Chapter 11 - Content
What 6 things does billing have the responsibility of?
(1) Accounting for serially numbered shipping documents (2) Comparing shipping documents with sales orders and customers' purchase orders and change notices (3) Entering pertinent data from documents on sales invoice (4) Applying prices/discounts from price lists to invoice (5) Making necessary extensions/footings (6) Accumulating total amounts billed
The working paper used to analyze N/R show IR and date of issuance of each note. What are the 4 columns in the working paper?
(1) Accrued interest receivable at beginning of year (2) Interest earned during year (3) Interest collected during year (4) Accrued interest receivable at end of year
What are 4 typical questions in an internal control questionnaire regarding receivables and revenues?
(1) Are orders from customers initiated and reviewed by sales department? (2) Are sales invoices prenumbered and all numbers accounted for? (3) Are all sales approved by credit department before shipment? (4) Are estimates of revenue performed by competent personnel using appropriate methods?
What 6 procedures are used in developing an estimate and evaluating reasonableness of management's estimate?
(1) Compare details of aging of A/R to prior years' aging (2) Investigate credit ratings for delinquent or unusually large accounts (3) Review confirmation exceptions for indication of amounts in dispute or other clues as to possible uncollectible accounts (4) Summarize in working paper accounts whose collectability doubtful based on preceding procedures (5) Review with credit manager current status of significant doubtful accounts, determining collection action taken and opinion of credit manager as to ultimate collectability (6) Compute relationships, like number-of-days' sales in A/R, relationship of valuation allowance to: (a) A/R and (b) Net credit sales
What are 4 business risks management faces in terms of receivables and revenues?
(1) Decline in sales due to economic declines, product obsolescence, increased competition, or shifts in product/service demand (2) Inability to collect receivables (3) Improper revenue recognition (4) Restrictions placed on sales by laws and regulations
By obtaining written acknowledgment of debt by the debtor, auditors obtain evidence that helps to do what 2 things?
(1) Establish existence and gross valuation of asset (2) Provide some assurance that no lapping or other manipulation affecting receivables being carried on BS date
What are 2 risks associated with obtaining confirmations from third parties?
(1) Information may be delivered to inappropriate address/signed by non-authentic source (2) Improper intervention into delivery of properly addressed confirmation request
What are 15 substantive procedures that test revenues and receivables?
(1) Obtain aged TB of trade accounts receivable and analyses of other accounts receivable and reconcile to ledgers. (2) Obtain analyses of notes receivable and related interest. (3) Inspect notes on hand and confirm those with holders. (with the makers) (4) Confirm receivables with debtors. (with the customers - send confirmations) (5) Review YE cutoff of sales transactions. (6) Perform analytical procedures for accounts receivable, notes receivable, and revenue. (7) Review significant YE sales contracts and agreements for unusual terms. (8) Test valuation of notes receivable, computation of interest income, interest receivable, and amortization of discount or premium. (9) Evaluate propriety of client's accounting methods for receivables and revenue. (10) Evaluate accounting estimates related to revenue recognition. (11) Determine adequacy of client's allowance for uncollectible accounts (12) Ascertain whether any receivables have been pledged. (13) Investigate any transactions with or receivables from related parties. (14) Evaluate business purpose of significant and unusual sales transactions. (15) Evaluate FS presentation and disclosure of receivables and revenue.
In terms of the revenue cycle, what 10 duties should a different department be responsible for?
(1) Preparations of sales order (2) Credit approval (3) Issuance of merchandise from stock (4) Shipment (5) Billing (6) Invoice verification (7) Maintenance of control accounts (8) Maintenance of customers' ledgers (9) Approval of sales returns/allowances (10) Authorization of write-offs of uncollectible accounts
When an aged trial balance or analyses of A/R is furnished by client employees, what 4 things must an auditor verify?
(1) Proper extent of testing in relation to adequacy of controls over receivables (2) Test footings, cross-footings, agings (3) Totals of schedules prepared by client compared with related controlling accounts (4) Balances in subsidiary ledger records verified by footing debit/credit columns on test basis
What are the 3 initial steps in controlling customers' orders?
(1) Registering customer's purchase order (2) Reviewing items/quantities determine whether order can be filled within reasonable time (3) Preparing sales order
What are the auditors' 3 objectives in auditing receivables and revenues?
(1) Use understanding of client/environment to consider inherent risks (including fraud risks) related to receivables/revenue (2) Obtain understanding of IC over receivables/revenue (3) Assess risks of material misstatement and design tests of controls and substantive procedures
What is the process of collecting receivables?
- Collected by receipt of customers' checks and remittance advices through mail or electronically - Remittance advices/listing of receipts forwarded to A/R section of data processing department - Record in appropriate accounts in customers' ledger - Total reduction in A/R posted periodically to GL control account from total of A/R column in cash receipts journal - Aged trial balance prepared
Why is audit risk significant in regard to receivables and revenues?
- Many incidences of fraud have involved overstatement of receivables and revenue - Revenue recognition may be based on complex accounting rules - Receivables and revenues usually subject to valuation using significant accounting estimates
The working papers include evidence of what 7 things?
1. Aged trial balance of A/R 2. Analyses of other accounts receivable 3. Analysis of notes receivable and related interest 4. Analysis of allowance for doubtful accounts and notes 5. Comparative analyses of revenue 6. Documentation of internal control 7. Risk analyses and audit program
In internal control over notes receivables, what 3 duties require separation?
1. Custodian of N/R not have access to cash or to general records 2. Acceptance/renewal of notes authorized in writing by responsible official who does not have custody of notes 3. Write-off of defaulted notes approved in writing by responsible officials and effective procedures adopted for subsequent follow-up of defaulted notes
What are the 6 revenue cycle documents?
1. Customer purchase order 2. Sales order 3. Bill of lading 4. Invoice 5. Control listing 6. Credit memorandum (if returned)
The date of each invoice should be compared with what 2 other dates?
1. Date on related shipping document 2. Date of entry in A/R subsidiary ledger
What are 4 characteristics of a company's effective control environment?
1. Effective BOD that provides effective oversight of principles and IA function 2. Tone at top that encourages integrity and ethical reporting 3. Incentives for dishonest reporting eliminated 4. Commitment to competence related to key financial personnel
What are 6 examples of tests of controls related to auditing receivables?
1. Examine significant aspects of a sample of sales transactions. 2. Compare a sample of shipping documents to related sales invoices. 3. Review the use and authorization of credit memoranda. 4. Reconcile selected cash register tapes and sales tickets with sales journals. 5. Test IT application controls. 6. Examine evidence of review and approval of revenue estimates
In what 3 ways do internal auditors contribute to the monitoring process of revenues and receivables?
1. Periodically taking over mailing of monthly statements to customers 2. Sending confirmations/investigating discrepancies reported 3. Performing extensive reviews of shipping reports, invoices, cash receipts, credit memoranda, aged trial balances of A/R
SEC, in Staff Accounting Bulletin No. 104 provides what 4 criteria that ordinarily should exist for revenue to be recognized?
1. Persuasive evidence of arrangement exists 2. Delivery has occurred or services have been rendered 3. Seller's price to buyer is fixed or determinable 4. Collectability reasonably assured
What are the two forms of confirmation requests?
1. Positive 2. Negative
To identify related party transactions, what 4 things can auditors review?
1. Proxy and other filings with SEC or other regulatory agencies 2. Conflict-of-interest statements by management 3. Transactions with unusual terms 4. Accounting records for unusual balances or transactions particularly near year-end
What are 4 possible misstatements of revenue?
1. Recording unearned revenue 2. Early (late) recognition of revenue - cutoff problems 3. Recording revenue when significant uncertainties exist 4. Recording revenue when significant services still must be performed by seller
What are 2 internal controls over credits for returned merchandise?
1. Requirement goods received/examined before credit given 2. Credit memoranda should bear serial number of receiving report on returned shipment
What are 5 examples of management's ongoing monitoring activities of receivables and revenues?
1. Reviewing various types of performance reports 2. Review aging of A/R 3. Solicit feedback from customers about accuracy of billings 4. Use software to identify unusual transactions 5. Follow up with customers when unexpected amounts/unusual transactions discovered to determine reasons
In accordance with AICPA AU-C 540 (PCAOB 342), auditors audit accounting estimates by doing what 3 things?
1. Reviewing/testing management's method of developing estimates 2. Developing own estimates 3. Reviewing subsequent transactions and other events that provide evidence about accuracy of estimates
What are 7 potential revenue recognition problems?
1. Sales with unusual right to return 2. Side agreements 3. Franchise fees 4. Bill and hold transactions 5. Sales using notes with unusual interest rates 6. Percentage-of-completion method of revenue recognition 7. Multiple element agreements
What are 11 internal controls over the revenue cycle?
1. Segregation of duties 2. Matching of sales invoices and shipping documents 3. Clerical accuracy checks on invoices 4. Credit approval for sales transactions 5. Mailing of monthly statements 6. Reconciliation of bank accounts 7. Use of control listing of cash receipts 8. Use of budgets and analysis of variances (to actual) 9. Control over shipping and billing documents 10. Use of authorized credit memoranda 11. Use of chart of accounts and review of account codings
Accounts receivables should be confirmed unless fall under one of what 3 criteria?
1. They are immaterial 2. Use of confirmations would be ineffective 3. Auditors' combined assessment of inherent and control risk is low, and audit risk can be reduced to acceptably low level with substantive tests
Fictitious sales are occasionally recorded at YE as means of overstating financial results. For this reason, auditors should be aware and investigate what 4 areas?
1. Unusually large increases in YE sales to single customer or a few 2. Large increases in revenue/receivables along with increases in gross profit margins inconsistent with client's experience or industry averages 3. Inappropriate changes in accounting principles that result in increase in recorded revenue 4. Substantial sales returns following BS date that might indicate merchandise shipped to customers without customer order for those goods or channel stuffing
In what period of time are accounts receivable expected to be converted to cash?
12 months
How many days is a normal payment term?
90
What do most positive confirmations confirm?
Accuracy of dollar amount shown on request
What is window dressing?
Action taken by client shortly before BS date to improve financial picture presented in FS
What do credit memoranda support?
Adjustments for allowances, returns, write-offs of A/R
What are aged trial balances designed to show?
Aging of accounts, estimate of probable credit losses, and confirmation control information
During risk assessment stage, professional standards require auditors to perform what? What is their objective?
Analytical procedures Objective of identifying potential misstatements of revenue
Unless company uses FV option, how are N/R valued?
At outstanding FV plus/minus unamortized premium or discount
What is external confirmation?
Audit evidence obtained by auditors as direct written response to auditors from third party (confirming party) in paper form or by electronic or other medium
What is channel stuffing an example of?
Booking tomorrow's revenue today in order to window dress
Who controls and deposits checks?
Cashier
What are internal factors affecting a company's risk assessment?
Changes in accounting principles, introduction of new products/services, use of new types of sales transactions
What are external factors affecting a company's risk assessment?
Changes in economic conditions, competition, customer demand, regulations
Who makes formal requests for confirmation? Who controls process?
Client; auditors
What is the opportunity for fraud in regard to credit memoranda? How is it prevented against?
Collect cash, misappropriate cash, issue memoranda (to get A/R off books) Only authorized people issue credit memoranda
To whom should write-offs be turned over to?
Collection agency or retained/transferred to separate ledger and control account
Procedures for verification of transaction begins with what?
Comparison of customer's purchase order, sales order, and duplicate copy of sales invoice
What are the primary audit objectives of verifying interest earned on notes receivable?
Completeness
How do auditors determine the accrued interest receivable at the end of the year?
Compute it
How do auditors determine interest earned during year on N/R?
Computed from terms of notes
When a note is owned by the client but held by others at the time of examination, what should the auditors do?
Confirm in writing from holder of note considered acceptable alternative to inspection
What is the overall process of confirming receivables? (7 steps)
Confirmation request prepared/signed by client --> CPA determines appropriate confirming party/mails it --> Request delivered to party --> Party responds to request --> Response delivered to auditors
If interim audit work is done, how does it effect YE audit work?
Considerably modifies it
What does interim audit work consist of?
Consideration of controls and in some cases confirmation of A/R
When ratios are computed for A/R, N/R, and revenue, what are they compared to?
Corresponding data for preceding years, budgets, performance statistics, comparable industry averages
What can ineffective controls lead to?
Costly expenses to business; large credit losses
Who determines whether goods may be shipped to a customer on an open account?
Credit department
Who supervises the credit department?
Credit manager who reports to treasurer or VP of finance
Who should initiate the uncollectible receivable write-off process?
Credit managers (with subsequent authorization by treasurer)
When a customer's credit is not approved, what happens?
Customer notified/effort made to negotiate other terms (cash on delivery)
In terms of segregation of duties, no two people should handle the what of transactions?
Debit AND credit
What does the effectiveness of controls over the revenue cycle depend on?
Degree of segregation of duties between shipping, receiving, billing
What is a subsequent liquidation test?
Determines customers who paid after YE and who do not need to be added to a reserve account - best evidence of collectibility
What is the most essential and conclusive step in the verification of A/R and N/R?
Direct communication with debtors
What are examples of transactions resulting in notes receivables?
Disposal of items of PPE, sale of divisions of company, issuance of capital stock, making loans to officers/employees/affiliated companies
Who prepares aged trial balances?
Employees of client for auditors, often in form of computer print-out
What should auditors do when assessing risk?
Evaluate design of related controls and determine they are implemented
What are the primary audit objectives of inspecting notes on hand and confirm those not on hand?
Existence, occurrence, and rights
What are the primary audit objectives of reviewing YE cutoff of sales transactions?
Existence, occurrence, rights, cutoff
What are the primary audit objectives of performing analytical procedures?
Existence, occurrence, rights, cutoff, valuation, accuracy
What are the primary audit objectives of reviewing significant YE sales contracts?
Existence, occurrence, rights, cutoff, valuation, accuracy
What are the primary audit objectives of confirming receivables with debtors?
Existence, occurrence, rights, valuation, accuracy
When should a positive confirmation be used?
For larger account balances or balances aged over 90 days
Auditors should evaluate propriety of client's treatment of certain transactions to determine meet criteria in what two things?
Form and substance
Once new customer granted line of credit, approval of transaction involves determination of whether customer has sufficient unused credit. Who performs this function?
IT system
Why do company's send monthly statements?
If something not correct, customer brings to organization's attention
What does the credit department do?
Implements management's credit policies/uses them to evaluate prospective and continuing customers by studying customer's FS or by referring to reports of credit agencies
What is the confirming party?
Individual who responds to confirmation request
What industries use installment notes?
Industrial machinery, farm equipment, automobiles
An analysis of what accounts may reflect charges from pledging of receivables to finance companies?
Interest expense
Internal controls over notes receivables are stronger if who periodically confirms notes directly with makers?
Internal audit
What time of evidence does the confirmation of receivables provide about completeness/valuation assertions?
Limited evidence - only recorded amounts confirmed
What should be summarized in the working papers in regard to uncollectible accounts?
List customer names, doubtful amounts, reasons for considering accounts doubtful
What is an aged trial balance?
Listing of individual customers' accounts classified by number of days subsequent to billing, that is by age
What are examples of accounts receivable?
Loans to officers/employees, loans to subsidiaries, claims against other firms, claims for tax refunds, advances to suppliers
What is channel stuffing?
Marketing practice that suppliers sometimes use to boost sales by inducing customers to buy substantially more inventory than they can promptly resell
What does AICPA GAAS require in regard to accounts receivable?
Must be confirmed in writing when material
What do new risks indicate?
Need to implement new types of controls
Which confirmation (positive or negative) is less expensive?
Negative - don't need to follow up
How are accounts receivable shown on the balance sheet?
Net realizable value
Can auditors rely on evidence obtained in prior periods regarding operating effectiveness of related controls?
No
Can auditors rely solely on analytical procedures to address risk?
No
What are typically used for handling transactions of substantial amount?
Notes receivables
What is usually the single most important asset of banks and financial institutions?
Notes receivables
What is billing?
Notifying customer of amount due for goods/services delivered
When is the decision to carry out confirmation of receivables before YE justified?
ONLY when risk of material misstatement for existence is low
Much of audit work can be performed how many months before BS date?
One or two
What are bill and hold transactions effect on revenue?
Overstate revenues and NI if don't meet specific requirements for recognition of sales
What is the most frequent form of auditors obtaining confirmations (electronic or paper)?
Paper form
What is the best evidence of collectability of A/R?
Payment by debtors subsequent to BS date and analyzing subsequent transactions (documented in working papers)
Which confirmation (positive or negative) provides the most assurance?
Positive
What are blank forms?
Positive confirmations that do not state amount on request, ask to fill in balance
How do auditors determine the accrued interest receivable at beginning of year?
Preceding work papers
What does the auditors consideration of controls begin with?
Preparation of written description/flowchart and completion of IC questionnaire
What is a preliminary step in estimating the collectibility of accounts receivable?
Preparing an aged trial balance
What are the primary audit objectives of ascertaining existence of pledged receivables?
Presentation and disclosure
What are the primary audit objectives of evaluating FS presentation and disclosure?
Presentation and disclosure
What are the primary audit objectives of investigating receivables from related parties?
Presentation and disclosure
What are examples of performing analytical procedures for A/R, N/R, and revenue?
Ratios
When a note is owned by the client but held by others at the time of examination, a confirmation letter is sent to bank, collection agency, or secured creditor. What should the letter contain?
Request for verification of name of maker, balance of note, interest rate, and due date
What is a confirmation request?
Request sent to confirming party requesting they consider accuracy of information included in request
What is a positive information request?
Requests confirming party respond directly to auditor providing requesting information or indicating whether confirming party agrees or disagrees with information in request
What is a negative confirmation request?
Requests confirming party respond directly to auditors indicating where they disagree with information in request
In order to determine if significant accounting estimates indicate bias on part of management, auditors are required to perform what?
Retrospective review of prior year's significant accounting estimates
What should be required for renewal of a note?
Review and approval
Why is the control environment so important when it comes to receivables and revenues?
Risk of intentional misstatement of revenues is high
What guideline states bill and hold transactions must meet stringent requirements to qualify as a sale?
SEC Staff Accounting Bulletin No. 104
What is the primary source of revenue for most companies?
Sale of goods/services
What are bill and hold transactions?
Sales billed but goods not shipped
To guard against misstatements due to inaccurate cutoff of records, what should the auditors compare?
Sales recorded for several days before and after BS date with duplicate sales invoices and shipping documents
What are examples of accounting estimates?
Sales returns, revenues accounted for by percentage-of-completion method, allowance for uncollectible accounts
In a negative confirmation request, what does a lack of reply mean?
Satisfactory evidence
What is the basic characteristic of effective internal control?
Separation of duties
What are credit memoranda?
Serially numbered documents signed by officer/employee having no duties relating to cash handling or to maintenance of customers' ledgers
What are bills of lading?
Shipping documents; created at time of loading goods into cars or trucks and are numerically controlled
What are billing contracts?
Specify prices, delivery procedures, inspection and acceptance routines, method of liquidating advances, other details; important source of information for preparation of sales invoice
Why should statements requesting payments already written off continue to be mailed?
Subsequent collections may be embezzled by employees without necessity of falsifying records to conceal theft
Examining significant aspects of sample of sales transactions is an example of a test of control or substantive procedure?
Test of control
What is a control over shipping and billing documents?
They are numerically accounted for
What is meant by the pledging of receivables?
To assign to bank, factor, finance company, or other lender exclusive claim against A/R as security for debt
What can internal audit's extensive reviews of shipping reports, invoices, cash receipts, credit memoranda, aged trial balances of A/R be used for?
To improve operating effectiveness of control activities
Why is the inspection of notes on hand performed concurrently with the count of cash and securities?
To prevent concealment of shortage by substitution of cash for misappropriated negotiable instruments
What are lead schedules?
Top schedule with all A/R, N/R accounts summarized
How do auditors determine interest collected during the year?
Traced to cash receipt records
How is a no-reply treated for a positive confirmation?
Treated as difference - keep following up or look at source documents to confirm balance (or confirm subsequently paid)
How long should auditors maintain complete control over all negotiable instruments?
Until count and inspection is complete
What is an installment note or contract?
Used in exchange that grants possession of goods to purchaser but permits seller to retain lien on goods until final installment under note has been received
What are the primary audit objectives of determining adequacy of allowance for uncollectible accounts?
Valuation
What are the primary audit objectives of evaluating accounting estimates related to revenues?
Valuation and accuracy
What are the primary audit objectives of evaluating propriety of client's accounting for transactions?
Valuation and accuracy
What are the primary audit objectives of obtaining aged listing of receivables and reconcile to ledgers?
Valuation and accuracy
What are the primary audit objectives of obtaining analyses of notes receivable and related interest?
Valuation and accuracy
What are the primary audit objectives of evaluating business purpose of significant and unusual sales transactions?
Valuation, accuracy, presentation, disclosure
How can auditors can verify prices discounts on invoices?
Verify with authorized price lists, catalogs, contracts with customers
When are notes receivables used?
When sale of goods where collection period or repayment period extends beyond normal payment terms
When are confirmations considered more relevant and reliable evidence?
When sent to confirming parties who auditors believe are knowledgeable about information confirmed
When should a negative confirmation be used?
When there is a low level of assessed risk of material misstatements; small account balances
What does internal audit's extensive reviews of shipping reports, invoices, cash receipts, credit memoranda, aged trial balances of A/R determine?
Whether prescribed control activities being carried out consistently
Do auditors have to follow-up on no-replies for positive confirmations? For negative confirmations?
Yes; no
