7-35 Following are examples of control deficiencies that may represent significant deficiencies or material weaknesses.
For each control deficiency, indicate whether it is a significant deficiency or material weakness. Justify your decision.
a. The entity uses a standard sales contract for most transactions. Individual sales transactions are not material to the
entity. Sales personnel are allowed to modify sales contract terms. The entity’s accounting function reviews significant or
unusual modifications to the sales contract terms but does not review changes in the standard shipping terms. The
changes in the standard shipping terms could require a delay in the timing of revenue recognition. Management reviews
gross margins on a monthly basis and investigates any significant or unusual relationships. In addition, management
reviews the reasonableness of inventory levels at the end of each accounting period. The entity has experienced limited
situations in which revenue has been inappropriately recorded in advance of shipment, but amounts have not been
material.
Significant deficiency because individual sales transactions are not material and the
compensating detective controls operating monthly and at the end of each financial reporting
period should reduce the likelihood of a material misstatement going undetected.
b. The entity has a standard sales contract, but sales personnel frequently modify the terms of the contract. The nature
of the modifications can affect the timing and amount of revenue recognized. Individual sales transactions are frequently
material to the entity, and the gross margin can vary significantly for each transaction. The entity does not have
procedures in place for the accounting function to regularly review modifications to sales contract terms. Although
management reviews gross margins on a monthly basis, the significant differences in gross margins on individual
transactions make it difficult for management to identify potential misstatements. Improper revenue recognition has
occurred, and the amounts have been material.
Material weakness because individual sales transactions are frequently material, and gross
