Cut-off testing by Maltese audit firms : an evaluation

Abstract

Apart from being an assertion implied by management when preparing the entity's financial statements, cut-off is considered to be one of the tests of detail implemented by the auditor to ensure that the cut-off assertion has been appropriately dealt with by the entity's management. Cut-off testing seeks to verify that transactions and events have been recorded in the proper accounting period. The main objectives of this study are to evaluate the manner in which cut-off testing is being implemented by Maltese audit firms, to ascertain the different types of cut-off tests (inventory, debtors and creditors) and to determine whether there is a relationship between fraudulent financial reporting and cut-off testing. The objectives within this research are achieved through personal interviews conducted with the Big Four audit firms, six medium-sized audit firms and eight small audit firms. From the study it emerges that the detection of a material and intentional cut-off error requires the auditor to change the overall audit strategy, which eventually leads to a modification of the nature, timing and extent of further audit procedures. Cut-off tests related to stock are the most extensive, whereas the utilisation of circularisation letters in the verification of debtors' cut-off and creditors' cut-off is being replaced by alternative testing comprising 'receipts after year-end', 'tracing to sales invoices', 'payments after year-end' and the use of suppliers' statements. The study also reveals a moderate strong relationship between the implementation of cut-off procedures and the detection of fraudulent financial reporting from the cut-off assertion context. The verification of the entity's accounting policies, the scrutiny of journal entries, the bank cut-off and specific compliance tests comprising enquiry and observation have been indicated by various auditors to represent an extension of cut-off procedures.