You are on page 1of 22

CHAPTER 14

AUDITING THE REVENUE CYCLE
Learning Check
14-1.

14-2.

a.

The revenue cycle includes the activities involved in the exchange of goods and
services with customers and the realization of the revenue in cash.

b.

The classes of transactions in this cycle for a merchandising company are sales, sales
adjustments, and cash receipts. The primary accounts affected by these transactions
are sales, accounts receivable, cost of sales, inventory, cash, sales discounts, sales
returns and allowances, bad debts expense, and allowance for uncollectable accounts

a.

Specific audit objectives for the revenue cycle are derived from the five categories of
management's financial statement assertions.

b.

Specific audit objectives for credit sales transactions include the following:
Specific Audit Objectives
Transaction Objectives
Occurrence. Recorded sales transactions represent goods shipped or services provided
during the period.
Recorded cash receipt transactions represent cash received during the period.
Recorded sales adjustment transactions during the period represent authorized
discounts, returns and allowances, and uncollectable accounts.
Completeness. All sales cash receipts and sales adjustments made during the period
were recorded.
Accuracy. All sales and cash receipts and sales adjustments are accurately valued
using GAAP and correctly journalized, summarized and posted.
Cutoff. All sales, cash receipts and sales adjustments have been recorded in the correct
accounting period.
Classification. All sales, cash receipts, and sales adjustments have been recorded in
the proper accounts.
Balance Objectives
Existence. Accounts receivable representing amounts owed by customers exists at the
balance sheet date.
Completeness. Accounts receivable include all claims on customers at the balance
sheet date.
Rights and Obligations. Accounts receivable at the balance sheet date represent legal
claims of the entity on customers for payment.
Valuation and Allocation. Accounts receivable represents gross claims on customers
at the balance sheet date and agrees with the sum of the accounts receivable subsidiary
ledger. The allowance for uncollectable accounts represents a reasonable estimate of
the difference between gross receivables and their net realizable value.

Solutions Manual to Modern Auditing: Copyright 

2005, John Wiley and Sons, Inc.

14-1

Disclosure Objectives
Occurrence and Rights and Obligations. Disclosed revenue cycle events and
transactions have occurred and pertain to the entity.
Completeness. All revenue cycle disclosures that should have been included in the
financial statements have been included.
Understandability. Revenue cycle information is appropriately presented and
information in disclosures is understandable to users.
Accuracy and Valuation. Revenue cycle information is disclosed accurately and at
appropriate amounts.

14-3. Following are a few examples of differences between how the auditor might use the
knowledge of the entity and its environment for a computer company v. a hotel.
a.

Certain balance sheet accounts like accounts receivable and inventories are going to
be very significant for the computer manufacturer, but relatively immaterial for the
hotel. The computer company is also likely to have a higher ratio of sales to fixed
assets, or sale to total assets, than the hotel.

b.

The computer company auditor will have significant issues associated with the risk
of misstatement with respect to the existence of receivables and inventories that are
not present for the hotel. The computer company auditor will also have to address
valuation and allocation issues associated with the collectability of receivables and
lower of cost or market of inventories that are insignificant for the hotel. The hotel
will have a potential risk of material misstatement in terms of how it accounts for
revenues from properties that it manages for others, as opposed to properties that it
owns.

14-4. Factors that might motivate management to deliberately misstate revenue cycle assertions
include:
 Pressures to overstate revenues in order to report achieving announced revenue or
profitability targets or industry norms that were not achieved in reality owing to such
factors as global, national, or regional economic conditions, the impact of technological
developments on the entity's competitiveness, or poor management.
 Pressures to overstate cash and gross receivables or understate the allowance for
doubtful accounts in order to report a higher level of working capital in the face of
liquidity problems or going concern doubts.
Factors that might contribute to unintentional misstatements in revenue cycle assertions
include:
 The volume of sales, cash receipts, and sales adjustments transactions is often high,
resulting in numerous opportunities for errors to occur.
 The timing and amount of revenue to be recognized may be contentious owing to factors
such as ambiguous accounting standards, the need to make estimates, the complexity of
the calculations involved, and purchasers' rights of return.

Solutions Manual to Modern Auditing: Copyright 

2005, John Wiley and Sons, Inc.

14-2

Several control environment factors and their applicability to revenue cycle assertions are:  Integrity and ethical values . This procedure is primarily related to the adequacy of the allowance for uncollectable accounts. Requires knowledge of the total market size in the industry. 14-3 .  Possible Analytical Procedures Use past ratio of net sales to capacity with adjustments for capacity changes. Analytic Procedure Accounts receivable turn days Evaluate the entities history of uncollectable accounts expense to net credit sales. Following are example analytical procedures that the auditor might use to estimate total revenue for a household appliance manufacturer and for an airline. The above history of accounts receivable turn days would be most useful for evaluating estimating gross receivables given sales. Estimate net revenues using information on utilization of capacity (airline seat miles) and average revenue per seat. a.reduction of risk of overstatement of revenues and receivables by eliminating incentives to dishonest reporting. Industry Household Appliance Mfg.   Airline b. Analytic Procedure Compare historical trends in market share and gross margin with current unaudited data. Two analytical procedures that the auditor might use to estimate gross margin for company might include. with adjustment for economic conditions Audit Significance Understanding a company’s history of accounts and sales volume can assist the auditor in evaluating net receivables and the adequacy of the allowance for doubtful accounts. Companies with a high proportion of revenues from new products may earn premium gross margins due to the ability to innovate. John Wiley and Sons. Evaluate the percentage of revenues coming from new products. c. Two analytical procedures that the auditor might use to estimate net receivables and the allowance for doubtful accounts for company might include. Inc.14-5. Use a combination of past ratios of market share with adjustments of current changes in market share. 14-6. Solutions Manual to Modern Auditing: Copyright  2005. Audit Significance Companies with commanding market shares often are able to obtain larger gross margins.

The following table summarizes the functions that apply to credit sales transactions. Inc. and the principal documents or records produced in performing the function. John Wiley and Sons. Commitment to competence .7. Line operating departments for services. Recording sales Accounting (Billing) Documents Shipping documents Reports of unfilled orders and back orders Computer Files and Records Open Order File Perpetual Inventory Shipping File Documents Sales Invoice Sales Reports and Sales Journal Various Exception Reports Monthly Customer Statements Computer Files and Records Sales Transaction File Accounts Receivable Master File Solutions Manual to Modern Auditing: Copyright  2005. 14-4 .bonding of employees who handle cash 14.  Human resource policies and practices .  Management's philosophy and operating style . Department that Principal documents and records Function performs function produced in performing the function. Initiating credit Sales department Documents sales Customer Order Credit department Sales Order Computer Files and Records Customer Master File (with credit information) and Accounts Receivable Master File.by chief financial officers and accounting personnel. Perpetual Inventory Authorized Price List Open Order File Delivering good Warehousing and shipping and services department for goods.conservatism in developing such accounting estimates as the allowance for uncollectable accounts and allowance for sales returns. the department that performs the functions.

with a sales invoice. A sales invoice has The computer matches Submit test data for sales incorrect quantities quantities on a sales invoices invoices that both do and do not or prices. A fictitious sales The computer will not Submit test data with sales invoice. is recorded.14-8. b. recognized. documents. both with and information. 14-5 . Programmed controls usually report exceptions noted when performing the control. All shipping without a supporting sales documents must be matched invoice. related shipping files. Inc. Sales are made The computer searches a Submit test data for sales orders without credit field for appropriate credit that both are and are not approval. Potential Programmed Control CAATs (Assuming Test Data) Misstatement a. e. c. The following tables describes programmed controls for a typical manufacturing company. Control Programmed control procedures Computer general control procedures Manual follow-up procedures. John Wiley and Sons. authorization before an order supported by appropriate credit is placed on an open order authorization. with underlying shipping match underlying shipping information and matches information and authorized prices with an authorized price lists. As a result auditors also need to test the effectiveness of manual controls that follow-up on reported exceptions. Importance to Control Risk Assessment If a programmed control procedure in critical to a low control risk assessment then the auditor should directly test the control procedure. Sales invoices may The computer compares Submit test data for a not be recorded. or a sales prepare a sale invoice invoice information that both is transaction for without underlying and is not supported by which revenue information on shipping underlying shipping should not be files. entries in the sales journal transaction that has shipping with underlying shipping information. information. In order to assess control risk as low based on programmed control procedures the auditor should test the following. Sales invoice may The computer compares Submit test data with dates on be recorded in the dates on the sales invoice sales invoices that both do and wrong accounting with dates on shipping do not match with dates on period. 14-9. In order to obtain assurance that the programmed control procedure functions effectively throughout the period the auditor also needs to these the effectiveness of computer general control procedures. d. Solutions Manual to Modern Auditing: Copyright  2005. file.

CAATs (Assuming Test Data) Submit test data for batches that with complete and incomplete data sets in terms of completed transactions. 14-10. Sales invoices may not be posted or may not be journalized g. Inc. Further management responsible for warehousing and shipping should review daily or weekly sales and inventory movement reports to assess the reasonableness of recorded sales and inventory removed from the perpetual inventory. Two important controls pertaining to the initial handling of mail receipts are (1) immediate restrictive endorsement of checks received and (2) preparation of a multicopy listing (prelist) of mail receipts. Sales invoices may be posted to the wrong customer’s accounts. with the ending receivable balances. and sends the remittance advices to the company for use in updating accounts receivable. The sub-functions involved in cash receipts include (1) receiving cash receipts.Potential Misstatement f. b. 14-11. cash disbursements should not be made out of undeposited receipts. Submit test data with underlying information that both does and does not match with information on previously created sales order and shipping files. Two important controls pertaining to cash sales and the transaction class audit objectives to which they relate are:  The customer's expectation of a printed receipt and supervisory surveillance of over the counter sales transactions helps to ensure that all cash sales are processed through the cash registers or terminals . This control reduces Solutions Manual to Modern Auditing: Copyright  2005.existence or occurrence and valuation or allocation. Programmed Control price list. The computer checks run-torun totals of beginning accounts receivable balances. This system eliminates the risk of diversion of the receipts by company employees and failure to record the receipts. John Wiley and Sons. and verification of agreement of cash on hand with totals printed by a cash register or terminal . (2) depositing cash in bank. and the shipping documents. The computer matches customer information on the sales invoice with the master customer file. and (3) recording the cash receipts. a. b. that is. A common management control involves having managers with responsibility for sales to review daily or weekly sales reports to assess the reasonableness of recorded sales.completeness. 14-13. plus sales transactions. The bank picks up the mail daily. 14-6 . credits the company for the cash. Depositing receipts intact daily means that all receipts are deposited. a.  Independent check by supervisor on the accuracy of cash count sheets. A lockbox is a post office box that is controlled by the company's bank. the sales order. 14-12.

or existence of occurrence. a.the risk that receipts will not be recorded (completeness). b. Mailing of monthly statements to customers. John Wiley and Sons. Solutions Manual to Modern Auditing: Copyright  2005. and an approved write-off authorization memo for writing off uncollectable customer accounts. The following three types of controls pertaining to sales adjustments transactions have as their common focus establishing the validity. 14-15. The accounts receivable balance is a function of the transactions that are posted to the account. Four controls that can aid in preventing or detecting errors or irregularities in recording cash receipts are summarized below along with potential tests of controls: Control Independent check of agreement of validated deposit slip with daily cash summary. A sound system of internal controls over these three transaction cycles that ensure the completeness and accuracy of these transactions. and examine reports or other evidence of follow-up. cash receipts. and sales adjustments. Test of Control Inspect a sample of daily cash summaries and examine evidence of agreement with validated deposit slip by responsible employee. granting sales returns and allowances. namely credit sales. Computer check of information included in the cash receipts journal with information from prelist. particularly the use of an approved credit memo for granting credit for returned or damaged goods. and the resulting bank deposit record establishes the existence or occurrence of the transactions. should also ensure the completeness and accuracy of account receivable. Use CAATs to test computer matching of information from cash receipts journal with electronic prelist. Observe the mailing of monthly statements to customers. Examine a sample of periodic bank reconciliations. Also follow-up on how exceptions are reported and examine evidence or correction of errors reported on exception reports. Preparation of periodic independent bank reconciliations. of such transactions:  Proper authorization of all sales adjustments transactions. 14-16. Inc. and determining uncollectable accounts. 14-14. Make inquiries about bank reconciliation procedures and test accuracy on a sample basis. Make inquiries about procedures to follow-up on issues raised by customers. The functions pertaining to sales adjustments transactions are: granting cash discounts. 14-7 . a.  Segregation of duties for authorizing sales adjustment transactions and handling and recording cash receipts.  The use of appropriate documents and records.

Submit test data with invoice prices that do not match the authorized price list or sales order. Valuation and Allocation (Accuracy) Presentation and Disclosure (Classification) Computer matches customer number on sales invoice with customer number on sales order. Cash Receipts Solutions Manual to Modern Auditing: Copyright  2005. The primary control over the balance involves sending monthly statements to customers and having an independent function to receive and follow-up on any issues raised by customers. Observe and reperform procedures for documenting receivables that have been factored or sold. The rights and obligations assertion for accounts receivable involves selling. d. 14-17. Completeness (Completeness) Computer prints a report of all goods shipped but not billed. These records should be compared with monthly statements received from a bank or factoring agent. it should keep a documentary record of the receivables that have been sold or pledged. The following table provides example controls and tests of controls for each assertion (and transaction level audit objective) related to credit sales and cash receipts. Submit test data with shipments that have not been billed to test accuracy of report of all good shipped but not billed. and have a process for following up on collection of those receivables and the reduction of the related liability to the factoring agent. Submit test data with shipments in one period and billing in the subsequent period. Rights and Obligations If an entity sells its receivables. it should keep a documentary record of the receivables that have been sold and it should compare that record with monthly statements received from a factoring company. If an entity sells its receivables. cash receipts. Public companies normally control establish controls over the presentation and disclosure assertion and related audit objectives through an effective and independent disclosure committee. c. Credit Sales Assertion (Audit Objective) Existence and Occurrence (Occurrence) Control Computer matches sales invoice information with underlying shipping information. Student should note that tests of controls should also emphasize testing computer general controls. John Wiley and Sons. Existence and Occurrence / Completeness (Cutoff) Comparison of invoice date with the accounting period when goods were shipped. Examples emphasize programmed control procedures where appropriate. observing exception reports. 14-8 . Computer matches sales prices with authorized price list and sales order.b. Test of Controls Submit test data where invoice data does not match with underlying shipping information. or factoring. Inc. Submit test data the customer information on the sales invoice does not match the underlying sales order. The disclosure committee should have individuals who are knowledgeable about GAAP and the transactions being processed. and testing manual follow-up of items that appear on exception reports.

Observe and reperform manual controls to check independent check of the prelist with the cash receipts journal. In assessing control risk for the existence or occurrence account balance assertion for accounts receivable. Independent check of agreement of cash and checks with cash count sheets and prelist. Observe notes and procedures used to follow-up upon questions raised by customers. Test of Controls Observe and reperform manual controls to check independent check of the prelist with the cash receipts journal. b. Make inquiries about mailing of monthly statements to customers. c.  Completeness for cash receipts and sales adjustments transactions that decrease accounts receivable. The transaction classes that should be considered in assessing control risk for accounts receivable assertions are: credit sales. it should keep a documentary record of the receivables that have been sold and it should compare that record with monthly statements received from a factoring company. Observe and test the accuracy of independent bank reconciliations. control risk assessments. and analytical procedure risk assessments. Inc. 14-9 . a. the following transaction class control risk assessments should be considered:  Existence or occurrence for sales transactions that increase accounts receivable. A revised acceptable level of detection risk for tests of details and a revised level of substantive tests must be determined for an assertion when the relevant final or actual inherent risk assessments. Independent check of agreement of cash and checks with cash count sheets and prelist. Observe and reperform procedures for documenting receivables that have been factored or sold. Solutions Manual to Modern Auditing: Copyright  2005.Assertion (Audit Objective) Existence and Occurrence (Occurrence) Completeness (Completeness) Existence and Occurrence / Completeness (Cutoff) Valuation and Allocation (Accuracy) Presentation and Disclosure (Classification) Rights and Obligations 14-18. Mailing of statements to customers. Preparation of periodic independent bank reconciliations. If an entity sells its receivables. cash receipts. and sales adjustments. Observe and reperform manual controls to check independent check of the prelist with the cash receipts journal. Control Independent check of agreement of cash and checks with cash count sheets and prelist. John Wiley and Sons. differ from the planned assessed levels.

However. High or maximum due to subjective nature of allowance. Moderate to high depending on reliability of expectation model. It will also reduce the extent of cutoff tests.14-19. Moderate to high depending on internal controls over collection of receivables. In vouching recorded accounts receivable transactions to supporting documentation. the auditor may be present at the balance sheet date to personally observe the promptness of the cutoff.  Inspecting invoices for a period of time before and after the cutoff date to ascertain the validity and propriety of the shipments and corresponding entries. Moderate to high depending on the entity’s ability to generate operating cash flow. Inherent risk is usually high or maximum. Moderate to high depending on internal controls over disclosures. Maximum to High. The auditor should consider extensive tests of the allowance after year-end. and customer orders. rights and obligations. Analytic Procedures Risk Moderate to high depending on reliability of expectation model. sales orders. Low if internal controls over the occurrence of sales are strong. In particular. 14-21. Maximum: Analytical procedures are not directed at testing disclosures. It will also reduce the extent of cutoff tests.  Inquiring of management about any direct shipments by outside suppliers to customers and determining the appropriateness of related entries. 14-10 . Moderate to high which will allow for smaller sample sizes and changing the timing of confirmations of receivables. It is often cost effective to substantively test disclosures which are not complex for receivables. and valuation or allocation assertions for accounts receivable. John Wiley and Sons. Not a significant inherent risk. Assertion Existence and Occurrence Completeness Rights and Obligations Valuation and Allocation Presentation and Disclosure Inherent Risk Control Risk Maximum due to revenue recognition problems. control are more nonroutine than routine. Low: Consider confirming with factoring agent and search for large unusual cash receipts.  Tracing shipping documents to sales and inventory records to establish that the entries were made in the correct accounting period. Moderate to high depending on internal controls. The sales cutoff test involves:  Examining shipping documents for several days before and after the cutoff date to determine the date and terms of shipment. Test of Details Risk Moderate which will allow for smaller sample sizes and changing the timing of confirmations of receivables. The auditor can test the accuracy of receivables at gross value with confirmation. Low if internal controls over the occurrence of sales are strong. Moderate. the auditor determines that Solutions Manual to Modern Auditing: Copyright  2005. Moderate to high depending on reliability of expectation model. The following table explains some example preliminary audit strategies for each financial statement assertion in the context of the audit risk model. Moderate to high depending on reliability of expectation model. In performing a cash receipts cutoff test. Inc. a sample of debits to customers' accounts is compared to data on supporting sales invoices and matching shipping documents. Both the sales cutoff test and the cash receipts cutoff test pertain to accounts receivable. 14-20. The evidence obtained pertains primarily to specific audit objectives derived from the existence or occurrence.

c. a. such as that all nonresponses pertain to year-end transactions. Inc. projected as 100% misstatements to the population and added to the sum of all other unadjusted differences. Alternatively.  The use of confirmations would be ineffective as an audit procedure. is sufficient to reduce audit risk to an acceptably low level for the applicable financial statement assertions. and that assessment. b. The aged trial balance is used primarily in assessing the adequacy of the allowance for uncollectable accounts. the auditor may review the daily cash summary and validated deposit slip for the last day of the year. a.  The auditor's combined assessment of inherent risk and control risk is low. Solutions Manual to Modern Auditing: Copyright  2005. Both cutoff tests relate to the occurrence and completeness audit objectives for accounts receivable. b. 14-22.all collections received prior to the close of business are included in cash on hand or in deposits in transit and are credited to accounts receivable. Factors to be considered in choosing the form of confirmation request are (1) the acceptable level of detection risk and (2) the composition of the customer balances. The negative form should be used only when all three of the following conditions apply:  The acceptable level of detection risk for the related assertions is moderate or high. Alternate procedures may be omitted when both of the following conditions apply:  There are no unusual qualitative factors or systematic characteristics related to the nonresponses. When no response is received after the second or third positive confirmation request to a customer. would not affect the auditor's decision about whether the financial statements are materially misstated 14-23. Procedures applied to the aged trial balance include (1) footing and crossfooting the aged trial balance and comparing the total to the general ledger balance for accounts receivable and (2) testing the aging of the amounts shown in the aging categories by examining supporting documentation such as dated sales invoices.  The auditor has no reason to believe that the recipients of the requests are unlikely to give them consideration. 14-11 .  A large number of small balances is involved. made in conjunction with the evidence expected to be provided by analytical procedures or other substantive tests of details. the auditor should apply such alternative procedures as (1) examining subsequent collections and (2) vouching open invoices comprising the customer's balance. John Wiley and Sons. The positive form is used when detection risk is low or individual customer balances are relatively large. It may not be necessary to confirm accounts receivable when:  The balance is immaterial to the financial statements.  The nonresponses.

 Appropriate classification of material credit balances. and collection history for specific customers. affiliated companies and other related parties. credit reports. The reliability of management’s process for developing this accounting estimate can be gauged by evaluating estimates in prior periods and the degree to which those estimates accurately estimated subsequent uncollectable accounts. Inc. Comprehensive Questions 14-25. aging trends. The auditor needs to consider the same issues as Solutions Manual to Modern Auditing: Copyright  2005. GAAP disclosure for accounts receivable include:  Disclosure of receivables from employees.  Examine past due accounts for evidence of collectability such as correspondence with customers and outside collection agencies. 14-24. The auditor might consider evaluating the summer season separate from the balance of the year as the auditor will expect occupancy to be high during that time of year and the auditor will also expect that revenues should reflect higher rates. The auditor would also expect that for the balance of the year occupancy should be lower and revenues per night will be reduced due to significant price competition. Revenues for the 27 owned properties represent direct revenues of the motel chain. John Wiley and Sons. assigning.  Evaluated management’s process for estimated the allowance for doubtful accounts using hindsight. 14-12 .  Disclosure of pledging. Knowledge of the industry will be particularly helpful in gauging the reasonableness of occupancy rates and revenues per unit.  Appropriate classification of current and noncurrent receivables. Revenues for the 40 managed hotels will likely be related to management fees based on revenues earned for absentee owners. Hindsight allows auditors to evaluate the reasonableness of management’s process for estimating the allowance for doubtful accounts. (Estimated Time: 15 Minutes) The auditor should consider separately audit the revenues associated with the 27 owned properties and the 40 managed properties.  Evaluate the adequacy of the allowance given information about industry trends. officers. d. and customers’ financial statements.c. or factoring receivables. After testing the accuracy of the aged trial balance the auditor should perform the following procedures to draw a conclusion about the fair presentation of the allowance for doubtful accounts.  Discuss collectability of accounts with appropriate management personnel.

The following table provides the solutions to the quantitative requirements in parts a through g. but also need to determine the appropriateness of the management fee based on the contract with absentee owners. 14-26. John Wiley and Sons. Receivables are growing faster than sales. accounts receivable turn days increased during the last year.20 minutes) 1. 3. (Estimated time . 2.25 minutes) 1. during this period of accounts receivable growth. In addition. This might be evidence of problems with revenue recognition. In addition. Internal Control Questionnaire Question Are cash registers or point-of-sale devices used for over-the-counter sales? Is there periodic surveillance of cash sales procedures? Are customers who pay by check required to provide identification? Are checks restrictively endorsed on receipt? Solutions Manual to Modern Auditing: Copyright  2005. 2. (Estimated time . 14-27. 4. and the uncollectable account expense to account receivable write-off has gone down. Inc. Sales price per unit has gone up and the ratio of sales to total assets has increased.above. Yes No 14-13 . The auditor should also consider whether the allowance for doubtful accounts is adequate.

Is cash deposited intact daily? 8. The financial secretary should receive a copy of the collection report for posting to the financial records. Is an independent check made of agreement of amounts journalized with daily cash register summaries and validated deposit slips? 10. The head usher should maintain a copy of the report for use by the audit committee. should be instituted. the finance committee has not performed the auditing function. Contributions are not deposited intact. John Wiley and Sons. The auditing function has been assigned to the finance committee. If it 2005. Moreover. which also has responsibility for the administration of the cash function. Finance committee should assume a more active supervisory role. and cash should remain under joint surveillance until counted and recorded so that any discrepancy will be brought to attention. Recommended Improvement To extent possible. Finance committee is not exercising its assigned responsibility for collections. Vulnerability to robbery will also be reduced by increasing the number of counters. financial secretary's responsibilities should be confined to record keeping. Is a receipt produced by the cash register given to each customer? 6. 14-14 . Inc. An audit committee should be appointed to perform periodic auditing procedures or engage outside auditors to perform the procedures. such as locking and bolting the door during the period of the count. The collection is vulnerable to robbery while it is being counted and from the church safe prior to its deposit in the bank. Is an independent check made of agreement of daily cash register summaries with validated deposit slips? 9. Are periodic independent bank reconciliations made? 11. Is an independent check made of agreement of cash and checks on hand with cash count sheets and cash register readings? 7. Physical safeguards. The head usher's count lacks usefulness from a control standpoint because he surrenders custody of both the cash and the record of the count. The head usher has sole access to cash during the period of the count. Are employees who handle cash bonded? 14-28.5. Solutions Manual to Modern Auditing: Copyright  The number of counters should be increased to at least two. Contributions should be deposited intact. One person should not be left alone with the cash until the amount has been recorded or control established in some other way. (Estimate Time: 30 Minutes) Weakness Financial secretary exercises too much control over collections. The collection should be deposited in the bank's night depository immediately after the count.

ushers should stamp the church's misappropriation. often on a shortterm basis. 14-29. thus making the checks completely payable to the church. prepared. Consolidated Electricity Company: Cash Receipts Flowchart Documentary Audit Trail Key Reports Computer Programs and Files Customer Payment Remittance Advice CASH RECEIPTS PROGRAM: Updates AR Master File and Daily Transaction Tape. restrictive endorsement (For Deposit Only) on the back of the check. untrained church members. Members are asked to draw checks to Members should be asked to make checks "cash". Written instructions for handling cash Because much of the work in cash collections apparently have not been collections is performed by unpaid. No mention is made of bonding. Inc. 14-15 . she expenditures will be properly accounted for. should be provided with a cash working fund. (Estimated Time: 30 minutes) a. The fund should be replenished by check based upon a properly approved reimbursement request and satisfactory support.Weakness Recommended Improvement There is no assurance that amounts is considered necessary for the financial withheld by the financial secretary for secretary to make cash expenditures. Key employees and members involved in receiving and disbursing cash should be bonded. At the time of the negotiable and vulnerable to count. detailed written instructions should be prepared. John Wiley and Sons. Also Produces Deposit Slip for Cash Received Data Entry at CRT Accounts Receivable File rece Cash Receipts Transaction File Deposit Slip Solutions Manual to Modern Auditing: Copyright  2005.

Financial Statement Assertion Valuation or allocation c. Inc. 14-16 . which probably is too soon. There should be safeguards to detect or prevent unauthorized entries to the system. Substantive Test Vouch aged trial balance to supporting documentation Apply analytical procedures Vouch recorded receivables to supporting documentation Perform sales cutoff test Confirm accounts receivable Vouch aged trial balance to supporting documentation Vouch recorded receivables to supporting documentation Verify accuracy of accounts receivable trial balance and agreement with general ledger control Examine subsequent b. Yes. These problems include the following:  There are some potential control problems in the data entry procedures. This can be accomplished by periodically dumping the accounts receivable file on magnetic tape or another disk  There is no assurance that all cash receipts have been entered correctly into the system. rights and obligations. (Estimated Time – 25 Minutes) a. Any errors or operator alterations not discovered by the end of the next business day would be difficult to trace and correct. rights and obligations. Valuation or allocation Analytical Existence or occurrence. The company should keep a backup of the accounts receivable file in case the file is destroyed. 14-30. valuation or allocation Existence or occurrence. John Wiley and Sons. valuation or allocation Valuation or allocation Documentary Existence or occurrence. the new cash receipts procedures have created some systems and internal control problems. valuation or allocation Existence or occurrence. The CRT operator should be restricted to cash receipts processing activities. completeness All except presentation and disclosure. completeness.b.  The old master file records are destroyed in the update process. Documentary Solutions Manual to Modern Auditing: Copyright  Documentary Documentary Confirmation Documentary Mathematical 2005. Type of Evidence Documentary Existence or occurrence. There should be some independent computation of batch and/or hash totals involving the remittance advices and the number of transactions so that a comparison at the conclusion of processing would reveal omissions or errors  The remittance advices The remittance advices are destroyed the next day.

completeness c.a. 15 minutes) a.600 6. Solutions Manual to Modern Auditing: Copyright  2005. Transaction D E F H Total Cost of Goods Sales Sold Under Over Under Over 4. and that assessment. The positive form is used when detection risk is low or individual customer balances are relatively large.600 CR (Estimated time King might justify omitting the confirmation of Cycle's accounts receivable when:  Th e 5.  The auditor has no reason to believe that the recipients of the requests are unlikely to give them consideration. the composition of the client's customer balances. the auditor considers the acceptable level of detection risk needed to be achieved. balance is immaterial to the financial statements.000 5. (Estimated Time – 20 minutes) Schedule of Adjustments 14-32. Financial Statement Assertion completeness.400 10. valuation All except presentation and disclosure Presentation and disclosure Existence or occurrence. is sufficient to reduce audit risk to an acceptably low level for the applicable financial statement assertions.600   b.600 Adjusting Entry Inventory DR 5. and the likelihood that the customers will conscientiously respond.000 5. Substantive Test collections or allocation Confirm accounts receivable Compare statement presentation with GAAP Perform cash receipts cutoff test b. In designing confirmation requests. Inc. 14-17 .  A large number of small balances is involved.000 14. made in conjunction with the evidence expected to be provided by analytical procedures or other substantive tests of details. The use of confirmations would be ineffective as an audit procedure.000 8. The negative form should be used only when all three of the following conditions apply:  The acceptable level of detection risk for the related assertions is moderate or high. The auditor's combined assessment of inherent risk and control risk is low. Type of Evidence Confirmation Documentary Documentary 14-31.000 14. John Wiley and Sons.000 2.

13 55 47 8 49 48 1 48 47 1 48 47 1 AR collection period Industry Median Difference Uncollectable account expense to net credit sales Industry Median Difference Uncollectable account expense to bad debt writeoffs b. Cases 14-33.26 0.000 2. Inc.25% 1. Alternate procedures may be omitted when both of the following conditions apply:  There are no unusual qualitative factors or systematic characteristics related to the nonresponses.029 Year 1 Unaudited 175.25% 1. would not affect the auditor's decision about whether the financial statements are materially misstated. Inc. show the following:  There was a significant increase in sales compared to total assets.625 24.05% 1.400) 169.000 1.29 0.500 17.200.30 1.500 Year 2 Unaudited 207.500 Year 3 Unaudited 265.000 1.30% -0.000 21.600 1.000 a.000 14. particularly when compared to industry averages. the auditor should apply such alternative procedures as (1) examining subsequent collections and (2) vouching open invoices comprising the customer's balance.600 Yar 4 Unaudited 295.493 1.24 1.275) 259.200.400.65 1.53 0.000 The unaudited figures for Aurora Manufacturing.800.725 1.25% 1. 14-18 .01 1.25% 1.046 0.000 ($5.500 ($5. When no response is received after the second or third positive confirmation request to a customer. 1.25% 0.00% 1. John Wiley and Sons.000 2.000 ($14.000 15.000 25.400) 288.000.200.  The nonresponses.01 1.25 0.000 ($6.000 1. such as that all nonresponses pertain to year-end transactions.600 1.01 AR Growth to Sales Growth 2.000 17.875 22.050.500) 520.23 0.15 1.25% 0.972 1. This is an indication of possible existence and occurrence problems as past history of the ratio of total assets to sales would predict Solutions Manual to Modern Auditing: Copyright  2005.000 33.500 2.900) 201. Selected Ratios Sales to average total as sets Industry Median Difference 1.500.25% 1. projected as 100% misstatements to the population and added to the sum of all other unadjusted differences.10 1. (Estimated Time – 30 Minutes) Accounts Receivable Gros s Allowance for Uncollectable Accounts Net Receivables Total Assets Total Revenues Uncollectable Accounts Expense Writeoff of Accounts Receivable Year 5 Unaudited 535.00% 1.27 1.750.50% -0.600 1.750 22.c.000 ($5.35 1.700.

See separate file with answers to the comprehensive case related to the audit of Mt. accounts receivable are growing faster than sales. The auditor needs to expand the scope of tests of collection of current receivables. The auditor should expand the scope of accounts receivable confirmations. The Aurora continues to use a historical rate of 1. See separate file with answers to the comprehensive case related to the audit of Mt. John Wiley and Sons. Comprehensive Cases 14-34. lower sales levels.25% of credit sales to provide for uncollectable accounts while industry trends show an increase in the rate of bad debts to credit sales. The collection period is increasing relative to industry averages and past history. Hood Furniture that is included with this chapter. Inc. Hood Furniture that is included with this chapter. 14-19 . Further. the allowance for uncollectable accounts. See separate file with answers to the comprehensive case related to the audit of Mt. Solutions Manual to Modern Auditing: Copyright  2005. 14-35. and the provision for bad debt expense. The is an indication of possible problems of associated with the net realizable value of receivables. 14-36. Hood Furniture that is included with this chapter.

0 Auditor’s Expectation Range 42 days – 48 days Sales Growth: 6% . the ratios of accounts receivable turn day and sales to net fixed assets are both significantly larger than the auditor’s expectation.0 The above analytical procedures show that receivables are growing faster than sales.0 – 8.Professional Simulation Analytical Procedures Situation Internal Controls Risk Assessment Audit Procedures To: Audit File Re: Analytical procedures From: CPA Candidate Ratio Accounts Receivable Turn Days Sales and Accounts Receivable Growth Rates Sales to Net Fixed Assets Unaudited Ratio 54 days Sales Growth: 7% Accounts Receivable Growth: 14% 10. Solutions Manual to Modern Auditing: Copyright  2005.9% Accounts Receivable Growth: 6% 9% 6. Inc. 14-20 . The most likely misstatement due to the potential overstatement of both sales and receivables relates to the occurrence of sales and the existence of receivables due to revenue recognition problems. John Wiley and Sons. The increase in accounts receivable turn days also points to possible problems with the valuation of receivables at net realizable value due to the understatement of the allowance for doubtful accounts.

Rights and Obligations D. The computer matches the customer number on      the sales invoice with the customer number on the master customer file. 3. Solutions Manual to Modern Auditing: Copyright  2005. A conservative risk assessment would be to use a moderate risk assessment for control risk when planning the confirmation of accounts receivable. The computer matches the date on the bill of      lading with the accounting period when the sales invoice is recorded. The computer matches prices on the sale invoice      with prices on the master price list. 2. Accounts receivable is affected by the existence and occurrence assertion for credit sales (low in this case) and the completeness control related to cash receipts (moderate in this case) and sales return (low in this case).Internal Controls Situation Analytical Procedures Risk Assessment Audit Procedures Assertion A. 4. The computer prints a report of all shipments that      have not resulted in a sales invoice. 5. John Wiley and Sons. (A) (B) (C) (D) (E) Internal Control 1. Valuation and Allocation E. The computer compares control totals on      shipping documents with corresponding control totals Risk Assessment Situation Analytical Internal Procedures Controls Audit Procedures To: Audit File Re: Control Risk Assessment From: CPA Candidate Based on the following assessments the auditor should assess control risk as moderate for the purpose of considering the controls over the accounts receivable balance. Inc. Existence and Occurrence B. 14-21 . Check all that apply. Presentation and Disclosure Identify the appropriate assertion for each of the following internal controls. Completeness C.

Select a sample of recorded sales transactions from several days before and after year-end and examining supporting sale invoices and shipping documents to determine that sales were recorded in the proper period. The computer prepares a daily report of authorized sales returns that have not resulted in a receiving report or a credit memo. All sales during the period may not be recorded. H. 3. B. Determine the audit procedure that best addresses the following risks. A prelist is prepared for cash receipts and compared with deposit slips. Send positive confirmations for accounts receivable and follow-up on disputed confirmations. Risk 1. Compare uncollectable accounts expense to net credit sales.Control Risk Assessment Low Control The computer matches sales invoice information with underlying shipping information. F. 2. Review activity in the general ledger account for accounts receivable and investigate entries that appear unusual in amount or source. 4. The computer matches sales prices with the authorized price list. Use generalized audit software to recompute the aging of accounts receivable and investigate the credit history of accounts that are over 60 days past due. John Wiley and Sons. I. The allowance for doubtful accounts may not reasonably estimate the difference between gross receivables and their net realizable value. Trace a sample of revenue transactions from shipments to recorded sales invoices in the sale journal. C. Trace beginning balance for accounts receivable to the prior year’s working papers. G. E. Low Moderate Low Audit Procedures Situation Analytical Internal Procedures Controls Risk Assessment Audit procedure A. Observe that all cash received through the close of business on the last day of the fiscal year is include in cash on hand or deposits in transit and that now receipts of the subsequent period are included. 5. 14-22 . Send confirmations to entities that have purchased accounts receivable. J. D. Solutions Manual to Modern Auditing: Copyright  (A) (F)   (B) (G)   (C) (H)   (D) (I)   (E) (J)                                           2005. Accounts receivable information may not be appropriately classified and presented in the financial statements. Determine whether there are credit balances that are significance in the aggregate that should be reclassified as liabilities. Recorded sales may not represent goods shipped during the year. Inc. All legal claims on accounts receivable are adequately disclosed.