Title: Assertions, objectives, and audit procedures
1AUDITING CHAPTER 11Accounts Receivable Cash
Balances
- TOPICS
- Assertions, objectives, and audit procedures
- Audit risk client strategies and substantive
tests - Substantive tests for assertions
- Revenue recognition, earnings manipulation,
channel stuffing - Audit sampling accounts receivable
- Computer-assisted audit techniques
2ASSERTIONS OBJECTIVES
Topic 1 Assertions, objectives, and audit
procedures
- Management assertions Recorded receivables
cash balances - Exist
- Include all transactions (completeness)
- Represent rights of entity
- Are valued appropriately
- Are presented disclosed properly
3RELATING ASSERTIONS AUDIT PROCEDURES
4OBJECTIVES PROCEDURES Existence/Occurrence
- Objective determine whether all recorded sales,
receivables, cash balances actually exist and
whether all recorded transactions actually
occurred - Procedures
- Existence
- Physical observation
- Confirmation
- Transactions occurred
- Cutoff testing for proper period
5OBJECTIVES PROCEDURES Completeness
- Objective determine whether all receivables,
sales, cash of period are presented in financial
statements - Procedures
- Examine documents
- Apply analytical procedures
- Cutoff bank statements, bank reconciliations, etc.
- An auditor generally tests the completeness of
credit sales transactions by - Confirming receivables balances with debtors
- Reviewing the collectability of receivables
outstanding - Inquiring of management
- Performing analytical procedures
6OBJECTIVES PROCEDURES Rights/Obligations
- Objective determine whether entity has property
rights to cash, accounts receivable - Procedures
- Examine documentation
- Confirmations
- Inquiries
7OBJECTIVES PROCEDURESValuation, Allocation
- Objective determine whether entity has recorded
items in correct amounts, accounts, time
periods - Procedures
- Confirm balances
- Verify mathematical accuracy
- Examine details of recording
8OBJECTIVES PROCEDURES Presentation, Disclosure
- Objective determine whether recorded
transactions, balances properly classified,
described, disclosed - Procedures
- Compare presentation to GAAP
- Annual updates of AICPA guidelines
9AUDIT RISK MODEL
Topic 2 Audit risk client strategies and
substantive tests
- AR CR x IR x DR
- Detection risk (DR) likelihood that error could
occur not be detected - Based on
- Control risk (CR) Likelihood of material error
not detected by internal control - Inherent risk (IR) Strategies threats
- Nature, extent, timing substantive tests
- Nature more/less persuasive tests
- Extent larger/smaller samples
- Timing balance sheet date or interim
- 2. If tests of controls show that controls over
shipping and billing are likely ineffective, the
auditor would - Assess control risk at the minimum
- Perform audit procedures at an interim date
- Increase the extent of testing on receivable
balances - Not rely on managements representations
10Topic 3 Substantive tests for assertions
ASSERTIONS PROCEDURESACCOUNTS RECEIVABLE
SALES
11ASSERTIONS PROCEDURESACCOUNTS RECEIVABLE
SALES
- 5. Positive accounts receivable confirmations
are appropriate when - There is reason to believe that a substantial
number of accounts may be in dispute - Control risk is low
- Accounts receivable consists of many small
balances - Confirmations are mailed during an interim period
- 6. Under which of the following conditions might
an auditor justify not confirming receivables
balances with debtors? - The auditor accepted the engagement after the
balance sheet date - Prior-year confirmations revealed no errors in
the receivables balance - A small number of customers comprise almost all
of the receivables balance - The client is a government contractor
- How might an auditor proceed to address
confirmations that customers do not return? - Review customer purchase orders
- Interview billing employees
- Propose the customer balances as an audit
adjustment - Review subsequent cash collections
12ASSERTIONS PROCEDURESACCOUNTS RECEIVABLE
SALES
- 3. Which of the following might be detected by
sales cutoff tests? - Overstated receivables c. Kiting
- Overstated sales d. Misappropriates inventory
4. To test whether all sales transactions have
been recorded, an auditor should test a sample
drawn from an entitys file of a. Receiving
reports b. Bills of lading c. Sales orders d.
Sales invoices
- 8. Which of the following procedures could
reveal unrecorded sales at the balance sheet
date? - Comparing shipping documents with sales records
- Applying gross profit percentages to inventory
shipped during the period - Tracing payments received after the balance sheet
date to accounts receivable records - Sending accounts receivable confirmations
13Case 11-5 Analytical Procedures and Accounts
Receivable
- Martin Kline, engagement partner on RCT
Manufacturing Company, a February 28, 2007,
year-end client, is performing analytical
procedures to better understand RCTs business
and to determine where audit effort ought to be
concentrated. The balance sheets and statements
of operations for 2006 and 2007 follow. - Refer to page 502 for balance sheets and income
statements - Additional information
- Cash sales are insignificant
- Year-end figures are comparable to the average
for each respective year. - Required For each year, compute accounts
receivable turnover and, based on turnover,
identify and discuss procedures Kline should
include in the audit of accounts receivable
14ASSERTIONS PROCEDURES CASH
15- 10. A standard bank confirmation
- Requests information about indebtedness
- Is sent to the bank by the client
- Is signed by the clients chief executive and
chief financial officers - Requests information about account numbers
- 11. Assuming cash receipts from credit sales
have been misappropriated, which of the following
is likely to conceal the misappropriation and
unlikely to be detected? - Understating the sales journal
- Overstating the accounts receivable control
account - Overstating the accounts receivable subsidiary
ledger - Overstating the cash receipts journal
- 12. Which of the following interbank cash
transfers misstates cash at December 31? - Disbursement Receipt .
- Recorded in books Paid by bank Recorded in
books Received by bank - 12/31/06 01/04/07 12/31/06 12/31/06
- 01/04/07 01/05/07 12/31/06 01/04/07
- 12/31/06 01/05/07 12/31/06 01/04/07
- 01/04/07 01/11/07 01/04/07 01/04/07
- 9. An auditor requests a cutoff bank statement
primarily to - Verify the cash balance reported on the bank
confirmation - Verify reconciling items on the clients bank
reconciliation - Detect lapping
- Detect kiting
- 13. The purpose of a cutoff bank statement is to
- Reconcile cash on the books with cash in the bank
- Test deposits in transit and outstanding checks
- Reconcile accounts payable to cash disbursements
- Test subsequent cash receipts
16Case 11-9 Auditing a Client-Prepared Bank
Statement
- The following client-prepared bank reconciliation
is presented to Kautz during an audit of the
financial statements of Cynthia Company. - Balance per bank (a) 18,375.91
- Deposit in transit (b)
- 12/30 1,417.10
- 12/31 2,840.69 4,311.79
- Subtotal 22,787.70
- Outstanding checks (c)
- 837 6,000.00
- 1941 671.80
- 1966 320.00
- 1984 1,855.42
- 1985 3,621.22
- 1987 2,576.89
- 1991 4,420.88 (19,466.21)
- Subtotal 3,221.49
- NSF check returned
- 12/29 (d) 200.00
- Bank charges 5.50
- Error, Check No. 1932 148.10
17REVENUE RECOGNITION EARNINGS MANIPULATION
Topic 4 Revenue recognition, earnings
manipulation, channel stuffing
- Increasingly, I have become concerned that the
motivation to meet Wall Street earnings
expectations may be overriding common sense
business practices. - Arthur Levitt, Jr., The Numbers Game. Speech
NYU, 1998.
- 15. Which of the following is most likely to
provide management with incentives to overstate
earnings? - Projected quarterly dividends
- Issuance of preferred stock
- Unbudgeted increases in materials prices
- A projected stock split
18REVENUE RECOGNITIONSAB 104
- Criteria
- Persuasive evidence of arrangement exists
- Delivery has occurred or services rendered
- Sellers price fixed or determinable
- Collectibility reasonably assured
- 17. Under which of the following circumstances
does management have some discretion in timing
the recognition of revenue? - The timing of revenue is not reasonably
determinable and the earnings process is not
complete - The amount and timing of revenue is reasonably
determinable - The earnings process is complete or reasonably
complete - The transaction is at arms length
19COMMON MEANS TO MANIPULATE EARNINGS - 1
- Method Revenue Recognition
Error
20COMMON MEANS TO MANIPULATE EARNINGS - 2
- Method Revenue Recognition Error
21COMMON MEANS TO MANIPULATE EARNINGS - 3
- Method Revenue Recognition Error
22MANIPULATED EARNINGSChannel Stuffing
- Definition incentives to induce incremental
demand - Examples
- Bausch Lomb
- Told distributors to buy large amount of
inventory to maintain distributorship - BL recognized extra 22 million
- Sunbeam
- Used price discounting to encourage customers to
hold 80 weeks of inventory
23MANIPULATED EARNINGSAsset Swaps
- Definition companies trading right to use others
asset - Examples
- Global Crossing
- Treated underseas cables as real estate
- Recognized revenue by treating swap as sale
- 20. Global Crossing exploited capacity swaps to
- Understate telecom assets c. Overstate net cash
flow - Recognize revenue prematurely d. Defer revenue
24MANIPULATED EARNINGSOther
- Improper expense capitalization
- Chambers Development
- Capitalized landfill expenses after determining
earnings necessary to meet analysts expectations - MicroStrategy
- Recognized revenue before all services provided
for software sales
- 16. A vendor sold software to an engineering
company, recorded revenue of 15,000, and
included in the price end-user support for a
number of hours the vendor and company have yet
to determine. This is an example of - A side agreement c. A kickback sale
- A consignment sale d. A conditional sale
25AUDIT SAMPLING ACCOUNTS RECEIVABLE
Topic 5 Audit sampling accounts receivable
- Update assessment of control risk
- Planning confirmations selecting plan
- Identify population, sampling unit, anticipated
error - Estimate tolerable error risk incorrect
acceptance - Calculate sample size
- Choose sample selection method
- Evaluate results
26COMPUTER ASSISTED TESTS
Topic 6 Computer-assisted audit techniques
- AR Accuracy
- Foot, crossfoot recorded amounts within master
file - Total balances
- Display/print exceptions
- AR Aging
- Trace individual balances from master file to
sales journal - Classify balances by invoice dates/age
- Display/print aged trial balances
- AR Credit Balances
- Scan master receivables file for net credit
balances - Display/print listing credit balance accounts
27Case 11-10 Computer-Assisted Audit Tests
- After determining that computer controls are
valid, Hastings is reviewing the sales system of
Rosco Corporation to determine how
computer-assisted audit techniques may be used to
assist in performing tests of Roscos sales
records. Rosco sells corns from one central
location. All orders are received by mail or fax
and indicate that pre-assigned customer
identification number, desired quantity, proposed
delivery date, method of payment, and shipping
terms. Since price fluctuates daily, orders do
not indicate a price. Price sheets are printed
daily, and details are stored in on computer. The
details of orders also are maintained on
computer. - Each morning the shipping clerk receives a
computer printout that indicates details of
customers orders to be shipped that day. After
the orders have been shipped, the shipping
details are entered in the computer, which
simultaneously updates the sales journal,
perpetual inventory records, accounts receivable,
and sales accounts. The details of all
transactions, as well as daily updates, are
maintained on computer and are accessible by
Hastings. - How man Hastings use computer-assisted audit
techniques to perform substantive tests of
Roscos sales records? - What other auditing procedures should Hastings
perform in order to complete the audit of Roscos
sales records?