Chapter 09 - Auditing: A Practical Approach Third Canadian Edition PDF

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Auditing: A Practical Approach
Third Canadian Edition
by
Robyn Moroney
Fiona Campbell
Jane Hamilton
Valerie Warren...

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Moroney, Campbell, Hamilton, Warren

Auditing: A Practical Approach, Third Canadian Edition

Solutions Manual to accompany

Auditing: A Practical Approach Third Canadian Edition by

Robyn Moroney Fiona Campbell Jane Hamilton Valerie Warren Chapter 9 Auditing Sales and Receivables

John Wiley & Sons Canada, Ltd. 2018

Chapter 9 Auditing Sales and Receivables Solutions Manual

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SOLUTIONS TO REVIEW QUESTIONS REVIEW QUESTION 9.1 Inherent risks specific to sales and receivables: • Pressure to overstate sales in order to report that announced sales or profitability targets were achieved when, in fact, they were not. • Pressure to overstate cash and accounts receivable or understate the provision for bad debts in order to report a higher level of working capital in the face of liquidity problems or going-concern doubts. • The volume of sales, cash receipts and sales adjustment transactions, resulting in numerous opportunities for errors to occur. • Contentious issues relating to the timing of revenue recognition, such as the effect of purchasers’ rights of return. • Susceptibility to misappropriation of liquid assets generated by cash receipts. • The use of sales adjustment transactions to conceal thefts of cash received from customers.

REVIEW QUESTION 9.2 Control risk assessments for the completeness assertion for a transaction class that decreases an account balance, affect the assessments for the opposite account balance assertions. Thus, because both cash receipts and sales adjustment transactions decrease the accounts receivable balance, the assessment for completeness for these transaction classes affects the assessment for the occurrence existence for the accounts receivable balance.

REVIEW QUESTION 9.3 • The principal inherent risk is that of overstatement of sales revenue and accounts receivable balances. In the audit of transaction classes, this relates to the occurrence and measurement assertions for sales transactions and to the completeness assertion for cash receipts and sales adjustments. In most entities, controls relative to these assertions for sales and cash receipts are effective and the auditor is able to adopt a lower assessed level of control risk strategy for these transaction classes. • In the design of substantive audit procedures, the large volume of sales and cash receipt transactions means that it is normally cost-effective to obtain most of the evidence from the application of substantive procedures to the accounts receivable balance.

REVIEW QUESTION 9.4 The procedures involved in performing accounts receivable confirmations are: • Prior to selecting the sample for confirmation, verify the list of balances as being

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complete and accurate. • Stratify population, having regard to factors such as size, age, etc. and determine size of sample from each stratum, having regard to assessments of risk and materiality. • Select required number of accounts from each stratum in manner effectively random. • Draw up a list of selected accounts and verify that confirmation requests, prepared and signed by the entity’s management at the auditor’s request, are in complete agreement with that list. • Ascertain that the amount, name and address on the confirmation agree with the corresponding data in the customer’s account. • Maintain custody of the confirmations until they are mailed. • Use the audit firm’s own return address envelopes for the confirmations. • Personally deposit the requests in the mail. • Require that the replies be sent directly to the auditor.

REVIEW QUESTION 9.5 The best evidence is the receipt of payment from the customer. The matching of such cash receipts to unpaid invoices at the confirmation date, evidenced by the remittance advice accompanying the cash receipt, establishes the existence and collectability of the accounts. Alternatively, if payments are made by direct credit to the entity’s bank account, there is usually some identifier or corresponding email supporting the receipt and identifying items covered in the payment. Any unpaid balances should be vouched to supporting documentation, preferably a dispatch note signed by the customer acknowledging receipt of the goods, or a written order from the customer.

REVIEW QUESTION 9.6 Sales adjustments could arise because of instances such as sales returns and incorrect pricing. Controls would include ensuring that sales returns are genuine and approved by the sales manager and accounted for by the inventory control manager through authorized receiving reports. A related issue is that sales returns in the month after balance date would need to be checked, to ensure that sales in the prior period were not inflated, particularly if the sales force is commission-driven. Pricing is normally automatically calculated by the computerized information system and any errors that require adjustment to sales should be reviewed closely to ensure there are no systemic problems in the pricing system. Any bad debt write-offs would require authorization by the credit manager and although shown as an expense in the financial statement, effectively represent an adjustment in the sales revenue.

REVIEW QUESTION 9.7 The main inherent risk is that an entity will overstate revenue and the related accounts receivable balances. This is a particular danger with cut-off at balance date, where inadequate controls could lead to either overstatement or understatement of sales. If Solutions Manual

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cut-off procedures and authorizations for returns are adequate, then over or under statements of sales are not likely. However, earnings management has been a major issue in recent times (WorldCom, Enron, HIH Insurance etc.), and the auditor needs to be aware and watchful with respect to such practices.

REVIEW QUESTION 9.8 The possibility of fraud will depend to a large extent on the inherent and control risks in an entity. Some entities are inherently more prone to fraud than others, but good control procedures, including proper segregation of duties, can minimize these risks. In the area of sales, fraud can occur through actions such as underpricing, fraudulent credit notes and lack of follow-up on returned goods. Cash defalcations can be easily covered up by journal entries such as writing off accounts as bad debts. In the case of any write offs, they should be approved by the credit manager and then only after exhaustive credit collection procedures have been undertaken.

REVIEW QUESTION 9.9 'Cut-off' tests are performed on sales and cash receipts as part of the year-end work, to verify the recorded balance at year-end. The sales cut off test, which traces movements a few days on either side of balance date, is designed to ensure that sales and accounts receivable are recorded in the correct accounting period, as is the related inventory. The cash receipts cut off test is designed to ensure cash receipts are recorded in the proper accounting period.

REVIEW QUESTION 9.10 The underlying issue for the auditor is the assessed levels of inherent risk and control risk. In particular, the control risk for sales transactions, cash receipts and sales adjustments need to be assessed in determining the sampling approach taken. A major consideration with accounts receivable sampling is to obtain sufficient dollar value coverage, as it normally constitutes a major asset. It is not uncommon for a relatively small number of accounts to represent a large dollar value in respect of the total and thus these accounts would be selected for testing.

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SOLUTIONS TO PROFESSIONAL APPLICATION QUESTIONS PROFESSIONAL APPLICATION 9.1 — Audit objectives over the sales cycle a) Sales are made to customers that do not have approved credit. The objective is to ensure appropriate valuation of accounts receivable b) Goods not ordered by the customer are shipped. The objective is to ensure that transactions occurred and that sales are not overstated. c) Unit prices on customer invoices are incorrect. The objective is to ensure the accuracy of the financial information. d) Invoices are not posted to customer accounts. • The objective is to ensure completeness of the financial information e) Goods are shipped but not invoiced The objective is to ensure completeness. e) Sales may be made to unauthorized customers. The objective is to ensure valuation is correct. f) Fictitious sales may be recorded. The objective is to ensure that transactions occurred.

PROFESSIONAL APPLICATION 9.2 — Sales cycle documents For each of the following documents, describe its purpose and how it contributes to internal control over the sales cycle: a) Customer order: Orders submitted in writing or electronically on a customer order provide ready evidence of legitimacy in that they indicate goods were ordered by an actual customer, which supports the occurrence assertion. b)

Sales order: Form showing the description of the goods, the quantity ordered and other relevant data. It is signed by the clerk accepting the order and serves as the basis for internal processing of the customer order. Sales orders are commonly pre-numbered in case they are misplaced and business is lost as a result. This supports the completeness assertion for sales. It also represents the start of the transaction trail of documentary evidence and confirms the existence of a valid order. It thus relates to the audit objective occurrence. c)

Accounts receivable master file: A computer file containing customer details such as contact information, address, and approved credit limits. For an auditor,

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controls over credit approval reduce the risk of a sales transaction being initially recorded in an amount in excess of the amount of cash expected to be realized, and thus contributes to the audit objective of accuracy. Controls over credit approval enable management to make a more reliable estimate of the size of the allowance needed. Strong controls over extending credit reduce the likelihood of sales being made on credit to customers unable to pay in the future and ensure appropriate valuation and allocation. d)

Shipping document: Segregating responsibility for shipping from the responsibility for approving and filling orders prevents shipping clerks from making unauthorized shipments. In addition, shipping clerks are normally required to make independent checks to determine that goods received from the warehouse are accompanied by an approved sales order form or an electronic authorization. Shipping documents on pre-numbered forms are usually produced by the computer information system using order information already logged into the system with appropriate delivery data added (such as quantities shipped, carrier details, and freight charges). Subsequent checks of the numerical continuity of the shipping documents invoiced ensure completeness of recorded sales transactions. Pre-numbering shipping documents also helps in establishing cut-off at year end as the auditor can ensure that the last goods shipped out are the last goods invoiced, and that orders shipped after year end are invoiced after year end. Shipping documents provide evidence that goods were shipped and thus of the occurrence of the credit sale, giving rise to a claim against the customer within accounts receivable. e)

Sales invoices: A form detailing the goods or services supplied to a customer and the amount owing. The main control objective is to ensure that sales invoices are recorded accurately and in the proper period, which is usually when the goods are shipped.

f)

Monthly customer statement: Should be sent to each customer to give the customer an opportunity to alert a designated accounting supervisor (who is not otherwise involved in the execution or recording of sales transactions) if the balance does not agree with the customer’s records. g)

Deposit slip: A listing of cash, coins, and individual cheques for deposit with the bank, endorsed by the bank teller, a copy of which is retained by the entity. The resulting bank deposit record establishes the occurrence of the transactions.

PROFESSIONAL APPLICATION 9.3 — Control weaknesses • Absence of appropriate segregation of incompatible duties: The customer service clerk (CSC) receives the order, approves the order, and authorizes the shipment. • Absence of review and approval of transactions: No one checks the CSC’s sales invoice. No one checks sales invoice quantity, prices, and extensions by the CSC. Solutions Manual

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• Management over-ride: Management sent a shipment without a sales invoice. • The regular use of casual labour may leave the company more susceptible to

problems caused by incompetent and/or untrustworthy personnel: A CSC sent goods to a friend at a price below the company’s cost. • Improper/inaccurate documentation policy: The sales invoice shows a shipping date of 1 day after the order date.

PROFESSIONAL APPLICATION 9.4 — Cash sales system controls a) Weaknesses in the cash sales system: Sales ordering 1. Phone orders should be authenticated by requiring an order number. There should also be a check of the customer’s details to an approved customer list as well as a check as to the availability of inventory. Dispatch of goods 2. There do not appear to be any shipping documents produced. The sales order can be used as a shipping document. There should be a check that the goods shipped match the amount on the sales order. Cash receipts 3. There does not appear to be a cash register or point of sale terminal: these devices are indispensable. They provide: • Immediate visual display of the amount of the cash sale and the amount tendered; • A printed receipt for the customer and an internal record of the transaction; • A printed record of the day’s receipts. 4. At the end of the day there should be an independent check of the total printed by the register with the amount of cash on hand. 5. The cash should then be forwarded to the cashier’s department for deposit in the bank, together with the register or terminal printed totals. 6. The total printed by the cash register and the validated deposit slip should be sent to general accounting to be entered in the cash receipts journal. 7. An employee not otherwise involved in executing or recording cash transactions should perform periodic bank reconciliations. b)

It would be difficult to ensure that there was no material error or fraud within this system. This is because of the problem associated with the lack of segregation of duties over the cash receipts function, due to the role undertaken by the driver. You could select a sample of a copy of the sales order kept in the sales department. Each of these orders should be then vouched to:

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• Details of the goods dispatched in the dispatch department • The handwritten sales invoice • Bank deposit details The problem is that there is too much control by the cashier and it would be difficult to determine whether all cash received was banked. To provide any conclusive evidence, an auditor would probably have to be engaged separately (not as part of the audit because of the excessive cost). The objective of the separate audit assignment should be kept confidential. The auditor should select sales details for a whole month and vouch every transaction to dispatch records, invoices and banking details. Any discrepancies should be carefully followed up. If there were too many discrepancies, the auditor should check another month to ensure that they were not systematic differences.

PROFESSIONAL APPLICATION 9.5 — Control strengths and weaknesses a) List the control strengths • The cash tills are kept in a vault • Compare cash sales to the amount deposited per the bank statement • Compare the admission revenues to the cash collected • The tills are counted by the cashiers and again by the admissions manager b)

Weakness: Cashier puts cash in an envelope and gives it to admissions manager- admissions manager counts the cash prepares the deposit and the sales report Implication: Lack of segregation of duties- Manager is given uncounted cash (custody) and also is responsible for the recording of the sales. Therefore, the Manager can take cash and hide it by reporting the wrong sales figure to cover it up. Recommendation: The Cashier should count the cash and completes the sales summary. The Admissions Manager should count the cash and prepares the deposit. Weakness: Sales are recorded based on the sales report sent by the Admissions Manager Implication: Sales may be recorded incorrectly if there is an error on the report. Recommendation: Sales should be recorded based on the sales report per the cash till. The accounting staff should compare the amount deposited for the day to the cash sales for the day. PROFESSIONAL APPLICATION 9.6 — Revenue cycle strengths and weaknesses a) Strengths 1. All revenue is only recorded when cash or other goods are received. This ensures there is no unrecorded revenues, and all revenues are recorded in the period received.

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2. The initial data entry is performed by Ling, who is not responsible for physically depositing the cheques (Andrea). This ensures fictitious revenues are not recorded. b) Bank reconciliations are performed by the accounting department and this is reviewed by the Executive Director. This ensures only actual donations are recorded and there are no unrecorded deposits. It also ensures recorded amounts are accurate. a) Grant revenue received is deferred and amortized over an appropriate period. Such entries and amortization are tracked and reviewed by the executive director throughout the year. This ensures the revenue is recognized when earned and ensures revenues are recorded at the correct amounts. 3. Deposits are matched to the journal entry - ensures all deposits are recorded. 3. Volunteer canvassers use a pre numbered sequential receipt book — this helps to ensure all cash receipts are recorded. Duplicate receipts are provided to the donors. b)

Weaknesses Weakness: Deposits are only done once a week Implication: The longer cash is on hand the greater the risk it may go missing. Recommendation: Deposits should be done daily Weakness: Bank reconciliations are only performed when time allows Implication: Bank reconciliations are a key control. If they are not done regularly, unrecorded deposits or missing deposits may go undetected. Recommendation: Bank reconci...