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Assertions, objectives, and audit procedures

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Title: Assertions, objectives, and audit procedures


1
AUDITING 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

2
ASSERTIONS 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

3
RELATING ASSERTIONS AUDIT PROCEDURES
4
OBJECTIVES 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

5
OBJECTIVES 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

6
OBJECTIVES PROCEDURES Rights/Obligations
  • Objective determine whether entity has property
    rights to cash, accounts receivable
  • Procedures
  • Examine documentation
  • Confirmations
  • Inquiries

7
OBJECTIVES 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

8
OBJECTIVES PROCEDURES Presentation, Disclosure
  • Objective determine whether recorded
    transactions, balances properly classified,
    described, disclosed
  • Procedures
  • Compare presentation to GAAP
  • Annual updates of AICPA guidelines

9
AUDIT 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

10
Topic 3 Substantive tests for assertions
ASSERTIONS PROCEDURESACCOUNTS RECEIVABLE
SALES
11
ASSERTIONS 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

12
ASSERTIONS 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

13
Case 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

14
ASSERTIONS 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

16
Case 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

17
REVENUE 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

18
REVENUE 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

19
COMMON MEANS TO MANIPULATE EARNINGS - 1
  • Method Revenue Recognition
    Error

20
COMMON MEANS TO MANIPULATE EARNINGS - 2
  • Method Revenue Recognition Error

21
COMMON MEANS TO MANIPULATE EARNINGS - 3
  • Method Revenue Recognition Error

22
MANIPULATED 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

23
MANIPULATED 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

24
MANIPULATED 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

25
AUDIT 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

26
COMPUTER 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

27
Case 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?
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