Auditing the Revenue Cycle Day 10

Accounts Receivable: Key documents used for auditing

-A/R Confirmations -A/R Aging Report -Allowance for Doubtful Accounts Rollforward

Best Alternative to Positive Confirmations non-responses

1. cash collections (if they were paid) 2. 3 way match

Audit Procedures: 3 Gross Sales Substantive Analytics

1. compare total units shipped and product revenue 2. compare gross profit margin by product line to industry average 3. compare sales in the final month to the rest of the year

Tracing shipping documents to pre-numbered sales invoices provides evidence that a. no duplicate shipments or billings occurred b. shipments to customers were properly invoiced c. all goods ordered by customers were shipped d. all pre-numbered sales invoices were accounted for

b shipments to customers were properly invoiced

An auditor selected items for test counts while observing a client's physical inventory. The auditor then traced the test counts to the client's inventory listing. Tracing test counts most likely obtained evidence concerning the relevant assertion about a. rights and obligations b. completeness c. existence d. accuracy, valuation and allocation

b. completeness

Which of the following audit procedures probably would provide the most reliable evidence concerning the entity's assertion of rights and obligations related to inventories? a. trace test counts noted during the entity's physical count to the entity's summarization of quantities b. inspect agreements to determine whether any inventory is pledged as collateral or subject to any liens. c. select the last few shipping advices used before the physical count and determine whether the shipments were recorded as sales. d. inspect the open purchase order file for significant commitments that should be considered for disclosure

b. inspect agreements to determine whether any inventory is pledged as collateral or subject to any liens

In auditing accounts payable, an auditor's procedures most likely will focus primarily on the relevant assertion about a. existence b. classification c. completeness d. accuracy, valuation and allocation

c. completeness

related party transactions

don't properly eliminate intercompany sales

The most critical control for the process revenue is

segregation of duties -credit from billing -A/R from GL -shipping from billing -cash receipts from A/R

A/R cutoff testing

select a sample from list of memos issued before and after year end

If A/R confirmation is not returned, look for....

subsequent cash receipt on bank statement

verify mathematical accuracy of bank reconciliation: Other Items

test if material

Interbank Transfer schedule is testing that the date recorded in the Client's books for the DISBURSING BANK is equal to.....

the date recorded in the Client's books from the RECEIVING BANK if date is equal, good to go

What assertion is ADA especially meaningful for?

Accuracy/Valuation

channel stuffing

induce distributers to buy more inventory than they can promptly resell. issues having to do w/right of return, accepting returns beyond the stated periods

Cash: Key Documents used for Auditing

original bank statements (including cut off bank statements) bank reconciliations bank confirmations (between auditor and external bank)

fraud in % of completion method

overstate status of completion on project

FOB Destination

ownership is transferred once reaches destination, seller assumes risk until reaches destination

FOB Origin

ownership is transferred once shipped and buyer assumes risk

Verify mathematical accuracy of bank reconciliation: Deposits in Transit

pull a sample from reconciliation and agree to bank statements

verify mathematical accuracy of bank reconciliation: Outstanding Checks

pull a sample of checks and wires from cutoff bank statement. Check for proper inclusion/exclusion

fictitious sales

record sales to fictitious customers OR ship goods to real customers that they never ordered

Skimming

remove cash from company before its entry into accounting system ex: stealing A/R payments

Audit Procedures: ADA Rollforward

-Control: test write offs for proper authorization (attribute sampling) -Test any A/R recoveries for existence (cash collection on the bank statement)

A/R Aging Report

-The top half would come from the client (PBC) -A/R year end aged trial balance -The bottom half is the auditor's test work -% historically uncollectible -expected allowance -tolerable error threshold

Kiting

-another way to cover up cash theft -employee steals cash from a bank account, then covers the shortage by transferring money from another bank account -exploits a timing difference in processing checks/wire transfers (cash shows up in 2 places at the same time in the accounting records)

Kiting example

-bank 1: US Bank, Bank 2: Wells Fargo (steal from this) -write a check from US bank account -deposit in account at Wells Fargo just before YEAR END -takes 1-2 days for US Bank to process disbursement -don't record it as an outstanding check at US Bank at year end same cash shows up twice

Test Reasonableness of ending A/R Reserve (ADA)

-compare against historical collection rates -validate historical collection by -examine A/R write offs in prior year, current year and after current year end -compare historical write offs against credit sales (or total receivables)

other considerations for testing A/R Reserve

-compare current A/R customer mix to historical mix (if applicable) - understand method of payment and credit terms (credit card, customer account) ultimately this is an estimate so its a matter of professional judgement

Negative Confirmations

-customer response is NOT required -requires response only when they disagree w/the amount due to the client -weak assurance since confirmation may be ignored or discarded

Which Assertions does Confirming A/R test?

-existence -rights and obligations

Confirmation Mailing:

-mail confirmations outside the client's facilities -include stamped return envelopes w/ accounting firm's address -if electronic, needs to be verified. Can't just use email addresses the client gives you (online website to verify)

Lapping

-most common way of skimming -cover cash shortage by taking cash from another customer payment and applying it to the 1st (stolen) customer's A/R -Then eliminate the shortage in the accounting records by recording credit memos or write offs

How auditors catch kiting

-obtain and/or create, and test, an interbank transfer schedule (a cutoff test for cash) -TEST CONTROLS

Possible strategy for confirmations

-positive for big customers -negative for smaller ones if controls are strong

Positive Confirmations

-respond whether they agree or disagree w/ the amount -provides revised amount if they disagree (watch out for TIMING DIFFERENCES) -non-responses require auditor to follow up or use alternative procedures -greater assurance and more common in practice

How auditors catch lapping:

-review journal entries involving write offs or credit memos -review irregular entries into cash account -TEST CONTROLS

Sales/Revenue: key documents used for auditing

-sales documents and records -GL detail of record sales, COGS, discount and returns -sales reserves calculation and policy -list of sales recorded shortly before and after year end

Test of details for Revenue. 3 way match

-select a sample of revenue items (invoices) and compare them to purchase orders or shipping documents -invoices to purchase orders or shipping documents tests EXISTENCE (book to world) -purchase orders/shipping documents to invoices tests COMPLETENESS (world to books)

Professional standards assume that A/R will be confirmed, unless

1. A/R is deemed immaterial 2. Confirmations would not be effective (ex: the client performs the customer's bookkeeping)

Five Step process to Revenue Recognition

1. Identify the contracts w/ the customer 2. Identify the separate performance obligations in the contract 3. determine the transaction price 4. allocate the transaction price to the separate performance obligations 5. recognize revenue when (or as) the entity satisfies a performance obligation

2 types of confirmations

1. Positive: customer response is required 2. Negative: customer response is NOT required

The client gives the auditor the bank reconciliation and the auditor REPERFORMS the reconciliation in 3 steps

1. The auditor confirms the bank balance DIRECTLY with the bank 2. The auditor INSPECTS DOCUMENTS related to the reconciling items 3. After RECALCULATING the rec, make sure it MATCHES what is in the books

Bank Reconciliation, Start with balance per bank then 1. add ______ 2. deduct _____ 3. = balance per books, unadjusted 4. make adjustments to books 5. to get balance per books, adjusted

1. add Deposits in transit 2. deduct outstanding checks

ADA Rollforward: For a rollforward, auditors will typically:

1. agree beginning balance to prior year 2. test the changes 3. agree ending balance to the books

Confirming A/R 3 steps

1. auditor selects customers, provides the customer names, amounts, and template to the client 2. client prepares the confirmations (also true for cash) 3. but the AUDITOR reviews them and actually sends them (also true for cash)

3 Ways to Test Sales Discounts

1. can be analytical, based on terms of discounts/rebates/returns 2. can also select a sample from the GL detail for discounts, and gain supporting documents to verify discount is valid 3. test controls around authorization of discounts, credit memos

9 Common Fraud Schemes: Revenue

1. early revenue recognition 2. side agreements 3. channel stuffing 4. bill and hold sales 5. fictitious sales 6. fraud in % completion 7. related party transactions 8. price fixing 9. failure to record sales returns

4 steps: Sales cutoff testing

1. get list of sales recorded some number of days before and after year end 2. select samples from each side and see if included in the proper period 3. obtain purchase order, invoice, and shipping documents for each 4. pay attention to FOB origin vs Destination

If A/R not paid after year end, then examine these 3 documents in the 3 way match...

1. sales order 2. shipping document 3. sales invoice

5 things the PCAOB says that auditors need to consider when setting an analytic expectation

1. was data was obtained from independent sources outside the entity or from sources w/in the entity? 2. were sources w/in the entity independent of those responsible for amount being audited? 3. was the data developed under a reliable system w/adequate controls 4. was the data subject to audit testing in the current or prior year 5. were the expectations developed using data from a variety of sources

if the objective of a test is to detect overstatement of sales, the auditor should compare transactions in the a. cash receipts journal with the sales journal b. sales journal with the cash receipts journal c. source documents with the accounting records d. accounting records with the source documents

D. accounting records with the source documents a test to detect the overstatement of sales, is a test for existence (vouching), book to world. a and b are book to book and c is world to book. Overstatement of sales likely result from entries with no supporting documents

Early Revenue Recognition

hold the books open past fiscal year end or record sale before shipping product/performing service

Best control to prevent skimming and lapping?

Segregation of Duties

Which of the following procedures would an auditor most likely perform for year end accounts receivable confirmations when the auditor did not receive replies to second request? a. Review the cash receipts journal for the month prior to year end b. Intensify the study of internal control concerning the revenue cycle c. Increase the assessed level of detection risk for the existence assertion d. Inspect the shipping records documenting the merchandise sold to the customers

d. Inspect the shipping records documenting the merchandise sold to the customers.

An auditor confirms a representative number of open accounts receivable as of 12/31 and investigates respondents' exceptions and comments. By this procedure, the auditor would be most likely to learn which of the following? a. one of the cashiers has been covering a personal embezzlement by lapping b. one of the sales clerks has not been preparing charge slips for credit sales to family and friends c. one of the computer control clerks has been removing all sales invoices applicable to his account from the data file d. the credit manager has misappropriated remittances from customers whose accounts have been written off

a. one of the cashiers has been covering a personal embezzlement by lapping lapping is the theft of cash payment from one customer

Cooper CPA, is auditing the financial statements of a small rural municipality. The receivable balances represent residents' delinquent real estate taxes. Internal control at the municipality is ineffective. To determine the existence of the accounts receivable balances at the balance sheet date, Cooper would most likely a. send positive confirmation requests b. send negative confirmation requests c. examine evidence of subsequent cash receipts d. inspect the internal records such as copies of the tax invoices that were mailed to the residents

a. send positive confirmation requests

Verify mathematical accuracy of bank reconciliation: Bank Confirmation

agree to bank balance on reconciliation

side agreements

alter terms of contract to entice customers to buy. don't record the terms of the side agreement (ex: right of return)

The auditing standards define external confirmation as "a direct written response to the auditor from a third party (the confirming party), either in paper form or by electronic or other medium." The assertions for which confirmation of AR balances provides primary evidence are a. completeness and presentation b. classification and rights and obligations c. rights and obligations and existence d. existence and completeness

c. rights and obligations and existence the confirmation provides evidence that (1) receivables are valid (2) the client has ownership of the accounts and the right of collection (3) the customer has the obligation to pay

price fixing

client agrees w/companies on price to charge customers

verify mathematical accuracy of A/R aging then

compare to balance on books

bill and hold sales

customer agrees to buy item, but seller holds onto it until buyer requests shipment. Delivery criteria not met, so sale shouldn't be recorded

An auditor's purpose in reviewing credit ratings of customers with delinquent accounts receivable most likely is to obtain evidence concerning relevant assertions about a classification b. existence c. rights and obligations d. accuracy, valuation and allocation

d. accuracy, valuation and allocation