Audit Exam 2: Chapter 7

Inherent Risks of Revenue Cycle

1) improper revenue recognition: Fictitious sales Side agreements: Arrangements used to alter the terms and conditions of recorded sales to entice customers to accept delivery of goods / services cut-off: recognizing revenue too early or wrong period bill and hold: Customer agrees to purchase, but seller retains physical possession until customer requests shipments channel stuffing: Boost sales by inducing distributors to buy substantially more inventory than they can promptly resell 2) returns and allowances 3) collectability of receivables

Account: Revenue Assertion: Occurrence WCGW?

1. Management may overstate sales by adding fictitious transactions or inflating actual sales. 2. Management may fail to recognize the possibility of customer returns.

3 way match

1. Sales Order 2. Shipping Document (bill of lading) 3. Sales Invoice

4 Basic Activities in Revenue and Collection Cycle:

1. receiving and processing customer orders 2. delivering goods and services to customers 3. billing customers and accounting for accounts receivable 4. collecting and depositing cash received from customers

Open-Order Report

A report of all customer orders for which processing has not been completed.

Account: Accounts Receivable Assertion: Existence WCGW?

Accounts receivable are overstated and do not represent amounts owed from actual sales.

What assertion?: Observe client comparing shipping quantities to quantities recorded as sold. Examine evidence of client making the comparison

Accuracy

Account: AR Control Activity: Check invoices with the shipping document to the A/R ledger Assertion?

Completeness

Account: AR Control: Include a sample of zero-balance accounts in the confirmation process. Assertion?

Completeness

Customer Sales Order

Contains the details of the type and quantity of products or services ordered by the customer.

Account: AR Control Activity: Check the sales order and shipping document to make sure sales were earned and a customer owes a balance. Assertion?

Existence

Credit Approval Form

For credit sales, the entity must have a formal procedure for investigating the creditworthiness of the customer.

Auditors Primary concerns about revenue? (WCGW-ROMM)

Is revenue recognized when appropriate? (realizable) Is there a possibility of customers returning the goods?Are the accounts receivable collectible?

________ confirmations are most appropriate when the assessed level of risk is low, dollar balances on accounts are small, and the auditor believes recipients will give consideration to the confirmations

Negative

Account: Accounts Receivable Assertion: Completeness WCGW?

Not all accounts receivable have been recorded.

Account: Revenue Assertion: Completeness WCGW?

Not all sales are recorded.

Sales Journal

Once a sales invoice has been issued, the sale needs to be recorded in the accounting records. The sales journal is used to record information about the sales transaction.

Account: Accounts Receivable Assertion: Valuation WCGW?

Receivables are not included in financial statements at the appropriate amount, and the uncollectible portion of the balance is not properly estimated.

Account: AR Control: 1. Inquire whether any receivables have been sold or factored. 2. Inspect the bank confirmations, loan agreements, and minutes of the board for indications of pledged, discounted, or assigned receivables. Assertion?

Rights and obligations

Account: Revenue Assertion: Cutoff WCGW?

Sales have been recorded in incorrect periods.

________________ _____________ are designed to obtain direct evidence about the dollar amounts in account balances, while ______ __ ________ are designed to obtain evidence about the company's performance of its own control activities

Substantive procedures; tests of controls

An auditor is in the process of planning procedures to test the client's accounts receivable balances. Assuming the auditor decides not to use accounts receivable confirmations for the client, which of the following would be least compelling reason to eliminate this method of testing?

The auditor suspects that some accounts receivables may be fake.

As part of the current audit, the auditor performs a preliminary review of a large client's internal controls over AR. Which of the items below would the auditor flag as an internal control weakness over AR?

The controller prepares an aging schedule and for all accounts ninety days or more past due she authorizes write-off (R&A)

Sales Invoice

The document is used to bill the customer. This document contains information on the type of product or service, the quantity, the price, and the terms of trade.

Shipping Document

This document generally serves as a bill of lading and contains information on the type of product shipped, the quantity shipped, and other relevant information.

Customer Statement

This document is mailed to the customer and contains details of all sales, cash receipts, and credit memorandum transactions.

Credit Memorandum

This document is used to record credits for the return of goods by a customer.

Remittance Advice

This is usually the part of the customer's bill that should be returned with the payment.

Cash Receipts Journal

This journal is used to record the cash receipts of the entity.

Accounts receivable subsidiary ledger

This ledger contains an account and the details of transactions for each customer.

Aged Trial Balance of Accounts Receivable

This report summarizes all the customer balances in the accounts receivable subsidiary ledger. Each account is classified as current or placed into one of several past due categories.

Account: AR Control: ensure that all credit sales are authorized based on a credit limit in the customer master file. Assertion?

Valuation

What assertion?: Changing economic conditions also make it difficult to estimate AR collectability

Valuation

Account: AR Control Activities: Authorize and record discounts when customers take them; Management evaluates the collectability of delinquent receivables on a timely basis Assertion?

Valuation: WCGW? Receivables are not included in financial statements at the appropriate amount, and the uncollectible portion of the balance is not properly estimated.

Which of the following internal control activities will most likely prevent the concealment of a cash shortage by improperly writing off a trade account receivable? a. Write-offs must be approved by a responsible officer after review of credit department recommendations and supporting evidence. b. Write-offs must be supported by an aging schedule showing that only receivables overdue several months have been written off c. Write-offs must be approved by the cashier who is in a position to know whether the receivables have, in fact, been collected d. Write-offs must be authorized by company field sales employees who are in a position to determine customers' financial standing

a. Write-offs must be approved by a responsible officer after review of credit department recommendations and supporting evidence. (Impropriety of write-offs can be controlled by the review and approval of someone outside the credit department.)

If an auditor is concerned with a possible overstatement of sales, they would most likely trace documents from the:

accounting records with the source documents

The pricing master file can be compared to an official price source for

accuracy

For a sample of customers with long outstanding balances, verify that the AR manager reviewed a customer's credit file prior to the account being written off. Also ensure the treasurer has approved the write off. What assertion?

accuracy/valuation

Test of control: For a sample of cash disbursements, verify the evidence of voucher packet review and authorization (signature)?

accuracy/valuation

When auditing the revenue and collection cycle, auditors normally select balances to confirm from the a. Sales journal. b. Accounts receivable listing c. General ledger d. Cash receipts listing

b. Accounts receivable listing

Which of the following might be detected by auditors' cutoff review and examination of sales journal entries for several days prior to the balance sheet date? a. Lapping year-end accounts receivable. b. Inflating sales for the year c. Kiting bank balances d. Misappropriating merchandise

b. Inflating sales for the year (lapping/kiting pertains to cash receipts, not sales)

Revenues are normally considered to have been earned when a. All possibility of return has expired. b. The company has substantially accomplished what it must to be entitled to the benefits c. The cash is collected d. Goods have been shipped

b. The company has substantially accomplished what it must to be entitled to the benefits

Auditors sometimes use comparisons of ratios as audit evidence. An unexplained decrease in the ratio of gross profit to sales may suggest which of the following possibilities? a. Unrecorded purchases. b. Unrecorded sales c. Merchandise purchases being charged to selling and general expense d. Fictitious sales

b. Unrecorded sales

Confirmation of individual accounts receivable balances directly with debtors will, of itself, normally provide the strongest evidence concerning the a. Collectability of the balances confirmed. b. Ownership of the balances confirmed c. Existence of the balances confirmed d. Internal control over balances confirmed

c. Existence of the balances confirmed

Which of the following would be the best protection for a company that wishes to prevent the "lapping" of trade accounts receivable? a. Separate duties so that the bookkeeper in charge of the general ledger has no access to incoming mail. b. Separate duties so that no employee has access to both checks from customers and currency from daily cash receipts c. Have customers send payments directly to the company's depository bank d. Request that customer's payment checks be made payable to the company and addressed to the treasurer

c. Have customers send payments directly to the company's depository bank (The cash is not in the same physical place as the employees; therefore it cannot be stolen.)

Sales are normally recorded on the date of the a. Customer purchase order. b. Bill of lading c. Sales invoice d. Payment check

c. Sales invoice (normally same as bill of lading date)

When accounts receivable are confirmed at an interim date, auditors need not be concerned with a. Obtaining a summary of receivables transactions from the interim date to the year-end date. b. Obtaining a year-end trial balance of receivables, comparing it to the interim trial balance, and obtaining evidence and explanations for large variations c. Sending negative confirmations to all customers as of the year-end date d. Considering the necessity for some additional confirmations as of the balance sheet date if balances have increased materially

c. Sending negative confirmations to all customers as of the year-end date

Which of the following internal control activities most likely would deter lapping of collections from customers? a. Independent internal verification of dates of entry in the cash receipts journal with dates of daily cash summaries. b. Authorization of write-offs of uncollectable accounts by a supervisor independent of credit approval c. Separation of duties between receiving cash and posting the accounts receivable ledger d. Supervisory comparison of the daily cash summary with the sum of the cash receipts journal entries

c. Separation of duties between receiving cash and posting the accounts receivable ledger

The control procedure "credit sales approved by credit department" is directed toward which assertion? a. Existence/Occurrence b. Completeness c. Valuation/Accuracy d. Cutoff

c. Valuation/Accuracy

If mgmt asserts that "all cash accounts are Presented & Disclosed correctly, which of the following would be the most appropriate population to sample from to verify this assertion?

cash accounts described in the financial stmts balance sheet and footnotes

What assertion?: Customer orders, shipping documents, and invoices should be in prenumbered sequence so the system can check the sequence and determine whether any transactions have not been recorded

completeness

What assertion?: Tracing sample of shipping documents to invoices?

completeness

Auditors will review items in the pending orders file (Sales transactions that were initiated but are not yet completed, and thus not yet recorded as sales) for evidence of the:

completeness of recorded sales and accounts receivable

Verifying the dates on the documents helps reduce risk of misstatement related to the _________ assertion of revenue

cutoff

If the following A/R confirmations responses were received by the auditor, which of the following is likely an error on the client's part for AR balance (i.e an exception the auditor needs to further investigate for impact on the financial statements)? a. "we confirm this amount as of 12/31/21" b. "We sent a check for this amount 12/31/21" c. "We did not receive these goods or invoice until 1/3/22" d. "We returned these items on 12/20/21"

d. "We returned these items on 12/20/21"

An audit team is auditing sales transactions. One step is to vouch a sample of debit entries from the accounts receivable subsidiary ledger back to the supporting sales invoices. The purpose of this audit procedure is to establish that a. Sales invoices represent bona fide sales. b. All sales have been recorded c. All sales invoices have been properly posted to customer accounts d. Entries in the accounts receivable subsidiary ledger were properly invoiced.

d. Entries in the accounts receivable subsidiary ledger were properly invoiced.

An auditor is in the process of planning procedures to test the client's accounts receivable balances. Assuming the auditor decides not to use AR confirmations for the client, which of the following would be the least compelling reason to eliminate this method of testing? a. AR deemed immaterial b. inherenent and control risk are low c. low response rate so confirmations are an ineffective method d. the auditor suspects that some AR may be fake

d. the auditor suspects that some AR may be fake

Which of the following represents sufficient controls over cash receipts for a large company? a. the accounts receivable department matches the details from the bank deposit ticket with the details from the remittinance advices. b. a lockbox is used for customer payments c. checks received are endorsed and deposited daily d. a triplicate detail listing of cash receipts is sent to the cashier (along with the cash receipts), accounting department, and accounts receivable department e. all of them

e. all of them

management has an incentive to overstate revenues. Thus, auditors may assess inherent risk for the __________ assertion to be higher than for the completeness assertion for these accounts

existence

the tendency to use fictitious sales to overstate assets and revenues, the ________ assertion is extremely important in the audit of accounts receivable

existence

By requiring a 3-way match of documents to be present before recording a revenue, a company reduces the risk of overstating revenues and accounts receivable, providing assurance related to the ___________ of accounts receivable, and the __________ of revenue.

existence; occurrence

Confirmations provide evidence of __________ as well as ______&_________ of accounts and notes receivable

existence; rights and obligations

In relation to the revenue cycle, auditors should presume that there is a fraud risk involving _______ _______ ________

improper revenue recognition

What assertion?: Customer orders, shipping documents, and invoices should be in prenumbered sequence so the system can check the sequence and determine whether any transactions have been duplicated

occurence

What assertion?: Vouching sample of invoices to shipping documents

occurence

the tendency to use fictitious sales to overstate assets and revenues, the ________ assertion is extremely important in the audit of sales

occurence

Primary methods of CONFIRMING A/R: (3)

positive confirmation: asks the customer to respond as to whether the balance is correct or incorrect. Blank confirmation: (variation of positive confirmation) does not contain the balance; customers are asked to fill it in themselves negative form: asks for a response only if something is wrong with the balance

Which of the following controls is least likely to be used to safeguard cash?

receiving reports

The most effective audit procedure for determining the collectibility of an account receivable is:

review of subsequent cash collections (valuation)

Which of the following internal control activities would deter lapping of collections from customers?

separation of duties between receiving cash and posting the accounts receivable ledger.

If an auditor is concerned with a possible understatement of sales, they would most likely trace documents from the:

shipping documents to the sales invoices

Because revenue is a presumptive high-fraud risk and an overall significant risk, the auditor always performs substantive procedures in the revenue cycle. These procedures are classified as: (2)

substantive analytical procedures and substantive tests of details

Substantive analytical procedures definition

the auditor substantiates an account or disclosure by developing an independent estimate of the amount and then comparing the recorded balance to the estimate ex. the evaluation of the accounting estimate for the allowance for doubtful accounts generally involves an analytical review of the adequacy of the provision for bad debt expense

Substantive tests of details definition

the auditor substantiates an account or disclosure by directly testing the transactions that make up the account or the items that constitute the balance of the account ex. auditors will generally send confirmations to customers to substantiate the existence and rights and obligations assertions of accounts receivable

2 significant accounts in Revenue and Collection cycle

-Revenue (O,C,Cutoff) -A/R (E,C,V)

Procedures used in tests of controls are: (6)

-client inquiry -observation -inspection of documents and records -reperformance -walkthroughs -vouching/tracing/scanning