Chapter 11

Question 1

Why are income statements audited?

I rly dont know the proper question

Answer 1

Many income statement accounts are audited when the related balance sheet accounts are audited, as listed in table 11.1. This is because each balance sheet account is linked to one or more income statement accounts due to the double-entry system of accounting. By focusing on auditing the balance sheet accounts, the auditor is also gathering evidence over the related income statement accounts.

Question 2

Objectives in auditing revenue

All sales included in the income statement represent the exchange of goods or services with customers for cash or other consideration during the period.

All other revenues included in the income statement for the period have accrued to the entity at year end.

Revenues applicable for future periods have been deferred.

Answer 2

Occurrence (O)

Question 3

Objectives in auditing revenue

All sales and other revenues that accrued to the entity during the period are included in the income statement.

Answer 3

C

Question 4

Objectives in auditing revenue

Sales and other revenues are stated at the appropriate amounts.

Answer 4

Accuracy and cut-off (A&CO)

Question 5

Objectives in auditing revenue

Sales and other revenues are properly classified, described, and disclosed in the financial statements, including the notes.

Answer 5

Classification (Cl), classification and understandability (C&U)

Question 6

Example substantive tests of transactions—sales
Sales Process

Perform a proof of cash by reconciling the activity per the client records to activity per the bank. Correlate activity with the recorded sales for the year and the change in trade receivables balance. (Effectiveness of procedures is limited to less complex engagements.)

Answer 6

(O, A)

Question 7

Example substantive tests of transactions—sales
Sales Process

Test the records of products ordered and shipped to the sales records. Agree dates, customers, products, quantities, prices, and amounts.

Answer 7

(C, A)

Question 8

Example substantive tests of transactions—sales
Sales Process

Test the posting of individual sales invoices to the sales ledger and to the trade receivables sub-ledger.

Answer 8

C

Question 9

Example substantive tests of transactions—sales
Sales Process

Account for the numerical sequence of sales invoices, sales orders, and shipping documents during a specific period

Answer 9

C

Question 10

Example substantive tests of transactions—sales
Sales Process

Test recorded sales to the records of products shipped. Agree dates, customers, products, quantities, prices, and amounts.

Answer 10

O, A

Question 11

Example substantive tests of transactions—sales
Sales Process

Investigate large or unusual credit memos issued subsequent to year end.

Answer 11

O

Question 12

Example substantive tests of transactions—sales
Sales Process

Review the sales ledger, the sales returns and allowances ledger, and the cash receipts ledger for unusual items. Investigate any such items observed.

Answer 12

A

Question 13

Example substantive tests of transactions—sales
Sales Process

Test the pricing and mathematical accuracy of sales invoices.

Answer 13

A

Question 14

Example substantive tests of transactions—sales
Sales Process

Test the accounting classification of sales transactions.

Answer 14

CI

Question 15

Example substantive tests of transactions—sales
Sales Process

Test the mathematical accuracy of the sales ledger.

Answer 15

A

Question 16

Example substantive tests of transactions—sales
Sales Process

Trace accounts receivable to the trade receivables sub-ledger (debtors’ trial balance). Investigate reconciling items.

Answer 16

C

Question 17

Example substantive tests of transactions—sales
Sales Process

Test the postings of the sales ledger to the general ledger and the trade receivables sub-ledger.

Answer 17

C

Question 18

Example substantive tests of transactions—sales
Sales Returns

Compare credit memos and supporting documents with the sales returns and allowances ledger as to dates, customers, products, quantities, prices, and amounts.

Answer 18

C

Question 19

Example substantive tests of transactions—sales
Sales Returns

Account for the numerical sequence of credit memos during a specified period.

Answer 19

C

Question 20

Example substantive tests of transactions—sales
Sales Returns

Test the posting of individual credit memos to the sales returns and allowances ledger and to the trade receivables sub-ledger.

Answer 20

C, A

Question 21

Example substantive tests of transactions—sales
Sales Returns

Compare credit memos with the documents supporting returns and allowances as to dates, customers, products, quantities, prices, and amounts.

Answer 21

C, A

Question 22

Example substantive tests of transactions—sales
Sales Returns

Test the authorization of credits, discounts, and allowances.

Answer 22

A

Question 23

Example substantive tests of transactions—sales
Sales Returns

Test the pricing and mathematical accuracy of credit memos.

Answer 23

A

Question 24

Example substantive tests of transactions—sales
Sales Returns

Test the cut-off in processing credits and allowances granted to customers.

Answer 24

CO

Question 25

Example substantive tests of transactions—sales
Sales Returns

Test the timeliness with which credits granted to customers are processed.

Answer 25

A

Question 26

Example substantive tests of transactions—sales
Sales Returns

Test the accounting classification of credit memos.

Answer 26

CI

Question 27

Example substantive tests of transactions—sales
Sales Returns

Test the mathematical accuracy of the sales returns and allowances ledger.

Answer 27

A

Question 28

Example substantive tests of transactions—sales
Sales Returns

Test the postings of the totals in the sales returns and allowance ledger to the general ledger and the trade receivables sub-ledger.

Answer 28

A

Question 29

Example substantive tests of transactions—sales
Sales Returns

Test and evaluate the procedures for approving customer credit and for collecting past due accounts.

Answer 29

A

Question 30

Example substantive tests of transactions—sales
Sales Returns

Test and evaluate the procedures for approving credit and allowances granted to customers.

Answer 30

A

Question 31

Example substantive procedures in auditing revenue

EXAMPLE TESTS ALWAYS PERFORMED

Answer 31

Compare the monthly income statements to the budget and/or prior year statements and investigate any unexpected fluctuations or the absence of expected fluctuations. (C, A, Cl)

Test the cut-off of revenues by inspecting the sales ledger, billings, shipping documents, and other supporting documents immediately before and after the cut-off date to determine that the transactions were recorded in the proper period. Compare the cut-offs of revenue with cut-offs in related areas—for example, accounts receivable and inventory. (CO)

Question 32

Example substantive procedures in auditing revenue
EXAMPLE ANALYTICAL PROCEDURES
General

Answer 32

General
Review the client’s comparison of budgeted and actual revenues by month or by quarter. Corroborate some of the reasons identified by the client for important variations. Investigate any unexpected variations or the absence of expected variations that were not identified by the client. (C, A, Cl)

Question 33

Example substantive procedures in auditing revenue
EXAMPLE ANALYTICAL PROCEDURES
(Sales)

Answer 33

Sales
Compare sales to the current year’s budget and to the prior period’s actual sales by product line or geographic area. (C, A, Cl)

Compare sales volume to industry output in total or by geographic area (if available). (C, A, Cl)

Compare gross profits with those of the prior period by product line or geographic area.

Compare other operating relationships, both sales and cost of sales, to units shipped with prior periods. (C, A, Cl)

Compare sales for several days prior to and after year end to the average daily sales for the year. (C, A, Cl)

Compare the current period’s sales returns and the allowance for sales returns as percentages of sales by product line with prior period percentages. (A)

Compare the number and amounts of credits issued with those of prior periods. (A)

Review the relationships between sales and cost of sales, such as gross margin analysis, comparison of standards and actual costs, and reconciliation between cost of sales and outgoing shipments. (C, A, Cl)

Review the relationships between certain types of expenses and sales—for example, freight out to units billed, and sales bonuses to sales. (A, Cl)

Question 34

Example substantive procedures in auditing revenue
EXAMPLE ANALYTICAL PROCEDURES
(Other Revenue)

Answer 34

Perform an overall test of revenue—for example, compare published fee rates for a school multiplied by the number of students by classification/year level. (A)

Perform an overall test of interest and dividend income on investments and receivables by, for example, multiplying the average amounts invested by interest rate or dividend yields. (A)

Question 35

Example substantive procedures in auditing revenue
EXAMPLE OTHER GENERAL PROCEDURES
Sales

Answer 35

Sales
Enquire about management, sales personnel, or other parties who may be receiving products without billing or payment. (O, A)

Determine rights of return offered to customers under the terms of sale agreement or as a matter of practice. (O)

Question 36

Example substantive procedures in auditing revenue
EXAMPLE OTHER GENERAL PROCEDURES
Other Revenue

Answer 36

Obtain detailed analysis of selected revenue accounts and trace the details to the source data. (Cl)

Review the marketable securities and related accounts—for example, interest and dividend income in the general ledger—for unusual items. (A)

Test accrued interest and interest earned during the period to average interest rates and cash balances. (A)

Verify interest and dividend income on marketable securities, investments, and equity in earnings of investees by calculating interest earned or by referring to published records of dividends paid or to the financial statements of investees. (A)

Inspect authorizations and other data supporting sales and other disposals of property, plant, and equipment, and test the computations of the resulting gains and losses. (A)

Identify and examine items that may require separate disclosure in the financial statements, including the notes; for example, discontinued operations, segment information, and gains or losses on foreign currency transactions. (C&U, V&A)

Review minutes, agreements, union contracts, budgets, and plans for evidence of new sources of revenues that may have been earned. Investigate significant items noted. (C, Cl)

Question 37

Explain the relationship between the overall risk assessment for a significant account and the extent and timing of substantive procedures, and the differences between auditing income statement and balance sheet accounts.

Answer 37

The higher the overall risk of error or misstatement, the higher the level of substantive procedures required, assuming that no controls have been tested or can be relied on. When controls are effective and the overall risk assessment is therefore lower, limited substantive testing is ordinarily required. Revenue and expense account balances reflect the entire reporting period, and auditors typically use substantive analytical procedures coupled with some tests of details.

Question 38

Design and understand how to execute substantive procedures to address audit risk related to revenue.

Answer 38

Sales revenue is typically significant due to its size, volume of transactions, and high inherent risk. The most important audit assertions for revenue are occurrence, accuracy, and cut-off. The two significant accounting processes that impact on the sales revenue account balance are sales and sales returns and allowances. It is normally efficient and effective to perform at least some controls testing over these processes.

Question 39

Design and understand how to execute substantive procedures to address audit risk related to cost of sales and other significant expenses.

Answer 39

Cost of sales and expenses are generally significant accounts. The key audit assertions for these accounts are accuracy, completeness, and cut-off. Typical procedures include vouching recorded amounts to supporting documentation, and testing of depreciation expense as part of the testing of property, plant, and equipment on the balance sheet. Opening and closing inventory is part of inventory testing. Purchases testing is most efficiently tested as part of controls testing. Incentives to achieve particular levels of profit could lead to a company deferring the recognition of expenses incurred before year end to the following period. Special consideration may be given to the payroll balances.

Question 40

Understand how to assess the results of the substantive procedures to determine whether additional substantive tests are necessary.

Answer 40

When tests performed identify errors or exceptions, it is important to continue testing until the error can be accurately quantified or until the balance has been fully tested to an extent that it proves a material error can no longer exist within the balance.