Chapter 9: Auditing the Revenue Cycle Chapter 9: Auditing the Revenue Cycle

Student: ___________________________________________________________________________

1. The revenue cycle considered by auditors includes the sales process but not collections. 
True    False

2. The revenue cycle involves the procedures in generating a sales order, shipping the products, recording the
transaction and collecting the receivable. 
True    False

3. The shipping department confirms the shipment of goods by completing the packing slip and returning it to
the purchasing department. 
True    False

4. Monthly statements provide a detailed list of the customer’s activity for the previous month and a statement
of all open items. 
True    False

5. Invoices are processed, including their mailing to customers, only subsequent to proof of valid delivery to
customers. 
True    False

6. The use of prenumbered sales invoices is the primary control procedure to satisfy the objective of
authorization. 
True    False

7. A comprehensive chart of accounts and a review of complex or unusual transactions by supervisory
personnel are control procedures necessary for proper classification of accounts. 
True    False

 
8. Formal procedures for approving acceptance of returns that are beyond the warranty period are an appropriate
control procedure for identifying and recording returned goods. 
True    False

9. One of the benefits of establishing a formal credit policy for granting credit is that management is freed from
the burden of monitoring accounts receivable. 
True    False

10. Monitoring of the revenue cycle may be accomplished partially through the use of exception reporting. 
True    False

11. An appropriate mix of evidence for a low risk client could include 20% tests of details, 40% analytics, and
40% tests of controls; an appropriate mix of evidence for a high risk client could include 60% tests of details,
20% analytics, and 20% tests of controls. 
True    False

12. The audit team is required by auditing standards to make an ordinary presumption of the risk of fraud due to
revenue misstatements on every engagement. 
True    False

13. A company that ships a large quantity of its products from its manufacturing plant to a warehouse that it
leases until the customer is ready for the product should record the delivery as revenue. 
True    False

14. The intentional loading of sales at the end of a period to customers that do not need the goods at that time
should not be recorded as revenues. 
True    False

15. All companies attempting to comply with GAAP should refer to the Securities and Exchange Commission
for guidance as it supersedes all AICPA, PCAOB, FASB and EITF literature. 
True    False

 
16. A certain tendency for fraud exists when stock options are close to becoming exercised by executives and
financial personnel. 
True    False

17. A red flag that may alert the auditor to fraud in the revenue cycle is a trend of revenue growth that is
consistent with industry results. 
True    False

18. Financial accounting personnel who do not have the proper education, experience and backgrounds may
signal the auditor to the risk of financial statement fraud. 
True    False

19. The auditor of James Corporation should be alert to the risk of material misstatements when James
Corporation's cash flows from operations are negative and net income (rather than loss) is reported. 
True    False

20. Ratio analysis performed by the audit team may include the comparison of gross sales to industry averages
and previous periods. 
True    False

21. The auditor's determination that day's sales in accounts receivable increased from 44 days to 100 days
would usually be found through the use of ratio analysis. 
True    False

22. Edge and Gregg, LLP would most likely discover channel stuffing in the financial statements of a client
through the use of trend analysis. 
True    False

23. Use of reasonableness tests by Bono Mullins, PC will include relationships between financial but not non-
financial data. 
True    False

 
24. The auditor has determined that the control risk for the existence assertion is low; therefore the auditor may
reduce the number of items tested on a substantive basis. 
True    False

25. Confirmations of bank accounts may help the auditor to determine if material amounts of accounts
receivable have been pledged or discounted. 
True    False

26. When the auditor seeks evidence concerning the allowance for doubtful accounts he or she would most
likely use an aged trial balance to help identify past due balances. 
True    False

27. Current auditing standards do not require the confirmation of receivables if accounts receivable are not
material. 
True    False

28. Accounts receivable confirmation letters should be prepared on the auditing firm's letterhead. 
True    False

29. Alternative procedures to the confirmation of receivables include review of subsequent collections and
examination of supporting evidence. 
True    False

30. Lapping of accounts receivable is least likely to occur when there is an inadequate segregation of duties. 
True    False

31. Positive accounts receivable confirmations should be used on all accounts which represent small immaterial
balances. 
True    False

 
32. When the client has a large number of relatively small accounts receivable and the assessed level of control
risk for receivables and related revenue transactions is high, the auditor is more likely to use negative
confirmations. 
True    False

33. The auditor would examine a sample of sales transactions throughout the entire period to determine if sales
were recorded in the proper period when performing a sales cutoff test. 
True    False

34. An example of a control over the sales cycle is the authorization of price lists by the appropriate sales and
marketing manager. 
True    False

35. An auditor would test control over the objective of the occurrence of sales transactions by sampling
recorded revenues and tracing them back to invoices and shipping documents. 
True    False

36. If control risk is assessed high, the auditor may send significantly fewer confirmations for a sample of
accounts receivable than if the control risk is assessed low. 
True    False

37. In planning an audit for the revenue cycle, the auditor must realize the integrated relationship of evidence
found between the accounts receivable and the notes payable accounts. 
True    False

38. A method of testing for the completeness of sales is to test the sequence of sales invoices used during the
period under audit. 
True    False

39. A review of the terms of client debt agreements assists the audit of the presentation and disclosure assertion
for accounts receivable. 
True    False

 
40. The use of audit software makes the audit of the revenue cycle more effective, but not more efficient. 
True    False

41. Testing cutoff involves procedures applied to sales transactions selected from those recorded immediately
prior to period end and immediately following period end. 
True    False

42. Valid evidence obtained in an audit for testing the cutoff of gross sales includes receiving reports for
returned merchandise. 
True    False

43. An example of a test for completeness in the revenue cycle includes the sampling of shipping documents
and tracing them to the sales journal and general ledger. 
True    False

44. Negative confirmations are used as an appropriate test with statistical sampling techniques. 
True    False

45. Exceptions found in the confirmations of accounts receivable balances need not be projected as errors to the
population as they are typically isolated errors. 
True    False

46. A timing difference type of exception in the confirmation process may include a misunderstanding by the
reader as to the date being confirmed. 
True    False

47. Negative confirmations are considered to be more persuasive than positive confirmations. 

True    False

48. The purpose of summarizing confirmation results is to list the extent of sales tested in relation to the
response rate. 
True    False

 
49. An auditor's primary concern with identifying related party sales and receivables rests with the presentation
and disclosure assertion. 
True    False

50. Customer complaints noted in returned accounts receivable confirmations may be an indicator of fraud. 
True    False

51. The audit team typically reviews journal entries in the receivables ledger for unusual entries that may be
indicators of fraudulent activity. 
True    False

52. Estimation of the allowance for doubtful accounts is a simple management decision as it is determined as a
percentage of sales. 
True    False

53. The auditor will come up with an independent estimation of the allowance for doubtful accounts based on a
thorough understanding of the client and the client's business that is compared to the recorded allowance. 
True    False

54. It is beneficial in the testing of notes receivable to confirm not only the balance of the notes, but also their
terms. 
True    False

55. The most important control to ensure completeness of sales and shipping is pre-numbered shipping and
billing documents. 
True    False

56. An aging of accounts receivable is useful in estimating the reasonableness of the allowance for doubtful
accounts. 
True    False

 
57. Which of the following processes are included in the revenue cycle? 
A. Shipping products to customers.
B. Sending disbursements to suppliers.
C. Issuance of capital stock.
D. Preparation of a time card.

58. Which of the following is the best example of the control objective in the revenue cycle that all transactions
are recorded accurately? 
A. Sales are recorded at the invoice price expected to be collected from customers.
B. Sales orders have sequential numbering.
C. Recorded sales transactions are evidenced by valid invoices and shipping documents.
D. Credits to customer accounts are classified as liabilities.

59. The relationship between the sales cycle and an inventory system can best be noted in which of the
following examples? 
A. Credit is established prior to completion of a sales order.
B. Invoices are sent to customers only after shipment is evidenced.
C. Availability of products ordered are verified prior to processing a sale.
D. Billing information is added to the database for new customers.

60. Credit approval policies are implemented by organizations primarily to accomplish which of the following
objectives? 
A. To determine revenue recognition policies.
B. To ensure customer satisfaction.
C. To prevent lapping by the accounts receivable department.
D. To ensure the realization of receivables.

61. Sales transactions should be documented at initiation in order to accomplish which of the following
objectives? 
A. To provide the customer a copy of the transaction.
B. To provide evidence of authorization and recording.
C. To offer credit to customers.
D. To generate back orders.

62. The significance of the bill of lading is to provide which of the following? 

A. The warehouse personnel with the product that must be shipped to customers.
B. Invoices to customers for proper collection.
C. A credit application for customer approval.
D. Evidence of title transfer of goods to customers.

 
63. The risk of material misstatement due to fraud relating to revenue recognition should be 
A. approached in a manner that is identical to control risk assessment.
B. given lower priority to the risk of embezzlement.
C. ordinarily presumed by the auditor.
D. assumed to have been considered by the FASB.

64. A method used by companies to fraudulently inflate revenues includes which of the following? 
A. Use of hidden “side letters” giving the customer an irrevocable right to return the product.
B. Recording of fictitious sales.
C. Shipment of product not ordered by customers.
D. All of the above.

65. Which of the following evidences delivery of product to customers sufficient for company recording as
revenues? 
A. A check received from the customer.
B. An agreement to purchase product signed by the customer.
C. A pick ticket in the warehouse.
D. A bill of lading and tracking number with the shipper.

66. Which of the following must exist prior to the recognition of revenue by a company from the sale of a
product? 
A. The cash is realized on the sale of the product.
B. A price is discussed based upon the customer's resale of the product.
C. The customer is given the option to return the product at any time.
D. The product is adequately delivered to the customer.

67. Fraud related to revenue recognition will most likely be identified by the auditor through which of the
following independent situations? 
A. Sales have increased 5% in the current period over the previous period and is consistent with the results of
competitors.
B. Gross margin is equivalent in the current period to previous periods and is below that of the industry.
C. Sales are higher in the month preceding each quarter end.
D. The sales of a revolutionary new product are increasing beyond that of the competition in the periods
immediately following its introduction.

 
68. Calculating the turnover of receivables is often used in testing the sales cycle by auditors when performing
which of the following? 
A. Trend analysis.
B. Ratio analysis.
C. Reasonableness testing.
D. Non-statistical sampling.

69. Hardman and Jennings, LLP, an audit firm, compares bad debt expense of a client in the current period to
bad debt recorded for the past three periods. Hardman and Jennings is performing which type of analysis? 
A. Trend.
B. Ratio.
C. Critical.
D. Reasonableness.

70. Lithgow and Harris, CPAs are performing the audit of WildFlower Grocery Stores. Lithgow and Harris
relates annual revenue by sales per square feet and sales per customer. What type of analysis is Lithgow and
Harris most likely performing? 
A. Ratio analysis.
B. Critical analysis.
C. Reasonableness tests.
D. Non-statistical analysis.

71. In an audit of financial statements, the risk of the high rate of return of products sold includes relates to
which of the following? 
A. Sales that are recorded improperly.
B. An estimate of accrued returns that reduces net income.
C. A reduction of net sales for an increase to the sales returns and allowance account.
D. Consignment goods that are returned and forwarded to third parties.

72. The major risk associated with receivables is related to which of the following? 
A. They may be sold to a bank with recourse.
B. They may be recorded as long-term when in fact they will be realized in the current period.
C. They will not be realized for the entire amount due.
D. They are pledged as collateral as disclosed in the footnotes to financial statements.

 
73. Which of the following is a proper control for the detection of unusual sales transactions recorded in the
general ledger? 
A. Electronic authorization prior to posting.
B. Use of sequentially numbered sales documents.
C. Random statements to customers.
D. Review of transactions by upper management or the board.

74. A control that may be implemented to ensure all sales that occur are recorded in the general ledger includes
which of the following? 
A. Use of prenumbered shipping, invoice and sales documents.
B. Use of prenumbered statements, inventory lists and credit memos.
C. Reconciliation of invoices with customer statements.
D. Use of pre-authorized price lists.

75. The internal audit department at Monument Company receives electronic exceptions reports for all sales
transactions entered over $10,000 in total. This process is performed for which purpose? 
A. Drafting financial statements.
B. Monitoring revenue transactions.
C. Providing management reports to the controller.
D. Providing suggestions for operational improvement.

76. Auditors will examine significant sales returns immediately subsequent to the period under audit in order to
do which of the following? 
A. Substantiate cutoff and the occurrence of net sales transactions.
B. Test the sufficiency of cash balances to cover refunds.
C. Monitor customer satisfaction for disclosure.
D. Assess the nature of procedures that will be performed for the next period's audit.

77. The auditor of the revenue cycle of ABC Company computes an estimate of ABC's allowance for doubtful
accounts and compares it to the estimate provided by ABC's management. The purpose for this procedure is to
substantiate which assertion? 
A. Existence of receivables.
B. Cutoff of receivables.
C. Valuation of receivables.
D. Rights to receivables.

 
78. What evidence is utilized by the auditor for analytical purposes in substantiating the completeness of the
allowance for bad debt estimate? 
A. Accounts receivable aging schedule.
B. Copies of checks received from customers.
C. Confirmations returned without exception.
D. Stock prices of customer companies.

79. Much of the understanding of revenue transactions for compliance with GAAP can be performed by
accomplishing which of the following tasks? 
A. Examining sales contracts and inquiry of management.
B. Confirming sales with customers.
C. Discussing the transactions with qualified members of the Financial Accounting Standards Board.
D. Comparing shipping documents with invoices.

80. The auditor traces recorded sales to invoices, sales orders and shipping documents in order to substantiate
which assertion? 
A. Cutoff.
B. Completeness.
C. Legality.
D. Occurrence.

81. In the audit of the revenue of Hiram Manufacturing Company, the auditors obtain a number of shipping
documents shortly before year-end and immediately following the year under audit. The auditors compare the
documents to the sales journal in order to test which of the following assertions? 
A. Existence of sales.
B. Presentation and disclosure of receivables.
C. Cutoff of sales transactions.
D. Completeness of receivables.

82. Completeness of revenues may be tested by the auditor through the selection of a sample of which of the
following? 
A. Shipping documents and tracing them to the sales journal.
B. Accounts receivable and tracing them to cash receipts.
C. Recorded sales transactions and tracing them to the general ledger.
D. Inventory records and tracing them to the shipping documents.

 
83. Homer and Moe, PC are auditing the financial statements of Lyoncraft, Inc. and decide to confirm a sample
of accounts receivable. This test is performed by Homer and Moe primarily to substantiate which of the
following assertions? 
A. Existence of related party transactions.
B. Existence of accounts receivable.
C. Obligation of debt.
D. Cutoff of the allowance for bad debt.

84. The aged accounts receivable report is utilized by the auditor to accomplish which of the following? 
A. Encourage the client to collect on receivables that are long past due.
B. Select the type of confirmations that will be sent to banks.
C. Assess the adequacy of the allowance for doubtful accounts.
D. Identify debits in the receivables balance that should be reclassified to payables.

85. According to auditing standards, accounts receivable confirmations are required to be used in which of the
following situations? 
A. On every audit engagement.
B. If the client agrees in writing to the procedure.
C. If the balance is material.
D. If environmental risk is low.

86. The primary difference between positive and negative confirmations used in the audit of accounts receivable
is which of the following? 
A. The mode of response.
B. The amount of information included.
C. The control of the confirmation process by the auditor.
D. The level of assurance provided.

87. For which of the following accounts receivable customer populations would the use of negative
confirmations be most appropriate? 
A. A retail truck and trailer sales company with high inherent risk and moderate control risk over the revenue
cycle.
B. A utility company with control risk over the revenue cycle assessed high.
C. A mortgage banking company with excellent control over the purchasing cycle.
D. A cable company with control risk over the revenue cycle assessed low.

 
88. Accounts receivable confirmations usually provide strong evidence about which of the following? 
A. The existence of receivables.
B. The completeness of receivables.
C. The presentation and disclosure of receivables.
D. The obligations of receivables.

89. Confirmations that are sent to select customers asking them to review the current balance due the client as
shown on the client's statement and return the letters directly to the auditor indicating whether they agree with
the indicated balance, are known by which of the following terms? 
A. Direct confirmations.
B. Indirect confirmations.
C. Positive confirmations.
D. Negative confirmations.

90. Which one of the following procedures would be considered improper by the auditor in the process of
confirming receivables? 
A. The auditor allows the client's staff to prepare the confirmation letters after the auditor has chosen the items
to be confirmed.
B. The auditor allows the client to sign the confirmations after they are prepared.
C. The auditor allows the client's staff to mail the confirmation letters after he or she has proofed the typing of
the letters.
D. The auditor asks the addressee to return the confirmation to the audit firm's office.

91. An auditor's examination of the sales account using a cut-off test would most likely detect which of the
following? 
A. Kiting.
B. Sales that should be deferred.
C. Lapping of accounts receivable.
D. Sales recorded in the wrong period.

92. Alternative procedures that would provide evidence of the existence of receivables would include which of
the following? 
A. Physical observation of customer facilities.
B. Review of subsequent collections.
C. Analysis of the aged trial balance.
D. A confirmation to the client management for customer accounts.

 
93. Auditors are concerned with the addresses provided for customers in the confirmation of accounts
receivable because of which of the following reasons? 
A. Confirmations are selected based upon zip codes.
B. A P.O. Box is more reliable than a street address.
C. Confirmations should be sent only to business addresses and not residential.
D. The address may be routed to the client for retrieval and fraudulent signing.

94. Unreturned positive confirmations for accounts receivable warrant which of the following actions? 
A. Replacing the sample selection with a new customer.
B. Sending second requests and possibly performing subsequent procedures.
C. The projection of larger misstatements to the population.
D. Requesting that the client send additional audit correspondence to customers.

95. An example of alternative procedures for the confirmation of accounts receivable includes which of the
following actions? 
A. Inquiry of management.
B. Tracing source documents to recorded amounts.
C. Review of subsequent collections on account by the client.
D. Providing an estimate of the allowance for doubtful accounts to be recorded by the client.

96. A key indicator of fraud in the revenue cycle is the auditor's detection of which of the following? 
A. Customer collections that are over 90 days past due.
B. Credit entries in customer accounts receivable for authorized writeoffs.
C. Recurring entries in the sales journal.
D. Altered shipping documents and invoices.

97. In the audit of accounting estimates, such as the allowance for doubtful accounts, the auditor strives to
provide reasonable assurance about which of the following? 
A. All material accounting estimates have been developed properly.
B. The estimates are reasonable.
C. The estimates are presented in accordance with GAAP.
D. All of the above are true.

98. The allowance for doubtful accounts will not be precise by either the client or the auditor because of which
of the following reasons? 
A. It is an accounting estimate based upon judgment.
B. GAAP is not clear on the calculation of the allowance.
C. It is merely a reserve that is reversed by the client as income is needed for profitable results.
D. The precision is determined by the results of confirmation responses.

 
99. To determine whether any accounts receivable are pledged or assigned to others, the auditor would most
likely perform which of the following procedures? 
A. Examine subsequent collections.
B. Test a sample of transactions to the general ledger.
C. Review loan agreements and board of directors' meeting minutes.
D. Derive an independent estimate of the allowance and compare it to pledged assets.

100. Which of the following criteria must be met in order to recognize revenue in the current accounting
period? 
A. Delivery has occurred or the services have been rendered.
B. Price is fixed or determinable.
C. Collectibility if reasonably assured.
D. All of the above.

101. Management has been found involved in many fraudulent schemes; a common one is “channel
stuffing.” What does “channel stuffing” involve? 
A. Overly complex transactions.
B. Growth through stock acquisitions.
C. Shipment of goods not ordered.
D. Management compensation schemes.

102. Which of the following is not a form of ratio analysis? 

A. Turnover of receivables.
B. Monthly sales analysis compared with past years.
C. Gross margin analysis.
D. Sales in last month to total sales.

103. Sources of audit planning information may come from which of the following? 
A. Knowledge of client’s business and industry.
B. Assessment of risk of material misstatement.
C. Results of analytical procedures.
D. All of the above.

104. Which of the following audit procedures does not address existence/occurrence for accounts receivables
and sales? 
A. Trace bill of lading to sales invoice and sales journal.
B. Confirm balances of unpaid invoices with customers.
C. Examine subsequent collection.
D. Scan sales journal for duplicate entries.

 
105. Which of the following audit procedures does not address the rights, presentation and disclosure assertion
for pledged, discounted, assigned, and related-party accounts receivable? 
A. Review work performed in other audit areas.
B. Inquire of management.
C. Review adequacy of allowance for doubtful accounts.
D. Review loan agreements.

106. A sample of positive confirmations is mailed for material accounts receivable balances. Frequently there is
a lack of response. Which of the following is not an acceptable alternative procedure? 
A. Subsequent collection.
B. Inquiry of management.
C. Mailing second and third confirmations.
D. Examination of supporting documents.

107. Internal control over the revenue cycle

White Floyd, Inc., a retail store, is concerned about the lack of control procedures over the recording of sales
transactions. The company is concerned that the transactions might not be recorded accurately and valued
properly in accordance with GAAP. Recommend control procedures to help ensure that transactions are
recorded accurately and valued properly. 

 
 

108. Control over completeness for the revenue cycle

What control procedures should be implemented to ensure the completeness objective is met with respect to
sales? 

 
 
109. Accounts receivable risks

In the financial statements, there are many risks associated with an audit that must be considered. Identify and
discuss five separate risks that may exist related to accounts receivable. 

 
 

110. Substantive procedures for sales and receivables assertions

The auditor for Knowles, Inc. is attempting to determine whether the recorded sales and accounts receivable are
supported by valid transactions. Identify the assertions being tested and develop the substantive procedures to
be used to satisfy the auditor's objectives. 

 
 

111. Accounts receivable presentation and disclosure

Develop a list of substantive tests to test whether pledged, discounted, assigned, and related-party accounts
receivable are properly disclosed. 

 
 
112. Improper revenue recognition

Historically the accounting profession has come under fire for fraudulent financial reporting due to questionable
improper revenue recognition. Identify at least six examples of questionable revenue recognition practices that
an auditor must consider in performing an audit engagement. 

 
 

113. Analytical Procedures

Explain ratio analysis as an analytical procedure used by auditor. Give examples of the ratios that auditor might
want to compute for revenue cycle accounts. 

 
 

114. Requirements for confirming accounts receivable

Confirmation of accounts receivable is required under GAAS unless certain conditions exist. Identify the
conditions that will be present in an audit that does not confirm accounts receivable. 

 
 
115. Confirmations of receivables

You are the auditor of Maple Bank for the year 2010. Maple has a large number of customers with consumer
loan accounts. The loan accounts have balances averaging $800 in a homogeneous population and the
customers usually pay close attention to their balances.

Your preliminary assessment of internal control over the loan area is that control risk is low and results of tests
of controls support that assessment. Inherent risk is deemed to be lower as well.

Discuss the confirmation process and the types of confirmations that may be used for the audit of Maple Bank.
Which confirmation type would you select for Maple and why? 

 
 

116. Confirmations of receivables at an interim date

When internal controls are strong, the auditor may decide to confirm receivables before year end. Roll-forward
procedures are then used to obtain adequate evidence for the roll-forward period. Discuss why the auditor
would want to confirm receivables before balance sheet date, the risks involved, and at least three of the roll-
forward procedures that the auditor performs to gain assurance on the roll-forward period. 

 
 
Chapter 9: Auditing the Revenue Cycle Key
 

1. The revenue cycle considered by auditors includes the sales process but not collections. 
FALSE

2. The revenue cycle involves the procedures in generating a sales order, shipping the products, recording the
transaction and collecting the receivable. 
TRUE

3. The shipping department confirms the shipment of goods by completing the packing slip and returning it to
the purchasing department. 
FALSE

4. Monthly statements provide a detailed list of the customer’s activity for the previous month and a statement
of all open items. 
TRUE

5. Invoices are processed, including their mailing to customers, only subsequent to proof of valid delivery to
customers. 
TRUE

6. The use of prenumbered sales invoices is the primary control procedure to satisfy the objective of
authorization. 
FALSE

7. A comprehensive chart of accounts and a review of complex or unusual transactions by supervisory
personnel are control procedures necessary for proper classification of accounts. 
TRUE

 
8. Formal procedures for approving acceptance of returns that are beyond the warranty period are an appropriate
control procedure for identifying and recording returned goods. 
TRUE

9. One of the benefits of establishing a formal credit policy for granting credit is that management is freed from
the burden of monitoring accounts receivable. 
FALSE

10. Monitoring of the revenue cycle may be accomplished partially through the use of exception reporting. 
TRUE

11. An appropriate mix of evidence for a low risk client could include 20% tests of details, 40% analytics, and
40% tests of controls; an appropriate mix of evidence for a high risk client could include 60% tests of details,
20% analytics, and 20% tests of controls. 
TRUE

12. The audit team is required by auditing standards to make an ordinary presumption of the risk of fraud due to
revenue misstatements on every engagement. 
TRUE

13. A company that ships a large quantity of its products from its manufacturing plant to a warehouse that it
leases until the customer is ready for the product should record the delivery as revenue. 
FALSE

14. The intentional loading of sales at the end of a period to customers that do not need the goods at that time
should not be recorded as revenues. 
TRUE

15. All companies attempting to comply with GAAP should refer to the Securities and Exchange Commission
for guidance as it supersedes all AICPA, PCAOB, FASB and EITF literature. 
FALSE

 
16. A certain tendency for fraud exists when stock options are close to becoming exercised by executives and
financial personnel. 
TRUE

17. A red flag that may alert the auditor to fraud in the revenue cycle is a trend of revenue growth that is
consistent with industry results. 
FALSE

18. Financial accounting personnel who do not have the proper education, experience and backgrounds may
signal the auditor to the risk of financial statement fraud. 
TRUE

19. The auditor of James Corporation should be alert to the risk of material misstatements when James
Corporation's cash flows from operations are negative and net income (rather than loss) is reported. 
TRUE

20. Ratio analysis performed by the audit team may include the comparison of gross sales to industry averages
and previous periods. 
FALSE

21. The auditor's determination that day's sales in accounts receivable increased from 44 days to 100 days
would usually be found through the use of ratio analysis. 
TRUE

22. Edge and Gregg, LLP would most likely discover channel stuffing in the financial statements of a client
through the use of trend analysis. 
TRUE

23. Use of reasonableness tests by Bono Mullins, PC will include relationships between financial but not non-
financial data. 
FALSE

 
24. The auditor has determined that the control risk for the existence assertion is low; therefore the auditor may
reduce the number of items tested on a substantive basis. 
TRUE

25. Confirmations of bank accounts may help the auditor to determine if material amounts of accounts
receivable have been pledged or discounted. 
TRUE

26. When the auditor seeks evidence concerning the allowance for doubtful accounts he or she would most
likely use an aged trial balance to help identify past due balances. 
TRUE

27. Current auditing standards do not require the confirmation of receivables if accounts receivable are not
material. 
TRUE

28. Accounts receivable confirmation letters should be prepared on the auditing firm's letterhead. 
FALSE

29. Alternative procedures to the confirmation of receivables include review of subsequent collections and
examination of supporting evidence. 
TRUE

30. Lapping of accounts receivable is least likely to occur when there is an inadequate segregation of duties. 
FALSE

31. Positive accounts receivable confirmations should be used on all accounts which represent small immaterial
balances. 
FALSE

 
32. When the client has a large number of relatively small accounts receivable and the assessed level of control
risk for receivables and related revenue transactions is high, the auditor is more likely to use negative
confirmations. 
FALSE

33. The auditor would examine a sample of sales transactions throughout the entire period to determine if sales
were recorded in the proper period when performing a sales cutoff test. 
FALSE

34. An example of a control over the sales cycle is the authorization of price lists by the appropriate sales and
marketing manager. 
TRUE

35. An auditor would test control over the objective of the occurrence of sales transactions by sampling
recorded revenues and tracing them back to invoices and shipping documents. 
TRUE

36. If control risk is assessed high, the auditor may send significantly fewer confirmations for a sample of
accounts receivable than if the control risk is assessed low. 
FALSE

37. In planning an audit for the revenue cycle, the auditor must realize the integrated relationship of evidence
found between the accounts receivable and the notes payable accounts. 
FALSE

38. A method of testing for the completeness of sales is to test the sequence of sales invoices used during the
period under audit. 
TRUE

39. A review of the terms of client debt agreements assists the audit of the presentation and disclosure assertion
for accounts receivable. 
TRUE

 
40. The use of audit software makes the audit of the revenue cycle more effective, but not more efficient. 
FALSE

41. Testing cutoff involves procedures applied to sales transactions selected from those recorded immediately
prior to period end and immediately following period end. 
TRUE

42. Valid evidence obtained in an audit for testing the cutoff of gross sales includes receiving reports for
returned merchandise. 
FALSE

43. An example of a test for completeness in the revenue cycle includes the sampling of shipping documents
and tracing them to the sales journal and general ledger. 
TRUE

44. Negative confirmations are used as an appropriate test with statistical sampling techniques. 
FALSE

45. Exceptions found in the confirmations of accounts receivable balances need not be projected as errors to the
population as they are typically isolated errors. 
FALSE

46. A timing difference type of exception in the confirmation process may include a misunderstanding by the
reader as to the date being confirmed. 
TRUE

47. Negative confirmations are considered to be more persuasive than positive confirmations. 

FALSE

48. The purpose of summarizing confirmation results is to list the extent of sales tested in relation to the
response rate. 
FALSE

 
49. An auditor's primary concern with identifying related party sales and receivables rests with the presentation
and disclosure assertion. 
TRUE

50. Customer complaints noted in returned accounts receivable confirmations may be an indicator of fraud. 
TRUE

51. The audit team typically reviews journal entries in the receivables ledger for unusual entries that may be
indicators of fraudulent activity. 
TRUE

52. Estimation of the allowance for doubtful accounts is a simple management decision as it is determined as a
percentage of sales. 
FALSE

53. The auditor will come up with an independent estimation of the allowance for doubtful accounts based on a
thorough understanding of the client and the client's business that is compared to the recorded allowance. 
TRUE

54. It is beneficial in the testing of notes receivable to confirm not only the balance of the notes, but also their
terms. 
TRUE

55. The most important control to ensure completeness of sales and shipping is pre-numbered shipping and
billing documents. 
TRUE

56. An aging of accounts receivable is useful in estimating the reasonableness of the allowance for doubtful
accounts. 
TRUE

 
57. Which of the following processes are included in the revenue cycle? 
A. Shipping products to customers.
B. Sending disbursements to suppliers.
C. Issuance of capital stock.
D. Preparation of a time card.

58. Which of the following is the best example of the control objective in the revenue cycle that all transactions
are recorded accurately? 
A. Sales are recorded at the invoice price expected to be collected from customers.
B. Sales orders have sequential numbering.
C. Recorded sales transactions are evidenced by valid invoices and shipping documents.
D. Credits to customer accounts are classified as liabilities.

59. The relationship between the sales cycle and an inventory system can best be noted in which of the
following examples? 
A. Credit is established prior to completion of a sales order.
B. Invoices are sent to customers only after shipment is evidenced.
C. Availability of products ordered are verified prior to processing a sale.
D. Billing information is added to the database for new customers.

60. Credit approval policies are implemented by organizations primarily to accomplish which of the following
objectives? 
A. To determine revenue recognition policies.
B. To ensure customer satisfaction.
C. To prevent lapping by the accounts receivable department.
D. To ensure the realization of receivables.

61. Sales transactions should be documented at initiation in order to accomplish which of the following
objectives? 
A. To provide the customer a copy of the transaction.
B. To provide evidence of authorization and recording.
C. To offer credit to customers.
D. To generate back orders.

62. The significance of the bill of lading is to provide which of the following? 

A. The warehouse personnel with the product that must be shipped to customers.
B. Invoices to customers for proper collection.
C. A credit application for customer approval.
D. Evidence of title transfer of goods to customers.

 
63. The risk of material misstatement due to fraud relating to revenue recognition should be 
A. approached in a manner that is identical to control risk assessment.
B. given lower priority to the risk of embezzlement.
C. ordinarily presumed by the auditor.
D. assumed to have been considered by the FASB.

64. A method used by companies to fraudulently inflate revenues includes which of the following? 
A. Use of hidden “side letters” giving the customer an irrevocable right to return the product.
B. Recording of fictitious sales.
C. Shipment of product not ordered by customers.
D. All of the above.

65. Which of the following evidences delivery of product to customers sufficient for company recording as
revenues? 
A. A check received from the customer.
B. An agreement to purchase product signed by the customer.
C. A pick ticket in the warehouse.
D. A bill of lading and tracking number with the shipper.

66. Which of the following must exist prior to the recognition of revenue by a company from the sale of a
product? 
A. The cash is realized on the sale of the product.
B. A price is discussed based upon the customer's resale of the product.
C. The customer is given the option to return the product at any time.
D. The product is adequately delivered to the customer.

67. Fraud related to revenue recognition will most likely be identified by the auditor through which of the
following independent situations? 
A. Sales have increased 5% in the current period over the previous period and is consistent with the results of
competitors.
B. Gross margin is equivalent in the current period to previous periods and is below that of the industry.
C. Sales are higher in the month preceding each quarter end.
D. The sales of a revolutionary new product are increasing beyond that of the competition in the periods
immediately following its introduction.

 
68. Calculating the turnover of receivables is often used in testing the sales cycle by auditors when performing
which of the following? 
A. Trend analysis.
B. Ratio analysis.
C. Reasonableness testing.
D. Non-statistical sampling.

69. Hardman and Jennings, LLP, an audit firm, compares bad debt expense of a client in the current period to
bad debt recorded for the past three periods. Hardman and Jennings is performing which type of analysis? 
A. Trend.
B. Ratio.
C. Critical.
D. Reasonableness.

70. Lithgow and Harris, CPAs are performing the audit of WildFlower Grocery Stores. Lithgow and Harris
relates annual revenue by sales per square feet and sales per customer. What type of analysis is Lithgow and
Harris most likely performing? 
A. Ratio analysis.
B. Critical analysis.
C. Reasonableness tests.
D. Non-statistical analysis.

71. In an audit of financial statements, the risk of the high rate of return of products sold includes relates to
which of the following? 
A. Sales that are recorded improperly.
B. An estimate of accrued returns that reduces net income.
C. A reduction of net sales for an increase to the sales returns and allowance account.
D. Consignment goods that are returned and forwarded to third parties.

72. The major risk associated with receivables is related to which of the following? 
A. They may be sold to a bank with recourse.
B. They may be recorded as long-term when in fact they will be realized in the current period.
C. They will not be realized for the entire amount due.
D. They are pledged as collateral as disclosed in the footnotes to financial statements.

 
73. Which of the following is a proper control for the detection of unusual sales transactions recorded in the
general ledger? 
A. Electronic authorization prior to posting.
B. Use of sequentially numbered sales documents.
C. Random statements to customers.
D. Review of transactions by upper management or the board.

74. A control that may be implemented to ensure all sales that occur are recorded in the general ledger includes
which of the following? 
A. Use of prenumbered shipping, invoice and sales documents.
B. Use of prenumbered statements, inventory lists and credit memos.
C. Reconciliation of invoices with customer statements.
D. Use of pre-authorized price lists.

75. The internal audit department at Monument Company receives electronic exceptions reports for all sales
transactions entered over $10,000 in total. This process is performed for which purpose? 
A. Drafting financial statements.
B. Monitoring revenue transactions.
C. Providing management reports to the controller.
D. Providing suggestions for operational improvement.

76. Auditors will examine significant sales returns immediately subsequent to the period under audit in order to
do which of the following? 
A. Substantiate cutoff and the occurrence of net sales transactions.
B. Test the sufficiency of cash balances to cover refunds.
C. Monitor customer satisfaction for disclosure.
D. Assess the nature of procedures that will be performed for the next period's audit.

77. The auditor of the revenue cycle of ABC Company computes an estimate of ABC's allowance for doubtful
accounts and compares it to the estimate provided by ABC's management. The purpose for this procedure is to
substantiate which assertion? 
A. Existence of receivables.
B. Cutoff of receivables.
C. Valuation of receivables.
D. Rights to receivables.

 
78. What evidence is utilized by the auditor for analytical purposes in substantiating the completeness of the
allowance for bad debt estimate? 
A. Accounts receivable aging schedule.
B. Copies of checks received from customers.
C. Confirmations returned without exception.
D. Stock prices of customer companies.

79. Much of the understanding of revenue transactions for compliance with GAAP can be performed by
accomplishing which of the following tasks? 
A. Examining sales contracts and inquiry of management.
B. Confirming sales with customers.
C. Discussing the transactions with qualified members of the Financial Accounting Standards Board.
D. Comparing shipping documents with invoices.

80. The auditor traces recorded sales to invoices, sales orders and shipping documents in order to substantiate
which assertion? 
A. Cutoff.
B. Completeness.
C. Legality.
D. Occurrence.

81. In the audit of the revenue of Hiram Manufacturing Company, the auditors obtain a number of shipping
documents shortly before year-end and immediately following the year under audit. The auditors compare the
documents to the sales journal in order to test which of the following assertions? 
A. Existence of sales.
B. Presentation and disclosure of receivables.
C. Cutoff of sales transactions.
D. Completeness of receivables.

82. Completeness of revenues may be tested by the auditor through the selection of a sample of which of the
following? 
A. Shipping documents and tracing them to the sales journal.
B. Accounts receivable and tracing them to cash receipts.
C. Recorded sales transactions and tracing them to the general ledger.
D. Inventory records and tracing them to the shipping documents.

 
83. Homer and Moe, PC are auditing the financial statements of Lyoncraft, Inc. and decide to confirm a sample
of accounts receivable. This test is performed by Homer and Moe primarily to substantiate which of the
following assertions? 
A. Existence of related party transactions.
B. Existence of accounts receivable.
C. Obligation of debt.
D. Cutoff of the allowance for bad debt.

84. The aged accounts receivable report is utilized by the auditor to accomplish which of the following? 
A. Encourage the client to collect on receivables that are long past due.
B. Select the type of confirmations that will be sent to banks.
C. Assess the adequacy of the allowance for doubtful accounts.
D. Identify debits in the receivables balance that should be reclassified to payables.

85. According to auditing standards, accounts receivable confirmations are required to be used in which of the
following situations? 
A. On every audit engagement.
B. If the client agrees in writing to the procedure.
C. If the balance is material.
D. If environmental risk is low.

86. The primary difference between positive and negative confirmations used in the audit of accounts receivable
is which of the following? 
A. The mode of response.
B. The amount of information included.
C. The control of the confirmation process by the auditor.
D. The level of assurance provided.

87. For which of the following accounts receivable customer populations would the use of negative
confirmations be most appropriate? 
A. A retail truck and trailer sales company with high inherent risk and moderate control risk over the revenue
cycle.
B. A utility company with control risk over the revenue cycle assessed high.
C. A mortgage banking company with excellent control over the purchasing cycle.
D. A cable company with control risk over the revenue cycle assessed low.

 
88. Accounts receivable confirmations usually provide strong evidence about which of the following? 
A. The existence of receivables.
B. The completeness of receivables.
C. The presentation and disclosure of receivables.
D. The obligations of receivables.

89. Confirmations that are sent to select customers asking them to review the current balance due the client as
shown on the client's statement and return the letters directly to the auditor indicating whether they agree with
the indicated balance, are known by which of the following terms? 
A. Direct confirmations.
B. Indirect confirmations.
C. Positive confirmations.
D. Negative confirmations.

90. Which one of the following procedures would be considered improper by the auditor in the process of
confirming receivables? 
A. The auditor allows the client's staff to prepare the confirmation letters after the auditor has chosen the items
to be confirmed.
B. The auditor allows the client to sign the confirmations after they are prepared.
C. The auditor allows the client's staff to mail the confirmation letters after he or she has proofed the typing of
the letters.
D. The auditor asks the addressee to return the confirmation to the audit firm's office.

91. An auditor's examination of the sales account using a cut-off test would most likely detect which of the
following? 
A. Kiting.
B. Sales that should be deferred.
C. Lapping of accounts receivable.
D. Sales recorded in the wrong period.

92. Alternative procedures that would provide evidence of the existence of receivables would include which of
the following? 
A. Physical observation of customer facilities.
B. Review of subsequent collections.
C. Analysis of the aged trial balance.
D. A confirmation to the client management for customer accounts.

 
93. Auditors are concerned with the addresses provided for customers in the confirmation of accounts
receivable because of which of the following reasons? 
A. Confirmations are selected based upon zip codes.
B. A P.O. Box is more reliable than a street address.
C. Confirmations should be sent only to business addresses and not residential.
D. The address may be routed to the client for retrieval and fraudulent signing.

94. Unreturned positive confirmations for accounts receivable warrant which of the following actions? 
A. Replacing the sample selection with a new customer.
B. Sending second requests and possibly performing subsequent procedures.
C. The projection of larger misstatements to the population.
D. Requesting that the client send additional audit correspondence to customers.

95. An example of alternative procedures for the confirmation of accounts receivable includes which of the
following actions? 
A. Inquiry of management.
B. Tracing source documents to recorded amounts.
C. Review of subsequent collections on account by the client.
D. Providing an estimate of the allowance for doubtful accounts to be recorded by the client.

96. A key indicator of fraud in the revenue cycle is the auditor's detection of which of the following? 
A. Customer collections that are over 90 days past due.
B. Credit entries in customer accounts receivable for authorized writeoffs.
C. Recurring entries in the sales journal.
D. Altered shipping documents and invoices.

97. In the audit of accounting estimates, such as the allowance for doubtful accounts, the auditor strives to
provide reasonable assurance about which of the following? 
A. All material accounting estimates have been developed properly.
B. The estimates are reasonable.
C. The estimates are presented in accordance with GAAP.
D. All of the above are true.

98. The allowance for doubtful accounts will not be precise by either the client or the auditor because of which
of the following reasons? 
A. It is an accounting estimate based upon judgment.
B. GAAP is not clear on the calculation of the allowance.
C. It is merely a reserve that is reversed by the client as income is needed for profitable results.
D. The precision is determined by the results of confirmation responses.

 
99. To determine whether any accounts receivable are pledged or assigned to others, the auditor would most
likely perform which of the following procedures? 
A. Examine subsequent collections.
B. Test a sample of transactions to the general ledger.
C. Review loan agreements and board of directors' meeting minutes.
D. Derive an independent estimate of the allowance and compare it to pledged assets.

100. Which of the following criteria must be met in order to recognize revenue in the current accounting
period? 
A. Delivery has occurred or the services have been rendered.
B. Price is fixed or determinable.
C. Collectibility if reasonably assured.
D. All of the above.

101. Management has been found involved in many fraudulent schemes; a common one is “channel
stuffing.” What does “channel stuffing” involve? 
A. Overly complex transactions.
B. Growth through stock acquisitions.
C. Shipment of goods not ordered.
D. Management compensation schemes.

102. Which of the following is not a form of ratio analysis? 

A. Turnover of receivables.
B. Monthly sales analysis compared with past years.
C. Gross margin analysis.
D. Sales in last month to total sales.

103. Sources of audit planning information may come from which of the following? 
A. Knowledge of client’s business and industry.
B. Assessment of risk of material misstatement.
C. Results of analytical procedures.
D. All of the above.

104. Which of the following audit procedures does not address existence/occurrence for accounts receivables
and sales? 
A. Trace bill of lading to sales invoice and sales journal.
B. Confirm balances of unpaid invoices with customers.
C. Examine subsequent collection.
D. Scan sales journal for duplicate entries.

 
105. Which of the following audit procedures does not address the rights, presentation and disclosure assertion
for pledged, discounted, assigned, and related-party accounts receivable? 
A. Review work performed in other audit areas.
B. Inquire of management.
C. Review adequacy of allowance for doubtful accounts.
D. Review loan agreements.

106. A sample of positive confirmations is mailed for material accounts receivable balances. Frequently there is
a lack of response. Which of the following is not an acceptable alternative procedure? 
A. Subsequent collection.
B. Inquiry of management.
C. Mailing second and third confirmations.
D. Examination of supporting documents.

107. Internal control over the revenue cycle

White Floyd, Inc., a retail store, is concerned about the lack of control procedures over the recording of sales
transactions. The company is concerned that the transactions might not be recorded accurately and valued
properly in accordance with GAAP. Recommend control procedures to help ensure that transactions are
recorded accurately and valued properly. 

Control procedures that should be implemented to ensure that sales transactions are properly recorded are:

· Sales orders are filled by authorized personnel following an authorized price catalog.
· Sales prices are to be maintained on the computer and access to the computer file is restricted to those authorized to change it.
· Internal audit department periodically should perform tests of sales invoices to see if the terms agree with authorized price lists.
· Executive approval should be required of all large, unusual, or complex sales transactions.
· Oral or written verification of prices with customers should be required for all nonstandard sales.
· Products shipped and billed must be checked against an existing product list.

108. Control over completeness for the revenue cycle

What control procedures should be implemented to ensure the completeness objective is met with respect to
sales? 

Control procedures to ensure that the objective of completeness is met for the revenue accounts are:

· Prenumbered shipping and invoice documents should be used and accounted for periodically.
· Online computer input of all transactions and independent logging of the transactions should be created for subsequent use in performing
reconciliations.
· Recorded transactions should be reviewed periodically, compared with budgets, and variances investigated.
· Monthly statements should be mailed regularly to customers.
· Subsidiary ledgers should be reconciled periodically to the general ledger and any differences investigated.
· A separate department should investigate all customer accounts receivable inquiries.

 
109. Accounts receivable risks

In the financial statements, there are many risks associated with an audit that must be considered. Identify and
discuss five separate risks that may exist related to accounts receivable. 

Potential risks associated with accounts receivable include:

· Sales of receivables made with recourse and recorded as sales transactions rather than financing transactions.
· Receivables pledged as collateral against specific loans with restricted use. Disclosures of such restrictions are required.
· Receivables incorrectly classified as current when the likelihood of collection during the next year is low.
· Collection of a receivable contingent on specific events that cannot currently be estimated.
· Payment is not required until the purchaser sells the product to its end customers.

110. Substantive procedures for sales and receivables assertions

The auditor for Knowles, Inc. is attempting to determine whether the recorded sales and accounts receivable are
supported by valid transactions. Identify the assertions being tested and develop the substantive procedures to
be used to satisfy the auditor's objectives. 

The auditor is testing the existence and occurrence assertion as the concern is from recorded amounts in the
direction of source documents and transactions. The auditor would most likely perform the following
substantive procedures:

· confirm balances or invoices with customers based on a sample that is representative of the receivables (and possibly sales) population.
· send second and possibly third confirmation requests.
· examine subsequent collections on account for receivables.
· scan sales journal for duplicate entries.
· trace recorded amounts of sales and receivables to customer sales invoices, orders and bills of lading

111. Accounts receivable presentation and disclosure

Develop a list of substantive tests to test whether pledged, discounted, assigned, and related-party accounts
receivable are properly disclosed. 

The substantive procedures that would be used to determine whether all appropriate disclosures are made
concerning accounts receivable and sales would include the following:

· obtain confirmations from banks and financial institutions.

· inquire of management.
· review work performed in other audit areas.
· review trial balance of accounts receivable for related parties.
   

 
112. Improper revenue recognition

Historically the accounting profession has come under fire for fraudulent financial reporting due to questionable
improper revenue recognition. Identify at least six examples of questionable revenue recognition practices that
an auditor must consider in performing an audit engagement. 

Questionable and improper revenue recognition practices would include:

· recording of sales in earlier periods, including channel stuffing.

· recording sales under "bill and hold" agreements, that is, recording a sale but not shipping the goods or shipping at a later date, pending
customer approval.
· recording shipments to the company's own warehouse as sales to a customer.
· undisclosed side agreements with customers giving them an unconditional right to return the product.
· shipment of unfinished product or shipment before agreed to by customer(s).
· over-shipment of products
· recording consignment sales as final sales.
· recording sales with rights of return when the likelihood of return is high without a proper corresponding estimate for returns.
· recording the entire amount of transactions involving operating leases up-front as sales transactions.
· recording fictitious sales that never occurred.
· shipping used goods that were previously returned as new.
· applying revenue recognition principles improperly and aggressively.

113. Analytical Procedures

Explain ratio analysis as an analytical procedure used by auditor. Give examples of the ratios that auditor might
want to compute for revenue cycle accounts. 

Ratio analysis is useful in highlighting account balances that are out of line or different from reasonable
expectations. Ratios can be compared across time for a client, as well as compared with the industry ratios. The
approach to ratio analysis is similar to what a financial analyst would perform in examining a financial
statement. Auditors might want to compute ratios like:
*Gross margin analysis, including a comparison with industry averages and previous year’s averages for the
client
*Turnover of receivables (ratio of credit sales to average net receivables) or the number of days’ sales in
accounts receivable
*Average balance per customer
*Receivables as a percentage of current assets
*Aging of receivables
*Allowance for uncollectible accounts as a percentage of accounts receivable
*Bad debt expense as a percentage of net credit sales
*Sales in the last month to total sales
*Sales discounts to credit sales
*Returns and allowances as a percentage of sales

 
114. Requirements for confirming accounts receivable

Confirmation of accounts receivable is required under GAAS unless certain conditions exist. Identify the
conditions that will be present in an audit that does not confirm accounts receivable. 

The auditor is required to confirm accounts receivable unless one of the following conditions exist:

· Accounts receivable are not material (or there are no receivables).

· The use of confirmations would be ineffective (recipients would not give full consideration).
· The auditor's combined assessment of inherent risk and control risk is low, and that assessment, in conjunction with the evidence provided
by other substantive tests, is sufficient to reduce audit risk to an acceptably low level.

 
115. Confirmations of receivables

You are the auditor of Maple Bank for the year 2010. Maple has a large number of customers with consumer
loan accounts. The loan accounts have balances averaging $800 in a homogeneous population and the
customers usually pay close attention to their balances.

Your preliminary assessment of internal control over the loan area is that control risk is low and results of tests
of controls support that assessment. Inherent risk is deemed to be lower as well.

Discuss the confirmation process and the types of confirmations that may be used for the audit of Maple Bank.
Which confirmation type would you select for Maple and why? 

Auditors may select positive or negative confirmations depending on the circumstances. Positive confirmations
are used in most situations where the client customer is asked to respond to the request in writing whether they
agree of disagree with its contents. Negative confirms, on the other hand are only returned by the client
customer if they disagree with the information listed. Negative confirmations may also only be used in certain
situations. In the case of Maple Bank, an argument could be made for either form of confirmation to
substantiate certain assertions relating to the loan receivable balances. Positive confirmations could be used
with statistical sampling methods; however the auditor may forgo efficiency because of the tedious nature of
positive form confirmation. Negative confirmations may be used if it is concluded that the balances represent a
large number of bank customers and are small, environmental risk is assessed low and the customer is expected
to give full consideration to the request. It may be a good idea for the auditor to use negative form
confirmations in the case of Maple as consumer loans are usually smaller in balance ($800 average), the
balances represent a large base of customers, and control risk and inherent risk are lower. The banking
customers may be also be expected to read the confirmation and to check it against their balances. This form,
however, may not be used with statistical methods of selecting the sample and projecting errors.

{Note: A student may also conclude that the balances are not small enough to use negative confirmations. This
assessment is judgmental in nature and more information and experience would be needed to make this
determination. The objective of this essay is to assess the student's understanding of positive versus negative
confirmations and the confirmation process.}

The auditor must also keep control of the confirmations as the sample is selected; confirmations are prepared,
mailed and then returned to the audit firm location. Though the confirmation may be on client letterhead and
signed by the appropriate officer, the auditor will mail the confirmations and offer a return envelope addressed
to the audit firm offices.

The auditor will also prepare a confirmation summary if positive confirmations are selected. This summary will
assist the auditor in monitoring the extent of exceptions, including errors, and following up on such matters and
non-returned confirmation letters. It will also be used in determining the extent of misstatements found in the
sample for projection back to the population.

 
116. Confirmations of receivables at an interim date

When internal controls are strong, the auditor may decide to confirm receivables before year end. Roll-forward
procedures are then used to obtain adequate evidence for the roll-forward period. Discuss why the auditor
would want to confirm receivables before balance sheet date, the risks involved, and at least three of the roll-
forward procedures that the auditor performs to gain assurance on the roll-forward period. 

The auditor usually prefers to perform as many audit procedures as possible before balance sheet date in order
to better spread out the work since many clients have a December 31 year-end. However, collecting evidence
before year-end increases the risk that the account may be materially misstated since the evidence is collected
before the completion of the entire year. As a result the auditor has to perform a cost/benefit analysis as to
whether it is beneficial to gather evidence at the interim. If there are good controls and a high degree of
reliability can be achieved using roll-forward procedures for the roll-forward period then performing
confirmations at the interim makes sense, e.g., with property, plant and equipment accounts. Depending upon
their materiality and risk of misstatement, confirming receivables at the interim may or may not be a useful
procedure since there may be no reduction of work after the balance sheet date. The auditor is responsible to
gather sufficient, competent evidence for the entire fiscal year, not just up to the roll forward period.

If the auditor decides that it is useful to confirm receivables at the interim, the evidence must be collect to extent
that conclusion to the year-end. Common roll forward procedures to do this are:

* Compare individual balances at the interim with the year-end and confirm any that have  substantially
increased.

* Compare monthly sales, collection, sales discounts, and sales returns and allowances during the roll forward
period with those for prior months and prior years to see if they appear out of line, in which case corroborative
evidence of management’s explanation has to be collected.

* Reconcile receivable subsidiary records to the general ledger at both the interim and the year-end dates.

* Test the cut-off of sales, cash collections, and credit memos for returns and allowances at year-end.

* Scan journals to identify receivables postings from unusual sources and investigate unusual items.

* Compute the number of days’ sales in receivables at both the confirmation date and year-end, and compare
these data with each other and with data from prior periods.

* Compute the gross profit percentage during the roll-forward period, and compare that to the percentage for the
year and for prior periods.