Module 4 - Tests of Details of Balance

Question 1

Methodology for desigining Tests of D.O.B for AR

What are the phases for designing tests of D.O.B. for A/R

Answer 1

Phase 1

• Identify client’s business risks affecting A/R
• Set performance materiality and assess inherent risk for A/R
• Asses Control risk for sales and collection cycle

Phase 2

Design and perform tests of controls and substantive tests of transactions (last module)

Phase 3

• Design and perform analytical procedures
• Design and tests of DOB

Question 2

What considerations are made when assessing the client’s business risks for A/R?

Answer 2

• Use of analytical procedures to indicate increased risk
• Evaluation of inherent risk and planned evidence based on economic/industry conditions

Question 3

What is performance materiality?

Answer 3

Auditor decides preliminary judgement about materiality for entire financial statements, and then allocates to significant balance sheet account

Question 4

Auditing standards assumption for revenue recogintion:

Answer 4

Auditors must normally identify a specific fraud risk for revenue recognition

This will affect the auditor’s assessmentof inherent risk for: Existence, sales cutoff, and sales returns/allowances

Question 5

Methodology for desigining Tests of D.O.B for AR

What is the importance of phase 2 for designing tests of DOB?

Answer 5

Weak controls/inefficient substantive testing will increase the need for tests of details of balance

Question 6

Relationship between sales (transaction) and A/R balace

Answer 6

Question 7

Relationship between cash receipts (transaction) and A/R balance:

Answer 7

Question 8

When are substantive analytics used throughout the audit?

Answer 8

Phase 1: Planning analytics (provides no assurance, risk assessment)

Phase 3: Substantive analytical procedure (usually done after balance sheet date to test all transactions/balances)

Phase 4: Part of completing audit

Question 9

What are the 4 steps to performing analytical procedures?

Answer 9

1. Develop expectation
2. Determine threshold
3. Calculate differences between expected and actual
4. Investigate reasons for differences over threshold and draw conclusion

Question 10

What analytical procedures would be performed by product line to detect possible overstatement/understatement of sales and accounts receivable?

Answer 10

• Compare gross margin % with previous years
• Compare sales by month over time
• Compare sales returns and allowances as % of gross sales** with previous years

_{Important to use % to smooth the results to the dependent variable (sales)}

Question 11

What are some analytical procedures might be performed to indicate misstatements in accounts receivable and related income statement accounts?

Answer 11

Compare individual customer balances over a stated amount with previous years

Question 12

What are some analytical procedures that could be performed to indicate uncollectible A/R that has not been realized?

Answer 12

Compare bad debt expense as % of gross sales with previous years

Question 13

What are some analytical procedures that may be performed to indicate an over/understatement of allowance for uncollectible accounts?

Answer 13

• Compare # of days of A/R outstanding with previous years
• Compare allowance for uncollectble accounts as % of A/R with previous years

Question 14

Auditor’s use this tool to help in designing tests of details of balances (phase 3):

Answer 14

Evidence planning worksheet

auditor ranks strength of factors that determine planned detection risk for each balance related objective

Question 15

What is PDR and what are some factors that affect it?

Answer 15

PDR = Risk that auditor will fail to detect material misstatement

• Inherent risk, control risk, and acceptable audit risk have inverse relationship with PDR (high control risk = low PDR)

Question 16

What is the relationship of planned detection risk and tests of details of balances?

Answer 16

PDR has inverse relationship with tests of DOB: High PDR = lower amounts of tests of DOB

Question 17

What is the first step an auditor should take when designing tests of details of balances for Accounts Receivable?

Answer 17

Auditor ensures amounts from aged trial balance correctly add and agree (foot) to the master file and general ledger

Aged trial balance = list of individual customer balances included in master file with details of how long outstanding

Question 18

What is the most important test of details of balances for accounts receivable?

Answer 18

Confirmation : Ensure sales occured and balance of receivables exist (existence and accuracy)

Existence of A/R outweighs other audit objectives because of risk of overstatement of sales

Question 19

What are the audit objectives the auditor must factor in when determining the tests of DOB for A/R?

What tests of DOB would be performed to satisfy the objective?

Answer 19

A/R are accurate: Confirmation

A/R are properly classified (Current/non-current): Aged trial balance

Cutoff for A/R is correct: inspection of sales doc

A/R stated at realizable value: recalculation of BDE

Client has rights to A/R: inspect documents

A/R presentation and disclosed properly: Presentation/disclosure checklist

Question 20

Requirement standards of Confirmations for A/R:

Answer 20

Confirmations for A/R required in U.S. (not international)

Not required when:

• Gross A/R is immaterial
• Expect low response rate
• Combined level of inherent risk/control risk is low enough that other substantive evidence will be sufficient

Question 21

Positive confirmation vs. negative confirmation

What are the differences?

Answer 21

Positive confirmation

Ask customer to respond to confirmation if amount is accurate or inaccurate

negative confirmation

Only ask customer to respond if debtor disagrees with stated amount

Question 22

Positive confirmation vs. negative confirmation

Which is more reliable and why?

Answer 22

Positive confirmation is more reliable because auditor can perform follow-up procedures

Negative: failure to respond will be assumed as correct

Question 23

What are these types of positive confirmations:

• Blank confirmation
• Invoice confirmation

Answer 23

Blank confirmation: Ask customer to “fill in” amount they think they ow

Invoice confirmation: Ask customer to respond on individual invoice amount (not whole balance)

Question 24

Auditing standards with positive confirmations:

Answer 24

Auditing standards require followup procedures for non-responses from customers when positive confirmations are used.

• Second or third requests
• Look at subsequent cash receipts
• Look at sales invoices and shipping documents

Question 25

What four factors should auditors consider when evaluating the results of confirmation procedures and alternative procedures?

Answer 25

1. Reliability of confirmation and alternative procedures
2. the nature of the exceptions, including implications (quantitative and qualitative)
3. The audit evidence provided by other procedures
4. Whether additional audit evidence is needed