Chapter 7 ~ Transaction Cycles ~ Test of Controls CHAPTER 7; SELF-TEST EXERCISES DISCUSSION QUESTIONS 1, Define transaction cycle. eee 2. Enumerate the five major categories of Caer 3. Describe the primary objectives of each transact dh 4. Identify the accounts affected by each transaction e7 a 5. Itemize the documents received, initiated and processed in revenue, rere, and disbursement cycles. puke) 6. Briefly discuss the functions of the different departments of reve receipt, disbursement and human resource and payroll cycl : 7. Identify the control-related duties and responsibilities of differer departments involved in the production, financing and investing cycles, 7-1 TRUE OR FALSE 1. Business processes are end to end steps done by an organization that help iq achieving its business objectives. 2. Inputs and outputs of a business process must be clearly defined in order ty add value to the service or product offered by an organization, 3. The overall objective in the audit of the order to cash business Process isto evaluate whether the account balances affected by the business process are fairly presented, 4. sales invoice indicates the credit approval of a customer, 5. Before a customer's order is received, credit approval is required, 6. The point on which goods are shipped is essenti al as it denotes the point in which the goods are released to the customer, 7. Emphasis is placed on the occurr i ence assertion when audit i s returns and allowances, sectors examine se a Pee are more useful than vendors’ statements when Pp Ing test of controls or Substantive tests of Purchase transactions. 9. Recognition of liability by companies normally occur upon receipt of goods. Payment vouchers r ir objective of purchases, lates mainly to the occurrence Aim... Believe... Claim. Page 270| i 22 13, 4 15, a ot ue on FALSE r _ transaction Cycles - Test of Controls ceiving reports are normally used to denote receipt of goods and not the seit of services. I youcher is 2 document received from the vendor which shows the pion and quantity of goods received, price including freight, discounts «auditor has assessed that the control risk is low, it is often more reduce the extent of test of controls and rely primarily on tests when auditing the expenditure and disbursement cycle. ith substantive uiing of personnel completes the payroll and personnel cycle. ribution of payroll checks must be done by personnel independent of the payroll and timekeeping functions. The payroll function and human resources department are often combined in an organization. A surprise payroll payoff in which employees pick-up and sign for their paycheck is one means of control to check for fraudulent hours charged by an employee. persons in charge of the custody of the inventory must also maintain the perpetual inventory records. Observation of the client inventory count and performance of test counts help in determining whether the recorded inventory was properly valued by the client. . Approved and prenumbered documents for the authorization of movement of inventory is a physical control that help prevent loss of assets. If the physical count shows higher quantities than the perpetual inventory records, an explanation of the difference might be due to unrecorded sales. The finance and investment cycle often involve low in volume but high in value transactions. ‘The share capital master file is used as the basis for the payment of dividends and helps in checking the accuracy of the share capital balance. Oisbursement of cash dividends to shareholders are often given to independent cash registrars. co to investment certificates are often given to at least two high-ranking. cers which is also known as joint custody. Page 271Chapter 7 ~ Transaction Cy! cles - Test of Controls 7-3 MULTIPLE CHOICE QUIZZERS L js to efficient processing of, 7 ‘The transaction cycles approach lead a8 ny, nsactions because ; ize. 2 ansacton cesar esi f wathin 2 given cycle ca 8. A large number of transactions wit 7 Bi a N be Ceti, "nto a relatively small number oe Ade 4 C.. The transaction cycle approach represen' Order of usin, 0. Transaction cycles are easy to understand. %, What is the major difference between the revenue and the pend, cle? Terr é The revenue cycle includes marketing activities; the expenditure oe does not. : : 7 ; 8. In the revenue cycle, cash is received; in the expenditure cycle cash, paid out. ; C. The expenditure cycle includes paying employees. Dd. The revenue cycle includes the activity of obtaining funds frominvestg The business owners obtain financing from outside investors, which Fesuls in an inflow of cash into the company. This transaction is considered tobe part of which cycle? A B. The revenue cycle C. The production cycle The payroll cycle D. The financing cycle All transaction cycles feed information directly into the AL B. Cc. D. Governmental reports Financial statements Financing operations General ledger and reporting system The overall objective in the audit of the sales and collection cycle is 2 evaluate whether A 8. oS . The sales account and ‘The sales account and the accounts receivable account are free of €°0! The sales account and th © accounts receivable are free of matet errors, The accounts balances affe in cted by th irly presented accordance with GAAP, the cycle are fairly p the accounts receivable account are preset! fairly in accordance with GAAP.| ter 7~ Transaction Cycles = Test of Controls chet nich of the following is not typically included in the « : cycle? pad debt expense Allowance for uncollectible accounts C._ Sales returns and allowances p. Cash credits from the cash disbursement journal +. Inconsidering internal control within the revenue/receipt cycle, what is the purpose of a transaction walk through? a, Toassure that employees are performing assigned functions accurately. g, To confirm the auditor's understanding of the internal control + C. Toselect documents for detailed tests of controls. p. Toverify the results of the auditor's sampling plan. g. Which among the following is a transaction document not found “revenue” cycle? A. Sales order C. Bill of lading 8. Requisition form D. Sales invoice 9. Which of the following is not normally considered a step in the credit functions? A. Accepting customer orders C. Approving credit B. Shipping the sales orders D. Acquiring goods to fill 10. Before goods are shipped on account, a properly authorized person must ‘A. Prepare the sales invoice 8. Approve the journal entry C. Approve credit D. Verify that the unit price is accurate 11. To determine whether internal control operates effectively to mini errors of failure to post invoices to the customer's accounts ledger, the auditor would select a sample of transactions from the population represented by the A. Bill of lading file 8. Sales invoice file C. Customer order file 0. Subsidiary customer accounts ledger 12. To test for unsupported entries in the ledger, the direction of audit testing should be from the A. Journal entries C. Original source documents 8. Ledger entries D. Externally generated documents RP Believe... Claim. Page 273 oe>| Test of Controls Chapter 7 - Transaction Cycles ~ to shipping documents provides evig invoice — 13. Tracing copies of sales invoi ing do : A. Shipments were recorded as receivable B. Billed sales were shipped C.. Shipments were billes , D. Debits to accounts receivable were for sales shipped i ions is not commo 14. Which of the following _ functio nto a expenditure/disbursement cycle? : oa A a Resources are acquired from vendors in exchange for obligations , B. Obligations to vendors are paid. C. Resources are held, used or transformed : D. Resources are acquired from employees in exchange for Obligations to pay. O pay, 15. The primary audit objective regarding the purchasing of materials by the client is to ‘A. Ascertain that materials paid for are on hand. B. Observe the annual physical count. C. Investigate the recording of unusual transactions regarding materials, D. Determine the reliability of financial reporting by the Purchasing function. 7-4 MULTIPLE CHOICE QUIZZERS 1. To achieve good internal control, which department should perform the activities of matching shipping documents with sales orders and preparing daily summaries? A. Billing department C. Credit department B. Shipping department D. Sales order department 2. Which of the following control customers for some shipments? A. Each shipment should be suy that is accounted for. 8. 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. Procedures may prevent the failure to bil ported by a pre-numbered sales invoice 3. In the event the customer fail the entity's personnel shall A. Credit manager B. Sales manager led to submit a remittance advice, who amos Prepare a remittance advice? C. Receptionist i D. Accounts receivable clerkchapter 7 ~ Transaction Cycles — Test of Controls 4, Which et re Maa controls most likely would be effective in offsetting the tendency of sales personnel to maximize sales volume at the e f high bad debt write-offs? te A. Employees responsible for authorizin; alee g bad debt write-offs are denied B. Employees involved in the credit granti tin faa granting are separated from sales Cc. Shipping documents and sales invoices are matched by an employee who does not have authority to write-off bad debts. D. Subsidiary accounts receivable records are reconciled to the control account by an employee independent of the authorization of credit. 5, To achieve control when there is no billing department, the billing function should be performed by the ‘A. Accounting department C. Sales department B. Shipping department D. Credit and collection department 6. Which of the following would the auditor consider to be an incompatible operation if the cashier receives remittances from the mail room? ‘A. The cashier makes the daily deposit at a local bank. B. The cashier prepares the daily deposit. C. The cashier endorses the checks. D. The cashier posts the receipts to the accounts receivable subsidiary ledger. 7. Which of the following fraudulent activities most likely could be perpetrated due to lack of effective control in the revenue cycle? A. The failure to prepare shipping documents may cause an overstatement of inventory balances. B. Authorization of credit memos by personnel w! permit the misappropriation of cash. C. Fictitious transactions may be recorded that may cause an understatement of revenues and overstatement of receivables. D. Claims received from customers for goods returned may be intentionally recorded in other customer's accounts. sales have been misappropriated, which the misappropriation and unlikely to be ho receives cash may 8 Assuming cash receipts from credit of the following is likely to conceal detected? A. Understating the sales journal 8. Overstating the accounts receivable control account C. Overstating the accounts receivable subsidiary ledger D. Overstating the cash receipts journal Page 275 Aim... Believe... Claim...Ny —Test of Controls Chapter 7 — Transaction Cycles ; > oe the review of a small cowner-managed company’s intemal ; cons the auditor discovers that the accounts receivable clerk approys memos and has access to cash. Which of the following controjs Wout this deficiency? . A. The owner reviews errors in billings to customers and pops. subsidiary records. B. The owner reviews credit memos after they are recorded, C. The controller reconciles the detailed receivables records to the ledger. D. The controller reviews the monthly bank statement directly 5, reconciles the checking accounts. ¢ if 1d Renan 10. Sales invoices may be recorded in the incorrect accounting percg , computer comparison of the invoice date with the accounting period yi, the goods were shipped relates to the : A. Valuation or allocation assertion. B. Completeness assertion. C. Existence or occurrence assertion. D. Existence or occurrence assertion and to the completeness assertion, 11. A request by an authorized employee for goods or services is made onthe A. Purchase order C. Debit memo B. Purchase requisition D. Acquisition transaction file 12. Which of the following is a primary function of the purchasing department? A. Ensuring the acquisition of goods of a specified quality. 8. Authorizing the acquisition of goods. C. Verifying the propriety of goods of a specified quality. D. Reducing expenditures for goods acquired. 13. Internal control is improved when the quantity of merchandise ordered omitted from the copy of the purchase order sent to the A. Department that initiated the requisition B. Purchasing agent C. Receiving department D. Accounts payable department 14. The purchase order forwarded to the receiving department indicates vendor's name and the quantities of materials ordered. This may Pe cause A. Payment for unauthorized items 8. Overpayment for incomplete deliveries C. Payment for unauthorized vendors : D. Delay in recording purchases| aa chapter 7 Transaction Cycles —Test of Controls 45, The document which specifies the amount of money owed to the vendor for an acquisition is the A. Receiving report C. Vendor's invoice B. Purchase order D. Accounts payable trial balance 7-5 MULTIPLE CHOICE QUIZZERS 4, The accounts payable department receives a purchase order form to accomplish all of the following, except ‘A, Comparing invoice price to purchase order price. B. Ensuring that the purchase had been properly authorized. C. Comparing quantity ordered to quantity purchased. D. Ensuring that the goods had been received by the party requesting the goods. 2. Matching the suppliers’ invoice, the purchase order, and the receiving report normally should be the responsibility of the A. Receiving department C. Purchasing department 8. Accounting function D. Treasury function 3. What is the reason for ensuring that every copy of a vendor's invoice has a receiving report? ‘A. To ascertain that merchandise billed by the vendor was received by the company. 8. To ascertain that merchandise received by the company was billed by the vendor. C. To ascertain that the invoice was correctly prepared. D. To ascertain that a check was prepared for every invoice. 4, Which of the following controls is not usually performed in the vouchers payable department? A. Matching the vendor’s invoice with the related receiving report. 8. Approving vouchers for payment by having an authorized employee sign the vouchers, C. Indicating the asset and expense accounts to be debited. D. Accounting for unused pre-numbered purchase orders and receiving reports, 5. For good internal control, the person who should sign checks is the A. Person preparing the checks —_C. Accounts payable clerk 8. Purchasing agent D. Treasurer 6. The internal control which requires that “purchase orders, receiving reports, and vouchers are pre-numbered and accounted for” satisfies the objective of A. Validity C. Completeness Authorization D. Valu: Page 277a. hong Chapter 7 — Transaction Cycles ~ Test of Controls 7. The mailing of disbursement checks and remittance adyieg controlled by the employee who A. Signed the checks last B. Approved the vouchers for payment C.. Matched the receiving reports, purchase orders, and vendor j D. Verified the mathematical accuracy of the vouchers advices FiGieg. ANd terpig 8. Which of the following is a standard control over cash disbursemenygy A. Checks should be signed by the controller and at | employee of the company. B. Checks should be sequentially numbered and the numerical should be accounted for by the person preparing bank reconciling, C. Checks and supporting documents should be marked. «.” immediately after the check returned with the bank statement, D. Checks should be sent directly to the payee by the employee yp, Prepares documents that authorize check preparation, tone oth, S46 paige 9. Which is incorrect? A. After payment, the purchase order, receiving report and vender; invoice are stamped paid to prevent duplicate payments B. Before recording in the journals, accounting department normaly matches purchase order, receiving report and vendor's invoice C. Voided checks are mutilated, retained and accounted for D. Two signatures must be present on checks regardless of its amount 10. Which of the following controls is most effective in assuring that recorded purchases are free of material errors? A. The receiving department compares the quantity ordered on purchast orders with the quantity received on receiving reports. 8. Vendor's invoices are compared with purchase orders by an employe? who is independent of the receiving department. C._ Receiving reports require the signature of the individual who authored the purchase. we D. Purchase orders, receiving reports, and vendor's invoices independently matched in preparing vouchers. 11. How can an auditor test to determine whether Receiving Depat Procedures are applied properly? Test a sample of receiving documents B. Interview Receiving department personnel C. Review procedures manuals D. Observe receiving procedures on a surprise basis A.yr cha ter 7 — Transaction Cycles — Test of Controls 2, The internal control which requires documentation before signing of checks by the objective of A. Validity 8, Completeness “examination of supporting an authorized person” satisfies C. Valuation and allocation D. Posting and summarization 43, Which of the following questions would be inappropriate on an internal control questionnaire concerning purchase transactions? A, Are an approved purchase requisition and a signed purchase order required for each purchase? 8, Are prenumbered purchase orders and receiving reports used and accounted for? C. Are all goods received in a centralized receiving department and counted, inspected, and compared with purchase orders on receipt? D. Are intact cash receipts deposited daily in the bank? 14. Which of these functions is not a test of acquisitions? A. Processing purchase orders C. Processing cash disbursements B. Recognizing the liability D. Receiving goods and services 15, It shows the total hours worked by each production employee in a day. A. Clock card C. Payroll register B. Job time ticket D. Time summary 7-6 MULTIPLE CHOICE QUIZZERS 1. Which of the following is not a common activity within personnel and payroll? A. Initiating terminations B. Preparing and recording payroll C. Preparing and updating personnel records D. Distributing paychecks to employees 2. Which of the following departments most likely would approve changes in pay rates and deductions from employee salaries? A. Personnel C. Treasurer 8. Controller D. Payroll 3. The proper use of prenumbered termination notice forms by the payroll department should provide assurance that all A. Uncashed payroll checks were issued to employees who have not been terminated. 8. Personnel files are kept up to date. © Employees who have not been terminated receive their payroll checks. 5. Terminated employees are removed from the payroll. - Believe... Claim. Page 279 aTa” Chapter 7 = Transaction Cycles - Test of Controls 4, The purpose of segregating the duties of hiring personnel and istributing payroll checks is to separate the / A. Human resources function from the controllership function 8. Administrative controls from the internal accounting controls C. Authorization of transactions from the custody of related assets D. Operational responsibility from the record keeping responsibility 5. To minimize the opportunities for fraud, unclaimed cash payroll should be A. Deposited in a safe deposit box B. Held by the controller C. Held by the payroll custodian D. Deposited in a special bank account 6. For appropriate segregation of duties, journalizing and posting summary payroll transactions should be assigned to the A. Treasurer's department C. General accounting B. Payroll accounting D. Timekeeping department 7. Which of the following statements best explains why the accuracy of payrail calculations and of payroll account distribution is critical to auditor? ‘A. Employees will complain to management if their paychecks do net reflect wages or salaries earned. B. Payroll is paid in cash, an account that is highly susceptible to frauds. Auditing standards require that tests of cash and payroll be coordinated D. Payroll impacts several statement of financial position and statement of comprehensive income accounts 9 8. It would be appropriate for the payroll accounting department to be responsible for which of the following functions? A. Approval of employee time records B. Maintenance of records of employment, discharges, and pay increases C. Preparation of periodic government reports as to employees’ earnings and withholding taxes D. Temporary retention of unclaimed employee paychecks 9. On a surprise basis, an auditor may elect to distribute paychecks employees personally. What is the primary purpose of this audit procedure? A. To assure that no extra payroll checks are prepared and distributed B. To test whether all paid employees exist C. To assure that paychecks are not distributed to an employee absen the day the auditor distributes checks. D. To test the procedures for distributing paychecks ton_ Transaction Cycles — Test of Controls coat corded payroll payments are for work actually performed by non- 30 ittious employees” satisfies the control objective of fem authorization C. Validity a completeness D. Valuation ogxistiN€ payroll transactions are recorded” satisfies the control objective of 1. quthorization C. Validity completeness D. Valuation the objectives of the internal structure for a production cycle are to provide assurance that transactions are properly executed and recorded, and that production orders are pre-numbered and signed by a supervisor Custody of work in process and of finished goods is properly maintained independent internal verification of activity reports is established . Transfers to finished goods are documented by a completed production report and a quality control report 12. A B. c 0. which of the following activities is not a common to the conversion cycle? Maintaining perpetual inventory records. 5. Accounting for fixed asset disposals and retirements. c._ Recording depreciation allocations. D. Implementing a just-in-time order entry system. 3. > 14, Which of the following policies is an internal control weakness related to the acquisition of factory equipment? ‘A. Advance executive approvals are required for equipment acquisitions. 8. Variances between authorized equipment expenditures and actual costs are to be immediately reported to management. C. Depreciation policies are reviewed only once a year. D. Acquisitions are to be made through and approved by the department in need of the equipment. .d in quantities and in peso, 15, When perpetual inventory records are maintaine are deficient, the auditor and internal control procedures over inventory would probably A. Want the client to schedule the physical invento the year. 8. Insist that the client perform physical counts of inventor times during the year. C. Increase the extent of tests for unreco! year. Have to disclaim an opinion on the income sta ry count at the end of ry items several rded liabilities at the end of the 2 tement that year. earn ‘im, | Believe. Claim. bhChapter 7 - Transaction Cycles ~ Te 7-7 MULTIPLE CHOICE QUIZZERS 1. I control, which of the followin st of Controls From the perspective of good interna! Bist, most appropriate individual to distribute payroll checks? "e A. The payroll clerk. C. Accounts receivable clerk, B. Apersonnel employee. D. Employee supervisors, Tracing shipping documents to prenumbered sales invoices provide evidence that ‘A. No duplicate shipments or billings occurred. B. Shipments to customers were properly invoiced. C. Allgoods ordered by customers were shipped. ices were accounted for D. All prenumbered sales invoi Which of the following controls most likely would assure that all billed sales are correctly posted to the accounts receivable ledger? ‘A. Daily sales summaries are compared to daily postings to the accouns receivable ledger. B. Each sales invoice is supported by a prenumbered shipping document, C.__ The accounts receivable ledger is reconciled daily to the control accout in the general ledger. D. Each shipment on credit is supporte! h voucher is submitted and paid only once, an mine d by a prenumbered sales invoice. To provide assurance that eacl auditor most likely would examine a sample of paid vouchers and deter whether each voucher is ‘A. Supported by a vendor’s invoice. B. Stamped “paid” by the check signer. CC. Prenumbered and accounted for. D. Approved for authorized purchases Which of the following controls would an entity most likely use to assst* satisfying the completeness assertion related to long-term investments? A. Senior management verifies that securities in the bank safe-depost >™ are registered in the entity’s name. B. The internal auditor compares the securities in the bank safe-der box with recorded investments. C. The treasurer vouches the acquisition of securities by compari brokers’ advices with canceled checks. ded D. The controller compares the current market prices of investments with the brokers’ advices on file. When verifying debits to a manufacturing company's perpetual invent rece, an auctor would be most interested in testing a sample of pure? . Approvals C.Invoi Ieiti, a Requisitions 0 OrdersYr chapter 7 ~ Transaction Cycles ~ Test of Controls 7. An auditor's tests of a client's cost accounting system are designed primarily to determine that ‘A, Quantities on hand have been computed based on acceptable methods that reasonably approximate actual quantities on hand. 8. Physical inventories substantially agree with book inventories. C. The system complies with generally accepted accounting princip| functions as planned. D. Costs have been assigned properly to finished goods, work in process, and cost of goods sold. nd g. Anauditor has accounted for a sequence of inventory tags and is now going to trace information on a representative number of tags to the physical inventory sheets. The purpose of this procedure is to obtain assurance that A. The final inventory is valued at cost B. All inventory represented by an inventory tag is listed on the inventory sheets C. Allinventory represented by an inventory tag is bona fide D. Inventory sheets do not include untagged inventory items 9, For several years, a client's physical inventory count has been lower than what was shown on the books at the time of the count so that downward adjustments to the inventory account were required. Contributing to the inventory problem could be deficiencies in internal control that led to the failure to record some A. Purchases returned to vendors _ C. Sales returns received 8. Sales discounts allowed D. Cash purchases 10. The physical count of inventory of a retailer was higher than shown by the perpetual records. Which of the following could explain the difference? A. Inventory items had been counted, but the tags placed on the items had not been taken off the items and added to the inventory accumulation sheets, B. Credit memos for several items returned by customers had not been recorded. C. No journal entry had been made on the retailer's books for several items returned to its suppliers. D. An item purchased "FOB shipping point" had not arrived at the date of the inventory count and had not been reflected in the perpetual records. 11 A company holds bearer bonds as a short-term investment. Responsibility for custody of these bonds and submission of coupons for periodic interest collections probably should be delegated to the A. Chief Accountant C. Cashier Internal Auditor D. Treasurer B,~Test of Controls i cles Chapter 7 ~ Transaction Cy‘ esponsibility that should not be assigneg toon ni 12, Which of the following is ar one employee? A. Access to securities i , B. Custodianship of the cash working fund. C. Reconciliation of bank statements. — D. Custodianship of tools and small equipment. in the company's safe deposit box. 13, Which of the following questions would an auditor most likely include ee internal control questionnaire for notes payable? A. Are assets that collateralize note payable critically needed for y, entity's continued existence? B. Are two or more authorized signatures required on checks that repay notes payable? C. Are the proceeds from notes payable used for the purchase tt noncurrent assets? D. Are direct borrowings on notes payable authorized by the board o directors? 14. In reviewing and evaluating internal control over marketable securities, the auditor would be specially concerned about: A. Recording of stock investments by the controller. 8. Approval of stock investment purchases by the Board of Directors, | C. Access to stock certificates by the corporate treasurer. D. Access to stock certificates by the controller. 15. When no independent stock transfer agents are employed and the Corporation issues its own stocks and maintains stock records, canceled stock certificates should A. Not be defaced but segregated from other stock certificates and retained in a canceled certificates file. Be destroyed to prevent fraudulent reissuance, Be defaced and sent to the secretary of state. D. Be defaced to prevent reissuance and attached to their corresponding | stubs. ' op “You have to be able to accept failure to get better.” LeBron James End of Chapter