Chapter 10- Practice (HW, Quiz, Assignments) Flashcards
For the control activities to be effective, employees maintaining the accounts receivable subsidiary ledger should NOT also approve:
a) Employee overtime wages.
b) Credit granted to customers.
c) Write-offs of customer accounts.
d) Cash disbursements.
c) Write-offs of customer accounts.
Which of the following controls is most likely to help ensure that all credit revenue transactions of an entity are recorded?
a) The billing department supervisor sends a copy of each approved sales order to the credit department for comparison to the customer’s authorized credit limit and current account balance.
b) The accounting department supervisor independently reconciles the accounts receivable subsidiary ledger to the accounts receivable control account each month.
c) The accounting department supervisor controls the mailing of monthly statements to customers and investigates any differences reported by customers.
d) The billing department supervisor matches prenumbered shipping documents with entries in the sales journal.
d) The billing department supervisor matches prenumbered shipping documents with entries in the sales journal.
Which of the following internal controls would be most likely to deter the 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 uncollectible accounts by a supervisor independent of the credit approval function.
c) Segregation 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) Segregation of duties between receiving cash and posting the accounts receivable ledger.
Smith Corporation has numerous customers. A customer file is maintained and includes a customer record with a name, an address, a credit limit, and an account balance. The auditor wishes to test this file to determine whether credit limits are being exceeded. The best procedure for the auditor to follow would be to:
a) Develop test data that would cause some account balances to exceed the credit limit and determine if the system properly detects such situations.
b) Develop a routine in IDEA or an audit data analytic to compare credit limits with account balances and identify any account with a balance exceeding its credit limit.
c) Request a printout of all account balances so that they can be manually checked against the credit limits.
d) Request a printout of a sample of account balances so that they can be individually checked against the respective credit limits.
b) Develop a routine in IDEA or an audit data analytic to compare credit limits with account balances and identify any account with a balance exceeding its credit limit.
Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this theft 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 disbursements journal.
a) Understating the sales journal.
If accounts receivable turnover (credit sales/receivables) was 7.1 times last year compared to only 5.6 times in the current year, it is possible that there were
a) Unrecorded credit sales in the current year.
b) Unrecorded cash receipts last year.
c) More thorough credit investigations made by the company late last year.
d) Fictitious sales in the current year.
d) Fictitious sales in the current year.
If the number of days sales in accounts receivable (365 days/receivables turnover) decreases significantly, which of the following assertions for accounts receivable most likely is violated?
a) Existence or occurrence.
b) Completeness.
c) Rights and obligations.
d) Classification.
b) Completeness.
Which of the following is most likely to be detected by an auditor’s review of an entity’s sales cutoff?
a) Unrecorded sales for the year.
b) Lapping of year-end accounts receivable.
c) Excessive sales discounts.
d) Unauthorized goods returned for credit.
a) Unrecorded sales for the year.
Negative confirmation of accounts receivable is less effective than positive confirmation of accounts receivable because:
a) A majority of recipients usually lack the willingness to respond objectively.
b) Some recipients may report incorrect balances that require extensive follow-up.
c) The auditor cannot infer that all nonrespondents have verified their account information.
d) Negative confirmations do not produce evidence that is statistically quantifiable.
c) The auditor cannot infer that all nonrespondents have verified their account information.
The negative request form of accounts receivable confirmation is useful particularly when:
a) The Assessed Level of Control Risk Relating to Receivables = LOW, The Number of Small Balances = HIGH, Consideration by the Recipient = LIKELY
b) The Assessed Level of Control Risk Relating to Receivables = LOW, The Number of Small Balances = LOW, Consideration by the Recipient = UNLIKELY
c) The Assessed Level of Control Risk Relating to Receivables = HIGH, The Number of Small Balances = LOW, Consideration by the Recipient = LIKELY
d) The Assessed Level of Control Risk Relating to Receivables = HIGH, The Number of Small Balances = HIGH, Consideration by the Recipient = LIKELY
a) The Assessed Level of Control Risk Relating to Receivables = LOW, The Number of Small Balances = HIGH, Consideration by the Recipient = LIKELY
An auditor should perform alternative procedures to substantiate the existence of accounts receivable when:
a) No reply to a positive confirmation request is received.
b) No reply to a negative confirmation request is received
c) The collectibility of the receivables is in doubt.
d) Pledging of the receivables is probable.
a) No reply to a positive confirmation request is received.
In evaluating the adequacy of the allowance for doubtful accounts, an auditor most likely reviews the entity’s aging of receivables to support management’s financial statement assertion of:
a) Existence.
b) Valuation and allocation.
c) Completeness.
d) Rights and obligations.
b) Valuation and allocation.
Describe the five-step process that is required for revenue recognition.
Step 1: Identify the contract(s) with a customer. A contract is an agreement between two or more parties that creates enforceable rights and obligations.
Step 2: Identify the performance obligations in the contract. A contract includes one or more promises to transfer goods or services to a customer.
Step 3: Determine the transaction price. The transaction price is the amount of consideration in a contract to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer.
Step 4: Allocate the transaction price to the performance obligations in the contract. An entity typically allocates the transaction price to each performance obligation on the basis of the relative standalone selling prices of each distinct good or service promised in the contract.
Step 5: Recognize revenue when the entity satisfies a performance obligation. An entity satisfies a performance obligation by transferring a promised good or service to a customer (which is when the customer obtains control of that good or service).
Describe the credit authorization function’s duties for monitoring customer payments and handling bad debts.
The credit function has the responsibility for monitoring customer payments.
An aged trial balance of accounts receivable should be prepared and reviewed by the credit function.
Payment should be requested from customers who are delinquent in making payments for goods or services.
The credit function is usually responsible for preparing a report of customer accounts that may require write-off as bad debts.
However, the final approval for writing off an account should come from an officer of the company who is not responsible for credit or collections.
When an entity does not adequately segregate duties, the possibility of cash being stolen before it is recorded is increased. If the auditor suspects that this type of theft is possible, what type of audit procedures can he or she use to test this possibility?
When the entity does not have adequate segregation of duties or if collusion is suspected, the possibility of a theft of cash is increased.
An employee who has access to both the cash receipts and the accounts receivable records has the ability to steal cash and manipulate the accounting records to hide the misstatement.
- This is sometimes referred to as lapping.
When lapping is used, the perpetrator covers the cash shortage by applying cash from one customer’s account against another customer’s account.
If the auditor suspects that this has occurred, the individual cash receipts have to be traced to the customers’ accounts receivable accounts to ensure that each cash receipt has been posted to the correct account.
If the cash receipt is posted to a different account, this may indicate that someone is applying cash to different accounts to cover a cash shortage.
Other possible procedures include custody and authorization of credit memos.
Lastly, confirmations that include not only A/R balances, but also total sales and cash receipts are a substantive procedure to address this issue.
The auditor needs to understand how selected inherent risk factors affect the transactions processed by the revenue process. Discuss the potential effect that industry-related factors and misstatements detected in prior periods have on the inherent risk assessment for the revenue process.
Industry-related factors such as the profitability and health of the industry in which the entity operates, the level of competition within the industry, and the industry’s rate of technological change affect the potential for misstatements in the revenue process.
The level of governmental regulation (e.g., by the Food and Drug Administration) within the industry may also affect sales activity.
Finally, most states have consumer protection legislation that may affect product warranties, returns, financing, and product liability. Such industry-related factors directly impact the auditor’s inherent risk assessment for the authorization and valuation assertions.
The presence of misstatements in previous audits is a good indicator that misstatements are likely to be present during the current audit. If material misstatements were present in previous audits, the auditor should assess inherent risk to be high.
In understanding the accounting system in the revenue process, the auditor typically performs a walkthrough to gain knowledge of the system. What knowledge should the auditor try to obtain about the accounting system?
The auditor needs to obtain the following knowledge for each major class of transactions in the revenue process when performing a walkthrough:
1) How sales, cash receipts, and sales returns and allowances transactions are initiated.
2) The accounting records, supporting documents, and accounts that are involved in processing sales,
cash receipts, and sales returns and allowances transactions.
3) The flow of each type of transaction from initiation to inclusion in the financial statements, including
computer processing of the data.
4) The process used to prepare estimates for accounts such as the allowance for uncollectible accounts
and sales returns.
What are the two major controls for sales returns and allowances transactions?
(1) each credit memorandum should be approved by someone other than the individual who initiated it
(2) a credit for returned goods should be supported by a receiving document indicating that the goods have been returned.
Describe how the auditor verifies the accuracy of the aged trial balance.
The auditor verifies the accuracy of the aged trial balance using the following steps.:
1) a copy of the aged trial balance of accounts receivable is obtained from the entity and the total balance is compared to the accounts receivable general ledger balance.
2) a sample of customer accounts is selected from the aged trial balance. For each selected customer account, the auditor traces the customer’s balance back to the subsidiary ledger detail and verifies the total amount and the amounts included in each column for proper aging.
These two steps mainly describe a manual approach to testing accuracy.
A second approach would involve the use of computer-assisted audit techniques.
If the general controls over IT are adequate, the auditor can use a generalized audit software package to perform the steps described in the first approach to examine the accuracy of the aged trial balance generated by the entity’s accounting system.
List and discuss the three factors mentioned in the chapter that may affect the reliability of confirmations of accounts receivable.
Three factors that affect the reliability of accounts receivable confirmations are:
1) The type of confirmation request.
2) Prior experience on the entity or similar engagements.
3) The intended respondent.
The types of confirmations include positive and negative confirmations.
- Positive confirmations are considered more reliable because the recipient is required to respond to the auditor regardless of whether a misstatement exists or not.
Prior experience with the entity in terms of confirmation response rates, misstatements identified, and the accuracy of returned confirmations should be considered when assessing the reliability of accounts receivable confirmations.
- For example, if response rates were low in prior audits, the auditor might consider obtaining evidence using alternative procedures.
Finally, the intended respondents to accounts receivable confirmations may vary from individuals with little accounting knowledge to highly qualified accounting personnel in large corporations.
The auditor should consider the respondent’s competence, knowledge, ability, and objectivity when assessing the reliability of confirmation requests.
Distinguish between positive and negative confirmations. Under what circumstances would positive confirmations be more appropriate than negative confirmations?
A positive accounts receivable confirmation requests that the customer indicate whether or not it is in agreement with the amount due to the entity stated in the confirmation.
- Thus, a response is required regardless of whether the customer believes that the amount is correct or incorrect.
- A negative confirmation requests that the customer respond only when it disagrees with the amount due to the entity.
Positive confirmations are generally used when an account contains large individual balances or if errors are anticipated because control risk is assessed to be high.
- Negative confirmation requests are used when there are a large number of accounts with small balances, control risk is assessed to be low, and the auditor believes that the customers will devote adequate attention to the confirmation.
Identify three other types of receivables the auditor should examine. What audit procedures would typically be used to audit other receivables?
Other types of receivables that the auditor should examine include:
1) Receivables from officers and employees.
2) Receivables from related parties.
3) Notes receivable.
The auditor would confirm and evaluate each type of receivable for collectibility.
The transactions that result in receivables from related parties are examined to determine if they were at “arm’s length.”
Notes receivable would also be confirmed and examined for repayment terms and whether interest income has been properly recognized.
T/F: The revenue process affects numerous accounts in the financial statements.
TRUE
Revenue Process -> Cash Sale Process
Purchases -> Inventory -> Cash Sales
Revenue Process -> Credit Sale Process
Purchases -> Inventory -> Credit Sales -> Account Receivable -> Cash Collection
Revenue Transaction (Sale Transaction) Process
Occurence = Sales Journal / General Ledger (Sample) -> Sales Invoice ($ amt) -> BOL (# amt) -> Customer Sales Order
- Added Customer Sales Order -> to leverage samples to obtain information for multiple assertions (efficiency)
Completeness = BOL (Sample)-> Sales Invoice (# amt) -> Sales Journal / General Ledger ($ Amt)
How to know if a sale occurred?
Fulfilled our obligation / shipped good
(Bill of Lading proves this verification/occurence)
Daily billing of goods shipped.
What revenue transaction assertion?
Cutoff
Authorized price list & specified terms of trade.
What revenue transaction assertion?
Authorization & Accuracy
Sales recorded only with approval customer order & shipping document.
What revenue transaction assertion?
Occurence
Shipping documents matched to sales invoices.
What revenue transaction assertion?
Completeness
Proper account codes used for different types of products/services.
What revenue transaction assertion?
Classification
Trace the sales transaction to the sales invoice, bill of lading, and customer sales order. Compare the description, amounts, and date of shipment for agreement.
What revenue transaction assertions?
Occurrence, Accuracy, Cutoff
Check for proper authorization of the sale.
What revenue transaction assertion?
Authorization
Trace the transaction to the GL for proper recording (proper account)
What revenue transaction assertion?
Classification
Trace shipping document to their respective sales invoice and to the sales journal
What revenue transaction assertion?
Completeness
Compare current year sales with prior years.
What revenue transaction assertions?
Occurence & Completeness
Compare sales trend with industry.
What revenue transaction assertions?
Occurence & Completeness
Discuss significant and/or unexpected changes with client management
What revenue transaction assertions?
Occurence & Completeness
For sales invoiced within the last 5 days prior to and first 5 days subsequent to YE: Select a sample of sales invoices from the sales journal and trace to the shipping documents to check the date of shipment compared to the date recorded.
What revenue transaction assertion?
Cutoff
For shipments made within the last 5 days prior to and first 5 days subsequent to YE: Select a sample shipping documents reviewing the date and trace to the sales journal to check period recorded.
What revenue transaction assertion?
Cutoff
Review returns after year-end and compare to shipments prior to year-end and customer orders.
What revenue transaction assertion?
Occurence
(if returned was it actually a valid sale)
Review sales journal for unusual items.
What revenue transaction assertion?
Occurence
Dual-Purpose Test has a ____ sample
larger sample size
(combines substantive and test of controls)
