Auditing Chapter 7

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. Correct The earning process is complete at this point.

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. Correct This would have the balance for confirming

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. Correct Impropriety of write offs can be controlled by the review and approval of someone outside the credit department.

The negative request form of accounts receivable confirmation is useful particularly when the Assessed Level of Risk of Material Misstatement Relating to Receivables Is Number of Small Balances Is Proper Consideration by the Recipient Is a. Low Many Likely b. Low Few Unlikely c. High Few Likely d. High Many Likely

a. Correct Negative 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.

The financial records of the Movitz Company show that R. Dennis owes $4,100 on an account receivable. An independent audit is being carried out, and the auditors send a positive confirmation to R. Dennis. What is the most likely reason as to why a positive confirmation rather than a negative confirmation was used here? a. Control risk was particularly low for accounts receivable. b. Inherent risk was particularly high for accounts receivable. c. Dennis's account was not yet due. d. Dennis's account was not with a related party.

b. Correct Because detection risk is lower for positive confirmations than negative confirmations, a positive confirmation is more likely when inherent risk is high.

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

c. Correct Credit approval helps ensure that the sale will be collectible.

Which of the following accounts is not normally part of the revenue and collection cycle? a. Sales b. Accounts Receivable. c. Cash. d. Purchases Returns and Allowances

d. Correct Even though this involves shipments, it is considered part of the expenditure and disbursement cycle.

An auditor noted that client sales increased 10 percent for the year. At the same time, Cost of Goods Sold as a percentage of sales had decreased from 45 percent to 40 percent and year-end accounts receivable had increased by 8 percent. Based on this information, the auditor is most likely concerned about a. Unrecorded costs. b. Improper credit approvals. c. Improper sales cutoff. d. Fictitious sales.

d. Correct Fictitious sales would increase sales. Because no actual product was shipped, COGS as a percent of sales would decrease. The most likely debit for fictitious sales is accounts receivable, causing accounts receivable to increase.

During the confirmation of accounts receivable, an auditor receives a confirmation via the client's fax machine. Which of the following actions should the auditor take? a. Not accept the confirmation and select another customer's balance to confirm. b. Not accept the confirmation and treat it as an exception. c. Accept the confirmation and file it in the working papers. d. Accept the confirmation but verify the source and content through a telephone call to the respondent.

D. Correct When a reply to a confirmation is received via fax the auditor must determine that the fax actually came from the appropriate person at the client. A telephone call to an appropriate person at the audit client is an acceptable method for verifying the legitimacy of the response.

Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this defalcation and be least likely to be detected by an auditor? a. Understating the sales journal. b. Overstating the accounts receivable control account. c. Overstating the accounts receivable subsidiary ledger. d. Understating the cash receipts journal.

a. Correct Not recording sales on account in the books of original entry is the most effective way to conceal a subsequent theft of cash receipts. The accounts will be incomplete but balanced, and procedures applied to the accounting records will not detect the defalcation.

When an audit team traces a sample of shipping documents to the related sales invoice copies, they are trying to find relevant evidence that a. Shipments to customers were invoiced. b. Shipments to customers were recorded as sales. c. Recorded sales were shipped. d. Invoiced sales were shipped.

a. Correct Shipments are traced to customers' invoices. (This does not imply that the invoices were recorded in the sales journal.)

When a sample of customer accounts receivable is selected for vouching debits, auditors will vouch them to a. Sales invoices with shipping documents and customer sales invoices. b. Records of accounts receivable write-offs. c. Cash remittance lists and bank deposit slips. d. Credit files and reports.

a. Correct The accounts receivable debits are supposed to represent sales that have been ordered by customers and actually shipped to them.

When an audit team does not receive a response on a positive accounts receivable confirmation, auditors should do all of the following except a. Send a second request. b. Do nothing for immaterial balances. c. Examine shipping documents. d. Examine client correspondence files.

b. Correct Because the confirmations are a sample of the account balance, even immaterial items should be followed up as they represent other balances in the universe of receivables.

An auditor is required to confirm accounts receivable if the accounts receivable balances are a. Older than the prior year. b. Material to the financial statements. c. Smaller than expected. d. Subject to valuation estimates.

b. Correct Confirmation are generally reserved for accounts that are material to the balance being examined, in this case, accounts receivable.

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. Correct False sales journal entries made near the end of the year may have shipping or other documents that reveal later dates or show lack of sufficient documentation.

In the audit of accounts receivable, the most important emphasis should be on the a. Completeness assertion. b. Existence assertion. c. Rights and obligations assertion. d. Presentation and disclosure assertion.

b. Correct Financial statement users are more likely to be damaged if assets are found not to exist or assets are overstated.

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. Correct Less sales revenue and correct amount of cost of goods sold results in less gross profit, therefore the ratio of gross profit to sales will decrease. (Actually, the gross profit numerator will decrease at a greater rate than the sales denominator

An auditor noted that client sales increased 10 percent for the year. At the same time, Cost of Goods Sold as a percentage of sales had decreased from 45 percent to 40 percent and year-end accounts receivable had increased by 8 percent. Based on this information, the auditor interviewed the sales manager, who stated that the increase in sales without a corresponding increase in cost of goods sold was due to a price increase enacted by the company during the year. How would the auditor test the sales manager's representation? a. Perform additional inquiries with sales personnel. b. Obtain copies of all price lists in use during the year and vouch the prices to sales invoices. c. Send confirmations asking customers about unit prices paid for product. d. Vouch vender invoices to payments made after year-end.

b. Correct Reviewing the changes in pricing during the year and ensuring that customers were charged the new prices provides sufficient, reliable evidence to support the sales manager's representation.

An audit client sells 15 to 20 units of product annually. A large portion of the annual sales occur in the last month of the fiscal year. Annual sales have not materially changed over the past five years. Which of the following approaches would be most effective concerning the timing of audit procedures for revenue? a. The auditor should perform analytical procedures at an interim date and discuss any changes in the level of sales with senior management. b. The auditor should inspect transactions occurring in the last month of the fiscal year and review the related sale contracts to determine that revenue was posted in the proper period. c. The auditor should perform tests of controls at an interim date to obtain audit evidence about the operational effectiveness of internal controls over sales. d. The auditor should review period-end compensation to determine whether bonuses were paid to meet earnings goals.

b. Correct Since a large portion of the sales occur in the last month the auditor needs to test end of year sales, specifically the determination of the timing of sales is important to ensure sales were recorded in the proper period.

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. Correct Accounts receivable confirmation enables recipients to respond that they owe the company or that they dispute or disagree with the amount the company says they owe.

Which of the following is the best reason for prenumbering in numerical sequence documents such as sales orders, shipping documents, and sales invoices? a. Enables company personnel to determine the accuracy of each document. b. Enables personnel to determine the proper period recording of sales revenue and receivables. c. Enables personnel to check the numerical sequence for missing documents and unrecorded transactions. d. Enables personnel to determine the validity of recorded transactions.

c. Correct Checking the sequence for missing numbers identifies documents not yet fully processed in the revenue cycle. It does not provide evidence about accuracy, cutoff. or occurrence.

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. Correct Lapping is the delayed recording of cash receipts to cover a cash shortage. Current receipts are posted to the accounts of customers who paid one or two days previously to avoid complaints (and discovery) when monthly statements are mailed. The best protection is for the customers to send payments directly to the company's depository bank. The next best procedure is to ensure that the accounts receivable clerk has no access to cash received by the mail room. Thus, the duties of receiving cash and posting the accounts receivable ledger are segregated.

Audit documentation often includes a client-prepared, aged trial balance of accounts receivable as of the balance sheet date. The audit team uses this aging primarily to a. Evaluate internal control over credit sales. b. Test the accuracy of recorded charge sales. c. Estimate credit losses. d. Verify the existence of the recorded receivables.

c. Correct The age of accounts is an indication of credit losses.

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. Correct The cash is not in the same physical place as the empployees; therefore it cannot be stolen.

Write-offs of doubtful accounts should be approved by a. The salesperson. b. The credit manager. c. The treasurer. d. The cashier.

c. Correct The treasurer or another high-ranking manager should approve write-offs.

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. Correct This is mainly because the other three choices are listed as appropriate work to do. Also, customers are likely to ignore negative confirmations after earlier responding to positive confirmations

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

c. Correct This is often the same as the bill of lading date.

Which of the following responses to an accounts receivable confirmation at December 31 would cause an audit team the most concern? a. "This amount was paid on December 30." b. "We received this shipment on January 2." c. "These goods were returned for credit on November 15." d. "The balance does not reflect our sales discount for paying by January 5."

c. Correct This should have been recorded as a reduction or credit to the receivable by 2/31.

A client has a separate sales group for its largest "preferred" customers, a select group of customers who normally make purchases in excess of $250,000 and often have accounts receivable balances in excess of $1 million. Which of the following audit procedures would the auditor most likely perform? a. Prepare a schedule of purchases and payments for these customers. b. Send out negative confirmations on a large sample of these customers. c. Inquire of the sales manager regarding the accounts receivable terms. d. Send out positive confirmations on a large sample of these customers.

d. Correct The most likely audit step when there are a few large accounts is to send out positive confirmations.

To conceal a theft involving receivables, a dishonest bookkeeper might charge which of the following accounts? a. Miscellaneous income. b. Petty cash. c. Miscellaneous expense. d. Sales returns.

d. Correct Using the sales returns account would raise the least suspicion because this account is more commonly linked to accounts receivable. A bookkeeper could steal money and "write off" to unsuspecting customer's balance with a fictitious "sales return."

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. Correct Vouching is used to establish support for recorded amounts.