Chapter 7 Flashcards
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 SG&A
d) Fictitious sales
Correct answer: b) Unrecorded sales
a) COGS too low
c) COGS too low
d) sales too high
Sales – COGS = Gross Profit
10-5=5 (5/10=.5)
8-5=3 (3/8=.375) decreased sales causes a decrease in ratio of gross profit
When a sample of customer AR is selected for vouching debits, auditors will vouch them to?
a) Sales invoices with shipping documents and customer sales orders.
b) Records of AR write-offs
c) Cash remittance lists and bank deposit slips.
d) Credit files and reports.
a) Sales invoices with shipping documents and customer sales orders.
What assertion does the error in sales process map to?
Sales recorded, goods not shipped
Existence/occurence
What assertion does the error in sales process map to?
Goods shipped, sales not recordedC
Completeness
What assertion does the error in sales process map to?
Goods shipped to bad credit risk customer
Valuation/accuracy
What assertion does the error in sales process map to?
Sales billed at the wrong price or wrong quantity
Valuation/accuracy
What assertion does the error in sales process map to?
Product A sales recorded as Product Line B
Presentation/disclosure
Want to be in the correct segment for segmented revenue schedule
What assertion does the error in sales process map to?
Failure to post charges to customers for sales
Completeness
What assertion does the error in sales process map to?
January sales recorded in December
Cutoff
Is there such thing as a typical revenue and collection cycle?
No
If shipping, when is revenue recognized?
Upon shipping the good
Customer Sales Order
Details of the type/quantity of products/services ordered by the customer
Credit Approval Form
Document if credit was granted
Open-Order Report
Shows all orders that aren’t complete
Shipping Document
generally serves as the bill of lading
Sales Invoice
The bill
Sales Journal
information for sales on credit NOT ALL SALES!! Only capturing when the debit is to A/R. Not capturing cash sales.
Bill of Lading
a receipt that the carrier gives to the company… consigning goods to shipper temporarily
Customer Statement
mailed to the customer and contains details of all sales, cash receipts, and credit memorandum transactions
Accounts Recievable Subsidiary Ledger
can see individual customer accounts
Aged Trial Balance of Accounts Receivable
for valuation of A/R. How late are payments, what is owed?
Remittance Advice
what account is the payment for?
Cash Receipts Journal
Shows cash received
Credit Memorandum
used to record credits for the return of goods
Write-off Authorization
authorizes final write-off of AR (generally authorized by the treasurer)
Sales Transactions
Accounts Receivable (Debit)
Sales (Credit)
Allowance for uncollectible accounts (Credit)
Bad debt expense (Debit)
Cash Receipts Transactions
Cash (Debit)
Accounts receivable (Credit)
Cash discounts (Debit)
Sales returns and allowance transactions
Sales returns (Debit)
Sales allowances (Debit)
Accounts Receivable (Credit)
When is an assertion considered relevant?
if there is a reasonable possibility it could contain a material misstatement
Revenue Cycle Inherent Risks
- Inflate revenue to increase profitability
- Returns and allowances
- Collectability of receivables
Inherent risks of revenue are mostly related to inflating revenue… there is an exception
Cookie Jar Reserves – incentive to pull back revenue and time things so they can put revenue into the next period
Revenue relevant assertions
- Occurance
- Completeness
- Cutoff
Accounts receivable relevant assertions
- existence
- completeness
- valuation
Revenue - Occurrence/Existence
What could go wrong?
Management may overstate sales by adding fictitious transactions.
Revenue - Occurrence/Existence
Internal Control
System requires a shipping document prior to recording revenue.
Revenue - Occurrence/Existence
Possible Test of Control
Review system control and evidence that it has been in place for entire period. Also, determine who can override the system control. Key thing: needs to be in place for the entire year…
Revenue - Occurrence/Existence
Possible substantive test
Randomly select sample of sales in sales detail file. Vouch to supporting shipping documents, invoice, customer order. From sales detail file BACK through to the shipping documents.
Revenue - Completeness
What could go wrong?
Not all sales are recorded.
Revenue - Completeness
Internal Control
System records revenue upon receiving a shipping document.
Revenue - Completeness
Possible Test of Control
Review system control and evidence that it has been in place for entire period. Also, determine who can override the system control.
Revenue - Completeness
Possible Substantive Test
- Randomly select sample of shipping documents. Trace to recording in sales detail file. (Exactly opposite of the occurrence substantive test.)
- Randomly select a sample of days and trace total for all shipping documents on those days to sales journal.
Different levels of precision
Accounts Receivable - Existence
What could go wrong?
Accounts receivable are overstated due to fictitious transactions.
Accounts Receivable - Existence
Internal Control
System requires a shipping document prior to recording accounts receivable.
Accounts Receivable - Existence
Possible Test of Control
Review system control and evidence that it has been in place for entire period. Also, determine who can override the system control.
Accounts Receivable - Existence
Possible Substantive Test
Randomly select sample of customer accounts in accounts receivable subsidiary file. Confirm these accounts receivable.
What are confirmations useful for verifying?
Existence
(also provides evidence for rights and obligations)
What are factors that are likely to affect the reliability of confirmations?
- Intended recipient of the confirmation
- Type of information being confirmed (entire balance versus individual transactions)
- Type of confirmation being sent
Cash confirmations
Confirming with the bank - typically electronic confirmations
Accounts receivable confirmations
Higher probability you see paper confirmations
Why are confirmations not great for verifying valuation?
(incentive on behalf of the confirming party) – If the company messes up and says you only owe $80 when you actually owe $100… I have incentive to say oh yeah, I only owe $80.
________ essentially requires confirmations to be used.
PCAOB
Positive Confirmation
Asks whether the balance is correct / incorrect
When are positive confirmations used?
- Small number of accounts are involved
- Large number of errors are anticipated
Blank confirmations
Should be used if the recipient is likely to return a positive confirmation without verifying the accuracy of the information get the customer to fill it in
Negative Confirmations
Asks for a response only if something is wrong
When should negative confirmations be used?
- the assessed level of risk of material misstatement is low
- a large number of small balances is involved materiality will not be affected by small balances most likely
- the client’s customers can be expected to consider the confirmations properly
Which provides more assurance… positive or negative confirmation?
Positive confirmations
(you don’t know if a negative confirmation is a real response or if they just aren’t responding because they don’t know how to appropriately deal with the confirmation)
“Please examine the data below carefully and either confirm its accuracy or report any differences directly to our auditors using the enclosed reply envelope.”
Positive confirmation letter
“Please examine the data below carefully and compare them to your records of your account with us. If the information is not in agreement with your records, please state any differences below and return directly to our auditors in the return envelope provided, fi the information is correct, no reply is necessary.”
Negative confirmation letter
Responses to positive confirmations provide _______ _________ evidence than negative nonresponses.
more reliable
Recipients of account receivable confirmations might not…
report understatements
Auditors must have heightened professional skepticism for…
unexpected responses
What are some examples of unexpected responses?
- responses via fax or email instead of mail
- All confirmations returned by the post office as non-deliverable must be investigated. The address is incorrect, the PO tries to deliver it, but it is sent back to be if they fail at delivering it. Is it a fake customer? Why does the client not know the customer’s address?
What should auditors do about non-response to positive confirmation requests?
- Follow up with second and sometimes third requests
- A lower-than-expected response rate could be indicative of fictitious customer accounts
- Follow-up on all exceptions
- Alternative procedures (special audit term) at a certain point you have to do something else that you didn’t plan to do, the original plan didn’t provide the evidence that they wanted it to provide
What is the trade-off between positive and negative confirmations?
Depends on the magnitude and risk associated with the receivables portfolio, as well as the likelihood of getting responses.
What is a common strategy for sending positive and negative confirmations?
send positive confirmations on individually significant balances and negative confirmations for a sample of other accounts.
What are some confirmation alternative procedures?
- Vouch to subsequent cash collections
- Examine shipping documents
- Examine supporting documentation, such as sales orders, invoices, and shipping documents
- Inspect correspondence files for past due accounts
Vouching to subsequent cash collections is usually sufficient evidence of what?
Existence and valuation
Why would someone pay money if they didn’t owe that money?
What shipping documents should be examined as an alternative procedure?
Bill of lading (third party evidence)
Examining supporting documentation, such as sales orders, invoices, and shipping documents depends on what?
Internal controls: if the company has really good controls this would provide really good evidence (if not… not as reliable)
Accounts Receivable - Valuation
What could go wrong?
The uncollectible portion of accounts receivable is not properly estimated.
Accounts Receivable - Valuation
Internal Control
Management evaluates the collectability of delinquent receivables on a timely basis.
Accounts Receivable - Valuation
Possible Test of Control
Inspect documentation for evidence of timely evaluation.
Accounts Receivable - Valuation
Possible Substantive Test
- Compare write-offs to estimates of doubtful accounts (Substantive analytical procedure).
- Randomly select sample of customer accounts more than 90 days overdue. - - - Inspect evidence of collectability and inquire of credit manager.
Recalculate allowance and bad debt expense.
