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

Question 1

A CPA is engaged in the annual audit of a calendar year client. The client took a complete physical inventory under the CPA’s observation on December 15 and adjusted its inventory account and detailed perpetual inventory records to agree with the physical inventory. The client considers a sale to be made in the period that goods are shipped. Listed below are four items taken from the CPA’s sales cutoff test worksheet. Which item does not require an adjusting entry on the client’s books?

                    Recorded           Credited to Shipped          as Sale               Inventory

12/14 12/16 12/16

12/10 12/19 12/12

1/2 12/31 12/31

12/31 1/2 12/31

Answer 1

12/10 12/19 12/12

Goods shipped on 12/10 would have been properly recorded as a sale on 12/19, a date within the same accounting period. Moreover, the credit to inventory on 12/12 preceded the physical count on 12/15. No adjustment is necessary.

Question 2

A CPA auditing an electric utility wishes to determine whether all customers are being billed. The CPA’s best direction of test is from the
Meter department records to the billing (sales) register.
Billing (sales) register to the meter department records.
Accounts receivable ledger to the billing (sales) register.
Billing (sales) register to the accounts receivable ledger

Answer 2

Meter department records to the billing (sales) register.

The best direction of testing is to proceed from the meter department records, which indicate those customers who have received service, to the billing (sales) register. Comparing services rendered with billings is the best way to detect omitted billings.

Question 3

Analytical procedures performed during an audit indicate that accounts receivable doubled since the end of the prior year. However, the allowance for doubtful accounts as a percentage of accounts receivable remained about the same. Which of the following client explanations would satisfy the auditor?
The client opened a second retail outlet during the current year, and its credit sales approximately equaled the older outlet.
A greater percentage of accounts receivable are listed in the “more than 120 days overdue” category than in the prior year.
Internal control activities over the recording of cash receipts have been improved since the end of the prior year.
The client tightened its credit policy during the current year and sold considerably less merchandise to customers with poor credit ratings.

Answer 3

The client opened a second retail outlet during the current year, and its credit sales approximately equaled the older outlet.

Opening a second outlet with about the same credit sales as the first explains the receivables effects. Given no change in credit policy, the characteristics of the customers served, or economic conditions, the ratio of doubtful accounts should not change.

Question 4

The standard AICPA form to financial institutions requesting information on direct liabilities on loans asks for the following information

I. The principal amount paid
II. Description of collateral
III. Date through which interest is paid

Answer 4

II and III only. The principal amount paid on a direct liability is not listed on the Standard Form to Confirm Account Balance Information with Financial Institutions. The form confirms account number/description, balance, due date, interest rate, date through which interest is paid, and a description of collateral.

Question 5

Assuming a low assessed risk of material misstatement, which of the following audit procedures would be least likely to be performed?
Search for unrecorded cash receipts.
Confirmation of accounts receivable.
Physical inspection of a sample of inventory.
Obtaining a client representation letter.

Answer 5

Search for unrecorded cash receipts.

GAAS do not specifically require a search for unrecorded cash receipts. Given a low assessed RMM, the auditor might decide to reduce the audit effort devoted to substantive tests of assertions about cash and omit the procedure.

Question 6

Which of the following procedures would an auditor most likely perform in auditing the statement of cash flows?
Vouch a sample of cash receipts and disbursements for the last few days of the current year.
Reconcile the cutoff bank statement to the proof of cash to verify the accuracy of the year-end cash balance.
Confirm the amounts included in the statement of cash flows with the entity’s financial institution.
Reconcile the amounts included in the statement of cash flows to the other financial statements’ amounts.

Answer 6

Reconcile the amounts included in the statement of cash flows to the other financial statements’ amounts.

The information presented on a statement of cash flows is taken from the income statement and balance sheet. Indeed, a reconciliation of net income and net operating cash flow is required to be presented. Thus, reconciliation of amounts in the statement of cash flows with other financial statements’ balances and amounts is an important procedure in the audit of the statement of cash flows.

Question 7

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
 	Completeness.
 	Valuation and allocation.
 	Existence.
        Rights and obligations.

Answer 7

Valuation and allocation.

Assertions about valuation and allocation concern whether financial statement components have been included at appropriate amounts in accordance with the applicable financial reporting framework. For example, management asserts that trade accounts receivable are stated at net realizable value (gross accounts receivable minus allowance for uncollectible accounts). Aging the receivables is a procedure for assessing the reasonableness of the allowance.

Question 8

An auditor ordinarily sends a standard confirmation request to all banks with which the client has done business during the year under audit, regardless of the year-end balance. A purpose of this procedure is to
Detect kiting activities that may otherwise not be discovered.
Provide the data necessary to prepare a proof of cash.
Request that a cutoff bank statement and related checks be sent to the auditor.
Seek information about other deposit and loan amounts that come to the attention of the institution in the process of completing the confirmation.

Answer 8

Seek information about other deposit and loan amounts that come to the attention of the institution in the process of completing the confirmation.

The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used to confirm specifically listed deposit and loan balances. Nevertheless, the standard confirmation form contains this language: “Although we do not request or expect you to conduct a comprehensive, detailed search of your records, if, during the process of completing this confirmation, additional information about other deposit and loan accounts we may have with you comes to your attention, please include such information below.”

Question 9

True or False: Although the auditor should test all assertions, if the risk of material misstatement is low, the primary tests for sales returns and allowances will concern the occurrence and existence assertions.

Answer 9

True. The auditor ordinarily tests the documentation that supports the return to determine whether proper authorization exists and the credit to the customer’s account was supported by a receiving report representing the return of goods

Question 10

True or False: Vouching recorded accounts receivable to shipping documents tests for existence.

Answer 10

True. Shipment of goods is typically the event creating the sale and receivable. Vouching recorded receivables to shipping documents, such as bills of lading, tests for existence.

Question 11

True or False: Two procedures to test the accuracy assertion for accounts receivable are accounting for the numerical sequence of documents and vouching shipping documents back to sales invoices.

Answer 11

False.

1. Both of these tests are used to test the completeness assertion.
2. Other tests of completeness include the reconciliation of the subsidiary ledger with the control account and various analytical procedures.

Question 12

True or False: Cash receipts after the balance sheet date provide the least evidence of collectibility.

Answer 12

False. Cash receipts after the balance sheet date provide the best evidence of collectibility.

Question 13

True or False: Allowance for uncollectible accounts should be added to accounts receivable and presented as a current asset.

Answer 13

False. Accounts receivable should be presented as a current asset, minus the allowance for uncollectible accounts.

Question 14

True or False: A proof of cash provides direct evidence regarding the beginning and ending cash balances.

Answer 14

True.

1. When control risk is high (when control activities for the transaction process are not effective), a proof of cash may be prepared.
2. It provides direct evidence that both the beginning and ending balances as well as deposit and disbursement transactions recorded by the bank reconcile with transactions recorded in the accounting records for a period of time, typically a month.

Question 15

True or False: Preparing a schedule of interbank transfers from the cash disbursement records assures detection of kiting.

Answer 15

False: Preparing a schedule of interbank transfers from the cash disbursement records assures detection of kiting.

Question 16

True or False: To confirm bank transactions and written or oral arrangements, auditors send a separate letter, signed by the auditor, to an official responsible for the financial institution’s relationship with the client.

Answer 16

To confirm bank transactions and written or oral arrangements, such as contingent liabilities, lines of credit, compensating balances, and security agreements, auditors send a separate letter, signed by the client, to an official responsible for the financial institution’s relationship with the client.

Question 17

True or False: The standard form to confirm account information is designed to substantiate only the information that is stated on the confirmation request.

Answer 17

True.

1. The auditor should be aware that the standard form is not intended to elicit evidence about the completeness assertion.
2. Nevertheless, the standard confirmation form contains this language: “Although we do not request or expect you to conduct a comprehensive, detailed search of your records, if during the process of completing this confirmation, additional information about other deposit and loan accounts we may have with you comes to your attention, please include such information below.”

Question 18

True or False: Risks related to ownership of cash are high.

Answer 18

False. In most cases, risks related to ownership (rights) are low and few specific tests are applied.

Question 19

On the last day of the fiscal year, the cash disbursements clerk drew a company check on bank A and deposited the check in the company account bank B to cover a previous theft of cash. The disbursement has not been recorded. The auditor will best detect this form of kiting by
Examining the composition of deposits in both bank A and B subsequent to year end.
Examining paid checks returned with the bank statement of the next accounting period after year end.
Preparing from the cash disbursements book a summary of bank transfers for one week prior to and subsequent to year end.
Comparing the detail of cash receipts as shown by the cash receipts records with the detail on the confirmed duplicate deposit tickets for three days prior to and subsequent to year end.

Answer 19

Examining paid checks returned with the bank statement of the next accounting period after year end.

Because the check used to make the bank transfer is not recorded in the current period, the check is not listed as outstanding on the reconciliation of the bank account on which it was drawn. The auditor detects kiting by 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. In other words, the auditor searches for checks that should have been listed as outstanding but were not.

Question 20

Which of the following sets of information does an auditor usually confirm on one form?
Accounts payable and purchase commitments.
Accounts receivable and accrued interest receivable.
Cash in bank and collateral for loans.
Inventory on consignment and contingent liabilities

Answer 20

Cash in bank and collateral for loans.

The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used by auditors to confirm the deposit balance held by the bank for a client. In addition, this confirmation requests loan information, such as a description of the collateral securing the loan.

Question 21

The standard AICPA form directed to financial institutions requests all of the following except
Due date of a direct liability.
The principal amount paid on a direct liability.
Description of collateral for a direct liability.
The interest rate of a direct liability.

Answer 21

The principal amount paid on a direct liability.

The principal amount paid on a direct liability is not listed on the Standard Form to Confirm Account Balance Information with Financial Institutions. The auditor is not concerned with the amount of a liability already paid. The form confirms account number/description, balance, due date, interest rate, date through which interest is paid, and description of collateral.

Question 22

Tracing copies of computer-prepared sales invoices to copies of the corresponding computer-prepared shipping documents provides evidence that
Entries in the accounts receivable subsidiary ledger were for sales actually shipped.
Sales billed to customers were actually shipped.
No duplicate shipments to customers were made.
Shipments to customers were properly billed.

Answer 22

Sales billed to customers were actually shipped.

Sales invoices are billing documents sent to customers. Tracing sales invoices to shipping documents tests for failure to ship.

Question 23

The most effective audit procedure for determining the collectibility of an account receivable is the
Examination of the related sales invoice(s).
Review of authorization of credit sales to the customer and the previous history of collections.
Review of the subsequent cash collections.
Confirmation of the account.

Answer 23

Review of the subsequent cash collections.

Collectibility pertains to the assertion of valuation. It is the principal issue with regard to the adequacy of the allowance for doubtful accounts. The best way to determine collectibility is to learn whether the receivable was subsequently collected. A confirmation provides evidence that a contract exists and that the debtor 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 24

In the confirmation of accounts receivable, the auditor would most likely
Seek to obtain positive confirmations for at least 50% of the total dollar amount of the receivables.
Request confirmation of a sample of the inactive accounts.
Require confirmation of all receivables from agencies of the federal government.
Require that confirmation requests be sent within 1 month of the fiscal year end.

Answer 24

Request confirmation of a sample of the inactive accounts.

When the risk of material misstatement at the relevant assertion level is at an acceptably low level, the auditor will confirm only a sample of receivables. The sample should include inactive or past due accounts. If such accounts are to be regarded as assets, acknowledgment of the debts must be obtained. Confirming inactive accounts may also detect lapping or establish what amounts are in dispute.

Question 25

What is the management assertion being tested below?
The auditor compared (reconciled) the total recorded amounts in the subsidiary ledger with the accounts receivable amount recorded in the general ledger.

Answer 25

Completeness. Comparing (reconciling) the total recorded amounts in the subsidiary ledger with the accounts receivable amount recorded in the general ledger is a standard audit procedure when auditing sales and receivables. This procedure is designed to test management’s assertion about completeness.

Question 26

What is the management assertion being tested below?
The auditor tracked cash receipts to determine that Superior Co. is collecting and depositing the proceeds into the bank accounts controlled by the entity.

Answer 26

Rights and Obligations. Tracking cash receipts to determine that an entity is collecting and depositing the proceeds into bank accounts controlled by the entity is a standard audit procedure when auditing sales and receivables. This procedure is designed to test management’s assertion about rights and obligations.

Question 27

What is the management assertion being tested below?

The auditor vouched accounts receivable to shipping documents.

Answer 27

Existence. Vouching recorded accounts receivable to shipping documents is a standard audit procedure when auditing sales and receivables. Because shipment of goods is typically the event creating the sale and receivable, vouching recorded receivables to shipping documents, such as bills of lading, tests for existence.

Question 28

What is the management assertion being tested below?

The auditor obtained a management representations letter that includes assertions relating to sales and receivables.

Answer 28

Accuracy. Obtaining a management representation letter that includes assertions relating to sales and receivables supports the assertion that transactions and events have been recorded appropriately.

Question 29

What is the management assertion being tested below?

The auditor reviewed the credit ratings of delinquent customers.

Answer 29

Valuation and Allocation. Reviewing delinquent customers’ credit ratings is a standard audit procedure when auditing sales and receivables. This step provides evidence for assessing uncollectibility of accounts receivables and therefore tests management’s assertion about valuation.