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Auditing and Assurance Services 6Th Edition Louwers Solutions Manual Full Chapter PDF
Auditing and Assurance Services 6Th Edition Louwers Solutions Manual Full Chapter PDF
Auditing and Assurance Services 6Th Edition Louwers Solutions Manual Full Chapter PDF
CHAPTER 07
LEARNING OBJECTIVES
2. Describe the revenue and collection 4, 5, 6, 7, 8 31, 32, 39, 43, 60, 67, 70
cycle, including typical source 46, 52
documents and controls procedures.
3. Give examples of tests of controls 9, 10, 11, 12, 30, 33, 34, 35, 61, 62
over customer credit approval, 13, 14 37, 47, 51, 55
delivery, and recording of accounts
receivable.
4. Give examples of substantive 15, 16, 17, 18, 36, 38, 41, 42, 63, 64, 66, 73,
procedures in the revenue and 19, 20, 21, 22 44, 45, 48, 49, 74, 75
collection cycle and relate them to 50, 53, 56, 57,
assertions about account balances at 58, 59
the end of the period.
5. Describe some common errors and 23, 24, 25 26, 40, 54 65, 69, 71
frauds in the revenue and collection 27, 28
cycle and design some audit and
investigation procedures for detecting
them.
7-1
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Chapter 07 - Revenue and Collection Cycle
7.2 Revenue recognition is used as a primary means for inflating profits for several reasons. First, it is not
always straightforward when revenues have been earned. Sales can be structured with return provisions or
can have other performance provisions attached. Second, the timing of shipments at year-end may be easy
to falsify. Third, markets often value companies based on a multiple of its revenue instead of net income.
7.3 New companies often do not show a profit during their first few years. Therefore, creditors and investors
often place more emphasis on the revenues, especially looking for revenue growth that might lead to future
profitability. Knowing this, management could try to inflate revenues.
7.4 The basic sequence of activities and accounting in a revenue and collection cycle is:
a. Receiving and processing customer orders. Entering data in an order system and obtaining a credit
check.
b. Delivering goods and services to customers. Authorizing release from storekeeping to shipping to
customer. Entering shipping information in the accounting system.
c. Billing customers, producing sales invoices. Accounting for accounts receivable.
d. Collecting cash and depositing it in the bank. Accounting for cash receipts.
e. Reconciling bank statements.
7.5 When documents such as sales orders, shipping documents, and sales invoices are prenumbered, someone
can later account for the numerical sequence and determine whether any transactions have failed to be
recorded. (Completeness assertion.)
7.6 Access to computer terminals should be restricted so that only authorized persons can enter or change
transaction data. Access to master files is important because changes in them affect automatic computer
controls, such as credit checking and accurate inventory pricing.
• Find the support for debit entries in the sales journal file. Expect to find evidence (copy) of a sales invoice,
shipping document, and customer order. The sales invoice indicates the shipping date.
• Find the support for credit entries in the cash receipts journal file. Expect to find a remittance advice (entry
on list), which corresponds to detail on a deposit slip, on a deposit actually in a bank statement for the day
posted in the customers’ accounts.
7-2
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Chapter 07 - Revenue and Collection Cycle
• Cash in bank
• Accounts receivable
• Allowance for doubtful accounts
• Bad debt expense
• Sales revenue
• Sales returns
• Sales allowances
• Sales discounts
7.10 These specific control procedures (in addition to separation of duties and responsibilities) should be in
place and operating in a control system governing revenue recognition and cash accounting:
• Access to inventory and the shipping area should be restricted to authorized persons.
• Access to billing terminals and blank invoice forms should be restricted to authorized personnel.
• Accountants should be instructed to record sales and accounts receivable when all the supporting
documentation of shipment is in order, and care should be taken to record sales and receivables as of the
date goods and services were shipped, and cash receipts on the date the payments are received.
• Customer invoices should be compared with bills of lading and customer orders to assure that the customer
is sent the goods ordered at the proper location for the proper prices and that the quantity being billed is the
same as the quantity shipped
• Pending order files should be reviewed in a timely manner to avoid failure to bill the customer and record
shipments
7.11 The purpose of the walkthrough is to obtain an understanding of the transaction flow, the control
procedures, and the populations of documents that may be utilized in tests of controls. In a walkthrough of
a sales transaction, auditors take a small sample (usually 1–3 items) of a sales transaction and trace it from
the initial customer order through credit approval, billing, and delivery of goods to the entry in the sales
journal and subsidiary accounts receivable records, and then its subsequent collection and cash deposit.
Sample documents are collected, and employees in each department are questioned about their specific
duties. The information gained from documents and employees can be compared to answers obtained on an
internal control questionnaire to ensure proper Procedures are taking place.
7.12 The assertions made about classes of transactions and events in the revenue and collection cycle are:
• Sales and related events that have been recorded have occurred and pertain to the entity.
• All sales and related events that should have been recorded have been recorded.
• Amounts and other data related to sales transactions and events have been recorded properly.
• Sales and related events have been recorded in the correct period.
• Sales and related events have been recorded in the proper accounts.
7.13 In general, the actions in tests of controls involve vouching, tracing, observing, scanning, and recalculating.
7-3
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Chapter 07 - Revenue and Collection Cycle
7.14 Dual direction tests of controls sampling refers to procedures that test file contents in two “directions”: the
occurrence direction and the completeness direction. The occurrence direction involves a sample from the
account balance (e.g., sales revenue) vouched to supporting sales and shipping documents for evidence of
occurrence. The completeness direction is a sample from the population that represents all sales (e.g.,
shipping document files) traced to the sales journal or sales account for evidence that no transactions
(shipments, sales) were omitted.
7.15 It is important to place emphasis on the existence assertion because auditors have often been sued for
malpractice by providing unqualified reports on financial statements that overstated assets and revenues
and understated expenses. For example, credit sales recorded too early (e.g., a fictitious sale) result in
overstated accounts receivable and overstated sales revenue.
7.16 These procedures are usually the most useful for auditing the existence assertion:
Confirmation. Letters of confirmation asking for a report of the balances owed to the company can be sent
to customers.
Verbal Inquiry. Inquiries to management usually do not provide very convincing evidence about existence
and ownership. However, inquiries about the company’s agreements to pledge or sell with recourse
accounts receivable in connection with financings should always be made.
Scanning. Assets are supposed to have debit balances. A computer can be used to scan large files of
accounts receivable, inventory, and fixed assets for uncharacteristic credit balances. The names of debtors
can be scanned for officers, directors, and related parties, amounts for which need to be reported separately
or disclosed in the financial statements.
Analytical Procedures. Comparisons of asset and revenue balances with recent history might help detect
overstatements. Relationships such as receivables turnover, gross margin ratio, and sales/asset ratios can be
compared to historical data and industry statistics for evidence of overall reasonableness. Account
interrelationships also can be used in analytical review. For example, sales returns and allowances and sales
commissions generally vary directly with dollar sales volume, bad debt expense usually varies directly with
credit sales volume, and freight expense varies with the physical sales volume. Accounts receivable
write-offs should be compared with earlier estimates of doubtful accounts.
7.17 Comparison of sales and accounts receivable to previous periods provides information about existence.
Other useful analytical procedures include receivables turnover and days of sales in receivables, aging,
gross margin ratio, and sales/asset ratios, which can be compared to historical data and industry statistics
for evidence of overall reasonableness. Auditors may also compare sales to nonfinancial data such as units
sold, number of customers, sales commissions, and so on. These comparisons can be made by product,
period, geographic region, or salesperson.
7.18 A positive confirmation is a request for a response from an independent party whom the auditor has reason
to expect is able to reply. A negative confirmation is a request for a response from the independent party
only if the information is disputed. Negative confirmations should be sent only if the recipient can be
expected to detect an error and reply accordingly. They are normally used for accounts with small balances
when control risk is low.
7.19 Justifications for the decision not to use confirmations for trade accounts receivable in a particular audit
include (a) receivables are not material, (b) confirmations would be ineffective based on prior years’
experience or knowledge that responses could be unreliable, and (c) analytical procedures and other
substantive procedures provide sufficient, competent evidence.
7-4
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Chapter 07 - Revenue and Collection Cycle
7.20 Auditors need to take special care in examining sources of accounts receivable confirmation responses.
Auditors need to control the confirmations, including the addresses to which they are sent. History is full
of cases in which confirmations were mailed to company accomplices who had provided false responses.
The auditors should carefully consider features of the reply such as postmarks, FAX, and email responses,
letterhead, electronic mail, telephone number, or other characteristics that may give clues to indicate false
responses. Auditors should follow up electronic and telephone responses to determine their origin (for
example, returning the telephone call to a known number, looking up telephone numbers to determine
addresses, or using a crisscross directory to determine the location of a respondent).
7.21 When positive confirmations are not returned, the auditor should perform the following procedures:
a. Send second and even third requests.
b. Apply subsequent cash receipts.
c. Examine sales orders, invoices, and shipping documents.
d. Examine correspondence files for past due accounts.
7.22 To determine the adequacy of the allowance for doubtful accounts, the auditor reviews subsequent cash
receipts from the customer, discusses unpaid accounts with the credit manager, and examines the credit
files. These should contain the customer’s financial statements, credit reports, and correspondence between
the client and the customer. Based on this evidence, the auditor estimates the likely amount of nonpayment
for the customer, which is included in the estimate of the allowance for doubtful accounts. In addition, an
allowance should be estimated for all other customers, perhaps as a percentage of the current accounts and
a higher percentage of past due accounts. The auditor compares his or her estimate to the balance in the
allowance account and proposes an adjusting entry for the difference.
7.23 Dual-direction testing involves selecting samples to obtain evidence about control over completeness in one
direction and control over occurrence in the other direction. The completeness direction determines
whether all transactions that occurred were recorded (none omitted), and the occurrence direction
determines whether recorded transactions actually occurred (were valid). An example of the completeness
direction is the examination of a sample of shipping documents (from the file of all shipping documents) to
determine whether invoices were prepared and recorded. An example of the occurrence direction is the
examination of a sample of sales invoices (from the file representing all recorded sales) to determine
whether supporting shipping documents exist to verify the fact of an actual shipment. The content of each
file is compared with the other.
7.24 In the Canny Cashier case, if someone other than the assistant controller had reconciled the bank statement
and compared the details of bank deposit slips to cash remittance reports, the discrepancies could have been
noted and followed up. The discrepancies were that customers and amounts on the bank deposit slips to
cash remittance reports did not match.
7.25 To prevent the cash receipts journal and recorded cash sales from reflecting more than the amount shown
on the daily deposit slip, internal controls should ensure that receipts are recorded daily and are complete.
A careful bank reconciliation by an independent person may detect such errors.
7.26 Confirmations to taxpayers who had actually paid their taxes would have produced exceptions, complaints,
and people with their counter receipts. These results would have revealed the embezzlement.
Inquiries: Personnel admitting the practices of backdating shipping documents in a “bill-and-hold” tactic or
personnel describing the 60-day wait for a special journal entry to record customer discounts taken.
Tests of Controls: The sample of customer payment cash receipts would have shown no discount
calculations and authorizations, leading to inquiries about the manner and timing of recording the
discounts.
7-5
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Chapter 07 - Revenue and Collection Cycle
Observation: When observing the physical inventory-taking, special notice should be taken of any goods
on the premises but excluded from the inventory. These are often signs of sales recorded too early.
Confirmations of Accounts Receivable: Customers who had not yet been given credit for their discounts can
be expected to take exception to a balance that is too high.
7.28 The auditors would have known about the normal Friday closing of the books for weekly management
reports, and they could have been alerted to the possibility that the accounting employees overlooked the
once-a-year occurrence of the year-end date during the week.
7.29 a. Incorrect Allowances can be made for anticipated returns if the earning process is
substantially complete.
b. Correct The earning process is complete at this point.
c. Incorrect Under accrual accounting, the cash does not have to be collected, only
collectible
d. Incorrect This is usually the method for determining (b.), but the shipment might be FOB
destination
7.30 a. Incorrect This only initiates the earnings process but it doesn’t complete it.
b. Incorrect This is often the case, but it depends on shipping terms.
c. Correct This is often the same as the bill of lading date.
d. Incorrect Under accrual accounting, the company doesn’t have to wait for the check to
record revenue.
7.31 a. Incorrect This would not have the outstanding balance; however, there are some times
when the auditor confirms the sale instead of the amount receivable.
b. Correct This would have the balance for confirming
c. Incorrect This would not have the individual customer balance
d. Incorrect This would not have the balance outstanding
7.33 a. Incorrect The sale could occur but not be approved for credit.
b. Incorrect The approval is unrelated to the completeness assertion.
c. Correct Credit approval helps ensure that the sale will be collectible.
d. Incorrect Credit approval will not affect in which period the revenue is earned.
7.34 a. Incorrect The general ledger bookkeeper doesn’t have access to the customer accounts.
b. Incorrect There’s no advantage to separating access to checks and currency.
c. Correct The cash is not in the same physical place as the empployees; therefore it cannot
be stolen.
d. Incorrect Normally checks are made payable to company. That doesn’t prevent lapping.
7.35 a. Correct Impropriety of write-offs can be controlled by the review and approval of
someone outside the credit department.
b. Incorrect Even write-offs of old receivables can conceal a cash shortage.
c. Incorrect The cashier could be the cause of the shortage.
d. Incorrect Write-offs should be separated from the sales function.
7-6
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Chapter 07 - Revenue and Collection Cycle
7.37 a. Incorrect This doesn’t verify that the sales invoices represent actual shipments.
b. Incorrect This would require tracing from shipping documents to invoices.
c. Incorrect This would require tracing from invoices to customer accounts.
d. Correct Vouching is used to establish support for recorded amounts.
7.39 a. Incorrect Additional inquiries would not provide sufficient corroborating evidence.
b. Correct Reviewing the changes in pricing during the year and ensuring that customers
were charged the new prices provides sufficient, reliable evidence to support the
sales manager’s representation.
c. Incorrect This is an ineffective use of confirmations and requires respondents to identify
unit costs and report information.
d. Incorrect Payments on vendor invoices would not indicate that prices had increased
during the year.
7-7
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Chapter 07 - Revenue and Collection Cycle
7.42 a. Incorrect A schedule of purchases and payments would be used to test transactions and
might be performed.
b. Incorrect Negative confirmations would not be an appropriate choice for large account
balances
c. Incorrect The terms on the accounts receivable would not provide information on balance
and transaction amounts
d. Correct The most likely audit step when there are a few large accounts is to send out
positive confirmations.
7.43 a. Incorrect The aged trial balance provides only indirect evidence about controls.
b. Incorrect The aged trial balance provides no evidence about accuracy.
c. Correct The age of accounts is an indication of credit losses.
d. Incorrect The aged trial balance provides no evidence about existence.
7.45 a. Incorrect Receiving a confirmation is not evidence that the customer will pay.
b. Incorrect Confirmation will not detect whether the receivables were sold or factored.
c. Correct Accounts receivable confirmation enables recipients to respond that they owe
the company or that they dispute or disagree with the amount the company says
they owe.
d. Incorrect Confirmation provides only indirect evidence that controls are working.
7.46 a Incorrect Prenumbering does not provide any assurance that the document is accutate
b Incorrect Prenumbering does not provide any assurance that the document was recorded
in the proper period.
c. Correct Checking the sequence for missing numbers identifies documents not yet fully
processed in the revenue cycle. It does not provide evidence about accuracy,
cutoff. or occurrence.
d. Incorrect Prenumbering provides no information as to the validity of the transaction.
7.47 a. Correct The accounts receivable debits are supposed to represent sales that have been
ordered by customers and actually shipped to them.
b. Incorrect This is not evidence about existence.
c. Incorrect This provides some evidence about existence, but even if the receivables haven’t
been paid, they may still be valid.
d. Incorrect These file will likely not provide detailed evidence about specific sales.
7.48 a. Incorrect This is an important assertion, but financial statement users are less likely to be
damaged if assets that have not been recorded are found.
b. Correct Financial statement users are more likely to be damaged if assets are found not
to exist or assets are overstated.
c. Incorrect Ownership is important, but doesn’t matter if the assets don’t exist.
d. Incorrect The presentation and disclosure assertion is important but not as important as
existence for asset accounts.
7-8
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Chapter 07 - Revenue and Collection Cycle
7.49 c. Correct This is mainly because the other three choices are listed as appropriate work to
do. Also, customers are likely to ignore negative confirmations after earlier
responding to positive confirmations
.
7.50 a. Correct Negative confirmations are most appropriate when the assessed level of risk is
low, dollar balances on accounts are small, and the auditor believes recipients
will give consideration to the confirmations.
b. Incorrect The auditor assumes customers are likely to respond to errors.
c. Incorrect Because negative confirmations offer higher detection risk, risk of material
misstatement should be low when they are used.
d. Incorrect Because negative confirmations offer higher detection risk, risk of material
misstatement should be low when they are used.
7.51 a. Correct Shipments are traced to customers’ invoices. (This does not imply that the
invoices were recorded in the sales journal.)
b. Incorrect See (a) above. The invoice copies need to be traced to the sales journal and
general ledger to determine whether the shipments were recorded as sales.
c. Incorrect Recorded sales were shipped is not established because the sample selection is
from shipments, not from recorded sales.
d. Incorrect See (c) above.
7.52 a. Incorrect Salespeople could write-off accounts for their friends to keep them from having
to pay.
b. Incorrect The credit manager may propose write-offs to reduce days outstanding and
make her or him look better.
c. Correct The treasurer or another high-ranking manager should approve write-offs.
d. Incorrect The cashier could fraudulently collect cash and write off the balance.
7.53 a. Incorrect A second request is the next action that should be performed.
b. Correct Because the confirmations are a sample of the account balance, even immaterial
items should be followed up as they represent other balances in the universe of
receivables.
c. Incorrect Shipping documents should be examined to test the existence of the receivable.
d. Incorrect Client correspondence files may also provide evidence the receivable exists.
7.54 a. Correct Not recording sales on account in the books of original entry is the most
effective way to conceal a subsequent theft of cash receipts. The accounts will
be incomplete but balanced, and procedures applied to the accounting records
will not detect the defalcation.
b. Incorrect The control account wouldn’t match the total of customer accounts.
c. Incorrect Customers would catch the overstatement when examining their statements.
d. Incorrect This is a possibility, but (a) is a better answer. There is less likelihood of getting
caught if the sale is never recorded.
7-9
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Chapter 07 - Revenue and Collection Cycle
7.57 a. Incorrect Since a large portion of the sales occur in the last month of the year using
analytical procedures at an interim date would not be effective.
b. Correct Since a large portion of the sales occur in the last month the auditor needs to test
end of year sales, specifically the determination of the timing of sales is
important to ensure sales were recorded in the proper period.
C. Incorrect Since a large portion of the sales occur in the last month of the year using testing
internal controls at an interim date would not be effective in determining that
year-end sales were accurate. Additional testing through year end would be
required.
D. Incorrect Period-end compensation may or may not be based on sales. Even if period-end
compensation is tied to sales, a review of the compensation would not provide
evidence of the valuation or cut-off of sales.
7.58 a. Incorrect There is no requirement to confirm accounts receivable that proceed the prior
year.
b. Correct Confirmation are generally reserved for accounts that are material to the balance
being examined, in this case, accounts receivable.
C. Incorrect There is no reason for management to intentionally understate accounts
receivable. Therefore, this would not be a required account for confirmation.
D. Incorrect If an account is subject to valuation estimates the auditor needs to review the
underlying assumptions of those estimates. Confirming the account will not
provide any information regarding the validity of the estimate.
7-10
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Chapter 07 - Revenue and Collection Cycle
7-11
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Chapter 07 - Revenue and Collection Cycle
Error Assertions
a. Sales recorded, Occurrence
goods not shipped
b. Goods shipped, Completeness
sales not recorded
c. Goods shipped to Accuracy
a bad credit risk
customer
d. Sales billed at the Accuracy
wrong price or
wrong quantity
e. Product A sales Classification
recorded as
Product line B
7-12
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Chapter 07 - Revenue and Collection Cycle
Sales invoice sample: Select a sample of random numbers representing recorded sales invoices, and
1(a). Inspect the attached sales order for credit approval signature.
1(b). Trace customer to up-to-date credit file/information underlying the credit approval.
2. Inspect the attached shipping document for (a) existence, and (b) prenumbering imprint.
4. Find the sales invoice associated with the random number (failure to find this means an invoice
wasn’t recorded). Alternatively, use the computer to add up the recorded sales invoice numbers
and compare to a sum of digits check total.
5. Compare sales invoice to sales order for quantity, price, and other terms.
7. Check product line code for proper classification compared to products invoices.
Other
2. Count the number of shipping documents (subtract beginning number from ending number) and
compare to same-period count of sales invoices (to look for different number of documents).
2. Select a sample of random numbers representing shipping documents and look for them in the
shipping document file.
2. Use computer to add the shipping document numbers entered in the files and compare to a
computed sum of digits check total.
8. Find client’s sales dollar batch totals, recalculate the total, and compare to sales journal of the
relevant period.
9. Use the same sales dollar batch totals for comparison to separate total of accounts receivable
subsidiary postings, if available.
7-13
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Chapter 07 - Revenue and Collection Cycle
10. Study the accounting manual on date of shipment and make inquiry about accountants’
instructions to date sales.
12. Obtain client’s documentation showing the accounts receivable subsidiary total reconciled to the
accounts receivable control account. Alternatively, total the subsidiary and compare the amount to
the control account.
13. Obtain client’s documentation showing reconciliation of intercompany receivables and payables
for sales and purchases. Alternatively, confirm balances with subsidiaries or other auditors.
14. Select a sample of credit files and trace to customers’ accounts receivable, noting extent of update
for payment history.
15. Study client correspondence on investigation and collection efforts on overdue customer accounts,
noting any dispute conditions. If no effort is made, follow up overdue accounts with audit
procedures (confirmation, determine existence of debtor in directories, etc.)
a. Auditing standards presume that auditors will request confirmation of the client’s accounts
receivable. An auditor can justify omitting these confirmations if:
(2) The expected response rates to properly designed confirmation requests will be
inadequate, or responses are expected to be unreliable; hence, the confirmation
procedures would be ineffective.
(1) The confirmation form. Some positive forms request agreement or disagreement with
information stated on the form. Other positive forms, known as blank forms, request the
respondent to fill in the balance or furnish other information. Negative forms request a response
only if the recipient disagrees with the information stated on the request.
(2) The auditor’s prior experience with this client or similar clients is also likely to affect
reliability because the auditor will have prior knowledge of the expected confirmation response
rates, inaccurate information on prior years’ confirmations, and misstatements identified during
prior audits.
(3)The nature of the information being confirmed may affect the competence of the evidence
obtained as well as the response rate. For example, this client’s customers’ accounting systems
may permit confirmation of individual transactions, but not account balances, or vice versa.
(4)Sending the confirmation requests to the proper respondents will likely provide meaningful and
competent evidence. Each request should be sent to a person the auditor believes is knowledgeable
about the information to be confirmed.
7-14
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Chapter 07 - Revenue and Collection Cycle
c. The nature of the alternative procedures the auditor can apply when replies to positive
confirmation requests are not received varies according to the account and assertion in question.
Possible alternative procedures include:
(1) Examining subsequent cash receipts and matching such receipts with the actual items being
paid.
(2) Considering inspecting the client’s customers’ purchase orders on file and related shipping
documents.
(3) Inspecting correspondence between the client and its customers could provide additional
evidence.
(4) Establishing the existence of the client’s customers by reference to credit sources such as Dun
& Bradstreet or other sources of identification (e.g., telephone book, business directories, state
incorporation files).
2. Perform sales cutoff tests to obtain assurance that sales transactions and corresponding
entries for inventories and cost of goods sold are recorded in the same and proper period.
b. The client company has a legal right to all accounts receivable at the balance sheet date.
5. (best) Review loan agreements for indications of whether accounts receivable have
been factored or pledged.
d. Accounts receivable are properly described and presented in the financial statements.
6. (best) Review the accounts receivable trial balance for amounts due from officers and
employees.
AUDIT APPROACH
Objective
Obtain evidence to determine whether sales were recorded in the proper period and whether gross accounts
receivable represented the amounts due from customers at year-end.
Control
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Chapter 07 - Revenue and Collection Cycle
Sales terms should be properly documented. Accounting treatment, including billing at agreed-upon prices,
should follow the terms of the sale. If the risks and rewards of ownership have not been transferred to the
customer, or the price has not been reliably determined, or the collectibility of the amount is seriously in
doubt or not estimable, an accrual sale should not be recognized. Recorded sales should be supported by
customer orders and agreements. Shipping documents should be sufficient to show actual shipment or a
legitimate field warehousing arrangement.
Tests of Controls
Questionnaires and inquiries should be used to determine the company’s accounting policies. If the auditors
do not know about “bill-and-hold” practices, they should learn the details. For detail procedures, select a
sample of recorded sales, and examine them for any signs of unusual sales terms. Vouch them to customer
orders and other sales agreements, if any. Vouch them to shipping documents, and examine the documents
for external reliability—recognizing blank spaces (carrier name, date) and company representative’s
signature (two places, both company and carrier). Compare prices asked in customers’ orders to prices
charged on invoices. These tests follow the vouching direction—starting with data that represent the final
recorded transactions (sales) and going back to find originating supporting source documents. These
procedures might reveal some transactions of the problem types—bill and hold, and overbilling. The last
month of the fiscal year (although a typical seasonal low month) could be targeted for more attention
because the sales are much higher than the previous January and because the auditors want to pay attention
to sales cutoff in the last month.
Select a sample of shipping documents, trace them to customer orders, and trace them to invoices and to
recording in the accounts receivable with proper amounts on the proper date. These tests follow the tracing
direction: starting with data that represent the beginning of transactions (orders, shipping) and tracing them
through the company’s accounting process. If extra attention is given in January for cutoff reasons, this
sample might reveal some of the problem transactions.
Audit of Balance
Confirm a sample of customer accounts. Follow up exceptions noted by customers relating to bill and hold
terms, excessive prices, and double billing. Even a few exceptions raise red flags for the population of
receivables.
Use analytical comparison on comparative month’s sales. Investigate any unusual fluctuations (e.g.,
January this year much higher than January last year, the reversal month next year with negative sales). The
January comparative increase in sales should cause auditors to extend detail procedures on some of the
month’s transactions.
Discovery Summary
The auditors performed a detail sales cutoff test on January sales, selecting a sample of recorded sales.
However, they did not notice the significance of “bill and hold” marked on the invoices, and they did not
figure out the meaning of the blank spaces and duplicate company employee signatures on the shipping
documents.
In the following year’s audit, they tested sales transactions in a month when the prior-year bill–and-hold
sales were reversed. They noticed the discrepancy but were told that it involved various billing errors. They
did not connect it with reversal of the prior-year sales.
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Chapter 07 - Revenue and Collection Cycle
The auditors confirmed a judgment sample of large accounts receivable balances. Twelve replies were
received on 103 confirmations. Six of the replies were from bill-and-hold customers who listed
discrepancies. The auditors followed up the six by examining sales invoices and shipping documents. They
did not grasp the significance of the bill-and-hold stamps or the features of the shipping documents
described earlier. Three confirmation responses indicated the customers did not owe the amounts. The
auditors relied on Mattel internal documents to decide that the customers were wrong. They did not
examine the sales orders that indicated that these customers had a right of cancellation.
The auditors did not perform month-by-month analytical sales comparisons with the prior year. Thus, they
did not recognize the significant fluctuations in the comparative January sales. In the next year’s audit, they
did not recognize the significant comparative decrease in monthly sales for the months when the prior-year
bill-and-hold sales were reversed.
File Information
This case is a summary of an actual situation and should be used to generate discussion of how auditors
must adapt to a changing environment. The solution suggested here represents the preliminary response by
the audit firm involved. You and your students will likely generate additional responses.
a. (1) Program change controls—The primary concern is the security of the programs that
process the quarry transactions at the quarry’s computers and at the home office.
Assuming that the auditors can test and evaluate these programs, the concern is how
changes are made in a controlled, authorized fashion. The auditors need assurance that
the same programs are used by all locations throughout the period.
(2) Access controls—Who is authorized to operate the quarry computers and how are
unauthorized personnel prevented from operations? Although not mentioned in the case,
access should be controlled through the use of a weigh master’s identification number
and password (changed periodically). Physical access should also be evaluated. Are the
computers kept in a locked, secure area?
(3) Sales transaction program controls—The system described is not unlike any online sales
order entry system. Certain edit or validation controls should be incorporated such as (a)
limit tests (for impossible weights and out-of-range numbers for rock grade), (b) missing
data tests (all fields have data), (c) valid character and sign tests (appropriate fields
numeric and positive), and (d) sequence tests (transaction numbers in sequence, by
quarry).
7-17
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Chapter 07 - Revenue and Collection Cycle
(4) Completeness controls—The system has to contain controls that ensure that all
transactions sent by the quarries are received at the home office. These can be as simple
as a signal sent back to the quarry microcomputer that the sale was received and as
complex as having the microcomputer accumulate control totals that are matched to home
office control totals at the end of the day. In such distributed systems, the computers
would most likely store all transactions (keep an onsite log) until receipt is confirmed. A
transaction-numbering scheme can also ensure that no transactions were missed.
b. The implication of the programs residing in the computers at the quarries is that programs may be
changed there as well as from the home office. Therefore, the change controls mentioned above
are important as well as how program modifications are made to the quarry computers. Obviously,
several sites will have to be visited.
A final point to have the class discuss is what is likely to happen when one of the computers goes
down at one of the quarries or the entire network is down. Rock Island will have to provide
manual backup procedures, which are normally not well controlled and thus become subject to
errors and frauds.
The Problem
Total patient accounts receivable have increased steadily and rapidly for eight months. Our last audit of this
area was 10 months ago. A favorable report is in the working paper file. I can see no apparent reason for
the increase because the number of beds, the occupancy rate, the billing rates and the insurance contracts
have not changed.
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Chapter 07 - Revenue and Collection Cycle
1. Has the accounting been put on computer within the last 10 months?
2. How many employees handle the accounting?
Computer ______________________
Noncomputer ___________________
To audit the performance of management controls, you will need to know quantitative standards of
acceptable performance. Standards for two policies are described in this memo.
a. Accuracy
Policy standard: No more than 3 percent of the sales invoices are figured with errors of
either quantity or unit price or extension error amounting to over $1 per
invoice.
Audit procedures:
(1) Audit for accuracy by selecting a sample of recorded sales invoices and (a)
vouch the customer name to supporting purchase orders and shipping
documents, (b) vouch the quantity shipped to supporting shipping documents,
(c) trace the unit price to the approved price list, and (d) recalculate the
extensions, including shipping charges and sales tax. Document all errors over
$1 per invoice.
(2) Audit for completeness by selecting a sample of shipping documents and tracing
them to recorded sales invoices.
7-19
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Chapter 07 - Revenue and Collection Cycle
b. Promptness
Policy standard: Sales invoices are to be entered in the sales journal and in customers’
accounts with a (mailing) date no later than one day after shipment.
Audit procedure: Using the samples in procedures 1 and 2 above, compare the sales
journal record date and the date shown in customers’ accounts with the
shipment date. Document the number and extent of time lags exceeding
one day. Inquire about the mailing date.
Policy standard: A complete and accurate aged trial balance is prepared monthly
showing receivables in categories (1) current, (2) 31-59 days overdue,
(3) 60-89 days overdue, and (4) more than 90 days overdue.
Audit procedures:
(1) Inspect the aged trial balances to determine whether they were actually prepared
each month.
(2) Audit for completeness by comparing the trial balance total to the general ledger
control account. (foot each if necessary.)
(3) Audit for accuracy by selecting a sample of customer accounts and tracing aged
data from the customers’ ledger accounts to the aged trial balance. This is the
important direction for the procedures because incorrect “underaging” thwarts
the collection effort. (Selecting a sample of noncurrent aging data from the trial
balance will not enable you to detect noncurrent amounts incorrectly aged as
current.)
Policy standard: Credit department personnel are supposed to receive the trial balance
within five days after each month-end and send different letters within
five business days of receiving the aged trial balance for accounts as
they become longer overdue and to turn accounts over to an outside
collection agency when they are more than 90 days past due. After 60
days, further credit is cut off and customers are put on a cash basis.
Audit procedure:
(1) Inspect the aged trial balances for indication of preparation date or a “date
received” stamp by the credit department to determine promptness of transmittal
within five days after each month-end.
7-20
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Chapter 07 - Revenue and Collection Cycle
(2) For a sample of past due amounts in different months, inspect copies of the
letters sent to customers and (a) observe whether the correct standard letter was
sent and (b) the date. Document exceptions to type of letter and mailing delay.
(3) Inspect correspondence relevant to determining the date that more than 90-day
accounts were turned over to an outside agent.
(4) Inspect notices of credit cutoff for customers with more than 60-day balances
and inspect the trial balance for evidence of new credit mistakenly extended to
such customers.
(5) Using the sample obtained in (2), verify the accuracy of the subsequent
collections report prepared by the credit department by vouching the data therein
to cash receipts records.
Dealing with these weaknesses gives students an opportunity to think about fraud possibilities that could
occur with and without collusion among these four employees. A useful discussion of intentional frauds
can be built around the weaknesses and possibilities shown in the following in the AICPA CPA
Examination answer to this problem.
Credit Manager
• Approves credit without reference to rating agencies (e.g., Dun & Bradstreet).
• Approves credit without using any established credit limits or policy.
• No supervision of the credit-granting function and no reviews of the results of the credit
manager’s credit decisions.
• Can alter the details of customer charges (authorize-initiate transactions) and prepare invoices and
records based on the alterations (a form of recordkeeping in this system).
• Does not use a control total (e.g., daily batch financial total) of the charge forms in comparison to
the total on the invoices and nobody else knows whether the totals agree.
• Does not reconcile the accounts receivable subsidiary ledger with the control account balance
(therefore can write-off accounts for friends because nobody reconciles the totals and nobody
compares the actual write-offs to the bookkeeper’s authorizations) (also the A/R supervisor can
simply not put a contractor’s balance on the report of overdue balances and therefore permit the
contractor to obtain additional credit past the standard six-month period).
Cashier
• Has custody of cash and controls the record keeping (the latter by sending the bookkeeper the only
documents—the remittance advices and daily cash register summary— available for recording the
cash receipts).
• Can alter or delay the bookkeeper’s cash information because no one else has the verified deposit
slip or the list of checks for comparison.
7-21
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Chapter 07 - Revenue and Collection Cycle
• Performs the bank reconciliation, which is not compatible with the cash custody and record-
keeping duties (can alter the reconciliation to cover up cash shortages).
Bookkeeper
• Authorizes account write-offs according to a fixed policy (six-month nonpayment period) without
reference to knowledge of reasons or details (and apparently without further correspondence with
the contractor).
• Allows a six-month grace period that is too long, and may grant credit for a time when it is not
justified.
• Can control the credit-refusal process by not notifying the credit manager of the overdue accounts.
• Can authorize and actually write off accounts without supervision (has the incompatible duties of
authorization-initiation of write-off orders and actually making entries in the records).
a. Observation. Visit the storage location yourself and see whether unauthorized persons
could obtain blank sales invoices.
Pick some up yourself to see what happens.
b. Someone could pick up a blank sales invoice and make a fictitious sale. However, getting
it recorded would be difficult because of the other controls such as matching with a copy
from the shipping department. (Thus, a control access deficiency may be compensated for
by other control procedures.)
a. Vouching and recalculation. Select a sample of recorded sales invoices and vouch
quantities thereon to bills of lading, vouch prices to price lists, and recalculate the math.
b. Errors on the invoice could cause lost billings and lost revenue or overcharges to
customers that are not collectible (thus, overstating sales and accounts receivable).
a. Observation and inquiry. Look to see who is performing bookkeeping and cash functions.
Determine who is assigned to each function by reading organization charts. Ask other
employees.
b. The bookkeeper might be able to embezzle cash and manipulate the accounting records to
give the customer credit and hide the theft. (Debit a customer’s payment to Returns and
Allowances instead of to cash or just charge the control total improperly.)
7-22
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Chapter 07 - Revenue and Collection Cycle
b. Accounting entries could be made inaccurately or incompletely and the control account
may be overstated or understated.
Instructor’s note: The answers to this case are numerous, and the case is meant to initiate a discussion as to the
subtleties of auditing revenue and the nature of the auditor’s responsibilities.
a. Several fraud issues have arisen because the auditor looked only at the numbers but did
not look at how the numbers were generated. In many of these instances, sales were
fictitious or inflated. While this case does not involve such blatant financial statement
fraud, “bait and switch” is considered fraud. In attempting to manage the audit risk, it is
clear that auditors must look at business practices and determine that the client is
generating review legally. However audit standards are clear that determining whether an
act is illegal is beyond an auditor’s competence (SAS 54).
b. If it is likely that the revenue is uncertain in its amount, there should be an adjustment to
reduce revenue by the amount deemed uncertain. The footnote for revenue should
disclose the reason for the adjustment.
If the financial statements were issued during the investigations and a loss appeared to be
reasonably possible, the auditor should ask for a footnote disclosure (FASB 5).
Follow-up note: Subsequent to the preceding article and the imitation of the investigations, Ticketmaster refunded a
substantial part of the revenue to customers who had purchased tickets on TicketsNow.
TBD
The Matsworth Co. is a manufacturer of fine rugs and wall hangings. Its products are sold by
retailers in large department stores. In addition, the products are displayed and sold on consignment
through independently owned and operated "gallery" stores. During the year 2 audit of Matsworth,
the auditor used specific ratios to measure multiyear company performance. The values calculated
for two ratios were considered to represent significant changes and are presented in the following
table. Turnover ratios are based on average balances.
Double-click in the shaded cells associated with each ratio and select the
two best explanations for the year 2 changes from the lists provided.
7-23
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McGraw-Hill Education.
Chapter 07 - Revenue and Collection Cycle
During the course of the year 2 audit of Chester Co., the auditor discovered potential cutoff problems
that may or may not require adjusting journal entries. For each of the following potential cutoff
problems, complete the required journal entries.
• Double-click in the shaded cells in the "Account Name" column and select the
appropriate account name from the list provided. If no entry is needed, select
"No entry required." An account may be used once or not at all for each entry.
• Enter the corresponding debit or credit amount in the appropriate column.
• Round all amounts to the nearest dollar.
• Be aware that all rows may not be required to complete each entry.
7-24
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Erklärung der Abbildungen auf Tafel X und XI 53
Tafeln
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