Further Procedures Flashcards
Proper segregation of duties reduces the opportunities to allow persons to be in positions to both
Perpetrate and conceal errors and irregularities.
An employee should not normally (1) authorize transactions (execution function), (2) have access to the related assets (custody function), and (3) perform accounting activities (record keeping function)
Transaction Cycle
Group of essentially homogeneous transactions
Within a given category of transactions, control risk is essentially constant, since all transactions within that category are processed subject to the same configuration of internal control policies and procedures
A transaction cycle is, therefore, the highest level of aggregation for which control risk may be viewed as a constant.
Transaction cycle examples:
- Revenue/receipts
- Expenditures/disbursements
- Payroll
- Inventory, especially manufactured inventory -
- Fixed assets
- Investing/financing
Remember that internal controls (specifically, “control activities”) should “SCARE” (AICPA)
Segregation of duties, Controls (as in physical controls), Authorization, Reviews (as in performance reviews)-Actual performance should be compared to appropriate budgets and forecasts EDP/IT (information processing)
An auditor’s tests of controls for completeness for the revenue cycle usually include determining whether
An invoice is prepared for each shipping document.
The auditor starts with a source document and agrees the item to the accounting records. Starting with a shipping document and tracing it to the sales journal (i.e., to a sales invoice recorded in the sales journal)
Which of the following would most likely be the result of ineffective internal control policies and procedures in the revenue cycle?
Final authorization of credit memos by personnel in the sales department could permit an employee defalcation scheme.
Allowing sales personnel to authorize credit memos is an internal control weakness
Sound internal control procedures dictate that defective merchandise returned by customers should be presented initially to the
Receiving clerk
Defective merchandise returned by customers should be presented initially to the receiving clerk. The function of the receiving department is to receive and inspect goods and to document the receipt in the form of a receiving report.
Proper authorization of write-offs of uncollectible accounts should be approved in which of the following departments?
Treasurer
Authorization of write-offs should be made by a department independent of recording or authorization duties pertaining to accounts receivable. The accounts receivable department maintains the accounts receivable records; the credit department approves credit for customers.
Flow Chart of Typical Internal Controls for Sales
Sales Order (PO) received - Shipping Documents - Sales invoice (billing) - Record in Sales Journal - Post to GL
Audit Considerations for Revenue (Sales) Cycle
- Segregation of duties- Credit to customers should be granted by an independent department, Returns should be accounted for by an independent clerk in the shipping/receiving area.
- Controls
- Authorization- Management should usually establish general approvals of transactions within specified limits and specifically approve transactions outside of those prescribed limits.
- Reviews (Performance Reviews) - entity’s recorded sales should be compared to appropriate budgets and forecasts.
- EDP/IT (Information Processing) - Important accounting documents (e.g., shipping documents and sales invoices) should be prenumbered and the numerical sequence should be accounted for.
- An aged trial balance for accounts receivable should be agreed (or reconciled) to the general ledger control account
Immediately upon receipt of cash, a responsible employee should
Prepare a remittance listing.
The same employee should not be responsible for both the receipt and the recording of cash in cash receipts journal.
Employers bond employees who handle cash receipts because fidelity bonds reduce the possibility of employing dishonest individuals and
Deter dishonesty by making employees aware that insurance companies may investigate and prosecute dishonest acts.
Upon receipt of customers’ checks in the mailroom, a responsible employee should prepare a remittance listing that is forwarded to the cashier. A copy of the listing should be sent to the
Accounts receivable bookkeeper to update the subsidiary accounts receivable records.
An auditor would be most likely to limit substantive audit tests of sales transactions when control risk is assessed as low for the existence or occurrence assertion concerning sales transactions and the auditor has already gathered evidence supporting
Cash receipts and accounts receivable.
Consider the accounts which are impacted by sales transactions, DR Cash or Accounts Receivable and CR Sales. The combination of low control risk in this area plus evidence supporting cash receipts and accounts receivable provides the auditor with assurance that sales transactions have actually occurred.
Which of the following internal control procedures would most likely deter lapping of collections from customers?
Lapping occurs when a remittance received from one customer is stolen and the shortage is hidden by crediting the first customer’s account with the cash received from a second customer. Lapping is best prevented by separating custody from recording. The person responsible for receiving cash should not also be responsible for posting the amounts to the accounts receivable subsidiary ledger.
Which of the following internal controls would be most likely to reduce the risk of diversion of customer receipts by an entity’s employees?
Establishing a bank lockbox system would provide the best control over customer receipts because it would prevent the employees from having access to the receipts.
An auditor would consider a cashier’s job description to contain compatible duties if the cashier receives remittances from the mailroom and also prepares the
Daily deposit slip.
Adequate segregation of duties provides for the separation of authorizing, recording, and custodial duties. Receiving remittances from the mailroom is a custodial duty. It may properly be combined with preparation of the daily deposit slip which would also require custody of the asset.
Cash Receipts SCARE- Segregation of Duties
- Segregation of Duties- A listing of cash receipts (sometimes referred to as a remittance listing or log of cash receipts ) is prepared upon opening the mail in the mail room; checks are restrictively endorsed immediately (“for deposit only . . . ”)
a. Cash-related activities, which are handled by separate personnel as appropriate are as follows:
- Opening the mail—handling the checks received, and verifying the accuracy of the payment indicated on the enclosed “remittance advice”
- Making the deposit—deposits should be made daily
- Applying payments received to the appropriate customers’ accounts receivable
- Preparing the bank reconciliation on a timely basis
Cash Receipts SCARE
- Controls (Physical Controls)- Employees with access to cash receipts should be “bonded,” Receipts should be deposited daily,The company might use a lockbox
- Authorization-Bank reconciliations should be appropriately reviewed with the reviewer’s approval indicated., adjusting journal entries should be approved by management
- Reviews (Performance Reviews)- The initial cash receipts listing from the mail room should be compared to the total according to the cash receipts journal, and traced to that day’s bank deposit, The cash accounts should be reconciled with the bank statements on a timely basis by someone not involved in handling cash receipts or updating the accounting records.
- EDP/IT (Information Processing)
In testing controls over cash disbursements, an auditor would be most likely to determine that the person who signs checks also
Is responsible for mailing the checks.
Having the signer mail the checks eliminates the opportunity for the check preparer or others with conflicting duties to modify and/or divert the checks before mailing.
In a well-designed internal control structure, employees in the same department most likely would approve purchase orders, and also
Negotiate terms with vendors.
Approval of purchase orders and negotiation of terms with vendors are both authorization functions which are properly performed by employees in the purchasing department.
Which of the following controls should prevent an invoice for the purchase of merchandise from being paid twice?
The check signer reviews and cancels the voucher packets.
An effective procedure to prevent duplicate payments is to cancel the documentation supporting the payment request at the time payment is made. For example, by stamping the documents as “paid.”
When the shipping department returns nonconforming goods to a vendor, the purchasing department should send to the accounting department the
Debit memo.
A debit memo advises accounting that the vendor invoice should not be paid in full due to returned goods. When the shipping department returns nonconforming goods to a vendor, purchasing should send accounting a debit memo.
When there are numerous property and equipment transactions during the year, an auditor who plans to assess control risk at a low level usually performs
Tests of controls and limited tests of current year property and equipment transactions.
The assessment of control risk at a low level requires that the auditor provide the basis for reducing the assessment.
Which of the following internal control procedures would most likely prevent direct labor hours from being charged to manufacturing overhead?
Use of time tickets to record actual labor worked on production orders.
Equipment acquisitions that are misclassified as maintenance expense would most likely be detected by an internal control procedure that provides for
Investigation of variances within a formal budgeting system.
When an entity uses a trust company as custodian of its marketable securities, the possibility of concealing fraud would most likely be reduced if the
Trust company has no direct contact with the entity employees responsible for maintaining investment accounting records.
The concealment of fraud pertaining to marketable securities is best controlled through controlling access and providing for adequate segregation of duties. Use of a trust company aids in both respects. Access to the marketable securities is controlled by the trust company, an independent entity, and the duties of authorization and recording are automatically separated from the duty of custody.
Management’s objectives in establishing and maintaining an internal control structure are to ensure that:
1) transactions are executed in accordance with management’s general or specific authorization;
2) transactions are recorded as necessary to permit preparation of the financial statements in accordance with GAAP and to maintain accountability for assets;
3) access to assets is permitted only in accordance with management’s authorization; and
4) the recorded accountability for assets is compared with the existing assets at reasonable intervals and differences are investigated and resolved. Ensuring that custody of work in process and of finished goods is properly maintained is an example of the third objective.
The safeguarding of inventory most likely includes
Periodic reconciliation of detailed inventory records with the actual inventory on hand by taking a physical count.
The authority to accept incoming goods in receiving should be based on a(an)
Approved purchase order.
In a well-designed internal control structure, the same employee may be permitted to
Mail signed checks, and also cancel supporting documents. both are custodial functions.
Which of the following internal control procedures is not usually performed in the vouchers payable department?
Accounting for unused prenumbered purchase orders and receiving reports.
Which of the following is usually a benefit of using electronic funds transfer for international cash transactions?
Reduction of the frequency of data entry errors.
An auditor generally tests the segregation of duties related to inventory by
Personal inquiry and observation.
This is a test of controls, not a substantive procedure
Which of the following controls would a company most likely use to safeguard marketable securities when an independent trust agent is not employed?
Two company officials have joint control of marketable securities, which are kept in a bank safe-deposit box.
An independent trust agent maintains custody over the marketable securities so that the company does not have physical responsibility for the asset. If an independent trust agent is not employed, the securities will physically come to the company and must be safeguarded. The combination of a bank safe-deposit box and dual access
Which of the following controls would be most effective in assuring that the proper custody of assets in the investing cycle is maintained.
The recorded balances in the investment subsidiary ledger are periodically compared with the contents of the safety deposit box by independent personnel.
Which of the following ratios would an engagement partner most likely consider in the overall review stage of an audit?
Cost of goods sold/average inventory.
This ratio is called “inventory turnover,” which is a traditional ratio that is useful in evaluating whether inventory might be slow-moving. In that event, inventory might need to be written down to better reflect the estimated future benefits. This might be appropriately considered in the partner’s review.
Which of the following factors would most likely influence an auditor’s determination of the auditability of an entity’s financial statements?
The adequacy of the accounting records.
Which of the following is an analytical procedure?
Comparing current-year balances to prior-year balances.
Analytical procedures are defined as “evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data.”
Which of the following best identifies the effect of an increase in the risk of material misstatement on detection risk and the extent of substantive procedures?
The acceptable level of detection risk decreases, and the extent of substantive procedures increases.
The Audit Risk Model
- Nature—The auditor has to decide what specific substantive procedures to perform. This includes determining how much emphasis should be placed on tests of details (which tend to be labor intensive and expensive, but which provide a relatively stronger basis for conclusions for most financial statement assertions) versus substantive analytical procedures
- Timing
- Extent
Substantive Audit Procedures
Tests of Details—These are the relatively precise (but usually rather expensive, labor-intensive) procedures (that suggest whether the client’s recorded amounts are right or not).
Analytical Procedures- Analytical procedures serve three distinct purposes:
- They are useful as a risk assessment procedure for planning purposes;
- They are useful (but not required) as a form of substantive evidence
- The auditor is required to perform analytical procedures as near the end of the audit to assist the auditor when forming an overall conclusion about the financial statements.
The AICPA states that the effectiveness and efficiency of substantive analytical procedures depends on the following four factors or considerations:
- Nature of the assertion—Substantive analytical procedures may be particularly effective in testing for omissions of transactions that would be hard to detect with procedures that focus on recorded amounts
- Plausibility and predictability of the relationship—Developing a meaningful expectation to compare to the client’s recorded balance is critical to the skillful use of analytical procedures (stable environment is more predictable)
- Availability and reliability of data used—The reliability of the expectation increases when the data used is (1) obtained from independent outside sources; (2) when it is subject to audit testing (either currently or in the past); or (3) is developed under conditions of effective internal control.
- Precision of the expectation—The likelihood of detecting a misstatement decreases as the level of aggregation of the data increases
Liquidity Ratios (also known as solvency ratios)
Working Capital = Current assets – Current liabilities.
Current ratio = Current assets/Current liabilities
Quick ratio (acid-test rat io) = (Cash + Marketable securities + A/R)/Current liabilities
Current cash to debt ratio = Net cash from operations/Average current liabilities
Activity Ratios (also known as turnover or efficiency ratios):
Asset turnover = Net sales/Average total assets
Receivable turnover = Net (credit) sales/Average trade receivable (net)
Number of days sales in receivables = 365 days/Receivable turnover
Inventory turnover = Cost of goods sold/Average inventory
Number of days sales in inventory = 365 days/Inventory turnover
Profitability Ratios
Profit margin on sales = Net income/Net sales
Gross profit percentage = (Sales – Cost of goods sold)/Sales
Rate of return on assets = Net income/Average total assets
Rate of return on common stockholders’ equity = (Net income – Dividends attributable to preferred stockholders)/Average common stockholders’ equity
Earnings per share = (Net income – Preferred dividends)/Average number of common shares outstanding
Price earnings ratio (P-E ratio) = Market price of stock/earnings per share
Coverage Ratios (also known as leverage ratios)
Debt to total assets ratio = Total liabilities/Total assets
Debt to equity ratio = Total liabilities/Total stockholders’ equity
Times interest earned = Income before interest expense and income taxes/Interest expense
Cash to debt coverage ratio = Net cash from operations/Average total liabilities
Which of the following is a management assertion regarding account balances at the period end?
There are 4 assertions applicable to account balances at the period end: (1) existence; (2) completeness; (3) rights or obligations; and (4) valuation and allocation.
Which of the following statements concerning evidential matter is correct?
A client’s accounting data cannot be considered sufficient audit evidence to support the financial statements.
The auditor must test the accounting data in order to develop persuasive evidence to support the opinion
Which of the following questions would most likely be included in an internal control questionnaire concerning the completeness assertion for purchases?
Are purchase orders, receiving reports, and vouchers prenumbered and periodically accounted for?
The standard control for completeness is controlling prenumbered forms.
Which of the following statements concerning audit evidence is correct?
The measure of the validity of audit evidence lies in the auditor’s judgment.
Sufficient Appropriate Audit Evidence
“Sufficient” refers to the quantity of evidence, whereas “appropriate” refers to the quality of evidence in terms of its relevance and reliability.
The quantity of evidence required (related to “sufficient”) is directly related to the risk of misstatement (the greater the risk, the more evidence is needed) and inversely related to the quality of evidence (the higher the quality, the less evidence is needed).
“Reliability” is affected by the source and nature of evidence
- Evidence obtained directly by the auditor is more reliable than evidence obtained indirectly or by inference (e.g., observation of the application of a control is more reliable than inquiry of entity personnel about the application of a control).
- Evidence is more reliable when obtained from independent (knowledgeable) sources
- Evidence generated internally is more reliable when the related controls are effective;
- Evidence is more reliable when it exists in documentary form
- Evidence provided by original documents is more reliable than evidence based on photocopies/fax
AICPA Professional Standards now classify assertions in three separate categories for the auditor’s consideration
Account balances;
Presentation and disclosure; and
Classes of transactions and events.
There are four assertions specific to “account balances at period end”
- Existence-assets, liabilities, and equity interests exist.
- Completeness- assets, liabilities, and equity interests that should have been recorded have been recorded. There are no omissions.
- Rights and obligations-entity holds or controls the rights to its assets, and the liabilities are the obligations of the entity. Any restrictions on the rights to the assets or obligations for the liabilities must be disclosed.
- Valuation and allocation-That assets, liabilities, and equity interests are included in the financial statements at appropriate amounts
