Learning Check

Chapter 14 inspected ac figureing the taxation enhancement Cycle Learning Check The revenue enhancement enhancement vibration includes the activities involved in the exchange of goods and serve with guests and the realization of the revenue in change. The yeargons of proceedings in this cycle for a merchandising participation ar gross gross revenue, gross sales adjustments, and exchange returns. The primary ac weighs affected by these legal proceeding atomic number 18 sales, accounts due, cost of sales, inventory, immediate payment, sales discounts, sales re travels and everyowances, bad debts expense, and b h brook for uncollectable accountsSpecific visit objectives for the revenue cycle argon derived from the five categories of managements fiscal statement assertions. b. Specific audit objectives for assurance sales transactions include the fol junior-gradee Specific Audit Objectives Transaction Objectives Occurrence. Recorded sales transactions r epresent goods shipped or services provided during the plosive speech sound. Recorded hard currency receipt transactions represent currency sure during the period. Recorded sales adjustment transactions during the period represent authoritative discounts, returns and eachowances, and uncollectable accounts. Completeness. All sales coin expediency and sales adjustments made during the period were save. Accuracy. All sales and hard currency gain and sales adjustments are accurately take accountd using GAAP and correctly diaryized, tot upmarized and posted. Cutoff.All sales, interchange receipts and sales adjustments sacrifice been introduceed in the correct accounting period. Classification. All sales, cash receipts, and sales adjustments gull been recorded in the proper accounts. Balance Objectives humans. Accounts due representing amounts owed by customers exists at the equaliser sheet date. Completeness. Accounts receivable include all claims on cus tomers at the rest period sheet date. Rights and Obligations. Accounts receivable at the balance sheet date represent legal claims of the entity on customers for payment. Valuation and Allocation. Accounts receivable represents gross claims on customers at the balance sheet date and agrees with the sum of the accounts receivable subsidiary ledger. The allowance account for uncollectable accounts represents a reasonable estimate of the discrimination between gross receivables and their net realizable value. Disclosure Objectives Occurrence and Rights and Obligations. tell revenue cycle events and transactions commit occurred and colligate to the entity. Completeness. All revenue cycle disclosures that should have been included in the financial statements have been included. Understandability. Revenue cycle training is appropriately presented and tuition in disclosures is understandable to expenditurers. b 14-3. Following are a few examples of differences between h ow the hearer expertness intake the knowledge of the entity and its environment for a computing machine attach to v. a hotel. a. Certain balance sheet accounts like accounts receivable and inventories are departure to be very signifi give the bouncet for the information processing system manufacturing business, but comparatively fresh for the hotel. The computer company is as well as likely to have a superior ratio of sales to fixed assets, or sale to supply assets, than the hotel. b.The computer company listener go out have significant issues associated with the guess of misstatement with revere to the reality of receivables and inventories that are non present for the hotel. The computer company listener go forth also have to address valuation and allocation issues associated with the collectability of receivables and depress of cost or grocery store of inventories that are insignificant for the hotel. The hotel will have a potential attempt of material mis statement in toll of how it accounts for revenues from properties that it manages for differents, as opposed to properties that it owns. 14-4.Factors that might motivate management to deliberately misstate revenue cycle assertions include Pressures to overstate revenues in tramp to report card achieving announce revenue or profitability targets or industry norms that were non achieved in reality owing to such factors as global, national, or regional frugal conditions, the impact of technological developments on the entitys competitiveness, or poor management. Pressures to overstate cash and gross receivables or understate the allowance for doubtful accounts in order to report a elevateder take of working capital in the face of liquidity problems or going concern doubts.Factors that might give to unintentional misstatements in revenue cycle assertions include The volume of sales, cash receipts, and sales adjustments transactions is often high, resulting in numerous oppor tunities for errors to occur. The timing and amount of revenue to be recognized whitethorn be contentious owing to factors such as ambiguous accounting standards, the choose to make estimates, the complexity of the calculations involved, and purchasers rights of return. 14-5. a. Following are example analytical functionings that the tender might procedure to estimate total revenue for a household appliance manufacturer and for an airline. Industry Possible analytical purposes Household Appliance Mfg. intake former(prenominal) ratio of net sales to capacity with adjustments for capacity changes. Use a combination of past ratios of market role with adjustments of current changes in market share. Requires knowledge of the total market size in the industry. Airline foretell net revenues using information on utilization of capacity (airline toilet miles) and average revenue per seat. b. Two analytical mental processs that the auditor might use to estimate gross ma rgin for company might include. Analytic Procedure Audit Significance Compare historical trends in market share and Companies with commanding market shares often are able to obtain large gross margin with current unaudited information. gross margins. Evaluate the percentage of revenues access from Companies with a high proportion of revenues from unexampled products whitethorn earn new products. premium gross margins due to the ability to innovate. c. Two analytical procedures that the auditor might use to estimate net receivables and the allowance for doubtful accounts for company might include. Analytic Procedure Audit Significance Accounts receivable turn days Understanding a companys narrative of accounts and sales volume can assist the auditor in evaluating net receivables and the enough of the allowance for doubtful accounts. Evaluate the entities history of uncollectable This procedure is earlier connect to the adequacy of the allowance for accounts expens e to net credit sales, with uncollectable accounts. The above history of accounts receivable turn adjustment for economic conditions days would be well-nigh useful for evaluating estimating gross receivables given sales. 14-6. Several look into environment factors and their applicability to revenue cycle assertions are Integrity and ethical values decrement of jeopardize of overstatement of revenues and receivables by eliminating incentives to dishonest reporting. Commitment to competence by chief financial attituders and accounting personnel. Managements philosophy and in operation(p) style conservatism in developing such accounting estimates as the allowance for uncollectable accounts and allowance for sales returns. Human resource policies and practices bonding of employees who handle cash 7. The undermentioned table summarizes the functions that apply to credit sales transactions, the department that performs the functions, and the principal documents or recor ds produced in perform the function. Department that performs function Principal documents and records produced in performing the Function function. Initiating credit sales Sales department Documents client revisal Credit department Sales Order calculator levels and Records Customer overpower File (with credit information) and Accounts Receivable Master File. Perpetual schedule clear Price List Open Order File Delivering good and computer memory and tape drive department for Documents services goods. Shipping documents Reports of unfilled orders and back orders fold operating departments for services. Computer Files and Records Open Order File Perpetual Inventory Shipping File Recording sales Accounting (Billing) Documents Sales write up Sales Reports and Sales Journal Various Exception Reports Monthly Customer Statements Computer Files and Records Sales Transaction File Accounts Receivable Master Fi le 14-8. In order to assess tick risk as low based on programmed control procedures the auditor should do the chase. Control splendor to Control bump Assessment Programmed control procedures If a programmed control procedure in critical to a low control risk judgment then the auditor should directly canvass the control procedure. Computer prevalent control procedures In order to obtain assurance that the programmed control procedure functions effectively throughout the period the auditor also needs to these the military capability of computer usual control procedures. Manual follow-up procedures. Programmed controls usually report exceptions noted when performing the control. As a result auditors also need to mental scrutinying the effectiveness of manual controls that follow-up on reported exceptions. 14-9. The following tables describes programmed controls for a typical manufacturing company. Potential Misstatement Programmed Control CAATs (Assuming Test D ata) a. Sales nibs may not be The computer analyses entries in the sales bend rivulet data for a transaction that has recorded. journal with underlying conveyance information. transport information, two with and without a All transferral documents must be find outed with asupporting sales invoice. sales invoice. b. Sales invoice may be recorded The computer compares dates on the sales interpret footrace data with dates on sales invoices in the wrong accounting period. invoice with dates on shipping documents. that both do and do not match with dates on cerebrate shipping files. c. A fictitious sales invoice, or The computer will not prepare a sale invoice take up test data with sales invoice information a sales transaction for which without underlying information on shipping that both is and is not back up by underlying revenue should not be files. shipping information. recognized, is recorded. d. Sales are made without credit The computer frontes a eye socket for appropriateSubmit test data for sales orders that both are approval. credit authorization before an order is and are not supported by appropriate credit placed on an open order file. authorization. e. A sales invoice has incorrect The computer matches quantities on a sales Submit test data for sales invoices that both do quantities or harms. invoices with underlying shipping informationand do not match underlying shipping information and matches prices with an authorise price and authorized price lists. list. f. Sales invoices may not be The computer influences run-to-run totals of Submit test data for batches that with complete posted or may not be beginning accounts receivable balances, plus and incomplete data sets in terms of completed journalized sales transactions, with the ending transactions. receivable balances. g. Sales invoices may be posted toThe computer matches customer information on Submit test data with underlying information that the wrong customers accounts. the sales invoice with the master customer both does and does not match with information on file, the sales order, and the shipping previously created sales order and shipping documents. files. 14-10. A common management control involves having managers with responsibility for sales to examine everyday or weekly sales reports to assess the discernment of recorded sales. Further management responsible for warehousing and shipping should refreshen daily or weekly sales and inventory movement reports to assess the reasonableness of recorded sales and inventory removed from the perpetual inventory. 14-11. The sub-functions involved in cash receipts include (1) receiving cash receipts, (2) depositing cash in bevel, and (3) transcription the cash receipts. 14-12. a.Two important controls pertaining to cash sales and the transaction class audit objectives to which they relate are The customers expectation of a printed receipt an d supervisory control of over the counter sales transactions helps to turn back that all cash sales are processed through the cash registers or terminals completeness. self-sufficing check by supervisor on the accuracy of cash count sheets, and verification of proportionateness of cash on hand with totals printed by a cash register or terminal existence or occurrence and valuation or allocation. b. Two important controls pertaining to the initial treatment of spot receipts are (1) immediate restrictive endorsement of checks find oneselfd and (2) supply of a multi-copy listing (prelist) of mail receipts. 14-13. a.A lockbox is a post office box that is controlled by the companys bank. The bank picks up the mail daily, credits the company for the cash, and sends the remittance advices to the company for use in updating accounts receivable. This system eliminates the risk of diversion of the receipts by company employees and failure to record the receipts. b. Depositing receip ts intact daily means that all receipts are deposited that is, cash disbursements should not be made out of undeposited receipts. This control reduces the risk that receipts will not be recorded (completeness), and the resulting bank deposit record establishes the existence or occurrence of the transactions. 14-14.Four controls that can aid in preventing or detecting errors or irregularities in recording cash receipts are summarized below along with potential tests of controls Control Test of Control commutative check of agreement of vali go out deposit slip Inspect a ideal of daily cash summaries and examine exhibit of with daily cash summary. agreement with validated deposit slip by responsible employee. Computer check of information included in the cash receipts Use CAATs to test computer matching of information from cash receipts journal with information from prelist. journal with electronic prelist. Also follow-up on how exceptions are reported and examine evidence or correction of errors reported on exception reports. Preparation of periodic mugwump bank expiations. Examine a sample of periodic bank reconciliations. Make inquiries about bank reconciliation procedures and test accuracy on a sample basis. Mailing of monthly statements to customers. watch the mailing of monthly statements to customers.Make inquiries about procedures to follow-up on issues increase by customers, and examine reports or other evidence of follow-up. 14-15. a. The functions pertaining to sales adjustments transactions are granting cash discounts granting sales returns and allowances and determining uncollectable accounts. b. The following leash types of controls pertaining to sales adjustments transactions have as their common focus establishing the validity, or existence of occurrence, of such transactions Proper authorization of all sales adjustments transactions. The use of appropriate documents and records, particularly the use of an approved credi t memo for granting credit for returned or damaged goods, and an approved write-off authorization memo for musical composition off uncollectable customer accounts. Segregation of duties for authorizing sales adjustment transactions and handling and recording cash receipts. 14-16. a. The accounts receivable balance is a function of the transactions that are posted to the account, namely credit sales, cash receipts, and sales adjustments. A sound system of sexual controls over these three transaction cycles that ensure the completeness and accuracy of these transactions, should also ensure the completeness and accuracy of account receivable. b.The primary control over the balance involves sending monthly statements to customers and having an independent function to receive and follow-up on any issues raised by customers. c. The rights and obligations assertion for accounts receivable involves selling, or compute, cash receipts. If an entity sells its receivables, it should keep a documentary record of the receivables that have been sold or pledged, and have a process for following up on collection of those receivables and the reduction of the related liability to the work out agent. These records should be compared with monthly statements received from a bank or factoring agent. d.Public companies commonly control establish controls over the presentation and disclosure assertion and related audit objectives through an effective and independent disclosure deputation. The disclosure committee should have individuals who are knowledgeable about GAAP and the transactions organism processed. 14-17. The following table provides example controls and tests of controls for distributively assertion (and transaction level audit objective) related to credit sales and cash receipts. Examples emphasize programmed control procedures where appropriate. Student should note that tests of controls should also emphasize testing computer general controls, observing exception reports, and testing manual follow-up of items that appear on exception reports. Credit Sales Assertion (Audit Objective) Control Test of Controls Existence and Occurrence (Occurrence) Computer matches sales invoice information Submit test data where invoice data does not match with underlying shipping information. with underlying shipping information. Completeness (Completeness) Computer prints a report of all goods Submit test data with shipments that have not been shipped but not bill. billed to test accuracy of report of all good shipped but not billed. Existence and Occurrence / Completeness Comparison of invoice date with the Submit test data with shipments in one period and (Cutoff) accounting period when goods were shipped. tutelage in the consequent period. Valuation and Allocation (Accuracy) Computer matches sales prices with Submit test data with invoice prices that do not match authorized price list and sales order. the authorized price list or sales orde r. Presentation and Disclosure Computer matches customer number on sales Submit test data the customer information on the sales (Classification) invoice with customer number on sales invoice does not match the underlying sales order. order. Rights and Obligations If an entity sells its receivables, it spy and reperform procedures for documenting should keep a documentary record of the receivables that have been factored or sold. receivables that have been sold and it should compare that record with monthly statements received from a factoring company. Cash receipt Assertion (Audit Objective) Control Test of Controls Existence and Occurrence (Occurrence) Independent check of agreement of cash and Observe and reperform manual controls to check checks with cash count sheets and prelist. independent check of the prelist with the cash receipts journal. Completeness (Completeness) Independent check of agreement of cash and Observe and reperform manual controls to check checks with cash count sheets and prelist. independent check of the prelist with the cash receipts journal. Existence and Occurrence / Completeness Preparation of periodic independent bank Observe and test the accuracy of independent bank (Cutoff) reconciliations. reconciliations. Valuation and Allocation (Accuracy) Independent check of agreement of cash and Observe and reperform manual controls to check checks with cash count sheets and prelist. independent check of the prelist with the cash receipts journal. Presentation and Disclosure Mailing of statements to customers. Make inquiries about mailing of monthly statements to (Classification) customers. Observe notes and procedures used to follow-up upon questions raised by customers. Rights and Obligations If an entity sells its receivables, it Observe and reperform procedures for documenting should keep a documentary record of the receivables that have been factored or sold. receivables that have bee n sold and it should compare that record with monthly statements received from a factoring company. 14-18. a. The transaction classes that should be considered in assessing control risk for accounts receivable assertions are credit sales, cash receipts, and sales adjustments. b.In assessing control risk for the existence or occurrence account balance assertion for accounts receivable, the following transaction class control risk assessments should be considered Existence or occurrence for sales transactions that increase accounts receivable. Completeness for cash receipts and sales adjustments transactions that fall accounts receivable. c. A revised acceptable level of espial risk for tests of flesh out and a revised level of substantive tests must be unyielding for an assertion when the relevant final or actual inherent risk assessments, control risk assessments, and analytical procedure risk assessments, differ from the plotted assessed levels. 14-19. The followin g table explains some example preliminary audit strategies for each financial statement assertion in the context of the audit risk model. Assertion Inherent Risk Control Risk Analytic Procedures Risk Test of Details Risk Existence and Maximum due to revenueLow if internal Moderate to high depending onModerate which will allow for smaller sample sizes Occurrence recognition problems. controls over the reliableness of expectation and changing the timing of confirmations of occurrence of sales aremodel. receivables. It will also reduce the extent of strong. cutoff tests. Completeness Moderate.Not a Low if internal Moderate to high depending onModerate to high which will allow for smaller significant inherent controls over the reliability of expectation sample sizes and changing the timing of risk. occurrence of sales aremodel. confirmations of receivables. It will also reduce strong. the extent of cutoff tests. Rights and ObligationsModerate to high Moderate to high M oderate to high depending onLow Consider confirming with factoring agent and depending on the depending on internal reliability of expectation search for large unusual cash receipts. entitys ability to controls. However, model. generate operating control are more cash flow. nonroutine than routine. Valuation and High or maximum due toModerate to high Moderate to high depending onThe auditor can test the accuracy of receivables Allocation subjective nature of depending on internal reliability of expectation at gross value with confirmation. The auditor allowance. controls over model. should consider extensive tests of the allowance collection of later year-end. receivables. Presentation and Inherent risk is Moderate to high Maximum Analytical Maximum to High. It is often cost effective to Disclosure usually high or depending on internal procedures are not directed substantively test disclosures which are not maximum. controls over at testing disclos ures. complex for receivables. disclosures. 14-20. In vouching recorded accounts receivable transactions to supporting documentation, a sample of debits to customers accounts is compared to data on supporting sales invoices and matching shipping documents, sales orders, and customer orders. The evidence obtained pertains primarily to specific audit objectives derived from the existence or occurrence, rights and obligations, and valuation or allocation assertions for accounts receivable. 14-21.Both the sales cutoff test and the cash receipts cutoff test pertain to accounts receivable. The sales cutoff test involves Examining shipping documents for several days before and after the cutoff date to realise the date and terms of shipment. Tracing shipping documents to sales and inventory records to establish that the entries were made in the correct accounting period. Inspecting invoices for a period of clipping before and after the cutoff date to ascertain the validity and c orrectitude of the shipments and corresponding entries. Inquiring of management about any direct shipments by outside suppliers to customers and determining the appropriateness of related entries.In performing a cash receipts cutoff test, the auditor may be present at the balance sheet date to personally observe the promptness of the cutoff. In particular, the auditor determines that all collections received prior to the close of business are included in cash on hand or in deposits in transit and are credited to accounts receivable. Alternatively, the auditor may review the daily cash summary and validated deposit slip for the hold up day of the year. Both cutoff tests relate to the occurrence and completeness audit objectives for accounts receivable. 14-22. a. It may not be necessary to confirm accounts receivable when The balance is immaterial to the financial statements. The use of confirmations would be ineffective as an audit procedure. The auditors combine assessment of inherent risk and control risk is low, and that assessment, made in conjunction with the evidence expected to be provided by analytical procedures or other substantive tests of details, is sufficient to reduce audit risk to an tolerably low level for the applicable financial statement assertions. b. Factors to be considered in choosing the form of confirmation request are (1) the acceptable level of sensing risk and (2) the composition of the customer balances. The supportive form is used when detection risk is low or individual customer balances are relatively large. The negative form should be used only when all three of the following conditions apply The acceptable level of detection risk for the related assertions is moderate or high. A large number of small balances is involved. The auditor has no reason to believe that the recipients of the requests are unlikely to give them consideration. c. When no response is received after the second or third positive confirmation req uest to a customer, the auditor should apply such choice procedures as (1) examining subsequent collections and (2) vouching open invoices comprising the customers balance. Alternate procedures may be omitted when both of the following conditions apply There are no unusual qualitative factors or systematic characteristics related to the nonresponses, such as that all nonresponses pertain to year-end transactions. The nonresponses, projected as 100% misstatements to the population and added to the sum of all other unadjusted differences, would not affect the auditors decision about whether the financial statements are materially misstated 14-23. a. The aged trial balance is used primarily in assessing the adequacy of the allowance for uncollectable accounts. b. Procedures applied to the aged trial balance include (1) footing and crossfooting the aged trial balance and comparing the total to the general ledger balance for accounts receivable and (2) testing the aging of the amounts s hown in the aging categories by examining supporting documentation such as dated sales invoices. c.After testing the accuracy of the aged trial balance the auditor should perform the following procedures to draw a conclusion about the uncontaminating presentation of the allowance for doubtful accounts. Examine past due accounts for evidence of collectability such as correspondence with customers and outside collection agencies, credit reports, and customers financial statements. Discuss collectability of accounts with appropriate management personnel. Evaluated managements process for estimated the allowance for doubtful accounts using hindsight. Evaluate the adequacy of the allowance given information about industry trends, aging trends, and collection history for specific customers. d.Hindsight allows auditors to adjudicate the reasonableness of managements process for estimating the allowance for doubtful accounts. The reliability of managements process for developing this accounting estimate can be gauged by evaluating estimates in prior periods and the degree to which those estimates accurately estimated subsequent uncollectable accounts. 14-24. GAAP disclosure for accounts receivable include Disclosure of receivables from employees, officers, affiliated companies and other related parties. Appropriate assortment of material credit balances. Appropriate classification of current and noncurrent receivables. Disclosure of pledging, assigning, or factoring receivables.