Chapter 12 Audit of The Revenue Cycle: Auditing, 14e (Arens)

Auditing, 14e (Arens)
Chapter 12 Audit of the Revenue Cycle
12.1 Identify the accounts and the classes of transactions in the revenue cycle
1) The two primary classes of transactions in the sales and collection cycle are
A) sales and sales returns.
B) sales and sales discounts.
C) sales and accounts receivable.
D) sales and cash receipts.
Answer: D
Diff: 1 Type: MC Page Ref: 391-392
Learning Obj.: 12-1 Identify the accounts and the classes of transactions in the revenue cycle
2) What are the six classes of transactions in the revenue cycle and what entries relate to each class of
transactions?
Answer: The six classes of transactions in the revenue cycle are:
1) sales (cash and sales on account net of cash discounts taken): cr sales, dr accounts receivable and cash
discounts taken.
2) cash receipts: dr cash in bank, cr accounts receivable.
3) sales returns and allowances: dr sales returns and allowances, cr accounts receivable.
4) charge-off of uncollectible accounts: cr accounts receivable, dr allowance for uncollectible accounts.
5) bad-debt expense: dr bad-debt expense, cr allowance for uncollectible accounts.
6) master file changes: no effect on general ledger accounts; effect is on master files.
Diff: 3 Type: ES Page Ref: 391-392
Learning Obj.: 12-1 Identify the accounts and the classes of transactions in the revenue cycle
12.2 Describe the business functions, documents, and records of the revenue cycle
1) Which of the following data elements would be included in the customer master file?
A) transaction date
B) credit limit
C) transaction amount
D) amount paid
Answer: B
Diff: 3 Type: MC Page Ref: 393
Learning Obj.: 12-2 Describe the business functions, documents, and records of the revenue cycle
2) Before goods are shipped on account to a new customer, a properly authorized person must
A) prepare the sales invoice.
B) approve the journal entry.
C) approve credit.
D) verify that the unit price is accurate.
Answer: C
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3) Poor controls over credit limit approval or in changing the credit limit in the master file may result in
A) confused and frustrated customers.
B) incomplete sales records.
C) financial statement errors for sales and AR accounts.
D) excessive bad debts and uncollectible accounts receivable.
Answer: D
4) Which of the following control weaknesses could result in problems with collectability of accounts
receivable?
A) Unauthorized individuals can establish or change credit limits.
B) Matching shipping documents to sales records is done weekly.
C) When there is one error in a batch of transactions, the whole batch is rejected.
D) Cash receipts are matched to the customer accounts rather than against specific invoices.
Answer: A
5) A document prepared for shipment of the goods sold using a trucking company is called the
A) sales order.
B) bill of lading.
C) sales invoice.
D) customer order.
Answer: B
6) Most companies recognize sales when

A) a customer order is received.
B) the merchandise is shipped.
C) the merchandise is received by the customer.
D) cash is received on account.
Answer: B
7) Which of the following documents and records is used to record the packages, weights, and sizes
shipped using an external trucking company?
A) remittance advice
B) shipping advice containing shipment tracking number
C) returns receiving report
D) bill of lading
Answer: D
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8) A document sent to each customer showing his or her beginning accounts receivable balance and the
amount and date of each sale, cash payment received, credit memo issued, and the ending balance is the
A) accounts receivable subsidiary ledger.
B) monthly statement.
C) remittance advice.
D) sales invoice.
Answer: B
9) Some companies use a lockbox system, whereby customers mail payments to a post office box address.
The lockbox contents could be handled by a bank, another external organization, or the owner of the
company. One of the advantages of using a lockbox is that it
A) improves segregation of duties.
B) results in more accurate bank deposits.
C) results in more accurate accounts receivables.
D) provides more detailed bank deposit information.
Answer: A
10) A document that describes which accounts receivable accounts are to be written off and why is called
a(n)
A) uncollectible account authorization form.
B) journal entry authorization form.
C) master file change form.
D) sales returns and allowances journal.
Answer: A
11) Zhang Corporation returned $6000 of defective goods to Meli Inc. Meli has a strict policy of no cash
refund. Meli should
A) write off the account receivable.
B) issue a credit memo to Zhang.
C) wait until Zhang places its next order to record the return.
D) not adjust their accounting records since $6000 is not material for Meli.
Answer: B
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12) Your audit client has many different types of accounts receivable: Canadian, American, and other
international accounts; and short- and long-term accounts. There are also some sales on consignment. The
company has used forward exchange contracts to reduce its exposure due to foreign exchange
fluctuations. How will this affect the audit engagement?
A) control risk will increase
B) inherent risks of error will decrease
C) risk of material misstatement increases
D) audit risk will be increased
Answer: C
13) The document that is used to prepare and reconcile the deposit of cash and improve control over the
custody of assets (cash) is the
A) sales invoice.
B) credit memo.
C) remittance advice.
D) cash receipts journal.
Answer: C
14) Which of the following lists outlines the best order for a typical sequence of activities in the revenue
and collection cycle?
A) delivering goods, billing customers, credit granting, collection activity
B) customer ordering, delivering goods, credit granting, collection activity
C) customer ordering, delivering goods, billing customer, cash receipts
D) credit granting, billing customers, delivering goods, cash receipts
Answer: C
15) Typical source documents involved in the revenue and collection cycle would be
A) cash disbursements.
B) vendor invoices.
C) shipping documents.
D) customer invoices.
Answer: C
16) Describe skimming.

Answer: Skimming is a common form of cash misappropriation in which the employees steal incoming
funds prior to their being recorded in the accounting records.
Diff: 3 Type: ES Page Ref: 395
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17) A) Describe the four business functions that result in sales transactions in a typical sales and collection
cycle, and state the key documents and records involved in each function.
B) State the five classes of transactions that comprise the sales and collection cycle.
C) The sales and collections cycle is comprised of nine business functions. The first four functions result
in sales transactions. Discuss the remaining four business functions that occur after sales transactions, and
identify the key documents and records involved in each of the five functions.
Answer:
A) The four business functions that result in sales transactions and their related documents and records
are:
• Processing customer orders. Key documents include customer purchase order and sales order.
• Granting credit. External credit report, credit change form, accounts receivable trial balance.
• Shipping goods. Shipping document (bill of lading), change of address form.
• Billing customers and recording sales. Sales invoice, sales journal, summary sales report, monthly
statements.
B) The five classes of transactions that comprise the sales and collection cycle are:
• sales (cash and sales on account)
• cash receipts
• sales returns and allowances
• write off of uncollectible accounts
• bad debt expense
• master file changes
C) The four business functions that occur after sales transactions, and related key documents and records,
are:
• processing and recording cash receipts: remittance advice, prelisting of cash receipts, cash receipts
transaction file, cash receipts journal or listing
• processing and recording sales returns and allowances: credit memo, sales returns and allowances
journal
• writing off uncollectible accounts receivable: uncollectible account authorization form, general journal
• providing for bad debts: general journal
• maintaining semi-permanent data: master file change form, master file change report
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12.3 Identify significant risks and assess risk of material misstatement in the revenue cycle
1) Audit risk is assessed for

A) the financial statements as a whole and is not usually allocated to various accounts or objectives.
B) the financial statements as a whole and then allocated to various accounts.
C) various accounts but not for the financial statements as a whole.
D) various accounts and objectives, and the sum is then assigned to the financial statements as a whole.
Answer: A
Learning Obj.: 12-3 Identify significant risks and assess risk of material misstatement in the revenue
cycle
2) As the quality of the enterprise risk management process declines, and the overall quality of internal
controls declines,
A) risk of fraud decreases.
B) risk of fraud increases.
C) the extent of control testing increases.
D) the extent of substantive testing decreases.
Answer: B
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3) There are three main types of revenue manipulations. Which of the following revenue manipulations
affects the occurrence objective?
A) recording subsequent period sales as current period sales
B) the use of "bill and holds" (goods are invoiced but not shipped)
C) understatement of bad debts
D) creation of fictitious sales that are misclassified as revenue
Answer: D
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affects the cutoff objective?
A) avoiding recording of returns and allowances for the year
B) recording subsequent period sales as current period sales
Answer: B
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affects the valuation objective?
A) recording subsequent period sales as current period sales
B) the use of "bill and holds" (goods are invoiced but not shipped)
Answer: C
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6) The most difficult type of cash defalcation for the auditor to detect is that which occurs
A) before the cash is recorded.
B) after cash is recorded but before it goes to the bank.
C) out of the balance kept in a cash register.
D) in amounts under $100.
Answer: A
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7) Which one of the following would the auditor consider to be an incompatible operation if the cashier
receives remittances from the mail room? The cashier
A) prepares the daily deposit.
B) makes the daily deposit at a local bank.
C) records the receipts to the customer files.
D) endorses the cheques with the company endorsement stamp.
Answer: C
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8) Cash receipts from sales on account have been misappropriated. Which of the following acts would
conceal this defalcation and be least likely to be detected by an auditor?
A) postponing recording of cash receipt entries
B) overstating the accounts receivable control account
C) overstating the accounts receivable subsidiary ledger
D) recording cash receipt entries early
Answer: A
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9) The defalcation process that postpones entries for the collection of accounts receivable to conceal an
existing cash shortage is referred to as
A) kiting.
B) lapping.
C) computer fraud.
D) financial statement fraud.
Answer: B
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10) An audit procedure that compares the name, amount, and dates shown on remittance advices with
cash receipts journal entries and with related duplicate deposit slips would be effective in detecting
A) kiting.
B) lapping.
C) illicit write-offs of customers as uncollectible accounts.
D) sales without proper credit authorization.
Answer: B
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11) Which of the following actions is more likely to be a result of error rather than fraud?
A) consignment sales are knowingly recorded as revenue
B) orders are shipped to a customer with a bad credit rating
C) fictitious revenue transactions are recorded and reported
D) subsequent period revenue is deliberately recorded in the current period
Answer: B
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12) Comparing bad debt expense as a percentage of gross sales with previous years will detect what kind
of possible misstatement?
A) uncollectible accounts receivable not provided for
B) overstatement of sales and accounts receivable
C) understatement of sales and accounts receivable
D) understatement of allowance for uncollectible accounts
Answer: A
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13) A risk of material misstatement in accounts receivable associated with the allocation balance-related
audit objective is that "long-term service revenue is recorded as current revenue or in the wrong period,
overstating revenue and accounts receivable." Which of the following tests of detail of balances would
respond to this risk?
A) Read customer contracts and audit the criteria used to allocate revenue to components of the sales
contract.
B) Check cash received after the year end and trace to accounts receivable master file.
C) Read the notes to the financial statements and compare to audited financial information.
D) Enquire with management about the process used to make sure that revenue is recorded in the correct
period.
Answer: A
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14) In the planning phase, Denis conducted an analytical procedure to compare the allowance for
doubtful accounts balance to the accounts receivable balance. In the prior years, the allowance for the
doubtful accounts/accounts receivable ratio was between 2.5% to 3.5%. This year, the number is 1.25%.
What should Denis do?
A) Change the assessed inherent risk
B) Conduct additional testing to justify the lower bad debt.
C) Advise management that they should increase the allowance for doubtful accounts provision.
D) Document this difference and continue with audit work to see if this is pervasive bias of management.
Answer: B
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15) You are the auditor of Foundry Inc., a company that manufactures chocolate bars and assorted
candies. The description of the sales and collection cycle for Foundry is as follows.
Clients and Credit Limits

Foundry has 50 clients, as it mostly sells to grocery stores' central purchasing departments or distributors.
For each customer, Foundry performs a credit check prior to setting the credit limit for the client. The
credit limit is reviewed each year. In the past year, the credit limits were increased by 10%. This is due to
the growth in Foundryès product lines and increased demand from customers. This also came at the
same time the CEO of Foundry set the objective of growing the company's revenue by 25% over the next
two years. Increasing the credit limit has helped Foundry move towards that objective.
Allowance for Doubtful Accounts

The allowance for doubtful accounts is calculated by the controller by taking a percentage of the total
sales for the month. The controller has been taking 3% of total sales. The estimate has not been revised in
the current year, but it has always been sufficient to cover for any write-offs incurred.
Required:
For each of the two areas discussed above, identify the risk areas and the most likely misstatements for
Foundry.
Answer:
Clients and Credit Limits
- Risk is mitigated because Foundry does not have a large number of clients.
- Risk increased in the current year since the credit limits have been increased. Since all credit limits were
increased by 10%, it is probable that some clients did not deserve such an increase. As a result, this
increases the likelihood that accounts receivable will not be collected.
- The information that the CEO is setting an aggressive goal for growth also places more pressure on
management to increase sales and accounts receivable as a result. This increases overall audit risk and
should be considered in the audit.
Allowance for Doubtful Accounts

Valuation requires professional judgment to determine if the balance is sufficient or if it is too large. In
the case of Foundry, the risk appears to be high, as there was no formal review of the percentage done
this year. Given that the credit limits were increased this year is an indication that a review should have
been performed. Further, the fact that the provision has been sufficient for the accounts written off in the
prior year is not sufficient to conclude that the process is adequate. Some accounts relating to this period
might have to be written off in the following period or it could also be that the current provision is too
high.
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16) What are the common indicators that the entity may be engaged in fraudulent financial reporting?
Answer: The common indicators that the entity may be engaged in fraudulent financial reporting are:
1) management is placing more emphasis on the need for a particular accounting treatment than on
understanding the economics of the transaction.
2) transactions that involve nonconsolidated related parties have not been properly reviewed or
approved by those in charge of governance.
3) the transactions involve previously unidentified related parties that do not have the substance or
financial strength to support the transaction without the support of the entity under audit.
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17) List the common fraud schemes relating to revenue.

Answer: The common fraud schemes relating to revenue are:
1) fictitious revenues or sham sales (occurrence assertion).
2) premature revenue recognition (occurrence and cutoff assertions) - sales can be recorded even though
the sales involved unresolved contingencies (such as customer acceptance, right of return, etc.).
3) round-tripping or recording loans as sales (occurrence assertion) - round-tripping involves recording
sales by shipping goods to alleged customers and then providing funds to pay back the company.
3) improper cutoff of sales (cutoff assertion) - subsequent period sales are recorded as current period
sales.
4) improper recording of sales from "bill-and-holds" that do not meet criteria for revenue recognition
(occurrence and (possibly) cutoff assertions) - companies may make arrangements with customers for
early billing and then hold the goods for shipping. Unless the customer has requested such an
arrangement and there appears to be a legitimate business reason, these types of arrangements generally
do not meet the revenue recognition criteria.
5) side arrangements that change the original terms of sale (such as a consignment arrangement or
generous right of return) or not meeting requirements for recording revenue (occurrence assertion) -
management or sales representatives design "side contracts" with customers that contravene the
company's normal business practice and revenue recognition policy.
6) manipulation of adjustments and estimates - returns and allowances are not recorded or are
understated (completeness assertion for returns and allowances, valuation and/or existence for accounts
receivable); or bad debts are understated (valuation assertion for accounts receivable).
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18) Discuss three examples of analytical procedures an auditor might perform while auditing the sales
and collection cycle. Also discuss the potential misstatement(s) that may be revealed by each analytical
procedure.
Note: students could also be asked to separately discuss ratios for planning and ratios as substantive
tests.
Answer: Analytical procedures applicable to the audit of the sales and collection cycle and possible
misstatements include:
Analytical Procedure Possible Misstatement

Compare gross margin percentage with Overstatement or understatement of
previous years. sales and accounts receivable.
Compare sales by month over time. Overstatement or understatement of
sales and accounts receivable.
Compare sales returns and allowances Overstatement or understatement of
as a percentage of gross sales with sales returns and allowances and
previous years. accounts receivable.
Compare individual customer balances
over a stated amount with previous Misstatements in accounts receivable
years. and related income statement accounts.
Compare bad debt expense as a Uncollectible accounts receivable that
percentage of gross sales with previous have not been provided for.
years.
Compare number of days that accounts Overstatement or understatement of
receivable are outstanding with allowance for uncollectible accounts and
previous years. bad debt expense.
Compare aging categories as a Overstatement or understatement of
percentage of accounts receivable with allowance for uncollectible accounts and
previous years. bad debt expense.
Compare allowance for uncollectible Overstatement or understatement of
accounts as a percentage of accounts allowance for uncollectible accounts and
receivable with previous years. bad debt expense.

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19) You are the auditor for GreenAcres, a non-profit home for homeless elderly. GreenAcres has a
December 31 year end. It receives government funding and also relies on donations for revenue.
GreenAcres has a major funding drive in November, when it collects pledges by means of activities at a
garage sale, a walkathon, and bake sales in the community.
In late February you had a meeting with Ellen Famous, the President of GreenAcres, at the
organization's premises. Ellen reviews and approves bank statements and is the second and final cheque
signer. Two other accounting staff have the following responsibilities:
• Paul approves pledge write-offs (which normally average about 15%), opens the mail, endorses cheques
received in the mail, prepares and delivers bank deposits, and posts transactions into the accounting
system.
• Diana, a retired bookkeeper, volunteers about 10 hours per week to reconcile the bank account, review
journal entries posted to the general ledger, and prepare payroll and accounts payable transactions for
processing.
Ellen normally reviews pledge write-offs, but was very busy in February, so she took a look while
you were there. To her surprise, she found that about 40% of the pledges had been written off. She asked
Diana to investigate, and Diana found that most of the write-offs had actually been paid.
Required:
A) What are possible causes of the inconsistency with the pledge write-offs?
B) What are the weaknesses in internal control that could allow the excess write-offs to occur? Provide
recommendations for improvement.
C) Identify audit procedures that you would complete to quantify any potential misstatement with
respect to the pledges receivable balance as at December 31.
Answer: A) The inconsistency could either be due to fraud (Paul stealing the funds) or error (too many
accounts written off by accident).
B) Paul controls the cash and cheques received, deposits the funds into the bank, and records the amounts
in the accounting system. He has control over the physical assets (the cheques and cash) and the
accounting records. It is possible that he could receive a cheque, deposit it in his own account, and write
it off.
Recommendations for improvement:
• Write-offs should be approved by Ellen (as she is independent of the custody of the assets and of
accounting).
• Mail should be opened by an independent individual, perhaps a volunteer.
• Cheques should be restrictively endorsed by the mail opener (stamped with the GreenAcres stamp).
• Custody of the cash and cheques should be separated from the accounting -- perhaps Ellen could take
these amounts to the bank.
• Bank deposit amounts should be agreed to the accounting records (cash receipts listing).
C) In the absence of a suspicion of fraud, the auditor would likely limit testing of pledges to testing of
subsequent cash receipts and tracing of unpaid amounts to either a pledges receivable register or to a
write-off listing. With the suspicion of fraud, the auditor might consider extended procedures such as
confirmation with individual donors with respect to the amount of their pledges and whether these
amounts have been paid or not (similar to positive confirmations of accounts receivable).
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20) You are conducting an audit and have obtained the following figures with respect to sales and
accounts receivable:
2018 2017
Accounts receivable $ 3 343 000 $ 2 694 000
Allowance for doubtful accounts 212 150 207 660
Sales 25 640 000 24 630 000
Required:
A) What are the audit implications of these figures?
B) Identify key audit steps that you would perform for any of the above accounts.
Answer:
A) Accounts receivable has increased substantially over the prior year but there has been only a small
increase in sales. This could indicate that there is an increase in uncollectible accounts. Although accounts
receivable has increased substantially, there has been only a small increase in the allowance for doubtful
accounts. This could mean that there is an increased risk of misstatement in the allowance for doubtful
accounts.
B) Additional work should be performed on the allowance for doubtful accounts. The following
techniques are suggested:
• Test the accuracy of the aged trial balance.
• Review the aged trial balance for unusually old amounts.
• Review the older amounts in the aged trial balance (perhaps over 90 days) for large amounts or for
customers that have not made any payments.
• Test subsequent receipts after year end.
• Confirm old and large accounts receivable amounts.
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21) Office Design Inc. (ODI) has been your audit client for five years. ODI designs and sells office
furniture such as desks, cabinets, and couches used in office reception areas. ODI has sales in Canada and
the U.S., with five distribution locations where furniture is available to prospective purchasers to try out
before purchasing. These locations are in Toronto, Montreal, Halifax, New York, and Chicago. The
company uses custom-designed software for its order processing and sales, which is kept current by one
of the five information systems personnel.
The Vice President of Finance is new. Executive management is paid a salary and a bonus based on
the annual net income of ODI. Unfortunately, the accounting staff at the head office (in Montreal) has
been downsized from ten people to six due to a recent slowdown in sales. Your review of the aged
accounts receivable trial balance revealed that one third of the accounts have been outstanding for more
than one year. ODI's profits have declined substantially from last year. Its line of credit and bank loans
are at their maximum and the company is considering selling its U.S. operations to provide cash flow.
Prior year working papers revealed few errors and indicate that you considered management
integrity to be good. However, due to segregation issues, you did not rely on the internal controls in the
prior year.
Required:
A) What issues in corporate governance and in the control environment affect your assessment of internal
controls for revenue? How does this affect the decision to conduct substantive testing (i.e. exclusion of
tests of controls)?
B) What is the likely assessment of computer general controls? How does this affect the type of audit
testing conducted at ODI?
Answer: A) Senior executives are motivated to overstate revenue since they are remunerated based on
net income (alternatively, they could also understate expenses, such as bad debt expense). This also
would motivate them to understate the bad debt allowance, which would increase revenue. Particularly
due to the decrease in staff, it would be easier for senior management to override internal controls. This
would motivate the auditor to increase substantive testing.
Customized programming is more complex and error-prone than software packages. Particularly
with a small information systems group, it is less likely that there would be controls over program
changes, meaning that auditors would need to look for compensating manual controls over revenue and
are less likely to be able to rely on automated controls. This takes us back to senior management potential
to override such manual controls, again supporting the need for increased substantive testing rather than
tests of controls.
B) With a small information systems group (only five people), it is less likely that there is adequate
segregation of duties in key information systems areas. Program change controls are likely difficult to rely
upon (see part A) due to the complexity of customized systems compared to packaged systems. Physical
access and security is not mentioned, but could be a problem if some information systems support
activities are handled by accounting personnel. Finally, documentation of programs and operations tends
to be poorer when there are customized systems and fewer personnel. This would lead the auditor to
place limited reliance on general controls, resulting in the need to conduct increased substantive testing.
[Note: This case is a good example for students to understand why it is still necessary to document
internal controls, even though they may decide not to conduct tests of controls. Identification of
weaknesses helps the auditor design substantive tests.]
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12.4 Understand key controls for the revenue cycle and assess control risk for the revenue cycle
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1) Two accounts receivable balance-related audit objectives are not affected by assessed control risk for
the sales and cash receipts classes of transactions. These objectives are
A) valuation; allocation.
B) allocation; rights and obligations.
C) valuation; rights and obligations.
D) accuracy; existence.
Answer: C
Learning Obj.: 12-4 Understand key controls for the revenue cycle and assess control risk for the revenue
cycle
2) For sales, the occurrence transaction-related audit objective affects the existence balance-related audit
objective. For cash receipts, the occurrence transaction-related audit objective affects which balance-
related audit objective?
A) existence
B) completeness
C) cutoff
D) valuation
Answer: B
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3) For cash receipts, the occurrence transaction-related audit objective affects the completeness balance-
related audit objective of accounts receivable. Which accounts receivable balance-related audit objective
does the cash receipts transaction-related audit objective of completeness affect?
A) allocation
B) completeness
C) rights and obligations
D) existence
Answer: D
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4) Three presentation and disclosure audit objectives are not affected by assessed control risk for the sales
transactions. These are
A) rights and obligations, valuation, and understandability.
B) understandability, valuation, and occurrence.
C) valuation, rights and obligations, and classification.
D) classification, understandability, and rights and obligations.
Answer: A
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5) Which of the following presentation and disclosure-related audit objectives has a matching transaction-
related audit objective, but not a matching balance-related audit objective?
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A) accuracy
B) classification
C) occurrence
D) completeness
Answer: B
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6) Which of the following presentation and disclosure-related audit objectives does not have a parallel
audit objective for both the transaction-related audit objectives and balance-related audit objectives?
A) allocation
B) classification
C) understandability
D) rights and obligations
Answer: C
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7) For each control on which the auditor plans to rely to reduce assessed control risk, he or she must
A) design one or more tests of controls to verify effectiveness.
B) report all weaknesses in the management letter.
C) quantitatively determine the effect on sampling error.
D) ensure that the test applies to several different transaction audit objectives.
Answer: A
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8) After the auditor has identified the key internal controls and weaknesses and assessed control risk, it is
appropriate to decide whether
A) substantive tests will be increased sufficiently to justify the cost of performing tests of controls.
B) substantive tests will be reduced sufficiently to justify the cost of performing tests of controls.
C) tests of controls will be increased sufficiently to justify the cost of performing substantive tests.
D) tests of controls will be reduced sufficiently to justify the cost of performing substantive tests.
Answer: B
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9) Analytical procedures are substantive tests and if the results of the analytical procedures are favorable
they will reduce
A) the extent of tests of details of balances.
B) the extent of tests of controls.
C) the analytical procedures.
D) all of the other tests.
Answer: A
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10) The auditor traces items from the source documents to the journals in order to satisfy the
A) existence objective.
B) completeness objective.
C) accuracy objective.
D) classification objective.
Answer: B
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11) An auditor selects a sample from the file of shipping documents to determine whether invoices were
prepared. This test is performed to satisfy the audit objective of
A) accuracy.
B) completeness.
C) control.
D) existence.
Answer: B
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12) A) Describe each of the six key control activities for sales.
B) When assessing planned control risk for sales, the auditor is concerned about proper authorization at
three key points. Discuss each of these three points.
C) When testing the existence objective for sales, the auditor is concerned with the possibility of three
types of misstatements. One type is sales being included in the journal for which no shipment was made.
Discuss the other two types of misstatements.
Answer:
A) The six key control activities for sales are:
• Adequate separation of duties. For example, persons responsible for inputting sales and cash receipts
transactions should not have access to cash.
• Proper authorization. Credit should be properly authorized before a sale takes place, goods should be
shipped only after proper authorization, and prices should be authorized.
• Adequate documents and recordkeeping procedures.
• Prenumbered documents that are accounted for periodically.
• Mailing monthly statements to customers.
• Internal verification procedures. An independent person should periodically check the processing and
recording of sales transactions.
B) Credit should be properly authorized before a sale takes place; goods should be shipped only after
proper authorization; and prices, base terms, freight, and discounts should be properly authorized.
C) The auditor is also concerned with the possibility of 1) shipments being made to nonexistent
customers and recorded as sales, and 2) sales being recorded more than once.
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12.5 Use professional judgment to develop an audit approach (strategy) for the revenue cycle
1) The overall objective in the audit of the sales and collection cycle is to evaluate whether
A) the sales account and the accounts receivable account are free of errors.
B) the sales account and the accounts receivable account are free of material errors.
C) the sales account and the accounts receivable account are presented fairly in accordance with an
applicable financial reporting framework.
D) the account balances affected by the cycle are fairly presented in accordance with an applicable
financial reporting framework.
Answer: D
Learning Obj.: 12-5 Use professional judgment to develop an audit approach (strategy) for the revenue
cycle
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12.6 Design and perform tests of control for the revenue cycle
1) The appropriate test of controls for separation of duties is

A) documentation.
B) confirmation.
C) examination.
D) observation.
Answer: D
Learning Obj.: 12-6 Design and perform tests of control for the revenue cycle
2) Which of the following internal control procedures will most likely prevent the concealment of a cash
shortage resulting from the improper write-off of a trade account receivable?
A) Write-offs must be approved by a responsible officer after review of credit department
recommendations and supporting evidence.
B) Write-offs must be supported by an aging schedule showing that only receivables overdue several
months have been written off.
C) Write-offs must be approved by the cashier who is in a position to know if the accounts receivable
have, in fact, been collected.
D) Write-offs must be authorized by company field sales employees who are in a position to determine
the financial standing of the customers.
Answer: A
3) One of the reasons that the auditor considers the type of information system and its functions is to
A) assess whether hardware functioning affects applications.
B) evaluate design effectiveness of internal controls.
C) complete risk assessment by audit assertion for cycles.
D) assess whether programmed controls can be relied upon.
Answer: D
4) Which of the following is an example of a key internal control for an online system that would help
ensure that recorded sales are for the amount of goods shipped and are accurately billed and recorded?
A) Shipping documents are matched to invoices.
B) Shipping details and price list are automatically used as the invoicing source.
C) Shipping documents are prenumbered and accounted for.
D) Transactions are summarized daily for posting to the general ledger.
Answer: B
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5) Which of the following control procedures may prevent the failure to bill customers for some
shipments?
A) Each shipment should be supported by a prenumbered sales invoice that is accounted for.
B) Each sales order should be approved by authorized personnel.
C) Sales journal entries should be reconciled to daily sales summaries.
D) Each sales invoice should be supported by a shipping document.
Answer: A
6) Invoices are prepared using a date equal to the shipping date. This control pertains to which
transaction-related audit objective?
A) posting and summarization
B) classification
C) cutoff
D) completeness
Answer: C
7) One of the key internal controls to prevent transactions in the sales and collection cycle to fictitious
customers is to
A) have the bank reconciliation done by someone who is independent of the treasury function.
B) account for the integrity of the numerical sequence of sales orders.
C) compare customer numbers entered to the customer master file.
D) include the sales price list of all products in the computer files.
Answer: C
8) Certain internal controls satisfy more than one objective. It is desirable to consider
A) each objective separately.
B) the objectives together.
C) the objectives that can be tested.
D) only the controls that satisfy more than one objective.
Answer: A
21
9) At every audit engagement the auditor is required to consider that there could be significant risks of
misstatement for revenue recognition. At ABC Ltd., the auditor has concluded that, yes, there are
material risks of misstatement associated with revenue recognition. How does this affect the extent of
testing for accounts receivable?
A) Audit risk will be increased.
B) Inherent risks will be decreased.
C) Decreased control testing is required.
D) Increased substantive testing is required.
Answer: D
10) Proper accounting requires that an account receivable must be written off by the client when
A) the client company concludes that an amount is no longer collectible.
B) the customer files for bankruptcy.
C) a collection agency cannot inspire the customer to pay the debt.
D) the account is at least six months old.
Answer: A
11) Tests of details of balances relate to which part of the Audit Risk Model?
A) control risk
B) inherent risk
C) substantive risk
D) planned detection risk
Answer: D
22
12) Following are three different situations with respect to the audit of accounts receivable and sales. For
each, specify the evidence mix that you would use (tests of control, substantive tests, type of
confirmation/timing), and explain why.
A) The client is in a volatile industry, selling products that can quickly become obsolete. Total accounts
receivable is $65 million with a bad debt allowance of $7 million. The company has recently laid off three
accounting staff to save money.
B) A small company has 45 different customers with balances ranging from $500 to $25 000 per customer.
There is one accountant on staff and a professional accountant comes in once per week for three hours to
review the staff accountant's work and prepare journal entries. Bad debts are rare, as the owner is actively
involved in accounts receivable collection.
C) Big Department Store Finance Corporation has fifty staff in the accounting department, a sophisticated
software package, and about $250 million in accounts receivable. The corporation manages the
department store's credit cards. About 100 000 credit card customers have balances less than $300 on their
accounts, while the balances for the remaining customers range up to a maximum of $5000.
Answer:
A) It is likely that internal controls are poor, due to the reduction in accounting staff. Accordingly,
substantive tests would be increased, particularly of the bad debt allowance, which is high (more than
10% of total accounts receivable). Positive confirmations would be used, since it is likely that the amounts
due to individual customers could be large. Due to the lack of internal controls, confirmations would
need to be sent at year end.
B) Since the owner is actively involved in accounts receivable, the likelihood of misstatement from the
accounting staff is low. However, the potential for management override (and collection of cash for
personal use) is high. Thus, there would be no reliance on internal controls and only substantive tests
would be conducted. Positive confirmations of larger balances would be sent as of the year-end date.
C) Since there are likely excellent internal controls, a combined audit approach can be used (internal
controls testing and substantive tests). Confirmations could be sent prior to the year-end date, if needed.
Negative confirmations would likely be used since the amounts are all small, particularly for the 100 000
accounts that are less than $300.
13) The auditor traces items from the journals back to the source documents in order to satisfy the
A) occurrence objective.
B) completeness objective.
C) ownership objective.
D) valuation objective.
Answer: A
23
14) The auditor would like to conduct dual purpose tests verifying that the programs performing the
totaling and aging of accounts receivable are functioning correctly as well as quantifying any errors.
Which of the following is a dual purpose test that the auditor could use?
A) use analytical review and compare amounts from current to prior
B) inquire how the calculations are performed
C) use test data and observe how the invoice(s) in the test are aged
D) use generalized audit software to reperform the calculations
Answer: D
15) When the client's internal control structure is adequate, the cutoff can usually be verified by
A) the client's representation letter.
B) inquiries of the controller.
C) obtaining the last shipping document number of the year and comparing it with current and
subsequent period recorded sales.
D) confirmation of the receivable for the last recorded sale.
Answer: C
16) Which of the following key controls helps ensure that sales transactions are classified to the correct
account?
A) Computer checks for gaps in shipping document numbers.
B) Invoices are prepared using prices and terms from the customer master file.
C) Management reviews sales reports regularly for reasonableness.
D) Posting is done automatically to the sales account based on periodic totals.
Answer: D
17) Which of the following controls pertains to audit trails in the batch processing of sales transactions?
A) groups of documents are totalled
B) audit trail is available in electronic form
C) the focus is on preventing incorrect transactions
D) remittance advice information is matched to sales invoice numbers
Answer: A
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18) A risk of material misstatement in accounts receivable associated with the accuracy balance-related
audit objective is that "sales recorded at the incorrect price result in revenue and accounts receivable that
are over- or understated." Which of the following tests of detail of balances would respond to this risk?
A) Select a sample of master file change forms and verify that all sales prices changes were appropriately
authorized.
B) Use audit software to match sales invoice price details to authorized prices in the sales price master
files.
C) Enquire with management with respect to the procedures used to update the sales price master file.
D) Match shipping details for a sample of invoices to the invoice details on an item by item basis.
Answer: B
19) Which of the following is an example of a data entry input edit that could be used to improve the
accuracy of online data entry of sales orders?
A) matching of customer number to master file
B) automatic posting of sales to the general ledger account
C) reconciliation of the customer master file to accounts receivable
D) daily point-of-sales control totals matched to cash receipts
Answer: A
20) A document that is used to describe and authorize additions, changes, or deletion of sales prices or
customer data is called a(n)
A) uncollectible account authorization form.
B) journal entry authorization form.
C) master file change form.
D) transaction file change form.
Answer: C
25
21) A) State the five specific transaction-related audit objectives for cash receipts and describe one
common test of controls for each objective.
B) Describe three tests of controls commonly used to test the accuracy objective for cash receipts.
Answer:
A)
• Recorded cash are for funds actually received by the company (occurrence). Observe separation of
duties.
•All cash received is recorded in the cash receipts (completeness). Discussion with personnel and
observation.
• Cash receipts are deposited and properly recorded at the amount received (accuracy). Inspect monthly
bank reconciliations.
• Cash receipts are recorded on correct dates (cutoff). Observe unrecorded cash at any point in time.
• Cash receipts are properly classified (classification). Review chart of accounts and computer-assigned
posting accounts
B) Note: Answers will vary beyond the three examples below. Three tests of controls commonly used to
test the accuracy objective for sales include:
• Observe separation of duties.
• Discussion with personnel and observation.
• Inspect monthly bank reconciliations
22) A) State the five specific transaction-related audit objectives for cash receipts and describe one
common test of controls for each objective.
B) Discuss what is meant by proof of cash receipts and explain its purpose.
Answer: A) The five specific transaction-related audit objectives for sales and common tests of controls
are:
• Recorded cash receipts are for funds actually received by the company (occurrence). Trace from cash
receipts journal to bank statements.
• Cash received is recorded in the cash receipts journal (completeness). Trace from remittance advices or
prelisting to cash receipts journal.
• Cash receipts are deposited and recorded at the amounts received (accuracy). Prepare a proof of cash
receipts.
• Cash receipts are recorded on the correct dates (cutoff). Compare dates of deposits with dates in the
cash receipts journal and prelisting of cash receipts.
• Cash receipts transactions are properly classified (classification). Examine documents supporting cash
receipts for proper classification.
B) A proof of cash receipts is an audit procedure in which the total cash receipts recorded in the cash
receipts journal for a given period are reconciled with the actual deposits made to the bank during the
same period. The purpose of a proof of cash receipts is to determine whether all recorded cash receipts
have been deposited in the bank account. It can also identify unrecorded deposits.
26
23) Your audit client is a large retail chain with its own credit card. It has annual sales of about $100
million. On December 31, there were approximately 40 000 open accounts with total receivables of
approximately $18.5 million. Very few customer balances exceed $1000. The company's general office
maintains the accounts receivable records. The large volume of transactions processed by the company
has necessitated extensive segregation of duties and frequent balancing of data during processing.
Accordingly, the company's general and system controls are considered to be very good. A complete
record of each customer's account is stored on a relational database and includes the following
information:
Description of field contents

Type of account (personal, corporate) Customer account number
Customer name and address Credit limit (code for 8 credit levels)
Status code (active, inactive, bad debt) Number of transactions this month
Current month's charges Current month's payments
Total outstanding balance Aged balance over 30 days
Aged balance over 60 days Aged balance over 90 days
Aged balance over 120 days Year account opened
Year last active Total purchases this year to date
Total returns this year to date Number of months active
Total purchases last year Number of months active last year
Source transactions are store purchase invoices, payments, and adjustments. Daily, all the orders are
received, entered into the computer, and processed against the customer master file. Each account is
updated and automatically analyzed to determine whether the transactions just processed have created a
condition that should be brought to the attention of the authorization or collection departments.
Exception reports are automatically printed and forwarded to these groups.
The company sends monthly statements to customers on a cyclical basis. About 2000 statements are
mailed each billing day. As the accounts are updated, the day's transactions are accumulated and added
to the starting control figure for each cycle. The new control figures are balanced with the sum of all the
individual accounts in the cycle (accumulated as each account is processed). In addition, a detailed
transaction and cycle control report is prepared, providing an audit trail in customer account number
sequence.
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Required:
Describe the audit procedures you would perform in your year-end audit work for this company's
accounts receivable. For each audit test, state the relevant audit assertion(s). Be sure to include different
types of tests as necessary (e.g. manual or computer-assisted audit techniques), and clearly identify those
tests that can be completed using CAATs.
Answer: There are many possible valid answers for this question. One appropriate method would be to
organize by audit assertion. Following are all substantive tests (normally year-end tests of accounts
receivable would be substantive). Those that can be completed using CAATs are marked with an *.
Analytical Review:
- * compare totals, bad debts, significant customers to prior periods
- * statistical analysis (e.g. regression) for a number of fields, e.g., balances, payments, returns
Completeness Assertion:
- * add the file and compare the total to the general ledger balance for accounts receivable
- * extract large/unusual balances for confirmation or for other follow up
- * discuss with client the cyclical billing process; gain an understanding of whether this impacts cutoff in
anyway and if it provides consistent and reasonable results on an annual basis
- * estimate unbilled amounts as at the end of the year.
Accuracy Assertion:
- * select a sample of customers for confirmation
- * stratify by size/nature of customer
- * will need to tie into cycle billing process
- * look for duplicates: address of customer or customer names
Valuation (and Existence) Assertions:
- * analysis of ratio of returns/purchase, especially in new year
- * analysis of inactive accounts: balances should be zero
- * look at customer balances that exceed credit limit
- * look at accounts where there has been no payment in the last 30 days - could identify a potential bad
debt
- * subsequent payments for confirmed accounts (may need to be manual)
- * recalculate the bad debt allowance and compare to statistics for reasonableness
- * look for credit balances and consider reclassification to accounts payable
Existence Assertion:
- * trace a sample of shipping documents to sales invoices and to the balances in the accounts receivable
master file
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24) A) State the five specific transaction-related audit objectives for sales and describe one common test of
controls for each objective.
B) Describe three tests of controls commonly used to test the accuracy objective for sales.
Answer:
A)
• Recorded sales are for shipments actually made to nonfictitious customers (occurrence). Inspect copies
of sales invoices for supporting bills of lading and customers' purchase orders.
• Existing sales transactions are recorded (completeness). Inspect report of missing shipping document
numbers for evidence of independent follow-up.
• Recorded sales are for the amount of goods shipped and are correctly billed and recorded (accuracy).
Take a sample of invoices and trace back to authorized list.
• Sales are recorded on the correct dates (cutoff). Compare dates of recorded sales transactions with dates
on shipping records.
• Sales transactions are classified to the correct account (classification). Conduct manual walk-through of
transactions from source to general ledger posting.
• Sales transactions are updated correctly to the customer master file and the posting to the general
ledger summed these transactions correctly. Compare customer master file totals with general ledger
balance on a monthly basis. Investigate any differences.
B) Note: Answers will vary beyond the three examples below. Three tests of controls commonly used to
test the accuracy objective for sales include:
• Test access controls.
• Take a sample of invoices and trace back to authorized list.
• Test for potential override of changes to price list.
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25) You are the audit senior responsible for a large photofinishing centre and camera store. The store uses
automated cash registers tied to inventory (also known as point-of-sale devices). The point-of-sale devices
take advantage of automated procedures and controls that can be programmed to reduce errors and
improve controls over completeness of transactions.
Required:
Provide examples of interdependent controls that should be used to complement the programmed
controls.
Answer: [Note: Student answers may vary.]
Error follow up: Any errors (such as rejected transactions or rejected user access attempts) should be
recorded by the computer systems and reviewed by a supervisor. The supervisor should ensure that
errors are investigated. Exception reports (such as high-dollar transactions or negative inventory) should
be reviewed by management regularly.
Reconciliation: Totals per the point-of-sale device by each cash receipt type should be reconciled to the
cash register drawer daily (i.e., cash, credit card, debit card). Credit card and debit card deposits should
be reconciled to the bank statement. Cash should be deposited daily and agreed to the duplicate deposit
slip.
Bank statements should be reconciled to the balance per general ledger in the cash account.
12.7 Design and perform substantive analytical procedures for the accounts in the revenue cycle
1) As part of audit planning, you have calculated gross margin for the last five years and compared gross
margin to industry averages. Your client's gross margin has increased by about 5% in the current year,
while the industry gross average has declined. One possible cause of this increased gross margin is
A) higher cost of goods sold.
B) increased bad debt expenses.
C) fictitious revenue.
D) fictitious expenses.
Answer: C
Learning Obj.: 12-7 Design and perform substantive analytical procedures for the accounts in the
revenue cycle
2) As part of audit planning, you have calculated gross margin for the last five years and compared gross
margin to industry averages. Your client's gross margin has increased by about 5% in the current year,
while the industry gross average has declined. One possible cause of this increased gross margin is
C) premature revenue recognition.
Answer: C
revenue cycle
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3) As part of audit planning, you have calculated accounts receivable turnover for the last five years and
compared it to industry averages. Your client's accounts receivable has decreased by about 1.25 times in
the current year, while the industry rate has improved. One possible cause of this lowered accounts
receivable turnover is
C) fictitious revenue.
Answer: C
revenue cycle
4) Comparison of individual customer balances with previous years will detect what type of possible
misstatement?
A) misstatement in gross profit and bad debt expense
B) overstatement or understatement of bad debt expense
C) overstatement or understatement of allowance for uncollectible accounts
D) misstatements in accounts receivable and related income statement accounts
Answer: D
revenue cycle
31
5) What are the criteria the auditor should take into account in order for substantive analytical procedures
to provide the necessary assurance?
Answer: The criteria the auditor should take into account in order for substantive analytical procedures
to provide the necessary assurance are:
1) Nature of Assertion - substantive analytical procedures are not effective for all assertions. For example,
they tend to be somewhat more effective than tests of details for completeness of revenue and the
reasonableness of the allowance for doubtful accounts. They also tend not to be as effective for testing
occurrence/existence nor are substantive analytical procedures always effective for rights and obligations.
That is not to say that these procedures are not often performed to test existence/occurrence, but when
they are performed, other substantive tests of details will supplement this evidence.
2) Plausibility and Predictability - The plausibility and predictability of relationships is crucial in
developing a properly designed substantive analytical procedure. For example, relationships are less
predictable in less stable environments or when amounts are determined from complex
processes, subjective judgments, or transactions subject to management discretion.
3) Availability of Reliable Data - A key concern in assessing the reliability is the source of the data and the
conditions upon which it was gathered. In the case of client data, the auditor should either test the design
or operating effectiveness of the related controls or perform other procedures to test completeness and
accuracy of the data.
4) Precision of Expectation - Analytical procedures used for planning— those that involve comparisons,
ratios, and trend analysis —do not have the precision necessary for the auditor to rely on them alone as a
substantive test. A key to developing more precise expectations is to disaggregate the data in order to
effectively evaluate the relationship between variables being examined.
5) Threshold for Investigation - When substantive analytical procedures uncover unusual fluctuations,
the auditor should make additional inquires of management. Management's responses should be
critically evaluated to determine whether they adequately explain the unusual fluctuation and whether
they are supported by corroborating evidence.
revenue cycle
12.8 Design and perform substantive tests of details for revenue accounts and assertions
1) To test for recorded sales for which there were no actual shipments, the auditor traces from the
A) bill of lading to the sales journal.
B) sales journal to the shipping documents.
C) sales journal to the accounts receivable subsidiary ledger.
D) bill of lading to the supporting customer order and sales order.
Answer: B
Learning Obj.: 12-8 Design and perform substantive tests of details for revenue accounts and assertions
32
2) Which of the following procedures would ordinarily be expected to best reveal unrecorded sales at the
balance sheet date?
A) Compare shipping documents with sales invoices.
B) Apply gross profit rates to inventory disposed of during the period.
C) Trace payments received subsequent to the balance sheet date.
D) Send accounts receivable confirmation requests.
Answer: A
3) Tamra is performing a test of control consisting of looking at the numerical sequence of credit memos
issued by the company. Tamra is performing a block test by looking for any missing number in the
sequence. This test will provide evidence of
A) completeness.
B) occurrence and completeness.
C) occurrence and accuracy.
D) accuracy and completeness.
Answer: B
4) To determine that sales are accurately charged, the unit prices on the duplicate sales invoices are
normally compared with
A) the original invoices.
B) the amounts recorded in the sales journal for that transaction.
C) the amounts posted to the customer's account in the accounts receivable master file.
D) an approved item master file.
Answer: D
5) An effective procedure to test for unbilled shipments is to trace from the

A) sales history file to the shipping documents.
B) shipping documents to the sales history file.
C) sales history file to the accounts receivable ledger.
D) sales history file to the general ledger sales account.
Answer: B
33
6) It is common to test sales for proper classification as part of testing for
A) cutoff.
B) accuracy.
C) valuation.
D) completeness.
Answer: B
7) The emphasis for the audit of sales return and allowances is often placed on testing the existence of
recorded transactions. However, the most important objective to consider is
A) cutoff.
B) valuation.
C) accuracy.
D) completeness.
Answer: D
8) If the internal controls for recording sales returns and allowances are evaluated as ineffective,
A) a larger sample is needed to verify cutoff.
B) sampling is not appropriate.
C) all sales returns must be traced to supporting documentation.
D) all sales returns must be confirmed with the customer.
Answer: A
9) Scanning sales invoices to determine whether there are any numbers missing in the sequence is a
control over which of the following objectives?
A) validity
B) completeness.
C) accuracy.
D) ownership.
Answer: B
10) The control objective associated with selecting a sample of recorded sales invoices from the sales
journal and recalculating the cross totals of quantities and prices is
A) validity
B) accuracy.
C) completeness.
D) ownership.
Answer: B
11) To determine whether sales transactions have been recorded in the proper accounting period, the
34
auditor performs cutoff tests. Which of the following best describes the overall approach used when
performing cutoff tests?
A) Ascertain that management's letter of representation includes the statement that transactions have
been accounted for in the proper accounting period.
B) Analyze transactions occurring within a few days before and after year-end.
C) Confirm year-end transactions with regular customers.
D) Examine cash receipts in the subsequent period.
Answer: B
12) A) An auditor is concerned that accounts receivable may be understated due to sales to customers that
have been omitted from the sales journal and from the accounts receivable master file. Describe the
procedure(s) the auditor should perform in these circumstances.
B) Describe how the auditor tests the classification objective for accounts receivable.
Answer: A) The understatement of sales and accounts receivable is best uncovered by substantive tests of
transactions for shipments made but not recorded by tracing from a sample of shipping documents (bills
of lading) to the sales journal to verify that each shipment has been recorded.
B) The classification objective is tested by reviewing the aged trial balance for material amounts
receivable from affiliates, officers, directors, or other related parties. If notes receivable or accounts that
should not be classified as a current asset are included with the regular accounts, these should also be
segregated. Finally, if credit balances in accounts receivable are significant, it is appropriate to reclassify
them as accounts payable.
13) A) Assuming the client's internal controls are adequate, describe how the auditor can verify proper
cutoff of sales transactions.
B) Describe how the auditor tests the rights objective for accounts receivable.
Answer: A) Assuming the client's internal controls are adequate, the auditor can verify proper cutoff of
sales transactions by obtaining the shipping document number for the last shipment made at the end of
the period and comparing this number with current and subsequent period recorded sales.
B) The auditor can test the rights objective for accounts receivable by reviewing the client's minutes,
discussions with the client, confirmation with banks, and the examination of correspondence files to
determine whether accounts receivable may have been pledged as collateral, assigned to someone else,
factored, or sold.
35
12.9 Design and perform substantive tests of details for accounts receivable and assertions
1) Stefano is performing a review of the accounts receivable for large and unusual amounts. Of the
following accounts receivables, Stefano should pay special attention to an account receivable
A) from a related party.
B) for a large dollar amount.
C) recorded close to year end.
D) that is recurring.
Answer: A
Learning Obj.: 12-9 Design and perform substantive tests of details for accounts receivable and
assertions
2) Which of the following audit procedures is a dual-purpose test?

A) Conduct analytical review to determine the reasonableness of the bad debt allowance.
B) Examine credit limit changes for authorization.
C) Calculate the accuracy of the accounts receivable aging.
D) Observe error message when incorrect customer number is entered.
Answer: C
assertions
3) The most important test of details of balances to determine the existence of recorded accounts
receivable is
A) tracing sales entries to shipping documents.
B) tracing the credits in accounts receivable to bank deposits.
C) tracing sales returns entries to credit memos issued and receiving room reports.
D) sending external confirmations of customers' balances.
Answer: D
assertions
4) One of the most important test of details of balances for accounts receivable is
A) recalculation of the aged receivables and uncollectible accounts.
B) confirmations.
C) tracing from shipping documents to journals to the accounts receivable ledger.
D) tracing credit memos for returned merchandise to receiving room reports.
Answer: B
assertions
36
5) If accounts receivable accounts with credit balances are significant, they should be
A) written off.
B) reclassified as accounts payable.
C) corrected by making adjusting entries.
D) moved to the debit side.
Answer: B
assertions
6) The control objective associated with selecting a sample of cash receipts remittance lists or daily cash
reports and tracing them through to the cash receipts journal is
A) validity.
B) completeness.
C) existence.
D) ownership.
Answer: B
assertions
7) Selecting a sample of debits from customer accounts receivable records and vouching them to
supporting sales invoices is an audit procedure designed to obtain evidence about the control objective of
A) completeness.
B) validity.
C) authorization.
D) accuracy.
Answer: B
assertions
8) Tracing a sample of recorded cash receipts to the customers' accounts in the accounts receivable
subsidiary ledger is an audit procedure designed to satisfy the control objective of
A) completeness.
B) accounting.
C) validity.
D) accuracy.
Answer: B
assertions
37
9) In the audit of cash and accounts receivable, the main emphasis should be on which assertion?
A) completeness
B) existence
D) presentation and disclosure
Answer: B
assertions
10) When a sample of customer accounts receivable is selected for the purpose of vouching debits for
evidence of existence, the auditors will vouch them to which other items?
A) records of accounts receivable write-offs
B) sales invoices with shipping documents and customer sales invoices
C) cash remittance lists and bank deposit slips
D) credit files and reports
Answer: B
assertions
11) To gather evidence about transactions with related parties, an auditor would most likely
A) send account confirmations.
B) scan the aged trial balance for names of officers and directors.
C) perform analysis of receivables turnover.
D) scan the receivables sub-ledger for credit balances.
Answer: B
assertions
12.10 Obtain and evaluate accounts receivable confirmations
1) Confirmation of individual accounts receivable balances directly with debtors will, of itself, normally
provide evidence concerning the
A) collectability of the balances confirmed.
B) ownership of the balances confirmed.
C) existence of the balances confirmed.
D) internal control over balances confirmed.
Answer: C
Learning Obj.: 12-10 Obtain and evaluate accounts receivable confirmations
38
2) Confirmation is most likely to be a relevant form of evidence with regard to assertions about accounts
receivable when the auditor has concerns about the accounts receivables'
A) valuation.
B) classification.
C) existence.
D) completeness.
Answer: C
3) The primary purpose of accounts receivable confirmation is to satisfy the

A) existence objective.
B) existence and cutoff objectives.
C) accuracy and cutoff objectives.
D) existence, accuracy, and cutoff objectives.
Answer: D
4) A risk of material misstatement in accounts receivable associated with the rights and obligations
balance-related audit objective is that "consignment goods are recorded as revenue, overstating both
revenue and accounts receivable." Which of the following tests of detail of balances would respond to this
risk?
A) Include confirmation of terms of sale with accounts receivable confirmations.
B) Check cash received after the year end and trace to accounts receivable master file.
C) Read the notes to the financial statements and compare to audited financial information.
D) Compare accounts receivable balances by customer last year end to this year.
Answer: A
5) Glee Inc. is a manufacturer of musical instruments and its year end is September 30. Copa Loca, a local
music school, purchased some instruments from Glee but was not satisfied with the quality and returned
the goods to Glee during the last week of September. Being very busy with year end, Glee received the
goods from Copa Loca on September 30 but only processed the returned merchandised and issued a
credit note in October. This represents a
A) cutoff (allocation) misstatement.
B) understandability misstatement.
C) significant misstatement.
D) classification misstatement.
Answer: A
39
6) There are two important assumptions that underly the auditor's use of external confirmations. The first
is that the person returning the confirmation is independent of the company and so will provide an
unbiased response. The second is that
A) only authorized employees of the company have prepared the response.
B) the person completing the response has carefully checked the data being confirmed.
C) the respondent has not been coerced or bribed to respond to the confirmation.
D) adequate controls exist at the client company to prevent unauthorized responses.
Answer: B
7) A communication addressed to the debtor requesting him or her to confirm whether the balance as
stated on the communication is correct or incorrect is a
A) legal confirmation.
B) negative confirmation.
C) positive confirmation.
D) bank confirmation.
Answer: C
8) A positive confirmation is more reliable evidence than a negative confirmation because

A) the auditor has a document that can be used in court.
B) follow-up procedures can be performed if a response is not received from the debtor.
C) the debtor's lack of response indicates agreement with the stated balance.
D) fewer confirmations can be sent out.
Answer: B
9) Negative confirmations of accounts receivable are less effective than positive confirmations of accounts
receivable because
A) a majority of recipients usually lack the willingness to respond objectively.
B) some recipients may report incorrect balances that require extensive follow-up.
C) the auditor cannot infer that all nonrespondents have verified their account information.
D) negative confirmations do not produce evidential matter that is statistically quantifiable.
Answer: C
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10) The auditor obtains corroborating audit evidence for accounts receivable by using positive or negative
confirmation requests. Under which of the following circumstances might the negative form of the
accounts receivable confirmation be useful?
A) A substantial number of accounts are in dispute.
B) Internal control over accounts receivable is ineffective.
C) Client records include a large number of relatively small balances.
D) The auditor believes that recipients of the requests are unlikely to give them consideration.
Answer: C
11) Which of the following circumstances would indicate that positive confirmations should be used on
this engagement?
A) A significant portion of the total accounts receivable balance is represented by a small number of
accounts with large balances.
B) The internal control over accounts receivable is good.
C) The recipients are mostly businesses rather than individuals.
D) The auditor is unaware of disputed or inaccurate accounts.
Answer: A
12) The use of the negative (as opposed to the positive) form of receivables confirmation is indicated
when
A) internal control surrounding accounts receivable is considered to be ineffective.
B) there is reason to believe that a substantial number of accounts may be in dispute.
C) a large number of small balances are involved.
D) accounts receivable consists of current balances only.
Answer: C
13) Beltrand, a PA, is auditing the financial statements of a small rural municipality. The receivable
balances represent residents' delinquent property taxes or receivables over the due date. The internal
controls at the municipality are weak. To determine the existence of the accounts receivable balances at
the balance sheet date, Beltrand would most likely
A) send positive confirmation requests.
B) send negative confirmation request.
C) examine evidence of subsequent cash receipts.
D) inspect the internal records such as copies of the tax invoices that were mailed to the residents.
Answer: A
41
14) The most reliable evidence from confirmations is obtained when they are sent
A) several months before the year-end, so the auditor will have adequate time to perform alternate
procedures if they are required.
B) at various times throughout the year to different sections of the sample, so that the entire sample is
representative of account balances scattered throughout the year.
C) as close to the balance sheet date as possible.
D) at various times throughout the year to the same group in the sample, so that the sample will not have
a time bias.
Answer: C
15) Frag Jones Company has a December year end with a tight reporting deadline, so the auditors
confirmed the accounts receivable as of November 30 using positive confirmations. In addition to
following up confirmation discrepancies, the auditor should
A) test December transactions.
B) send negative confirmations as of the end of December.
C) test November transactions.
D) do cutoff testing for the month of October.
Answer: A
16) After the items for confirmation have been selected, the auditor must maintain control of the
confirmations until
A) the names are provided to the client's personnel to type the envelopes.
B) the sealed envelopes are provided to the client's personnel to be mailed.
C) the responses are received by the client with the return mail.
D) they are returned by the debtor to the auditor.
Answer: D
17) An auditor should perform alternative procedures to substantiate the existence of accounts receivable
when
A) no reply to a positive confirmation request is received.
B) no reply to a negative confirmation request is received.
C) collectability of the accounts receivable is in doubt.
D) pledging of the accounts receivable is probable.
Answer: A
42
18) Positive accounts receivable confirmations were circularized, and there were many differences where
the client stated that the goods had not been received as of the date of the confirmation. In addition to the
possibility that the goods were not received by the client, this type of reported difference could be an
indication of
A) a cutoff misstatement.
B) timing differences with respect to recording sales returns.
C) improper recording of sales allowances.
D) theft of cash or lapping.
Answer: A
19) A common way to evaluate the adequacy of the bad debt allowance is to
A) review the results of tests of controls that are concerned with the client's credit policy.
B) inspect carefully the noncurrent accounts on the aged trial balance to determine which ones have not
been paid subsequent to the balance sheet date.
C) examine the program logic that is used to prepare the aged trial balance and to monitor the
implementation of credit policies.
D) send positive confirmations to all accounts with balances over 90 days based on the aged trial balance.
Answer: B
20) Celebra sold some goods to Frankfurt Corp. Frankfurt sent a cheque to Celebra to pay for the goods
on December 24. Celebra received the cheque on January 4. At December 31, Celebra still showed an
account receivable from Frankfurt while Frankfurt no longer had an account payable to Celebra. This
situation represents a
A) cutoff error.
B) timing difference.
C) error in presentation.
D) lack of communication between the two companies.
Answer: B
21) As part of the audit testing, the auditor is conducting substantive analytical review over time (trend
analysis) of bad debts to evaluate the quality of the accounts receivable. Which audit assertion is this
associated with?
A) valuation
B) classification
D) occurrence
Answer: A
43
22) The auditor has elected to conduct the following audit tests: reperform addition of the aged accounts
receivable trial balance for the total column and for the columns depicting the aging. Which audit
objective is associated with these audit tests?
A) valuation
B) classification
C) accuracy
D) occurrence
Answer: C
23) IFRS, ASPE, and ASNPO require that related party transactions be disclosed. Gregorio Limited has a
materiality threshold of $50 000. Which of the following standards apply to the disclosure of related party
transactions for Gregorio Limited?
A) Disclose all transactions that are greater than the current year's materiality.
B) Disclose all related party transactions, even those below materiality.
C) Disclose those related party transactions that relate to officers or directors of the corporation.
D) Disclose those related party transactions that could affect the decisions of a user.
Answer: B
24) Trade accounts receivable should exclude

A) accounts receivable denominated in foreign currencies.
B) past-due accounts receivable.
C) related party accounts receivable.
D) accounts receivable of clients entitled to receive discounts.
Answer: C
25) In the sales and collection cycle, the results of the tests of controls determine
A) the extent to which planned detection risk is satisfied for each accounts receivable objective.
B) whether assessed control risk for sales and cash receipts needs to be revised.
C) if tests of details of balances need to be performed.
D) whether positive or negative confirmations should be used for this engagement.
Answer: B
44
26) A) Describe the differences between positive and negative confirmations. Which type is more reliable?
B) Discuss the advantages and disadvantages of using negative accounts receivable confirmations rather
than positive confirmations.
C) Discuss the circumstances in which it is acceptable to use negative confirmation requests.
D) The auditor's decision regarding the type of accounts receivable confirmation to use involves a
continuum, starting with using no confirmations in some circumstances, to using only negatives, to using
both positives and negatives, to using only positives. Discuss the primary factors affecting this decision.
Answer: A) A positive confirmation requests the recipient to respond regardless of whether the balance
as stated on the confirmation is correct or incorrect. In contrast, a negative confirmation requests the
recipient to respond only if the balance as stated on the confirmation is incorrect. Positive confirmations
are more reliable because the auditor can perform follow-up procedures if a response is not received from
the customer and requires the customer to respond. A non-response will initiate a subsequent procedure
to complete.
B) The primary advantage of negative confirmations is that they are less expensive than positive
confirmations because there are no second requests and no follow-up of nonresponses. The primary
disadvantage of negative confirmations is that they are less reliable than positive confirmations because a
nonresponse is regarded as a correct response, even though the debtor may have ignored the
confirmation request.
C) CAS 505 states that negative confirmation should be used only when risks of material misstatement
are low and when the following are true:
• The items to be confirmed are homogeneous (i.e., similar in nature) and comprise small account
balances.
• No or few exceptions are likely.
• There is an expectation that the negative confirmations will be read and considered.
D) The primary factors affecting the decision regarding the type of confirmation to use are the materiality
of total accounts receivable, the number and size of individual accounts, control risk, inherent risk, the
effectiveness of confirmations as audit evidence, and the availability of other audit evidence.
27) Discuss the alternative procedures an auditor can perform to test the existence objective for accounts
receivable when customers do not respond to confirmation requests.
Answer: For any positive confirmation not returned, the auditor can examine the following to verify the
existence of individual sales transactions making up the ending balance in accounts receivable.
• Subsequent cash receipts: Evidence of the receipt of cash subsequent to the confirmation date includes
examining remittance advices and entries in the cash receipts records
• Duplicate sales invoices
• Shipping documents
• Correspondence between the customer and the client
45
28) Outline the audit procedures the auditor may consider performing to validate the valuation assertion
for accounts receivables.
Answer: The audit procedures the auditor may consider performing to validate the valuation assertion
for accounts receivable are:
• Inspect the noncurrent accounts on the aged accounts receivable trial balance to determine which have
not been paid subsequent to the balance sheet date.
• Compare size and age of unpaid balances with similar information from previous years to evaluate
whether the amount of noncurrent receivables is increasing or decreasing over time.
• Examine credit files, discuss with the credit manager, and review customer correspondence
files as needed. Consider past history to determine the percentage of current accounts that need to be
allowed for.
• Conduct substantive analytical review over time (trend analysis) of bad debts to evaluate quality of
accounts receivable.
• Verify accuracy of bad debt expense as a residual, checking validity of charges to the bad debt expense
if needed.
29) Outline the audit procedures the auditor may consider performing to validate the rights and
obligations assertion for accounts receivable.
Answer: The audit procedures the auditor may consider performing to validate the rights and
obligations assertion for accounts receivable are:
• Determine whether the receivables have been pledged as collateral, assigned to someone else, factored,
or sold at discount by inquiring of management and reviewing minutes of directors' meetings.
• To verify details, send confirmations to banks, and examine correspondence files.
30) Outline the audit procedures the auditor may consider performing to validate the presentation and
disclosure assertion for revenue and accounts receivables.
Answer: The audit procedures the auditor may consider performing to validate the rights and
obligations assertion for revenue and accounts receivable are:
• Evaluate whether the presentation of revenue on a gross basis (as a principal) versus net (as an agent) is
in conformity with the applicable financial reporting framework.
• Evaluate the adequacy and understandability of the presentation of the revenue recognition policy.
• Evaluate the understandability and completeness of the footnotes for accounts receivable: some
required footnote disclosure includes information about the pledging, discounting, factoring, assignment
of accounts receivable, and amounts due from related parties.
• Determine that trade accounts receivable are segregated from related-party accounts receivable, and
that different types of material transactions are clearly listed as separate line items to facilitate the
classification and understandability objectives.
• Read management's discussion and analysis (MD&A) to determine whether there are any
inconsistencies with the financial statements or other information that the auditor has collected in the
course of the audit.
46
31) State the five specific balance-related audit objectives as applied to accounts receivable.
Answer: The five specific balance-related audit objectives as applied to accounts receivable are:
1.The accounts receivable on the aged accounts receivable trial balance exist (existence).
2. The accounts receivable are valid receivables that are due to the company (rights and obligations).
3. All existing accounts receivable have been included in the records and are fully summarized and
posted (completeness).
4. Accounts receivable are stated at net realizable value, with any valuation adjustments appropriately
recorded (valuation).
5. Accounts receivable balances are appropriately recorded (accurately, in the correct period, in the
correct account), including any related adjustments (allocation).
12.11 Design and perform fraud procedures for the revenue cycle
1) Outline some examples of fraud related procedures that could be performed relating to the revenue
cycle.
Answer: Fraud related procedures that could be performed relating to the revenue cycle are:
1) Interview client personnel regarding knowledge of unusual sales transactions.
2) To test for fictitious customers, GAS can be used to identify post-office box addresses, duplicated
addresses, or addresses that are the same as those of employees, for example the bank confirmations are
sent to a post-office box
3) To test for unusual or unexpected revenue relationships or transactions, substantive analytical
procedures and computer-assisted audit techniques may be useful. Potential analytical procedures
include the following: compare credit memo and write-off activity to prior periods; compare the number
of weeks of inventory in distribution channels to prior years (if channel stuffing is suspected).
4) To test for occurrence of revenue, confirm with customers certain relevant contract terms and the
absence of side agreements. Contract terms may include acceptance criteria, delivery and payment terms,
the absence of future or continuing vendor obligations, the right to return the product, guaranteed resale
amounts, and cancellation or refund provisions.
5) If the auditor is concerned about cutoff, he or she should consider being physically present at one or
more locations at period-end to observe goods being shipped or being readied for shipment (or returns
awaiting processing).
6) Review accounting estimates (such as allowance for doubtful accounts or returns allowance) for biases
and evaluate whether the bias, if any, represents a risk of material misstatement due to fraud.
Learning Obj.: 12-11 Design and perform fraud procedures for the revenue cycle
47

Chapter 12 Audit of The Revenue Cycle: Auditing, 14e (Arens)

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Chapter 12 Audit of The Revenue Cycle: Auditing, 14e (Arens)

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Auditing, 14e (Arens)

Chapter 12 Audit of the Revenue Cycle

6) Most companies recognize sales when

16) Describe skimming.

1) Audit risk is assessed for

Clients and Credit Limits

Allowance for Doubtful Accounts

Allowance for Doubtful Accounts

17) List the common fraud schemes relating to revenue.

Analytical Procedure Possible Misstatement

Diff: 2 Type: ES Page Ref: 399

1) The appropriate test of controls for separation of duties is

Description of field contents

5) An effective procedure to test for unbilled shipments is to trace from the

2) Which of the following audit procedures is a dual-purpose test?

12.10 Obtain and evaluate accounts receivable confirmations

3) The primary purpose of accounts receivable confirmation is to satisfy the

8) A positive confirmation is more reliable evidence than a negative confirmation because

24) Trade accounts receivable should exclude

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