AUD Chap 11

The confirming party is asked to respond directly to the auditor providing the requested information or indicating agreement or disagreement with the information in the request when___

positive confirmations

Auditors obtain a sample of shipping documents issued during the year and compare these to sales invoices to obtain assurance that all orders ______

that have been shipped have also been billed

The credit department evaluates prospective customers by reviewing ______.

the customer's financial statements a report from a credit agency

Which of the following documents sets forth all of the terms of a sales transaction?

sales order

When control activities over sales on account are inadequate ______.

shipments may occur without notice to billing sales invoices may contain errors sales may be made to unapproved customers

Differences reported by customers in confirmation replies ______.

should always be resolved

Identify the control that is most likely to prevent the concealment of a cash shortage resulting from the improper write-off of a trade account receivable:

Write-offs must be approved by a responsible official after review of credit department recommendations and supporting evidence.

Audit evidence obtained as a direct written response to the auditors from a third party in paper form or by electronic or other medium is an external

confirmation

Accounts receivable consists of ______.

loans to officers or employees claims against customers from the sale of goods

A customer's response to a receivable confirmation contains restrictive language concerning its use, the restriction ______ the reliability of the response as audit evidence.

may or may not invalidate

True or false: When the amount of revenue must be estimated due to complexity in the transaction, such estimates should be made in conjunction with the external auditor.

FALSE

Analytical procedures are used by auditors to gain evidence about the adequacy of the allowance for uncollectible accounts.

T

Confirming accounts receivable is generally required by ______.

US auditing standards only

External factors that can influence the revenue cycle include ______.

competition customer demand

If an auditor is unable to inspect a note because it is being held by others at the time of examination, an acceptable alternative is to ______.

confirm the note with the holder

under US auditing standards auditors ______.

confirmations are not required if they would be ineffective

Auditors perform an independent computation of the interest earned during the year on notes receivable to audit the valuation of ______.

discount amortization interest receivable interest income

Under the new FASB revenue recognition standard, revenue is recognized ______

when performance obligations are satisfied

When positive confirmations are used and there are non-respondents, the auditors should ______.

follow up with a second request for information

he auditor's assessment of the risks of material misstatement include assessments of ____ and ____which are used to design further audit procedures.

inherent and control risks

Economic conditions have changed resulting in the possibility that the allowance for uncollectible accounts may need to be increased. Which of the following control components is likely to identify this issue?

monitoring

The aged trial balance is prepared by the client and is used in the audit to ______.

provide confirmation control information display the aging of customers' accounts estimate probable credit losses

Risks identified by auditors that require special audit consideration are referred to as

significant

Procedures used to audit the allowance for uncollectible accounts?

Compare the aging of accounts receivable with the prior year aging. Review confirmation exceptions. Use analytical procedures to test reasonableness.

Evaluating Revenue Estimates

Revenue recognition may involve significant accounting estimates. Auditors can evaluate these estimates by: • Reviewing and testing management's method of developing the estimates, • Developing their own estimates, or, • Reviewing subsequent transactions and other events that provide evidence about the accuracy of the estimates. The auditors are required to perform a retrospective review of the prior year's significant accounting estimates to determine whether they indicate bias on the part of management.

Sources of Accounts Receivable

Sources: • Claims against customers from sale of goods or services. • Loans to officers or employees. • Loans to subsidiaries. • Claims against various other refunds. • Claims for tax refunds. • Advances to suppliers. Shown on balance sheet at net realizable value.

Perpetual inventory records of finished goods should be maintained by ______.

accounting

Credit department

carries out the collection program

To control risks in the confirmation process, auditors should ______.

determine confirmation requests are directed toward an appropriate confirming party mail confirmation requests in envelopes bearing the CPA firm's return address

Relying upon the confirmation process to form an opinion about the fairness of accounts receivable as a whole ______.

provides valuable evidence is an important part of the auditor's work

To determine that all sales have been recorded, the auditors would select a sample of transactions from the:

Shipping documents file.

When it is impossible to confirm accounts receivable, the auditors may be able to satisfy themselves as to the existence of accounts receivable by alternative procedures.

T

Fraud Risk related to Receivables and Revenue

Understand controls established by management to control risks. Determine controls have been implemented. Response to risks. • An overall effect on audit. • Alter the design of audit procedures. • Performing procedures to address risk of material misstatement due to management override of internal control.

Auditors need to obtain an aged listing of receivables to reconcile to the ledgers and address which audit objective?

Valuation and accuracy

For effective control regarding notes receivable, the ______.

acceptance and renewal of notes should be authorized in writing by a responsible official who does not have custody of the notes write-off of defaulted notes should be approved by responsible officials

In obtaining assurance that all shipments have been billed, auditors should ______.

account for all documents by serial number

To identify related party transactions, auditors should review all of the following except ______.

accounting records for transactions with usual customers

Sales that are invoiced but not shipped are called

bill and hold transactions

The shipping document created at the time of loading the goods into cars or trucks is called a(n)

bill of lading

Notes receivable on hand should be inspected at the same time as the count of ______ to prevent the concealment of shortages.

cash and securities

When the amount of revenue from a complex transaction must be estimated, ______ should be considered.

comparisons of past estimates to actual revenues risks the relevance and reliability of data

The audit working papers often include a client-prepared, aged trial balance of accounts receivable as of the balance sheet date. This aging is best used by the auditors to:

estimate credit losses

The most common technique used by management to engage in fraudulent financial reporting is ______.

improper revenue recognition

Accounts receivable can be confirmed at an interim date rather than at year-end if risk of material misstatement for existence is ______.

low

For auditors, the audit of revenue and receivables represents an area of ______ risk.

significant

Internal Control over A/R and Revenue 1

Control Environment: • Important because of risk of intentional misstatement of revenue. • Commitment to integrity and ethical behavior. • Independence of board and audit committee. • Appropriate structure and lines of responsibility. • Commitment to recruit, develop, and retain competent. employees. • Holding employees accountable. Risk Assessment: • Risk of misstatement of revenue may be high based on its nature and complex rules regarding revenue recognition.

This department contributes to the monitoring of internal control over the revenue cycle by periodically taking over the monthly statement process, sending confirmations to customers, and reviewing revenue cycle documentation.

Internal audit

Sources of Notes Receivable

Nature: • Substantial loans to individuals or companies. • Installment note or contract can allow seller to hold lien on goods. Examples: • Sale of industrial machinery, or farm equipment. • Loans to subsidiaries or other types of related companies. • Loans to officers, employees.

Types of Confirmations

Two methods of confirmation of receivables: • Positive confirmations - request addressed to the debtor asking for a reply. • Ordinarily sent with balances due on them. • Blank forms - leave amount blank (used less frequently). • Negative confirmations - ask debtor to advise the auditors only if the balance shown is incorrect. • Low level of assessed risk of material misstatement. • Large number of small balances. • A low error rate is expected. • No reason to believe the respondent will ignore the request.

Auditors may choose to evaluate management's process of developing the allowance for uncollectible accounts balance by considering the reasonableness of the process and the ______.

competence of the personnel involved

Steps for Recognition of Revenue

• Step 1: Identify the Contract. Step 2: Identify the Performance Obligations. • Step 3: Determine the Transaction Price. • Step 4: Allocate the Transaction Price to the Performance Obligations. • Step 5: Recognize Revenue When the Performance Obligations Are Satisfied.

Audit Risk of Receivables

Audit risk significant because: • Many incidences of fraud have involved overstatement of receivables and revenue. • Revenue recognition may be based on complex accounting rules. • Receivables and revenues are usually subject to valuation using significant accounting estimates.

Confirmation of accounts receivable is generally required in all audits. Which of the following is not a legitimate reason to not perform the procedure?

The company has a relatively small number of customers with large balances.

Initial steps in controlling a customer's order (before preparation of a sales order) include ______.

registering the customer's purchase order determining if the order can be filled within a reasonable time

The audit of revenue recognition generally involves significant audit risk for all of the following reasons,

revenue recognition may involve significant estimates. management fraud often involves misstatement of revenues. the revenue recognition rules may be complex.

The audit of receivables and revenue represents significant audit risk because ______.

significant accounting estimates are used to value receivables and revenue complex accounting rules exist for revenue recognition

True or false: The purpose of window dressing is to fraudulently misstate the financial statements.

F; The purpose of window dressing is to improve the financial picture at the year end date. While fraud is possible, most window dressing techniques are appropriate business practices.

Which of the following is most likely to be an example of fraudulent financial reporting relating to sales?

Recording sales when the customer is likely to return the goods.

Auditors should be most concerned with investigating charge-offs of a note or account receivable from ______.

an officer, stockholder, or director

Calculating the gross profit rate by store and comparing the ratio of sales in the last month to total sales for the year are examples of ______.

analytical procedures

The process of writing-off uncollectible receivables should be initiated by the ______.

credit manger, treasurer authorizes

Auditors test management's estimate for the allowance for uncollectible accounts by ______.

developing their own estimate and comparing it to management's reviewing and testing management's method of developing the estimate

Installment notes are typically used in all of the following except ______.

isale of goods or services to customers

Risks in the confirmation of accounts receivable process ______.

may be due to customers failing to compare the balance with their records include inappropriate intervention by client personnel include omitting accounts with erroneous balances

Which of the following procedures is not generally used to audit the allowance for uncollectible accounts?

Review collection of certain accounts receivable during the year.

If management refuses to allow the auditors to perform external confirmation procedures, ______.

their reasons must be evaluated alternative procedures must be performed to obtain relevant and reliable evidence

When using a transaction cycle approach to assessing control risk, the auditor most likely would test control activities related to customer sales transactions with the:

Collection of receivables.

Problems auditors may encounter in auditing revenue recognition include ______.

cash receipts from franchise fees may be inappropriately recognized before services are rendered notes receivables may need to be discounted to present value

Any adjustments to sales for allowances and returns must be supported by serially numbered credit memoranda that is signed by an employee ______.

not responsible for cash handling or ledger maintenance

To test the existence assertion for recorded receivables, the auditors would select a sample from the:

Accounts receivable subsidiary ledger. (Remember existence= from journal/ ledger to source documents!)

Internal Control over Notes Receivable

Subdivision of duties: • The custodian of notes receivable should not have access to cash or to the general accounting records. • The acceptance and renewal of notes are authorized in writing by a responsible official who does not have custody of notes. • The write-off of defaulted notes are approved in writing by responsible officials and effective procedures adopted for subsequent follow-up of such defaulted notes.

Audit work that needs to be performed at year-end as opposed to an interim date include ______.

investigation of cutoff of sales and cash receipts aging of receivables confirmations of any large accounts that are new or delinquent

Confirming receivables with debtors obtains evidence regarding ______.

valuation and accuracy existence, occurrence, and rights

Revenue Cycle—Documents

• Customer purchasing--Purchase order. • Sales--Sales order. • Shipping--Bill of lading. • Billing—Invoice. • Receiving cash receipts--Control listing. • Authorizing adjustments to accounts receivable--Credit memo.

Internal factors that can influence the revenue cycle include ______.

new products and services new type of sales transactions

In a manual accounting system, controls to ensure the accuracy of the invoices before they are mailed to customers should include ______.

a second-person review of prices, credit terms, extensions, and footings

Management should make appropriate background checks of prospective employees and obtain ___ bonds on employees in positions of trust.

fidelity

Details on Understanding the Client Business

• The types of products and services sold. • The classes and categories of the client's customers. • Whether the business is affected by seasonal or cyclical demand. • Typical marketing policies for the client and its industry. • Policies regarding pricing, sales returns, discounts, extension of credit, and normal delivery and payment terms. • Compensation arrangements that are based on recorded revenue. • Typical revenue recognition principles used in the industry and their methods of application.

Objectives for the Audit of Receivables and Revenue

1. Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to receivables and revenues. 2. Obtain an understanding of internal control over receivables and revenues. 3. Assess the risks of material misstatement and design tests of controls and substantive procedures that: a. Substantiate the existence of receivables and the occurrence of revenue transactions. b. Establish the completeness of receivables and revenue transactions. c. Verify the cutoff of revenue transactions. d. Determine that the client has rights to recorded receivables. e. Establish the proper valuation of receivables and the accuracy of revenue transactions. f. Determine that the presentation and disclosure of receivables and revenue are appropriate.

What type of error is the certified public accountant (CPA) most likely to discover when he/she examines all shipping reports dated in January of 20X1, shipped free on board (FOB) shipping point, which were recorded in December of 20X0 as credit sales?

Accounts receivable are overstated at December 31, 20X0.

Which of the following questions may be included on an internal control questionnaire for revenue and receivables?

Are orders from customers initiated and reviewed by the sales department? Are sales invoices prenumbered and all numbers accounted for? Are all sales approved by the credit department before shipment? re estimates of revenue calculated by competent personnel

Auditors perform a test of control by observing and making inquiries about the segregation of duties over sales and collection of receivables that affects the auditors' assessment of risk for these assertions.

Completeness Existence

Internal Control over A/R and Revenue 2

Control Activities: • Prepare sales order. • Approve credit. • Issue merchandise from stock. • Shipment. • Billing. • Invoice verification. • Maintenance of control accounts. • Maintenance of customers' ledgers. • Approval of sales returns and allowances. • Authorization of write-offs of uncollectible accounts. Monitoring Controls: • Management review controls. • Internal audits.

Additional Tests of Controls

D. Perform further audit procedures—tests of controls. 1. Examples of tests of controls: a. Test the controls over sales transactions by examining the process of recording the transactions. b. Trace details of shipping documents to related sales invoices. c. Review the use and authorization of credit memoranda. d. Test controls over over-the-counter sales by reconciling cash register tapes or sales tickets with sales journals. e. Test management review controls. f. Test controls over accounting estimates related to revenues and receivables. 2. If necessary, revise the risks of material misstatement based on the results of tests of controls.

True or false: The storekeeper issues goods covered by a sales order to the shipping department and the sales order to the credit department for approval.

F; Goods are only issued after the sales order has been approved by the credit department.

Audit Documentation

Lead schedules for receivables and net revenue and Working papers. • Aged trial balance of A/R. • Analyses of other accounts receivable. • Analysis of notes receivable and related interest. • Analysis of allowance for doubtful accounts and notes. • Comparative analyses of revenue. • Documentation of internal control. • Risk analyses and audit plan (program).

Which of the following fraudulent activities most likely could be perpetrated because of ineffective internal controls in the revenue cycle?

The write-off of receivables by personnel who receive cash permits the misappropriation of cash.

Related Party Transactions

To identify related party transactions, auditors should review. • Proxy and other filings with S E C or other regulatory agencies. • conflict-of-interest statements by management. • Transactions with unusual terms. • Accounting records for unusual balances or transactions particularly near year-end. Determine that related party transactions are appropriately disclosed.

Risk Assessment for the Audit of Receivables

A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to receivables and revenue. B. Obtain an understanding of internal control over receivables and revenue. C. Assess the risks of material misstatement and design further audit procedures.

Confirmation of Receivables

Receivables should be confirmed, unless: • Accounts receivable are immaterial, • The use of confirmations would be ineffective, or, • The auditors' combined assessment of inherent and control risk is low, and audit risk can be reduced to acceptably low level with substantive tests,

Selecting a sample of sales invoices and examining them for evidence of a second-person review addresses which assertion?

Valuation and accuracy

Inherent risks related to receivables and revenue include all of the following except ______.

an increase in sales due to economic conditions; a DECREASE in sales is an inherent risk

Audit documentation (working papers) for receivables and revenues include ______.

analysis of other accounts receivable comparative analyses of revenue documentation of internal controls analysis of notes receivable and related interest

Notes receivable are typically used for transactions of substantial amounts with customers and typically represent the single most important asset for ______.

banks

For effective control, the custodian of notes receivable should not have access to_______.

both cash and general accounting records

The employee responsible for controlling and depositing checks should be the ______.

cashier

To address the threat of fictitious sales at year-end, auditors should be aware of and investigate all of the following except ______.

changes in accounting principles that lead to decreases in recorded revenue

Substantial sales returns following the balance sheet date may be indicative of boosting sales by inducing customers to buy in excess, which is known as

channel stuffing

Because of threat of misstatements due to inaccurate cutoff of sales records, auditors should compare the sales recorded for several days before and after the balance sheet date with ______.

duplicate sales invoices and shipping documents

Data Analytics

• Identify possible fictitious revenue by searching for unusual or large entries in revenue accounts. • Identify possible fictitious revenue by searching for entries into revenue accounts from unusual sources. • Identify possible revenue cutoff errors by examining unusual revenue transactions around year-end. • Identify related party transactions in the sales journal by selecting unusual transactions throughout the entire year. • Identify possible duplicate billings by reviewing the sales journal for sales of identical amounts to the same customers over a short period of time. • Identify possible unauthorized sales discounts by comparing discounts to individual customers in total and as a percentage of total sales. • Identify possible uncollectible amounts by identifying credit sales that exceed the amounts of customers' credit authorization amounts. • Identify misstatements of accounts receivable by identifying large credits to accounts receivable from unusual sources.

Audit of Allowance for Doubtful Accounts

• Review collections in subsequent period. • Develop estimate and evaluate reasonableness of management estimate. • Compare the details of the aging of accounts receivable to prior years' aging. • Investigate the credit ratings for delinquent and unusually large accounts. • Review confirmation exceptions for an indication of amounts in dispute or other clues as to possible uncollectible accounts. • Summarize in a working paper those accounts whose collectability is doubtful based on the preceding procedures. List customer names, doubtful amounts, and reasons for considering these accounts doubtful. • Review with the credit manager the current status of significant doubtful accounts. • Compute relationships, such as the number-of-days'-sales in accounts receivable and the relationship of the valuation allowance to (1) accounts receivable and (2) net credit sales.

Potential Revenue Recognition Problems

• Sales with unusual right to return. • Side agreements. • Franchise fees. • Bill and hold transactions. • Sales using notes with unusual interest rates. • Long-term construction contracts. • Multiple element agreements.

For any significant risk, the auditors ______.

should evaluate the design of the related controls should determine if the related controls are implemented may not rely on prior period evidence regarding the operating effectiveness of controls

One problem that auditors may encounter while testing methods for receivables and revenue is that management or employees may have established certain management ____ agreements that could affect the final terms of sale.

side

The billing department is responsible for ______.

comparing shipping documents with sales orders and customers' purchase orders preparing and mailing the sales invoice reviewing the information in formal contracts with customers

By receiving an external confirmation of the debt by the debtor, auditors obtain audit evidence to help ______.

establish the gross valuation of the asset provide some assurance no lapping of receivables is occurring

When a customer's response to a receivable confirmation contains restrictive language concerning its use ______.

further evidence to determine the accuracy of the account may or may not be required

Accounting estimate(s) related to receivables and revenue include all of the following except ______.

gross profit percentage Includes: revenue recognized under complex agreements allowance for uncollectible accounts sales returns

When the risk of material misstatement is low and a large number of small homogeneous balances are involved, a(n) ______ confirmation request is appropriate.

negative

As the auditors confirm their understanding of the revenue cycle, they are likely to ______.

perform a walk-through of the cycle review revenue budgets and variance inquire as to who performed various functions

To develop their own estimate of the allowance for uncollectible accounts auditors may ______.

review confirmation exceptions for indications of amounts in dispute review collectibility status of significant delinquent accounts with credit manager investigate the credit ratings for delinquent and unusually large accounts

If the objective of an auditor's test of details is to detect the overstatement of sales, the auditor should trace transactions from the:

Sales journal to the shipping documents. (Existence: journal/ledger to source document)

Auditors should obtain an aged trial balance from the client and verify the listing by performing all of the following steps except ______.

comparing customer terms to written agreements

The best alternative auditing procedure when confirmation replies are not received is an examination of ______.

subsequent cash receipts in payment of the receivable

Which of the following is least likely to be considered an inherent risk relating to receivables and revenues?

Over-recorded sales due to a lack of control over the sales entry function.

Substantive Tests

Perform further audit procedures—substantive procedures for receivables and revenue. 1. Obtain an aged trial balance 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. 4. Confirm receivables with debtors. 5. Review the year-end cutoff of sales transactions. 6. Perform analytical procedures for accounts receivable, notes receivable, and revenue. 7. Review significant year-end sales contracts for unusual terms. 8. Test the valuation of notes receivable, computation of interest income, interest receivable, and amortization of discount or premium. 9. Evaluate the propriety of the client's accounting methods for receivables and revenue. 10. Evaluate accounting estimates related to revenue recognition. 11. Determine the adequacy of the 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 the business purpose of significant and unusual sales transactions. 15. Evaluate financial statement presentation and disclosure of receivables and revenue.

Proper internal controls over credits for merchandise that has been returned typically will include a stipulation that ______ before credit can be given.

the goods be received and fully examined

For a reasonableness test, the accounts receivable turnover ratio for the current year should be compared to ______.

the ratio from last year budgeted ratios average ratios for the industry

Differences reported by customers in confirmation replies typically arise because of ______.

timing lags in recording sales transactions timing lags in recording cash receipts