St. Vincent de Ferrer College of Camarin, Inc.

SVFC Compound,
San Vicente Ferrer St., Area D, Brgy. 178, Camarin, Caloocan City
Telephone Number: 668-25-75;
Email address:st.vincentdeferrercollegeofccc@yahoo.com
Website: www.stvfc.com

Name: CANCERAN,MICHELLE M. Year: 5 year - BS Accountancy

th

Date: April 30, 2020

TEST 3

Questions and Problems

3-1 How do different levels of control risk in the revenue and collection cycle affect the nature, timing and extent of
accounts receivable confirmation procedures?

 Directly. Higher levels of control risk induce auditors to audit larger samples of receivables, with confirmation
date closer to the fiscal year end date. As for nature of the procedures: higher levels of control risk induce
auditors to use positive confirmations instead of negative confirmations, and to consider vouching subsequent
payments by the customers.

3-2 What feature(s) of cash receipts internal control system would be expected to prevent (a) an employee’s absconding
with company funds and replacing the funds during audit engagements with cash from the employee pension fund, and
(b) the cash receipts journal and recorded cash sales from reflecting more than amount shown on the daily deposit slip?

 The features of a cash receipts internal control system which would be expected to prevent an employee from
absconding with company funds and covering with funds from the employee pension fund is the prohibition
against one employee having custody of company funds and non-company funds. The auditor can detect such
transfer by controlling and counting both funds simultaneously.
 To prevent the cash receipts journal and recorded cash sales from reflecting more than the amount shown on
the daily deposit slip, the internal control system should provide that receipts be recorded daily and intact. A
careful bank reconciliation by an independent person could detect such errors.

3-3 What is the meaning of a strength in the transaction processing controls of the revenue and collection cycle? A
weakness? Why are the weaknesses not subject to test of controls auditing?

 A strength is defined as a control procedure that can detect, prevent or correct errors in a timely matter from
entering into the accounting records that form the basis of financial statements. A weakness is the lack of a
control procedure where the auditor thinks one should exist.
 Weakness are not subject to test of controls auditing because no reliance is placed on a weakness. Strengths
must be audited because the review phase only describes apparent strengths that may not actually exist.

3-4 Why is it necessary to evaluate the controls after the test of controls audit of the revenue and collection cycle when
an evaluation was already made after the understanding phase?

 The evaluation after the review phase was to determine which controls appeared adequate as a basis for
justifying a low control risk assessment. The final assessment after test of controls auditing is to determine if the
controls are operating as well as they appeared to be.

3-5 Describe the processing of transactions in the sales and collections cycle in the following functions:

a. Order entry
 - An order entry department generally receives customers’ requests to purchase merchandise either by
telephone or in the form of a written purchase order from the customer. A purchase order is a legal offer to
purchase goods under the terms specified. In some entities, on receipt of an order, the order entry department
generally prepares a sales order. The sales order is the first document prepared by the merchandiser in the sales
and collections cycle, and it should be prenumbered to facilitate control over processing transactions. A copy of
the sales order, acknowledging that the order has been received and is being processed, may be mailed to the
customer. Four copies of the sales order are sent to the credit department, which either approves or denies
credit and returns a copy of the sales order to the order entry department. The credit department then sends a
copy bearing credit approval (assuming it is granted) to the warehouse, the shipping department, and the billing
department. The sales order bearing credit approval serves as authorization to warehouse personnel to release
goods to shipping. Shipping personnel verify that the quantity and description of goods received from the
warehouse match the copy of the sales order received directly from order entry. Billing matches the customer
order, the sales order, and the shipping document before recording the sale. In some entities, when an order is
received, the purchase order is sent to the credit department for approval. The credit department’s decision is
returned to the order entry department. When the credit department has approved the sale, a multipart sales
invoice is prepared. One copy serves as a shipping order, another as the bill of lading, and another is sent to
billing. The sale, however, is not recorded (entered in the sales journal) until the bill of lading is received by
billing
b. Credit approval
- Before goods are shipped, the customer’s credit must be approved. The credit department maintains a list of
unauthorized customers and their credit limits, which an employee must review to determine whether to accept
an order. A credit department employee signs a copy of the sales order authorizing the credit sale. When an
order is received from a prospective customer not on the list or when a customer has exceeded the authorized
credit limit, the credit department generally conducts a credit investigation and makes a decision to accept or
reject the order. When the order is accepted, a copy of the sales order is sent to the warehouse and a copy is
retained in the credit department.
c. Warehousing
- Based on the sales order approved by the credit department, warehouse personnel issue goods to the shipping
department. The accounting department, rather than warehouse personnel, maintains perpetual records for the
inventory.
d. Shipping
- A document prepared to initiate shipment of the goods, indicating the description of the merchandise, the
quantity shipped and other relevant data. The original is sent to the customer and one or more copies are
retained. It is also used as a signal to bill the customer; one type of shipping document is a bill of lading.
e. Customer billing
- Billing of the customer includes preparation of a multi copy sales invoice and simultaneous updating of the
sales transactions file, and general ledger master file for sales and accounts receivable. This information is used
to generate the sales journal and along with cash receipts and miscellaneous credits, allows preparations of the
accounts receivable trial balance
f. Collecting accounts receivable
- When a company makes a sale but has not yet received payment for it, that sale enters the accounts receivable
cycle. Most businesses allow customers to receive goods or services before payment, believing in good faith that
they will receive their money after the customer receives an invoice. Accounts receivable is responsible for
taking the sales order and shipping document and generating a sales invoice that the company sends to the
customer. In addition to sending out the invoice, accounts receivable departments keep track of which
customers have paid and which payment are overdue. After a company receives payment, the accounting
department removes the balance from accounts receivable and documents it accordingly.
g. Granting credit for returns and allowances
- It is raised as a result of approval for customer's returns or granting allowances to customer. Its function is like
an invoice but acts in the opposite way that it indicates tie amount to be deducted from a customer's account.
h. Recording uncollectible accounts expense
- It is frequently recorded to general ledger to estimate the uncollectible accounts expense.
i. Writing off uncollectible accounts
 - Write off accounts identified as uncollectible and recorded in the general ledger.

3-6 Identify features of the following documents that facilitate control and explain how they do so:

a. Shipping document
- Businesses often use a bill of lading as a shipping document. The document may be a copy of the invoice or a delivery
ticket. The signature of the carrier on the shipping document provides externally created evidence that a sale has
occurred. Accounting for the numerical sequence determines that all shipments are recorded as sales.

b. Remittance advice
- A customer attaches a remittance advice to a check in payment of an invoice. The document may be a
turnaround document, a part of a check, or a statement identifying the invoices being paid. Remittance advices
facilitate recording cash receipts. If a customer does not return a remittance advice, the employee opening the
mail usually prepares one. A remittance advice indicates the date and amount of payment and the invoices paid.
Remittance advices are separated from cash and given to the accounts receivable clerk for posting to accounts
receivable.
c. Uncollectible account form
- Uncollectible account forms authorize an accounting clerk to write off an account receivable as an uncollectible
account. The form provides permanent written evidence that authorization was made for writing off an account

3-7 Why do people perpetrate fraud involving sales transactions?

 Managers may experience pressure to show high profits and may inflate sales because of the pressure to meet
target profits established by senior managers, to obtain bonuses, to retain the respect of senior managers, or
even to retain their jobs.

3-8 Why is it difficult to detect the withholding of cash receipts?

 Until a record of cash received has been made, removing cash is one of the easiest forms of fraud to commit and
among the hardest to detect because records do not reflect what has occurred.

3-9 Identify three ways an employee might misappropriate cash receipts.

 Answers will vary. Three possible examples are the following:

 A cashier in a retail establishment who does not ring up a transaction on the cash register can generally take
the cash without detection. Ringing up the transaction adds the receipt to the total cash receipts, which can
be compared to the cash on hand.
 An employee who has access to cash receipts and maintains accounts receivable records can record a sale at
an amount lower than the invoice amount. When the customer pays, the employee takes the difference
between the invoice and the amount recorded as a receivable.
 An employee who makes the cash deposit and also prepares the bank reconciliation can withhold cash and
hide the shortage by overstating deposits in transit on the bank statement, under footing the list of
outstanding checks, or omitting outstanding checks from the outstanding check list. Routinely testing bank
reconciliations should uncover this form of fraud.

3-10 Explain why auditors perform test of controls

 Auditors are not required to perform tests of controls. However, when a client has effective internal control,
performing tests of controls is cost effective because it may provide a basis for the auditor to assess control risk
at less than maximum. Assigning a reduced level of risk to control risk reduces the amount of substantive testing
the auditor must perform. Substantive tests are more expensive to perform than tests of controls. Hence,
auditors perform tests of controls when they believe it will enable them to reduce the amount of substantive
testing. Also, auditors may perform much of the testing of controls before year end, thus spreading the audit
work.

3-11 What concerns does an auditor have in auditing adjustment to sales?

  Adjustments to sales include cash discounts, sales allowances or reductions in price, returns of merchandise,
volume rebates, corrections of billing errors, and write-offs of uncollectible accounts. The greatest concern from
a control point of view is that one of these types of transactions will be recorded to cover a misappropriation of
cash receipts.

3-12 When an entity’s controls for collection are ineffective, what potential misstatements could arise in the financial
statements?

 The following potential misstatements could arise:Fictitious cash receipts may be recorded, or cash receipts
may be misappropriated.Cash may be misappropriated and lapping may occur.Bank reconciliations may
cover shortages.Credits posted to customers’ accounts may be overstated or understated.Entries may be
made to the wrong accounts.

3-13 What test of controls related to uncollectible accounts do auditors perform?

 Auditors’ primary concern about uncollectible accounts is that accounts written off have actually become
uncollectible, rather than being written off to cover a misappropriation. To prevent accounts from being written
off to cover misappropriations, any account written off must be authorized by a responsible official not involved
in the granting of credit. The auditor usually tests the effectiveness of this control by examining the approvals of
accounts written off. For a sample of accounts written off, the auditor generally examines correspondence
indicating that efforts were made to collect the account and that the account is uncollectible. Sometimes the
auditor examines credit reports on the accounts. The auditor should trace a sample of the entries to the
accounts receivable accounts.

3-14 The following questions relate to tests of controls. Choose the best response. (The following answers are in bold
and highlighted)

1. To determine whether an entity’s internal control operated effectively to minimize errors of failure to post
invoices to the customer’s accounts ledger, the auditor would select a sample of transactions from the
population represented by the
a. customer order life
b. bill lading of file
c. subsidiary customers’ accounts ledger
d. sales invoice file.

2. To gather audit evidence that uncollected items in customers’ accounts represented valid trade receivables, the
auditor would select a sample of items from the population represented by the
a. customer order file
b. bill of lading file
c. subsidiary customers’ accounts ledger
d. sales invoice file.

3. Tracing bills of lading to sales invoices will provide evidence that

a. recorded sales were shipped
b. invoiced sales were shipped
c. subsidiary customers’ accounts ledger
d. sales invoice file

4. Tracing copies of sales invoices to shipping documents will provide evidence that all
a. shipments to customers were recorded as receivables
b. billed sales were shipped
c. debit to the subsidiary accounts receivable ledger are for sales shipped
d. shipments to customers were billed
3-15 The following questions relate to internal controls. Choose the best response.

1. to achieve good internal control, which department should perform the activities of matching shipping
documents with sales orders and preparing daily sales summaries?
a. Billing
b. Shipping
c. Credit
d. Sales order

2. Which of the following would the auditor to be an incompatible operation for a cashier if the cashier receives
remittances from the mailroom?
a. Posting the receipts to the accounts receivable subsidiary ledger cards.
b. Making the daily deposit at the local bank
c. Preparing the daily deposit
d. Endorsing the checks
3. The most likely result of ineffective internal controls in the sales cycle is that
a. fictitious transaction could be recorded, causing an understatement of revenues and an overstatement of
receivables.
b. irregularities in recording transactions in the subsidiary accounts could delay the shipment of goods.
c. omission of shipping documents could go undetected, causing an understatement of inventory
d. final authorization of credit memos by personnel in the sales department could permit an employee deflection
scheme
4. For the most effective internal control, monthly bank statements should be received directly from the banks and
reviewed by the
a. controller
b. cash receipts
c. cash disbursements accountant
d. internal auditor