Solution manual auditing and services 2e by louwers chap007

Chapter 07 - Revenue and Collection Cycle

CHAPTER 7
Revenue and Collection Cycle
LEARNING OBJECTIVES
Review
Checkpoints

Exercises,
Problems, and
Simulations

1. Discuss inherent risks related to the revenue
and collection cycle with a focus on improper
revenue recognition.

1, 2, 3

59

2. Describe the revenue and collection cycle,
including typical source documents and
controls.

4, 5, 6, 7, 8

54, 55, 61, 63, 64,
66

3. Give examples of tests of controls over
customer credit approval, delivery, and

accounts receivable accounting.

9, 10, 11, 12, 13, 14

56, 65

4. Give examples of substantive procedures in
the revenue and collection cycle and relate
them to assertions about account balances at
the end of the period.

15, 16, 17, 18, 19,
20, 21, 22

57, 58, 60, 61, 67,
68, 69, 70

5. Describe some common errors and frauds in the
revenue and collection cycle, and design some
audit and investigation procedures for detecting
them.

23, 24, 25 26, 27,
28

59, 62, 65, 71

SOLUTIONS FOR REVIEW CHECKPOINTS
7.1

Revenue recognition refers to including revenue in the financial statements. According to GAAP, this is
done when revenues are (1) realized or realizable and (2) earned.

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, companies are often valued at multiples of revenue instead of net income.

7.3

“Bill and Hold” sales are recognized when sales are billed, thus creating a receivable, but the goods are
held by the seller until the customer actually wants them.

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Chapter 07 - Revenue and Collection Cycle

7.4

The basic sequence of activities and accounting in a revenue and collection cycle is:
1.
2.
3.
4.
5.

Receiving and processing customer orders. Entering data in an order system and obtaining a credit

check.
Delivering goods and services to customers. Authorizing release from storekeeping to shipping to
customer. Entering shipping information in the accounting system
Billing customers, producing sales invoices. Accounting for customer trade accounts receivable.
Collecting cash and depositing it in the bank. Accounting for cash receipts.
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 controlled so 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.

7.7

Auditors could examine these files for evidence of:
•
•
•

7.8

7.9

7.10

Unrecorded sales — pending order master file,
Inadequate credit checks — credit data/check files
Incorrect product unit prices — price list master file

With a sample of customer accounts receivable:
1.

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 showing recording on the
shipping date.

2.

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.

The account balances in a revenue and collection cycle include:
•
Cash in bank
•
Accounts receivable
•
Allowance for doubtful accounts
•
Bad debt expense
•
Sales revenue

•
Sales returns, allowances, discounts
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:
1.

No sales order should be entered without a customer order

2.

A credit-check code or manual signature should be recorded by an authorized means

3.

Access to inventory and the shipping area should be restricted to authorized persons

4.

Access to billing terminals and blank invoice forms should be restricted to authorized personnel

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Chapter 07 - Revenue and Collection Cycle

5.

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

6.

Customer invoices should be compared with bills of lading and customer orders to determine 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

7.

Pending order files should be reviewed timely to avoid failure to bill and record shipments

8.

Bank statements should be reconciled in detail monthly.

7.11

In a “walk through” of a sales transaction, auditors take a single example 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, 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. The purpose of the “walk through” 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.

7.12

The assertions made about classes of transactions and events in the revenue and collection cycle are:

1.
2.
3.
4.
5.

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.

7.14

Dual direction tests of controls refers to procedures that test file contents in two “directions” — the
occurrence direction and the completeness direction. The occurrence direction is 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 gotten into
malpractice trouble by giving unqualified reports on financial statements that overstated assets and
revenues and understated expenses. For example, credit sales recorded too early (fictitious sales?) 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 can be sent customers, asking for a report of the balances owed the
company
Verbal Inquiry. Inquiries to management usually do not provide very convincing evidence about existence
and ownership. However, inquiries should always be made about the company’s agreements to pledge or
sell with recourse accounts receivable in connection with financings.

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Chapter 07 - Revenue and Collection Cycle

Examination of Documents (Vouching). Evidence of existence can be obtained examining shipping
documents. Examination of loan documents may yield evidence of the need to disclose receivables pledged
as loan collateral.
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 estimate 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 non-financial data such as units
sold, number of customers, sales commissions, etc. 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 also 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: (1) receivables are not material, (2) confirmations would be ineffective, based on prior years’
experience or knowledge that responses could be unreliable, and (3) analytical procedures and other
substantive procedures provide sufficient, competent evidence.

7.20

Special care in examining sources of accounts receivable confirmation responses:
Auditors need to control the confirmations, including the addresses to which they are sent. Experience is
full of cases where confirmations were mailed to company accomplices, who provided false responses. The
auditors should carefully consider features of the reply such as postmarks, FAX and telegraph responses,

letterhead, electronic mail, telephone, 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 criss-cross directory to determine the location of a respondent).

7.21

When positive confirmations are not returned the auditor should perform the following procedures:
1.
Send second and even third requests.
2.
Apply subsequent cash receipts.
3.
Examine sales orders, invoices and shipping documents, and
4.
Examine correspondence files for past due accounts.

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Chapter 07 - Revenue and Collection Cycle

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 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 non-payment 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/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”, if someone other that 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 two 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, the internal control system should provide that receipts be recorded daily and
intact. A careful bank reconciliation by an independent person could 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.

7.27

Auditors might have obtained the following information:
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.
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 too large.

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.

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Chapter 07 - Revenue and Collection Cycle

SOLUTIONS FOR MULTIPLE CHOICE QUESTIONS
7.29

a.

Incorrect

b.
c.

Correct
Incorrect

d.

Incorrect

7.30

a.
b.
c.
d.

incorrect
incorrect
correct
incorrect

This only initiates the earnings process, it doesn’t complete it.
This is often the case, but it depends on shipping terms
This is often the same as the bill of lading date
Under accrual accounting, the company doesn’t have to wait for the check to
record revenue

7.31

a.

Incorrect

b.
c.
d.

Correct
Incorrect
Incorrect

This would not have the outstanding balance; however, there are some times
when the auditor confirms the sale instead of the amount receivable.
This would have the balance for confirming.
This would not have the individual customer balance
This would not have the balance outstanding

7.32

a.
b.
c.
d.

Incorrect
Incorrect

Incorrect
Correct

This is an essential part of the cycle
This is an essential part of the cycle
Cash is affected by the collections
Even though this involves shipments, it is considered part of the expenditure and
disbursement cycle

7.33

a.
b.
c.
d.

Incorrect
Incorrect
Correct
Incorrect

The sale could occur but not be approved for credit
The approval has nothing to do with completeness
Credit approval helps ensure the sale will be collectible
Credit approval will not affect when revenue is earned.

7.34

a.
b.

c.
d.

Incorrect
Incorrect
Correct
Incorrect

The general ledger bookkeeper doesn’t have access to the customer accounts.
There’s no advantage to separating access to checks and currency.
Nobody in the company has access to cash, therefore it cannot be stolen.
Normally checks are made payable to company. That doesn’t prevent lapping.

7.35

a.

Correct

b.
c.
d.

Incorrect
Incorrect
Incorrect

Impropriety of write-offs can be controlled by the review and approval by
someone outside the credit department.
Even write-off of old receivables can conceal a cash shortage.

The cashier could be the cause of the shortage.
Write offs should be separated from the sales function.

a.
b.

Incorrect
Correct

c.
d.

Incorrect
Incorrect

7.36

Allowances can be made for anticipated returns if the earning process is
substantially complete
The earning process is complete at this point
Under accrual accounting, the cash does not have to be collected, only
collectible.
This is usually the method for determining “b” but the shipment might be FOB
destination

This would increase gross profit.
Less sales revenue and correct amount of cost of goods sold results in less gross
profit, therefore the ratio of gross profit to sales will decrease. (Actually, the
gross profit numerator will decrease at a greater rate than the sales denominator
in the ratio, causing the ratio to decrease.)

This would increase gross profit.
This would increase sales and cost of sales, and the ratio would not change. If
cost of sales is not recorded, gross profit would increase

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Chapter 07 - Revenue and Collection Cycle

7.37

a.
b.
c.
d.

Incorrect
Incorrect
Incorrect
Correct

This doesn’t verify that the sales invoices represent actual shipments.
This would require tracing from shipping documents to invoices.
This would require tracing from invoices to customer accounts.
The direction of the test establishes support for recorded amounts.

7.38

a.

Incorrect

d.

Correct

Using the sales returns account would raise the least suspicion because this
account is more commonly linked to accounts receivable.
A bookkeeper could steal money and “write off” to unsuspecting customer’s
balance with a fictitious “sales return.”

7.39

a.
b.
c.
d.

Incorrect
Incorrect
Correct
Incorrect

The payment is probably in transit.
The shipment is probably in transit.
This should have been recorded as a reduction to the receivable by 12/31.
This occurred after the end of the period.

7.40

a.
b.
c.
d.

Incorrect
Incorrect
Correct
Incorrect

The aged trial balance provides only indirect evidence about controls.
The aged trial balance provides no evidence about accuracy.
The age of accounts is an indication of credit losses.
The aged trial balance provides no evidence about existence.

7.41

a.
b.

Incorrect
Correct

c.
d.

Incorrect
Incorrect

Lapping pertains to cash receipts, not sales.

False sales journal entries made near the end of the year may have shipping or
other documents that reveal later dates or show lack of sufficient documentation.
See answer a.
This step would not detect misappropriation of merchandise.

a.
b.
c.

Incorrect
Incorrect
Correct

d.

Incorrect

7.43

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.

7.44

a.

Correct

b.
c.

Incorrect
Incorrect

d.

Incorrect

The accounts receivable debits are supposed to represent sales that have been
ordered by customers and actually shipped to them.
This is not evidence about occurrence.
This provides some evidence about existence, but even if the receivables haven’t
been paid, they may still be valid.
These file will likely not provide evidence about specific sales.

a.

Incorrect

b.

Correct

c.
d.

Incorrect
Incorrect

7.42

7.45

Receiving a confirmation is not proof the customer will pay.
Confirmation will not detect if the receivables were sold or factored.
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.
Confirmation provides only indirect evidence that controls are working.

This is an important assertion, but financial statement users are less likely to be
damaged if assets are found that have not been recorded.
Financial statement users are more likely to be damaged if assets are found not
to exist.
Ownership is important, but doesn’t matter if the assets don’t exist.
Presentation and disclosure assertion is important, but not as important as
existence for asset accounts.

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Chapter 07 - Revenue and Collection Cycle

7.46

c.

Correct

7.47

a.
b.
c.

Correct
Incorrect
Incorrect

d.

Incorrect

a.

Correct

b.

Incorrect

c.

Incorrect

d.

Incorrect

a.

Incorrect

b.

Incorrect

c.
d.

Correct
Incorrect

a.
b.

Incorrect
Correct

c.
d.

Incorrect
Incorrect

a.

Correct

b.
c.
d.

Incorrect
Incorrect
Incorrect

a.
b.
c.

Incorrect
Incorrect
Correct

d.

Incorrect

7.48

7.49

7.50

7.51

7.52

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.
The auditor assumes customers are likely to respond to errors.
Because negative confirmations offer higher risk of material misstatement
should be low when they are used.
Because negative confirmations offer higher detection risk, risk of material
misstatement should be low when they are used.
Shipments are traced to customers’ invoices. (This does not imply that the
invoices were recorded in the sales journal.)
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.
Recorded sales were shipped is not established because the sample selection is
from shipments, not from recorded sales.
See (c) above.
Salespeople could write off accounts for their friends to keep them from having
to pay
The credit manager may propose write-offs to reduce days outstanding and make
him/her look better
The Treasurer or another high-ranking manager should approve write-offs.
The cashier could take receipts and write-off the balance.
A second request is the first step that should be performed.
As 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.
Shipping documents should be examined to test existence of the receivable.
Client correspondence files may also provide evidence the receivable exists.

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.
The control account wouldn’t match the total of customer accounts.
Customers would catch the overstatement when examining their statements.
This is a possibility, but (a) is a better answer. There is less likelihood of getting
caught if the sale is never recorded.
The stolen cash wouldn’t be in either of these documents.
Lapping is not accomplished through write-offs.
Lapping is the delayed recording of cash receipts to cover a cash shortage.
Current receipts are posted to the accounts of customers who paid one or two
days previously to avoid complaints (and discovery) when monthly statements
are mailed. The best protection is for the customers to send payments directly to
the company’s depository bank. The next best procedure is to assure that the
accounts receivable clerk has no access to cash received by the mail room. Thus,
the duties of receiving cash and posting the accounts receivable ledger are
segregated.
See answer (a).

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Chapter 07 - Revenue and Collection Cycle

7.53

a.
b.

Incorrect
Correct

c.

Incorrect

d.

Incorrect

A negative confirmation might be used if control risk is low.
As detection risk is lower for positive confirmations than negative
confirmations, a positive confirmation is more likely when inherent risk is high.
Whether the account is due or not usually doesn’t affect the type of
confirmation. However if it is long past due, a positive confirmation is more
appropriate.
This is a possible choice; however, even positive confirmations may be
problematic with related parties.

SOLUTIONS FOR EXERCISES, PROBLEMS, AND SIMULATIONS
7.54

Control Objectives and Procedures Associations

a. “Occurrence”
Sales recorded, goods not shipped
b. “Completeness”
Goods shipped, sales not recorded
c. “Accuracy”

Goods shipped to a bad credit risk customer
d. “Accuracy”
Sales billed at the wrong price or wrong quantity
e. “Classification”
Product line A sales recorded as Product line B
f. “Completeness”
Failure to post charges to customers for sales
g. “Cutoff”
January sales recorded in December
CONTROL PROCEDURES
1. Sales order approved for credit
X
2. Prenumbered shipping doc prepared, sequence checked
X
3. Shipping document quantity compared to sales invoice
X
X
4. Prenumbered sales invoices, sequence checked
X
5. Sales invoice checked to sales order
X
6. Invoiced prices compared to approved price list
X
7. General ledger code checked for sales product lines
X
8. Sales dollar batch totals compared to sales journal
X
X
9. Periodic sales total compared to same period accounts
X

receivable postings
10. Accountants have instructions to date sales on the date of
X
shipment
11. Sales entry date compared to shipping doc date
X
12. Accounts receivable subsidiary totaled and reconciled to
X
accounts receivable control account
13. Intercompany accounts reconciled with subsidiary company
X
records
14. Credit files updated for customer payment history
X
15. Overdue customer accounts investigated for collection
X
X
X

7-9

X
X

X

X


Chapter 07 - Revenue and Collection Cycle

7.54

Control Objectives and Procedures Associations (Continued)
EXHIBIT 7.54-1 Blank form for Students

a.
b.
c.
d.
e.
f.
g.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
7.55

Sales recorded, goods not shipped
Goods shipped, sales not recorded
Goods shipped to a bad credit risk customer
Sales billed at the wrong price or wrong quantity
Product line A sales recorded as Product line B
Failure to post charges to customers for sales
January sales recorded in December
CONTROL PROCEDURES
Sales order approved for credit
Prenumbered shipping doc prepared. sequence checked
Shipping document quantity compared to sales invoice
Prenumbered sales invoices, sequence checked
Sales invoice checked to sales order
Invoiced prices compared to approved price list
General ledger code checked for sales product lines
Sales dollar batch totals compared to sales journal
Periodic sales total compared to same period accounts
receivable postings
Accountants have instructions to date sales on the date of
shipment
Sales entry date compared to shipping doc date
Accounts receivable subsidiary totaled and reconciled to
accounts receivable control account
Intercompany accounts reconciled with subsidiary company
records
Credit files updated for customer payment history
Overdue customer accounts investigated for collection
Control Assertion Associations
Error

Assertions

Sales recorded, goods not shipped

Occurrence

Goods shipped, sales not recorded

Completeness

Goods shipped to a bad credit risk
customer

Valuation

Sales billed at the wrong price or
wrong quantity

Valuation

Product A sales recorded as Product
line B

Classification

Failure to post charges to customers
for sales

Completeness

January sales recorded in December

Cutoff

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Chapter 07 - Revenue and Collection Cycle

7.56

Client Control Procedures and Audit Tests of Controls
For each client control activity numbered 1-15, write an auditor’s test of control procedure that could
produce evidence on the question of whether the client’s control has been installed and is in operation.
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.

14.

Note whether credit files are updated for customer payment history.

2.

Inspect the attached shipping document for (i) existence, and (ii) prenumbering imprint.

3.

Compare billed quantity on sales invoice to shipped quantity on shipping document.

4.

Find the sales invoice associated with the random number (failure to find means an invoice wasn’t
recorded). Alternatively, use 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.

6.

Compare prices on sales invoice to approved price list.

7.

Check product line code for proper classification compared to products invoices.

11.

Compare invoice date to shipping document date.

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.

Computer-scan the shipping document file for missing numbers in sequence.

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.

10.

Study the accounting manual and make inquiry about accountants’ instructions to date sales on

date of shipment.

12.

Obtain client’s documentation showing A/R subsidiary total reconciled to A/R control account.
Alternatively, add up the subsidiary and compare to the control account.

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Chapter 07 - Revenue and Collection Cycle

13.
7.56

7.57

Obtain client’s documentation showing reconciliation of intercompany receivables and payables
for sales and purchases. Alternatively, confirm balances with subsidiaries or other auditors.
Client Control Procedures and Audit Test of Control Procedures (Continued)
14.

Select a sample of credit files and trace to customers’ accounts receivable, noting extent of up-date
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.)

Confirmation of Trade Accounts Receivable
a.

b.

Auditing standards presume that auditors will request confirmation of the client’s accounts
receivable. An auditor can justify omitting these confirmations if:
1.

The accounts receivable are immaterial to the financial statements.

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.

3.

The evidence expected to be provided by analytical procedures or other substantive
procedures is sufficient to reduce audit risk to an acceptably low level for the applicable
financial statement assertions.

These factors will affect the reliability of confirmations:
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.

7.57

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.
Confirmation of Trade Accounts Receivable (Continued)
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:

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Chapter 07 - Revenue and Collection Cycle

7.58

1.

Examining subsequent cash receipts and matching such receipts with the actual items
being paid.

2.

The auditor can also consider 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.

The auditor may also establish 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).

Audit Objectives and Procedures for Accounts Receivable
a.

Accounts receivable represent all amounts owed to the client company at the balance sheet date.
2.

b.

c.

The client company has 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.

4. (possible)

Obtain an understanding of the business purpose of transactions that resulted in
accounts receivable balances.

Accounts receivable are stated at net realizable value.
3.

d.

Perform sales cut-off 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.

Review the aged trial balance for significant past due accounts.

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.

4. (possible)

Obtain an understanding of the business purpose of transactions that resulted in
accounts receivable balances.

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Chapter 07 - Revenue and Collection Cycle

7.59

Overstated Sales and Accounts Receivable
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:
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 greater attention
because the sales are much higher than the previous January and because the auditors want to pay attention
to sales cut-off 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 cut-off 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 larger 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.

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Chapter 07 - Revenue and Collection Cycle

7.59

Overstated Sales and Accounts Receivable (Continued)
DISCOVERY SUMMARY
The auditors performed a detail sales cut-off 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’s 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’s sales.
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 month’s sales for the months when the prior year
bill and hold sales were reversed.

7.60

CAATs Application—Receivables Confirmation
File

7.61

Information

Master File—Debtor Name

Name of Debtor
Address of Debtor

Master File—Account Detail

Customer Account Number
Balance (gross)
Discount Available to Customer

Audit Simulation: Rock Island Quarry—Evidence Collection in an Online System
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 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.

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Chapter 07 - Revenue and Collection Cycle

b.

7.61

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 on-line 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).

4.

Completeness controls—The system has to contain controls that ensure 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 the
microcomputer accumulating 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.

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.

Audit Simulation—Rock Island Quarry—Evidence Collection in an Online System (Continued)
c.

Auditors debate whether “documentary evidence” includes evidence in computer-readable form.
The authors believe such evidence should be considered documentary evidence. The problem then
becomes one of whether this computer-readable evidence will be available during the period under
audit. In all probability, a log of all incoming transactions is captured at the home office so that a
complete audit trail exists. The auditors need to request these logs be retained. If the logs are
available, generalized audit software can be used to select samples to be printed.
If the logs are not retained, sampling will have to be done during transaction occurrence rather
than after the fact. This would involve selected testing throughout the audit period. The system
described would also be appropriate for CAATs
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 and such procedures are normally not well controlled and thus become
subject to errors and frauds.

7.62

Organizing a Risk Analysis
TO:

FROM:
DATE:
SUBJECT:

Senior Internal Auditor
Director of Internal Auditing
November 31, 199X
Risk analysis of accounts receivable accounting

These questions are for your guidance.

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Chapter 07 - Revenue and Collection Cycle

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.
What Financial/Economic Events Have Occurred in the Last 10 Months?
1.
2.
3.
4.
5.

Are a greater number of patients uninsured?
Is a larger number or greater dollar amount overdue?

Have any accounts been written off in the last 10 months? Number? Dollar amount?
Which accounts are presently considered doubtful of collection? Why?
Have patients complained about their bills?

Who Does the Accounting?
1.
2.
3.

Are new people doing the accounting?
Who is the accounting manager now?
Did resigned employees give reasons?

What Data Processing Procedures and Policies Are in Effect?
1a.
1b.
2a.
2b.
3a.
3b.
3c.

What are the current procedures for billing patients?
What changes have been made in the last 10 months?
What are the current procedures for recording changes and collections?
What changes have been effected in the last 10 months.
What are the credit and collection policies?
Are they being followed?
What changes have been effected in the last 10 months?

How is the Accounts Receivable Accounting Done?
1.
2.
7.63

Has the accounting been put on computer within the last 10 months?
How many employees handle the accounting?
Computer ______________________
Noncomputer ___________________
Study and Evaluation of Management Control
TO:
FROM:
DATE:
SUBJECT:

Internal Audit Staff
Senior Internal Auditor
July
Comparison standards for study and evaluation of management risk mitigation
control policies

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Chapter 07 - Revenue and Collection Cycle

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.
I.

Sales are billed to customers accurately and promptly.
A.

Accuracy
Policy Standard: No more than three 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:

B.

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
to recorded sales invoices.

3.

Audit for accuracy (related to shipping quantities, primarily) by confirming a
sample of customers’ balances (or individual unpaid invoices) and look for
customer disagreements.

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.

7.63

Study and Evaluation of Management Control (Continued)
II.

Accounts receivable are aged and followed up to ensure prompt collection.
A.

Accounts Receivable Aging
Policy Standard: A complete and accurate aged trial balance is prepared monthly
showing receivables in categories (a) Current, (b) 31-59 days overdue,
(c) 60-89 days overdue and (d) more than 90 days overdue.

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Chapter 07 - Revenue and Collection Cycle

Audit Procedures:

B.

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.)

Follow-up For Prompt Collection
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 turn accounts over to an outside
collection agency when they are over 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.

2.

For a sample of past due amounts in different months, inspect copies of the
letters sent to customers and (a) observe whether the right standard letter was
sent and (b) the date. Document exceptions to type of letter and mailing delay.

3.

Inspect correspondence relevant to determining date that over-90 day accounts
were turned over to an outside agent.

4.

Inspect notices of credit cut-off for customers with over-60 day balances and
inspect the trial balance for evidence of new credit mistakenly extended to such
customers.

5.

Using the sample of #2, verify the accuracy of the subsequent collections report
prepared by the credit department by vouching the data therein to cash receipts
records.

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Chapter 07 - Revenue and Collection Cycle

7.64

Audit Simulation: Cash Receipts and Billing Control
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 below 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
•
nobody supervises the credit-granting function and nobody reviews the results of the credit
manager’s credit decisions
ACCOUNTS RECEIVABLE SUPERVISOR
•

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 recordkeeping (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

•

Performs the bank reconciliation, which is not compatible with the cash custody and
recordkeeping 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)

•

The six month grace period is too long, and credit may be granted for awhile 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)

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Chapter 07 - Revenue and Collection Cycle

7.65

Test of Controls and Errors/Frauds
1.

2.

3.

4.

Controlled access to blank sales invoices.
a.

Observation. Visit the storage location yourself and see if unauthorized persons could
obtain blank sales invoices.
Pick some up yourself to see what happens.

b.

Someone could pick up a blank and make out 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 by
other control procedures.)

Sales invoices check for accuracy.
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 which are not collectible (thus overstating sales and accounts receivable).

Duties of accounts receivable bookkeeper.
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.)

Customer accounts regularly balanced with the control account.
a.

Recalculation. Review the client’s working paper showing the balancing/reconciliation.
Do the balancing yourself.

b.

Accounting entries could be made inaccurately or incompletely and the control account
may be overstated or understated.

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Chapter 07 - Revenue and Collection Cycle

7.66

Kaplan CPA Simulation: Internal Control Questionnaire
Sales and Accounts Receivable Internal Control Questionnaire Responses
Strength

Southland deposits its cash receipts on a daily basis.
The daily deposit of cash is an important control relating to the revenue and
collection cycle.

Strength

Access to the price master file is restricted to authorized personnel only.
Proper authorization and access to the price list reduces the occurrence of
fraudulent or inaccurate sales transactions (reduces “revenue leakage”).

Weakness

The accounts receivable manager approves the write-offs of uncollectible
receivables.
The approval of accounts receivable write-offs should be performed by an
individual independent of the sales and account receivable system, such as the
controller.

Neither

Southland’s president is the primary check signer and is also responsible for
mailing the checks.
The president signing and maintaining responsibility for mailing the checks is
a control over the cash disbursements system, not the sales and accounts
receivable system.

Weakness

The warehouse manager matches the pre-numbered shipping documents with
entries in the sales journal.

While the matching of the shipping documents to the sales journal entries
should provide assurance that all shipped items have been recorded as sales,
the warehouse manager is not the appropriate person to perform the function
since he is not independent of the shipping activity. This represents improper
segregation of duties.

Neither

The voucher register is reconciled to the control accounts by an independent
individual on a monthly basis.
A voucher register relates to the cash disbursement/accounts payable system,
not the sales and accounts receivable system.

Strength

Customer orders are agreed to an approved customer list.
The comparison of customer orders with the approved customer list will
provide assurance that credit sales are made only to customers that have been
granted credit (increases likelihood of ultimate collectibility).

Strength

Total amounts recorded in the accounts receivable ledger from remittance
advices are compared to the appropriate bank deposit slip.
Comparing the amounts recorded in the accounts receivable ledger to the
bank deposit should reveal incorrect postings to accounts receivable since any
differences would likely be investigated.

Weakness

Disagreements with customers generated by the monthly statements that are
sent by the client are resolved by the sales manager.
The sales manager should not be responsible for resolving billing
disagreements with customers because he is not independent from the sales
and accounts receivable process.

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Chapter 07 - Revenue and Collection Cycle

7.67

Kaplan CPA Simulation: Confirmation Form
a.

b.

Most receivables are collected by Norman, Inc. within 30 days of
billing.

Negative

The number of days sales in accounts receivable has gone up by a
relatively large amount since last year because the sales figure
has grown.

Positive

The CPA firm’s assessment of inherent risk in the area of

accounts receivable was higher than had been anticipated.

Positive

The CPA firm is particularly concerned about obtaining sufficient
evidence in connection with the existence assertion for the
company’s receivables.

Positive

The CPA firm’s assessment of control risk in the area of accounts
receivable was lower than had been anticipated.

Negative

The company had only a few receivables but most have relatively
high balances.

Positive

Analytical procedures were performed early in the audit and the
accounts receivable balance was determined to be within the
auditor’s anticipated range.

Negative

Confirmation of accounts receivable is normally performed in all audit engagements to help gain
sufficient evidence about these balances, especially in connection with the existence assertion.
However, in very specific circumstances, omission of the confirmation can be justified. The most
normal situation would be where such accounts are immaterial. If credit sales are only a minor

part of the organization’s revenues, the accounts receivable total may not be large enough to
warrant the time and effort of confirmation.
In addition, in some cases, the reliability of such confirmations is not strong enough to require the
effort. If the firm will have difficulty getting the confirmation to a customer official who has
knowledge of the balance or who will spend the time to determine the correct balance, little is
gained by confirmation. For example, confirmations sent to the United States government usually
provide no corroborating evidence and, therefore, should not be relied on in an audit.
Finally, if the assessment of the client company’s inherent risk and control risk is especially low,
the firm may be able to obtain sufficient audit evidence in order to provide by other means.

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Chapter 07 - Revenue and Collection Cycle

7.68

Kaplan CPA Simulation: Alternative Procedures
a.

Option

Procedure

Do Not
Perform

Compare the percentage of accounts receivable to sales for the audit period to prior
years. Obtain an understanding of unusual or unexpected variances.
Comparing the percentage of accounts receivable to sales is merely an analytical

review procedure. Since analytical review procedures only provide circumstantial
evidence, they are more appropriate for supporting assertions in which potential
misstatements are not apparent from examining detailed evidence or when detailed
evidence is not available. When testing accounts receivable for the existence
assertion, detailed evidence (such as subsequent payments from customers) should be
obtained to ensure a higher level of assurance.

Perform

For the non-replying customers, search the accounts receivable detailed listing for
cash receipts received after the confirmation date. Trace the cash receipt to
supporting documentation to determine if payment applies to the account receivable
balance as of the confirmation date.
Alternative procedures generally include reviewing subsequent cash collections and
tracing them to a particular item on the accounts receivable listing to provide
evidence that the specific account receivable does exist.

Do Not
Perform

Review the aged trial balance for material past due accounts.

Perform

Review the allowance for doubtful accounts activity subsequent to year end to
determine whether the unconfirmed accounts receivable were subsequently written
off.

Reviewing the aged trial balance will not provide evidence of the existence assertion.
It will, however, provide evidence with respect to the net realizable value (valuation

assertion) since it relates to the collectibility of accounts receivable.

Identifying accounts receivable balances that were subsequently written off after the
confirmation date could reveal that the unconfirmed account receivable did actually
exist at the confirmation date. Additionally, because of the subsequent write-off, it is
possible that there may have been a valuation impairment of that receivable at the
confirmation date. However, to test the valuation assertion would require a different
set of procedures and would not provide further evidence to support existence.
Do Not
Perform

Review the aged trial balance for material past due accounts.
Reviewing the aged trial balance will not provide evidence of the existence assertion.
It will, however, provide evidence with respect to the net realizable value (valuation
assertion) since it relates to the collectibility of accounts receivable.

Do Not
Perform

Perform test of controls for the sales/accounts receivable/cash receipts system to
confirm the effectiveness of accounting system.
Test of controls do not provide direct evidence of the existence assertion. They are
performed to determine whether reliance may be placed on a particular control and
relate to the internal control assessment prior to beginning field work.

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Chapter 07 - Revenue and Collection Cycle

7.68

Kaplan CPA Simulation: Alternative Procedures (Continued)
b.

Option

Procedure

True

The evidence gathered via the standard audit procedures for accounts receivable will
support that Amberly’s sales returns are properly valued.
Evidence supporting the valuation of sales returns will be gained via the audit
procedures for accounts receivable. Specifically, audit procedures for the allowance
for doubtful accounts should reveal any material misstatements of sales and/or sales
returns.

False

Vouching expenses, performed as part of the search for unrecorded liabilities, should
uncover any material misclassifications of expenses that occurred during the year.
Vouching expenses performed as part of the search for unrecorded liabilities will
only uncover any material misclassifications of expenses that occurred during the
year and were paid subsequent to year end. To gain assurance that expenses were not
misclassified for the entire year, the auditor must vouch a sample of expenses based
on materiality levels.

True

An unexplained increase in the gross profit ratio may suggest the presence of
unrecorded expenses.
An unexplained increase in the gross profit ratio may suggest the presence of
unrecorded expenses in COGS since unrecorded expenses would understate total
expenses and falsely increase the profitability ratios (i.e., net income).

False

Amberly’s bill and hold transactions may increase audit risk because the sales may
be understated at the end of the year.
Amberly’s bill and hold transactions may increase audit risk because such
transactions may result in sales being overstated at year end. Bill and hold
transactions usually involve selling products for large discounts to retailers and
holding them (perhaps in third-party warehouses) to be delivered at a later date.
Clearly the risk is of prematurely recorded or uncollectible sales.

c.

To:
From:

Controller, Amberly
Partner, Rapport

Negative confirmations solicit a response from the customer only if the reported balance is
incorrect. While it is a less-costly approach because second and third confirmation requests are
not sent out, it provides lower quality of evidence since an explicit corroboration of existence is
not received. Negative confirmations are typically used for small balances that are not old and
when both the inherent risk and control risk are assessed as low.
Positive confirmations request the customer to verify whether a particular accounts receivable

balance is correct. Since an explicit response is received in all cases, positive confirmations are
viewed as a better technique. Positive confirmations are generally used for large balances, old
balances, or where the risk of error is high.

7-25