Chapter 16 Homework

The following questions concern analytical procedures in the sales and collection cycle.
Choose the best response.

As a result of analytical procedures, the auditor determines that the gross profit percentage has
declined from 30% in the preceding year to 20% in the current year. The auditor should
consider the possibility of a misstatement in the financial statements.

An auditor's preliminary analysis of accounts receivable turnover revealed the following rates
over these account periods:
                                       
                            
2016 2015 2014
4.3 6.2 7.3
Which of the following is the most likely cause of the decrease in accounts receivable turnover?
Liberalization of credit policy

After a CPA has determined that accounts receivable have increased as a result of slow
collections in a "tight money" environment, the CPA will be likely to
expand tests of collectability.

The following questions deal with confirmation of accounts receivable. Choose the best
response.

Which of the following procedures will an auditor most likely perform for year-end accounts
receivable confirmations when the auditor did not receive replies to second requests?
Inspect the shipping records documenting the merchandise sold to the debtors.

The negative form of accounts receivable confirmation request is useful except when
individual account balances are relatively large.

The return of a positive confirmation of accounts receivable without an exception attests to the
accuracy of the receivable balance.

The following questions concern audit objectives and management assertions for accounts
receivable. Choose the best response.

Which of the following will most likely provide the most assurance concerning the
accuracy balance-related objective for accounts receivable?
Vouch amounts in the subsidiary ledger to details on shipping documents.

Which of the following audit procedures will best uncover an understatement of sales and
accounts receivable?
 Chapter 16 Homework

Test a sample of sales transactions, selecting the sample from prenumbered shipping

documents.
The confirmation of customers' accounts receivable rarely provides reliable evidence about the
completeness assertion because
customers may not be inclined to report understatement errors in their accounts.

The following questions concern auditor responsibilities related to the audit of accounts
receivable. Choose the best response.

Which of the following is least likely to be a reasonable explanation for an increase in accounts
receivable turnover?
Allowance of a new grace period for customer payments

An auditor who is auditing accounts receivable would least likely perform which of the
following tests?
Select cash disbursements made shortly after year-end and examine the supporting
documentation such as receiving reports and vendor invoices.

The auditor sends out positive accounts receivable confirmations for a client. Assuming a
second confirmation is sent out to a major customer who still fails to respond, the
auditor should:
Send out a third confirmation request and if no response, perform alternative procedures.

Distinguish among tests of details of balances, tests of controls, and substantive tests of
transactions for the sales and collection cycle. Explain how the tests of controls and
substantive tests of transactions affect the tests of details of balances.

Tests of details of balances are designed to determine the reasonableness of the balances
in sales, accounts receivable, and other account balances that are affected by the sales and
collection cycle. Such tests include confirmation of accounts receivable, and examining
documents supporting the balance in these accounts.
Tests of controls for the sales and collection cycle are intended to determine the effectiveness
of internal controls.
Substantive tests of transactions for the sales and collection cycle are intended to test the
substance of the transactions that are produced by this cycle. Such tests include examining
sales invoices in support of entries, reconciling cash receipts, or reviewing the approval of
credit.
The results of the tests of controls and substantive tests of transactions affect the procedures,
sample size, timing and items selected for the tests of details of balances.

Cynthia Roberts, CPA, expresses the following viewpoint: "I do not believe in performing tests
of controls and substantive tests of transactions for the sales and collection cycle. As
 Chapter 16 Homework

an alternative, I send a lot of negative confirmations on every audit at an interim date. If I

find a lot of misstatements, I analyze them to determine their cause. If internal controls
are inadequate, I send positive confirmations at year-end to evaluate the amount of
misstatements. If the negative confirmations result in minimal misstatements, which is often
the case, I have found that the internal controls are effective without bothering to perform
tests of controls and substantive tests of transactions, and the confirmation requirement has
been satisfied at the same time. In my opinion, the best test of internal controls is to go
directly to third parties." Evaluate her point of view.

When is it appropriate to use negative confirmation requests to reduce audit risk to an

acceptable level?  
All of the above.

Evaluate Cynthia's point of view by completing the following statement.

Cynthia's approach is questionable from the standpoint that nonresponses have not necessarily
proved the existence of the receivable, but her confirmation at an interim date requires her to
assume an assessed control risk less than maximum, but she has not tested the related internal
controls to justify this assumption.

List five analytical procedures for the sales and collection cycle. For each test, describe a
misstatement that could be identified. (Note that the letters corresponding to a potential
misstatement may be used more than once.)
A. A problem with collections, potentially causing an understatement of
bad debts and allowance for uncollectible accounts.
B. All returns were not recorded, or shipments to customers were not in
accordance with specifications and were returned (this could result in
significant operating problems).
C. Classification misstatement for nontrade liabilities.
D. Discounts that were taken by customers and allowed by the company
were not recorded.
E. Misstatement of accounts payable and expenses.
F. Misstatement in determining the allowance for uncollectible
accounts.
G. Sales cutoff errors or other misstatements involving sales; purchase
cutoff errors or other misstatements involving inventory or purchases.
H. Unrecorded or nonexistence payable accounts.

Analytical Procedure Potential Misstatement

1. Bad debts as a percentage of gross sales F
2. Sales, returns, and allowances as a percentage of gross sales by product line or segment B
3. Gross margin by product line G
4. Trade discounts taken as a percentage of net sales D
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5. Days sales in receivables outstanding A

Explain why you agree or disagree with the following statement:  "In most audits, it is more
important to test carefully the cutoff for sales than for cashreceipts." Describe how you
perform each type of test, assuming documents are prenumbered.

In most audits it is more important to carefully test the cutoff for sales because sales cutoff
misstatements are more likely to affect net earnings. Cash receipt cutoff misstatements
generally lead to a misclassification of accounts receivable and cash and, therefore, do not
affect income.

To perform a cutoff test for sales, the auditor should obtain the number of the last shipping
document issued before year-end and examine shipping documents representing shipments
before and after year-end and the related sales invoices to determine that the shipments were
recorded as sales in the appropriate period.

The propriety of the cash receipts cutoff is determined through tests of the year-end bank
reconciliation. Deposits in transit at year-end should be traced to the subsequent bank
statement. Any delays in crediting deposits by the bank should be investigated to determine
whether the cash receipts books were held open.

Identify the eight accounts receivable balance-related audit objectives. For each objective, list
one audit procedure.

Select the accounts receivable balance-related audit objective that relates to each general audit
objective. Then, select the corresponding audit procedure for each objective. (Audit procedures
may be used more than once or not at all.)
a. Accounts receivable in the aged trial balance agree with related
master fileamounts; the total is correctly added and agrees with the
general ledger.
b. Accounts receivable in the aged trial balance are properly classified.
c. Accounts receivable in the trial balance are accurately recorded.
d. Accounts receivable in the trial balance are owned.
e. Accounts receivable in the trial balance are stated at realizable value.
f. Existing accounts receivable are included in the aged trial balance.
g. The accounts receivable in the aged trial balance exist.
h. Transactions in the sales and collection cycle are recorded in the
proper period.

i. Review the minutes of the board of directors for any indication of pledged or
factored accounts receivable.
j. Trace ten accounts from the accounts receivable master file to the aged trial
 Chapter 16 Homework

balance.
k. Review the receivables listed on the aged trial balance for notes and related
party
receivables.
l. Trace twenty accounts from the trial balance to the related accounts in the
master file. Use audit software to foot the aged trial balance, and trace the total
to the general ledger.
m. Discuss with the credit manager the likelihood of collecting older accounts.
Examine
subsequent cash receipts and the credit file on older accounts to evaluate
whether receivables are collectible.
n. Select the last 10 sales transactions from the current year's sales journal and the
first
10 from the subsequent year's and trace each one to the related
shipping documents, checking for the date of actual shipment and the correct
recording.
o. Confirm accounts receivable using positive confirmations. Confirm all amounts
over
$15,000 and a statistical sample of the remainder.

General Balance-Related
Objective Audit Objective
1. Detail tie-in a.
2. Existence g.
3. Completeness f.
4. Accuracy c.
5. Classification b.
6. Cutoff h.
7. Rights d.
8. Realizable value e.
Audit

Procedure

l.

o.

j.

o.
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k.

n.

i.

m.

Why does an auditor review sales returns subsequent to year-end? What audit objective does
this procedure satisfy?

First, select the appropriate answer which indicates why an auditor reviews sales returns
subsequent to year-end. (Select all that apply.)
To identify whether the sales returns recorded are adequate.                                    
To evaluate whether sales returns are unusually high.

Next, select the audit objective(s) that this procedure satisfies. (Select all that apply.)
Occurrence
Completeness

State the purpose of footing the total column in the client's accounts receivable trial balance,
tracing individual customer names and amounts to the accounts receivable master file, and
tracing the total to the general ledger. Is it necessary to trace each amount to the master file?
Why?

State the purpose of footing the total column in the client's accounts receivable trial balance,
tracing individual customer names and amounts to the accounts receivable master file, and
tracing the total to the general ledger.
A necessary audit procedure is to test the information on the client's trial balance for detail tie-
in, which includes the purpose of footing the total column.

Is it necessary to trace each amount to the master file? Why?

No, unless a significant number of misstatements is noted and it is determined that reliance
cannot be placed upon the trial balance with less than100% testing.

Distinguish between accuracy tests of gross accounts receivable and tests of the realizable
value of receivables.

The purpose of the accuracy tests of gross accounts receivable is to determine the correctness
of the total amounts receivable from customers. The purpose of the tests of the realizable value
of receivables is to estimate the amount of the accounts receivable balance that will not be
collected.
 Chapter 16 Homework

Evaluate the following statement: "In many audits in which accounts receivable is material,
the requirement of confirming customer balances is a waste of time and would not be
performed by competent auditors if it were not required by auditing standards. When
internal controls are excellent and there are a large number of small receivables from
customers who do not recognize the function of confirmation, it is a meaningless procedure.
Examples include well-run utilities and retail stores. In these situations, tests of controls and
substantive tests of transactions are far more effective than confirmations."

Confirmations are typically more effective than tests of controls and substantive tests of
transactions for discovering certain types of misstatements, such as invalid accounts and
disputed amounts. Confirmations cannot guarantee the discovery of any of these types
of misstatements, but they are more reliable than tests of controls and substantive tests of
transactions. Tests of controls and substantive tests of transactions rely upon internally created
documents, whereas confirmations are obtained from independent sources.
Confirmations are typically more effective in uncovering overstatements of accounts receivable
than understatements, whereas tests of controls and substantive tests of transactions are
effective for discovering both types.
The use of tests of controls and substantive tests of transactions combined with the strengths
of confirmation result in a highly useful combination. If the auditor has carefully evaluated
internal control, tested internal controls for effectiveness, and concluded that the internal
controls are likely to provide correct results, it is appropriate to reduce the confirmation of
accounts receivable. On the other hand, it would be inappropriate to bypass confirmation
altogether.
In the situation being addressed in this problem, the auditor will want to put more emphasis on
tests of controls and substantive tests of transactions than confirmations because of the nature
of the customers and the effectiveness of internal control.

Why do CPA firms sometimes use a combination of positive and negative confirmations on
the same audit?

It is common to use a combination of negative and positive confirmations so the auditor can
focus the confirmation testing on large account balances, while still allowing for a
representative sample from the rest of the population.
Under what circumstances is it acceptable to confirm accounts receivable before the balance
sheet date?

Both A and B are correct.

State the most important factors affecting the sample size in confirmations of accounts
receivable. (Select four factors that apply from the list of choicesbelow.)
Inherent risk
Performance materiality
Achieved detection risk from other substantive tests
 Chapter 16 Homework

Type of confirmation
Control risk

Discuss whether email responses and oral responses are acceptable confirmation responses.
How can an auditor verify the addresses for confirmations sent bymail, and confirmations
sent electronically?

Discuss whether email responses and oral responses are confirmations.

Auditing standards indicate an oral response is not considered a confirmation, but constitutes
other evidence in support of a receivable balance.However, email responses are considered to
be valid confirmation responses if the auditor can be confident in the identity of the
confirmation respondent.
How can an auditor verify the addresses for confirmations sent by mail, and confirmations
sent electronically?
Auditors can verify mailing addresses to phone directories, or to information in the client's
accounts receivable master file if the client has adequate controls over the master file. Email
responses can be verified by third party intermediaries, or by verifying the domain of the email
address.

Under what circumstances would an auditor choose to confirm information such as the right
of return or special sales terms in addition to the customerbalance? (Select all that apply.)
When the auditor suspects aggressive revenue recognition techniques.                     
When the auditor identifies risks when performing substantive analytical procedures.
When the auditor suspects channel-stuffing or bill-and-hold sales.

Explain why the analysis of differences is important in the confirmation of

accounts receivable, even if the misstatements in the sample are not material.
Differences must be analyzed individually and in total to determine their effect on the total
accounts receivable balance. Even if individual differences are not material, they may indicate a
material problem when extended to the entire population.

State three types of differences that might be observed in the confirmation of accounts
receivable that do not constitute misstatements. For each, state an audit procedure that will
verify the difference.
Merchandise has been returned, but has not been received by the client at the confirmation
date. Receiving documents and the credit memo should be examined.
Payment has been made by the customer, but not received by the client at the confirmation
date. The subsequent payment should be examined as to the date deposited.
Merchandise shipped by the client has not been received by the customer at the confirmation
date. The shipping documents should be examined to verify that the goods were shipped
prior to confirmation date.
 Chapter 16 Homework

What is the relationship of each of the following to the sales and collection cycle: flowcharts,
assessing control risk, tests of controls, and tests of details ofbalances?
The flowcharts provide a means for the auditor to document and analyze the accounting
systems as represented by the client. The auditor would then make an initial assessment of
control risk based on the controls which are present in the accounting cycle as documented in
the flowcharts, and would plan the tests of controls based upon the selection of the significant
controls. The auditor would then perform the tests of the significant controls to determine the
effectiveness ofthe controls and to plan the substantive tests that are necessary based upon the
revised assessment of control risk for this accounting cycle. Finally, after considering the results
of tests of controls and substantive tests of transactions, the auditor would perform tests of
details of balances to determine whether material misstatements exist in the account balances.

Explain how unacceptable results from tests of controls and substantive tests of transactions
might impact the auditor's planned reliance on tests of details of balances.
The determination of test of details procedures is directly affected by results from tests of
controls and substantive test of transactions. When results of tests of controls and substantive
tests of transactions do not support the auditor's initial assessment of control risk, the auditor
will increase control risk, which then increases the need to perform additional substantive tests,
particularly tests of details.