Chapter 11 -- Evidence -- The Sales-Receivables-Cash Cycle

Question 1

Section 11.1: Substantive Testing of Sales and Receivables

What is the best way to test for the existence assertion in accounts receivable?

Answer 1

External confirmation of accounts receivable by sending requests to customers tests for existence.
They must be confirmed unless:
1. They are immaterial
2. Confirmation would be ineffective
3. The assessed risk of material misstatement is low and other procedures address the risk.

Question 2

Section 11.1: Substantive Testing of Sales and Receivables

What should an auditor do when collections of receivables have decreased?

Answer 2

• The auditor should determine the effects on the allowance for doubtful accounts
• Expand tests of collectibility
• The verification of the allowance for doubtful accounts ensures that receivables are fairly presented at their net realizable value in the balance sheet and that credit loss expense is fairly stated in the income statement.

Question 3

Section 11.1: Substantive Testing of Sales and Receivables

What are the key controls over sales returns and allowances should ensure proper approval and processing?

Answer 3

• Authorization by the sales department to return goods
• Receipt of the returned goods by the receiving department and preparation of a receiving report
• Separate approval of the credit memo related to a return or allowance by someone not in the sales department

Question 4

Section 11.1: Substantive Testing of Sales and Receivables

What is the most effective audit procedure for determining the collectibility of an account receivable?

Answer 4

• Review of the subsequent cash collections
• To learn whether the receivable was subsequently collected.
• A confirmation provides evidence that a contract exists and that the customer acknowledges the debt, but the subsequent collection of the receivable is the only means of gaining complete assurance that the amount will be paid.

Question 5

Section 11.1: Substantive Testing of Sales and Receivables

How are account receivables transfer misstatements identified?

Answer 5

Reconciling the accounts receivable ledger to the general ledger control account.

Question 6

Section 11.1: Substantive Testing of Sales and Receivables

What procedure should an auditor when collections of accounts receivable has slowed?

Answer 6

• The auditor should determine the effects on the allowance for doubtful accounts.
• They should expand tests of collectibility
• The verification of the allowance for doubtful accounts ensures that receivables are fairly presented at their net realizable value in the balance sheet and that credit loss expense is fairly stated in the income statement.

Question 7

Section 11.1: Substantive Testing of Sales and Receivables

What should an auditor do if a 2nd accounts receivable confirmation request has not been received?

Answer 7

The auditor should apply alternative procedures
Verify the transactions by examining supporting documents:
* Contracts
* Sales invoices
* Customer orders
* Shipping documents
* Subsequent collections
* Seek evidence of the existence, address, and financial standing of the customer

Question 8

Section 11.1: Substantive Testing of Sales and Receivables

What is the purpose of a sales cutoff test?

Answer 8

• To obtain assurance that receivables are recorded in the appropriate period.
• The auditor should examine sales and receivables recorded several days before and after the cutoff date and compare them with the sales invoices and shipping documents to assure they have been recorded in the proper period.

Question 9

Section 11.2: Substantive Testing of Cash

Why should an auditor test bank transfers for the last part of the audit period and first part of the subsequent period?

Answer 9

To determine if cash balances were overstated because of kiting.

Question 10

Section 11.2: Substantive Testing of Cash

Why does an auditor detect kiting?

Answer 10

• The auditor should examine a schedule of bank transfers for a period covering a few days before and after the balance sheet date.
• For the procedure to be effective, however, the auditor should be assured that all transfers have been identified.
• Comparing paid checks, returned in the next period and dated prior to year end, with the checks listed as outstanding on the related bank reconciliation.

Question 11

Section 11.2: Substantive Testing of Cash

What is kiting?

Answer 11

• Kiting is the recording of a deposit from an interbank transfer in the current period while failing to record the related disbursement until the next period.
• This fraud exploits the lag (float period) between the deposit of a check in one account and the time it clears the bank on which it is drawn.

Question 12

Section 11. 2: Substantive Testing of Cash

What audit procedures for cash are directed toward the existence assertion?

Answer 12

• Counting cash
• Obtaining bank confirmations
• Performing bank reconciliations
• Examining cutoff bank statements
• Preparing schedules of interbank transfers
• Preparing proofs of cash

Question 13

Section 11. 2: Substantive Testing of Cash

What assertions are performed in regard to account balances at the end of a period?

Answer 13

Assertions are based on balance sheet accounts:
* Existence
* Rights and obligations
* Completeness
* Accuracy, valuation, and allocation
* Classification
* Presentation.