The auditor is most likely to examine related party transactions very carefully while vouching
|a) credit sales|
b) sales returns
c) credit purchases
d) cash purchases
The Correct Answer Is:
- c) credit purchases
The correct answer is c) credit purchases. When an auditor is vouching transactions, especially related party transactions, credit purchases are one of the transactions that warrant careful examination. This is because credit purchases involve the acquisition of goods or services on credit terms, which are susceptible to manipulation and misrepresentation when related parties are involved.
Here’s a detailed explanation of why credit purchases are the most likely to be examined closely by auditors, along with explanations for why the other options are less likely to be scrutinized in the same way:
c) Credit Purchases:
Auditors pay special attention to credit purchases because they represent a significant financial transaction in which a company acquires goods or services on credit terms from suppliers or related parties. Related party transactions can pose a higher risk of financial misstatement, as there is a potential for collusion or non-arm’s length transactions that could be detrimental to the company or its shareholders.
Auditors examine credit purchases to ensure that they are made at fair market prices and that they are not biased in favor of related parties at the expense of the company’s best interests. Additionally, credit purchases are subject to potential overstatement or understatement, which can impact a company’s financial statements.
Auditors review documentation, contracts, and pricing terms to verify the legitimacy and fairness of these transactions. They also assess whether the credit purchases are consistent with the company’s normal business operations.
Now, let’s explore why the other options are not as likely to be examined as closely by auditors:
a) Credit Sales:
While credit sales are important transactions that generate revenue for a company, they are less likely to be scrutinized in the context of related party transactions compared to credit purchases.
Credit sales are usually subject to scrutiny during the examination of revenue recognition, but the focus is on whether revenue is recognized correctly and whether there is a risk of premature recognition or manipulation of sales figures. The primary concern with credit sales is related to revenue recognition, not the potential for related party influence on the transaction.
Auditors typically concentrate their efforts on ensuring that sales are made in accordance with the company’s revenue recognition policies and that revenue is earned and realizable.
b) Sales Returns:
Auditors may review sales returns to ensure that they are appropriately recorded and do not result in an overstatement of revenue. However, sales returns are less likely to be examined in the context of related party transactions. Sales returns are usually considered from the perspective of customer satisfaction, return policies, and their impact on the company’s revenue.
The primary concern with sales returns is whether they are properly accounted for and disclosed in the financial statements, rather than their potential for related party manipulation.
d) Cash Purchases:
Auditors often examine cash purchases to verify that cash disbursements are supported by proper documentation and that they are valid and accurately recorded. However, cash purchases are generally considered to be less susceptible to manipulation in the context of related party transactions.
The use of cash for purchases usually leaves a clear and traceable audit trail. While auditors may review cash purchases to ensure that the company is making legitimate and necessary expenditures, they are not as likely to focus on cash purchases as a source of potential related party transaction issues.
Instead, their attention is directed more towards credit transactions, which have greater potential for hidden related party dealings or biased terms.
In conclusion, when auditors are vouching transactions, especially in the context of related party transactions, credit purchases are the transactions that they are most likely to examine very carefully. This is because credit purchases involve the acquisition of goods or services on credit terms, which are more susceptible to manipulation and misrepresentation when related parties are involved.
Auditors scrutinize credit purchases to ensure they are made at fair market prices and not biased in favor of related parties at the expense of the company’s interests.
While credit sales, sales returns, and cash purchases are important financial transactions, they are generally less likely to be examined in the same detail regarding related party transactions. Auditors prioritize their examination of credit purchases due to their higher risk of potential issues related to related party influence or manipulation.