CH 11 Audit

If management refuses to allow the auditors to perform external confirmation procedures:

-Alternative procedures must be performed to obtain relevant and reliable evidence. -management's reasons must be evaluated.

Provide a list of related parties to all members of the audit team to assist in identification of the transactions

Financial statement presentation and disclosure.

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

account for all documents by serial number.

Most likely be detected by an auditor's review of the client's sales cutoff=

inflated sales for the year.

Receivables held by companies are collected by

receipts of customers' checks and remittance advices through the mail or electronically.

Recording sales when the customer is likely to return the goods

recording revenue when significant uncertainties exist.

To determine the existence of the accounts receivable balances at the balance sheet date=

send positive confirmation requests.

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

valuation and accuracy.

Audit documentation(working papers) for receivables and revenues include:

-Analysis of notes receivable and related interest. -Analysis of other accounts receivable -Documentation of internal controls.

Inherent risks

-a decline is sales due to economic declines. -Inability to collect receivables -Improper revenue recognition -Restrictions placed on sales by laws and regulations.

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.

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.

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

accounts receivable subsidiary ledger.

Risk assessment involves identification, analysis, and management of risks relevant to achieving the organization's objectives. In relation to the revenue cycle, management should develop a formal process of monitoring external factors, such as

changes in economic conditions, competition, customer demand, and regulations that may affect the risk of achieving the company's sales objectives.

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

competence of the personnel involved

relates to sales is most directly addressed when the auditors compare a sample of shipping documents to related sales invoices

completeness

Interest earned

computed based on the terms of the note

ending accrued interest receivable

computed by the auditors

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.

Vouch sales and cash receipt transactions occurring near period end

cutoff of transactions

An installment note or contract may be used in an exchange that

grants possession of goods to a purchaser but permits the seller to retain a lien on the goods until the final installment under the note has been received.

All adjustments to sales for allowances, returns, and write-offs of accounts receivable should be supported by serially numbered credit memoranda signed by an

officer or responsible employee having no duties relating to cash handling or to the maintenance of customers' ledgers.

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 are used.

An aged trial balance of customers' accounts should be

prepared at regular intervals for use by the credit department in carrying out its collection program.

The term billing means notifying the customer of the amount due for goods or services delivered. This notification is accomplished by

preparing and mailing a sales invoice in either electronic or paper form. A department not under the control of sales executives should perform billing.

Receivables that are written off should then either turned over to a collection agency or retained and transferred to a

separate ledger and control account.

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

significant risks.

The auditors' objectives in the audit of receivables and revenue are to

1. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to receivables and revenue., 2. Obtain an understanding of internal control over receivables and revenue. 3. Assess the risks of material misstatement and design test of controls and substantive procedures.

Audit documentation(working papers) for receivables and revenues include:

1. comparative analyses of revenue. 2. Analysis of other accounts receivable.

Provides the most assurance concerning the valuation of accounts receivable

assess the allowance for uncollectible accounts for reasonableness.

external confirmation can be in various forms except:

oral.

Most likely to be an example of fraudulent financial reporting to sales=

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

Intentional over shipment of goods

recording unearned revenues

The credit manager should initiate the process of

uncollectible receivable write-off, with subsequent authorization of the treasurer.

Compare the amount of credits given to customers in the subsequent period to the amount estimated by management

valuation of assets

Typical of the questions comprising an internal control questionnaire for revenue and receivables are:

-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 credit department before shipment? -Are estimate of revenue performed by competent personnel using appropriate methods?

Accounting estimates related to receivables and revenue include all of the following

-allowance for doubtful accounts -revenue recognized under complex agreements -sales returns

Under SEC rules criteria that ordinarily exist for revenue to be recognized=

-collectibility is reasonably assured -persuasive evidence of an arrangement exists -the seller's price to the buyer is fixed or determinable.

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

-interest receivable -interest income -discount amortization

confirming receivables with debtors obtains evidence regarding:

-valuation and accuracy -existence, occurrence, and rights.

If manual process is used, the billing section has the responsibility of:

1. accounting for the serially numbered shipping documents. 2. comparing shipping documents with sales orders and customers' purchase orders and change notices. 3. entering pertinent data from these documents on the sales invoice. 4. applying prices and discounts from price lists to the invoice 5. making the necessary extensions and footings 6. accumulating the total amounts billed.

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.

Select a sample of sales invoices in the subsequent period, and examine the related shipping documents for date of shipment to ascertain whether some of those shipments at the end of the period were inadvertently not recorded

completeness of assets

UNder US auditing standards auditors:

confirmations are not required if they would be ineffective.

Internal audit 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.

Because of the risk of intentional misstatement of revenues, the control environment is very important to effective

internal control over revenue and receivables.

Important intial steps include regestering the customer's purchase order, reviewing

items and quantities to determine whether the order can be filled within a reasonable amount of time, and preparing a sales order.

Trade notes and accounts receivable usually are relatively large in amount and should appear as

separate items in the current assets section on the balance sheet at their net realizable value.

Auditors can gather evidence of the pledging of receivables, which assigns the claim against

the receivable as security for a debt, through external confirmations.

interest collected

traced to cash receipts records

this department is supervised by a credit manager who reports to the

treasurer or the vice president of finance.

For a reasonable test, the accounts receivable turnover ratio for the current year should be compared to:

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

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

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

Review confirmations of liabilities to determine if receivables have been sold.

Rights to assets

The billing department is responsible for:

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

Auditors perform a test of control by observing and making inquiries about the segregation of duties over sales and collection of receivables which effects the auditors assessment of risk for these assertions:

-Existence -Completeness

By receiving an external confirmation of the debt by the debtor, auditor obtain audit evidence to help:

-provide some assurance no lapping of receivables is occuring -establish the gross valuation of the asset.

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 with a reasonable time.

The date of each invoice in a sample of sales transactions should be compared against:

-the date of entry in accounts receivable -the date on each related shipping document.

for related party transactions, the primary audit objective is:

presentation and disclosure.

Internal control over credit sales is strengthen by a division of duties so that different departments or individuals are responsible for:

1. preparation of sales order. 2. credit approval 3. issuance of control accounts. 4. shipment 5. billing. 6. invoice verification. 7. maintenance of control accounts 8. maintenance of customers' ledgers 9. approval of sales returns and allowances, 10. authorization of write-offs of uncollectible accounts.

For any significant risk, the auditors:

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

Differences reported by customers in confirmation replies typically arise because of:

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

To test notes and accounts written-off during the year auditors use an analysis of:

the allowance for doubtful accounts and notes.

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

when performance obligations are satisfied

For effective control, the custodian of notes receivable should not have access to:

both cash and general accounting records.

Notes receivable on hand should be inspected at the same time as the count of

cash and securities to prevent the concealment of shortages.

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

low.

One problem that auditors may encounter while testing methods for receivables and revenue is that management or employees may have established certain

side documents that could effect the final terms of sale.

The best alternative auditing procedure when confirmation replies are not received is and examination of:

subsequent cash receipts in payment of the receivable.

Controls should be established to ensure

the accuracy of the invoices before they are mailed to customers.

Confirm a sample of receivables by direct communication with the debtors.

Existence of assets

an example of misappropriation of assets relating to sales:

Theft of cash register sales.

Confirming accounts receivable is generally required by:

US auditing standards only.

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 auditors should confirm accounts receivable unless the auditors' assessment of the risk of material misstatement is low:

and accounts receivable are immaterial, or the use of confirmations would be ineffective.

Auditors are especially concerned with the presentation and disclosure of loans to officers, directors, and affiliated companies. These related transaction are commonly made for the convenience of the

borrower rather than to the benefit the lending company.

Holding the sales journal open to record next year's sales as having occurred in the current year

cutoff problems

The cashier will control and

deposit checks. The remittance advices or a listing of the receipts will then be forward to the accounts receivable section of the data processing department, which will then be record them in the appropriate accounts in the customers' ledger.

Before sales orders for new or unapproved customer are processed, the credit department must

determine whether goods may be shipped to the customer on open account.

When a customer's response to a receivable confirmation contains restriction language concerning its use:

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

The total reduction in accounts receivable will be posted periodically to the

general ledger control account from the total of the accounts receivable column in the cash receipts journal.

Accounts receivable also include a variety of miscellaneous claims such as

loans to officers, loans to subsidiaries, claims against other firms, claims for tax refunds, and advances to suppliers.

Of particular importance is an effective board of directors(and audit committee) that provides effective oversight of

management's judgements about revenue recognition principles and estimates, as well as effective internal audit function.

beginning accrued interest receivable

prior year audit workpaper

Ongoing monitoring activities by management primarily involve reviewing various types of performance reports, including sales by

product line, by major customer, by geographic area, and by salesperson.

Good internal control over credits for returned merchandise usually includes a

requirement that the goods be received and examined before credit is given.

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

shipping documents file.

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