantly in flux. Orders are fulfilled and inventory drops by each unit sold while new shipments arrive adding to the stacks. Inventory control requires diligent procedural control to give accounting consistent numbers. One shipment of inventory accounted for in the wrong month could lead to differences of tens of thousands of dollars in reports. If the accounting department is running its monthly reports, it needs several days time to pull all that information together. This means that warehouses must be given a firm deadline as to when inventory is counted for the month. The first department is the receiving and inspection department that takes in new shipments of goods. Assume the month-end report is due on the 20th, the procedure to close receiving could be four days earlier on the 26th of the month. Set a time to count all inventory, perhaps at noon of the 26th with all counted inventory being stamped, "Before Inventory" for clarity with reports submitted by end of business that day. Store operations and finishing areas must have similar deadlines to process all location inventory and all fulfilled orders by end of business on the 26th. This process gives accounting a defined period to determine actual inventory on hand and compare numbers from period to period. Accounts Payable Cut Off ProceduresMost vendors have their own billing cycles. This is good because it helps accounting know when to expect what bills. However, an accounting department cannot rely on outside vendors for consistency. Procedures place consistency in the calculations of how and when vendor payments are made. Set exact times for cutoffs otherwise carryover might affect another month's balance sheet. All payments should be immediately entered into the ledger when made. However, someone should be monitoring the month-end incoming invoices and payments. It is important to classify the expense and the liability in the right billing cycle. For example, if a vendor sends an invoice on July 27 for work done June 27, this is a liability for June and expense for July. The expense and liability would be for the same month if the work was done in July and not June. Accounting clerks must understand how the company defines liabilities, assets, expenses and revenues to ensure the books are accurate from month to month. Cutoff periods should trigger limited access to accounting data for accuracy and consistency. Audit ProceduresThe audit procedures for the company books is where the books are reconciled and all accounts payable classifications are confirmed. The process for the auditor is to look at the invoice and the payment and ask when the legal obligation to pay was. Some vendors have a 30 or 60-day payment term period that can affect liability recording dates. Income and revenue cannot be deferred. But if a payable is paid early, it may still be deferred to a later accounting period. The company should set a standard for deferred liabilities for consistency. While accounting principles allow for liability deferral, it might not be a policy that the company chooses to allow. The company might decide to hold all liabilities in the month they were established and not defer them at all. What is the purpose of sales cutoff testing?Revenue cutoffs
Cutoff testing procedures should be designed to detect potential misstatements related to timing issues, as well as to obtain sufficient relevant and reliable evidence regarding whether revenue is recorded in the appropriate period.
What does cutoff mean in accounting?In accounting, the cutoff date is the point in time that delineates when additional business transactions are to be recorded in the following reporting period. For example, January 31 is the cutoff date for all transactions that will be recorded in the month of January.
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