Review Question

1. How do different levels of control risk in the revenue and collection cycle affect the nature,
timing and extent of accounts receivable confirmation procedures?
Answer: In developing audit objectives for a particular engagement, the auditor should consider
the specific circumstances of the entity, including the nature of its economic activity and the
accounting practices unique to its industry. It affects directly, since higher level of control risk
persuade the auditors to audit larger samples of receivables. Confirmation of receivables
requires direct communication with debtors. The confirmation procedure typically involves a
written request asking a recipient to consider the accuracy of the information presented. With
the confirmation date closer to the fiscal year end date and as to the nature of the procedures,
higher levels of control risk persuade auditors to use positive confirmation because a positive
confirmation requests the debtor to respond whether the information presented is correct or, in
the case of a blank request, to fill in the blank. The negative confirmation requests the debtor to
respond only if they disagree with the information presented. We should also consider vouching
subsequent payments by the customers.

2. 2. What feature(s) of cash receipts internal control system would be expected to prevent (a) an
employee’s absconding with company funds and replacing the funds during the audit
engagements with cash from the employee pension fund and (b) the cash receipts journal and
recorded cash sales from reflecting more than the amount shown on the daily deposit slip?
Answer:
A. The cash receipts internal control system features of the business should prevent employee
from doing malicious acts in the company’s fund. There should be a proper segregation of
duties between transactions or accounts which could lead to potential source of fraud-
either employee or management fraud, within the entity. Further transaction authorization
should be separated from transaction processing in the company’s revenue cycle, this
procedure can prevent employees from transferring funds which is not related to the said
cycle alone. The employees scheme of absconding with the company’s funds during the
audit engagement with cash from the employee’s pension fund will lead to an audit trail
which the auditor can use as evidence that the entity’s internal control system is weak and
there is a high risk of potential misstatement due to fraud over its operation.
B. To prevent the cash receipt journal and recorded cash sales from reflecting more than the
amount shown on the daily deposit slip, the company should have a proper internal control
in overseeing its daily deposit, the amount of every transaction recorded in its books and
the balance in the company’s bank balance. An auditor should prepare the bank
reconciliation carefully and independently in order to correct possible misstatement in the
companies records

3. What is the meaning of strength in the transaction processing controls of the revenue and
collection cycle? A weakness? Why are the weaknesses not subject to test of controls auditing?
Answer: The strength identified in the revenue and collection cycle's transaction processing
controls is a control procedure that can quickly eliminate, identify, and avoid mistakes/errors in
the accounting records that form the foundation of financial statements. While, a weakness is
 the absence of a control procedure where the auditor suspects one will occur. A weakness is not
subject to test of controls of auditing so no guarantee is put on it.

4. Why is it necessary to evaluate the control after the test of controls audit of the revenue and
collection cycle when an evaluation was already made after the understanding phase?
Answer: Following the analysis process, the evaluation phase was used to evaluate which
controls appeared to be appropriate for justifying a low control risk assessment. The last step in
the controls auditing process is to decide whether the controls are really working as well as they
seem.

5. Describe the processing of transactions in the sales and collections cycle in the following
functions:

Order entry – The process usually begins when a customer approaches the company and files a
customer purchase order. The sales department receives the document and prepares a sales order
that is then sent to the credit department for a credit check. Remember that salespeople will not
perform credit checks because their position as a salesperson may influence their bias when making
credit decisions on customers. This separation is called segregation of duties. The credit department
then send a copy bearing credit approval to the warehouse, shipping, and billing department.
Shipping personnel verify that the quantity and description of goods received from the warehouse
matches the copy of the sale orders directly from the order entry and when the credit department
approved the sale, sales invoice are prepared. The copy should serve as a shipping order, for the bill
of lading and the other one is for billings. The sale should be recorded once the bill of lading is
received the billings.

Credit approval - The credit department must maintain a list of unauthorized customers and their
credit limits, wherein the employee must review copies from the sales are order are sent to credit
department wherein it will approve or denies the credit and returns the copy of sales order to the
order entry. If it is accepted, the credit department then send a copy bearing credit approval to the
warehouse, shipping, and billing department.

Warehousing - Once the credit department approves the sales order, the warehouse personnel
must issue goods with no defect to the shipping department. One of the warehouse personnel
which is the accounting department should maintain perpetual records for the inventory that has
been shipped.

Shipping - Shipping personnel verify that the quantity and description of goods received from the
warehouse matches the copy of the sale orders directly from the order entry and when the credit
department approved the sale, sales invoice are prepared. A document is prepared to initiate the
shipment of the goods indicating the description and quantity that has been shipped. The copy
should serve as a shipping order, for the bill of lading and the other one is for billings. The sale
should be recorded once the bill of lading is received the billings.

Customer billing - There must be a multi- copy sales invoice for the billing to the customers and
should always update the sales transaction file, and the general ledger must be accurate and have a
master file for sales and accounts receivable. This is used to generate sales journal with the cash
receipts and miscellaneous credits that allows to prepare the trial balance. Each invoice should be
reviewed by the person who is not involved in its preparation. The billing department should
develop a total of sales invoices and should be submitted directly to the clerk for maintaining the
receivable control account.

Collecting accounts receivable - The approved sales order and the shipping document are then sent
to the accounts receivable clerk, who then generates a sales invoice and makes the
necessary journal entry. Finally, once the cash is received from the customer, accounting or treasury
records the credit to cash and debits the balance in accounts receivable. Accounts receivable is
responsible for taking the sales order and shipping document in generating sales invoice that sends
to the customer. The accounts receivable department must track that customers have been paid
and which customer have an overdue.

Granting credit for returns and allowances - This will be now the result of approval for customers
returns or to rant allowances to the customers. This should also have the authorization with the
signature of an employee to issue credit memo receive the report when the merchandise has been
returned. The function of this is just like an invoice but the difference is, this indicates amounts to be
deducted from a customer’s account.

Recording uncollectible accounts expense - The business function for the sales and collection cycle
is comprise of the uncollectible accounts that are usually recorded to the authorization form general
ledger to estimate the uncollectible accounts. It should be approved or have the authorization by
the controller or chief accountant.

Writing off collectible accounts - Business functions for the sales and collection cycle is the key
activities that an organization must complete to execute and record business transactions for sales,
cash receipts, sales returns, and allowances, change off of uncollectible account, and bad debt
expense. Write off accounts identified as uncollectible and recorded in the general ledger. Accounts
written off should be transferred to the separate control account and also, the statements should
still continue to be sent to the debtors who will collect the account.

6. Identify features of the following documents that facilitate control and explain how they do so:
A. Shipping document - The entity prepares shipping document or bill of lading to initiate
shipment of goods, indicating facts pertaining to the merchandise shipped such as, but not
limited to, quantity shipped, description of the items, date of shipment, the name of the
carrier and freight charges. This document represents a formal contract between the seller
and the shipping company (carrier) to transport the goods to the customers. The signature
attached thereto of the carrier or the customer o the shipping document provides externally
created evidence that goods have been shipped. Sellers should account for the numerical
sequence to ensure that all shipments are recorded as sales.
B. Remittance advice - Customer attached remittance advice to a check in payment of an
invoice. This may be a turnaround document, a part of a check, or a statement identifying
the invoices being paid. This document facilitates recording of cash receipts. If a customer
does not return a remittance advice, the employee opening the mail usually prepares one. A
remittance advice indicate the date and amount of payment and the invoices paid.
 C. Uncollectible account form - The uncollectible account authorization form is a form of
document which authorize the accounting clerk to write an accounts receivable off as
uncollectible. This is further performed so that there is a segregation of duties in writing off
an accounts receivable to ensure that the said transactions are properly recorded.

7. Why do people perpetrate fraud involving sales transactions?

Answer: Senior managers may try to retain the confidence of their people by collect promotions
or even hold their positions, and may feel forced to display great profit and to inflate revenues,
that is why some people make fraud involving sales purchases because they are pressured to
achieve the target profit.

8. Why is it difficult to detect the withholding of cash receipts?

Answer: Removing cash is one of the simplest types of fraud to commit and one of the most
difficult to identify because reports do not show what has happened until a record of cash
obtained has been made.

9. Identify three ways an employee might misappropriate cash receipts.

a. An employee might misappropriate cash receipts if he/ she makes cash deposits and prepares
the bank reconciliation that can withhold cash and he/she will intentionally hide shortage by
overstating deposits in transit on the bank statement. Also, may change by under footing the list
of outstanding checks, or may omit outstanding checks from the list. One of the ways to uncover
this kind of fraud is to have a routine check of test bank reconciliations.
b. The other one, is in a cashier retail establishment wherein he/she does not have an intention to
ring up transactions on the cash registers so that he/she can take the cash without any
detection. After he/she rung up, the transactions will now add the receipt to the total cash
receipts that can be compared also to the cash on hand.
c. Also, an employee might misappropriate cash receipts by the employee who has access to the
cash receipts and who can maintain the records of accounts receivable that records sale at an
amount lower than the invoice amount. So, when the customer pays the employee will now
takes the difference between the amount recorded as receivable and the invoices that has been
recorded.

10. What concern does an auditor have in auditing adjustments to sales?

Answer: An adjustment on sales related account includes the following; Cash discount; Sales
allowances; Sales return; Volume Rebate; Billing error corrections; and write-offs of
uncollectible accounts. The risk in connection with these accounts is high if the company doesn’t
have a good internal control over the afar mentioned transactions. One account might be
recorded as part of the other in order to hide or cover a misappropriation of cash receipts.
11. When an entity’s controls for collection are ineffective, what potential misstatement could arise
in the financial statements?
Answer: When an entity’s controls for collection are ineffective, there is a possible
misstatement and questions that could arise in the financial statements. If the misstatement is
material to the financial statement, it can affect the decision making of the people involve in
engaging to the financial statement. If the Auditor noticed that there is a material misstatement
to the evidence that they are gathered and it is material, some of them might look to how the
client do a proper valuation to the receivables because bad debts could be manipulated and
turn it into understated to cover the un-collectability of the accounts because of lack of controls
to collect the receivable and inaccurate valuation and allocation of it and it may result to
overstated net income. Also, Cash can be easy manipulated because cash is prone to
misstatement and frauds because of the duplication of receipts and vouchers.

12. What tests of controls related to uncollectible accounts do auditors perform?

Answer: Auditors' main concern with uncollectible accounts is that they have genuinely become
uncollectible, rather than being written off to cover misappropriations. Any account written off
must be signed by a responsible official who was not involved in the credit approval process. The
auditor normally examines the approvals of accounts that have been written off to see how
successful this control is. In the case of accounts written-off, the auditor usually looks at
correspondence showing that attempts to recover the account were made but that the account
was uncollectible. The auditor may review credit reports on the accounts on occasion. A sample
of the entries to the accounts receivable accounts can be traced by the auditor.
Exercise # 1:

The following matters were noted in the audit of PAT Express.

1. No collection was ever made for sale to Sister Company because the invoice was never billed.
2. A cash collection for the account of Rain Company was misappropriated by the cashier.
3. The accounts receivable clerk posted to the Kiko’s account a sale made to Josie.
4. A shipment included four pairs of JC-1 clamps rather than four individual clamps.
5. A property executed invoice for a valid sale was not recorded.
6. An order was never billed because the shipping document was misplaced.
7. In an attempt to meet profit goals, more goods were shipped than customers had ordered.
8. A sale that occurred on December 31, the last day of the accounting period, was recorded in the
next accounting period.

Requirement:

Answer the following questions about each of the eight situations.

a. What control would have prevented or detected the misstatement?

b. What test should an auditor perform to test the control?
c. To which financial statement assertion does the misstatement relate?

Answer:

2. a. Cash receipts are pre-listed and cash register procedures are tracked.
b. Prelisting and comparing the deposit to the balance in the cash register
c. Completeness

3. a. Customers may receive a monthly statement from someone who is not interested with
accounts receivable or cash management.
b. Examine follow-up files and observe the protocol.
c. Existence or occurrence

4. a. Prior to delivery, products should be counted and specifications and quantities should be
compared to sales orders and shipping records quantities and descriptions.
b. Examine signatures on documents evidencing success using procedures such as, but not
limited to, sample.
c. Rights and obligations

5. a. To ensure that all sales invoice numbers are registered, keep track of them all.
b. Observe procedures such as, but not limited to, invoice sequences in which the numerical
sequence is accounted for.
c. Completeness

6. a. To ensure that all goods delivered are paid, shipping records should be kept track of.
b. Examine invoices for a sample of shipping papers, among other procedures to be observed.
c. Completeness
 7. a. Prior to delivery, products should be counted and specifications and quantities should be
compared to sales orders and shipping records quantities and descriptions.
b. Examine signatures on documents evidencing success using procedures such as, but not
limited to, sample.
c. Rights and obligations

8. a. To ensure that all purchases are registered in the correct timeframe, pre-numbered sales
invoices should be used and accounted for.
b. Examine entries in the sales journal for the series of sales invoices, among other things.
c. Completeness

Exercise # 4:

After determining that computer controls are valid, Honey is reviewing the sales system of Babe
Corporation to determine how a computerized audit program may be used to assist in performing tests
of Babe’s sales records.

Babe sells crude oil from one central location. All orders are received by mail and indicate the
preassigned customer identification number, desired quantity, proposed delivery date, method of
payment and shipping terms. Because price fluctuates daily, order do not indicate a price. Price sheets
are printed daily and details are stored in a permanent disk file. The details of orders are also
maintained in a permanent file.

Each morning the shipping clerk receives a computer printout with details of customers’ orders to be
shipped that day. After the orders have been shipped, the shipping details are entered into 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 disks that are available for
Honey to use in performing the audit.

Requirement:

a. How can Honey use a computerized audit program to perform substantive tests of Babe’s sales
records in their machine-readable form? Do not discuss accounts receivable and inventory.
Answer: Honey may use the machine to review records for quality to assess completeness and
accuracy, compare duplicate data stored in separate files for corrections, conduct analytical
procedures on reported sales using predetermined parameters such as percentage relationship,
gross margin and patterns over time (on a monthly or annual basis), select all debits posted to
sales accounts as well as all sales account postings from sources other than the sales journal,
print a working paper that includes a list of each item chosen, as well as related data in the
appropriate columns, via a review of the sales journal, pick sales transactions for review based
on predetermined parameters, ensure that all sales invoices and associated records have been
properly accounted for, verify the statistical accuracy of postings from the sales journal to
relevant ledger accounts, as well as the text extensions and footing of computerized sales
documents used to prepare invoices and the sales journal..
 b. After Honey performs these tests with the assistance of the computer, what other auditing
procedures should Honey perform to complete the examination of Babe’s sales record?
Answer: Honey may also test pricing by comparing invoices to regular price lists, verifying the
sales cut-off at the beginning and end of the period to see if reported sales reflect revenue for
the period, and determining the scope and type of business transacted with major customers,
examine documentation for proper approval, confirm that all shipping documents have been
accounted for, compare the dates of actual sales transactions to the dates on shipping reports,
trace data from sales invoices to the sales journal, and trace postings from the sales journal to
invoice copies.

Exercise # 5:

The following are audit procedures in the sales and collection cycle.

1. Examine a sample of shipping documents to determine if each has a sales invoice number
included on it.
2. Discuss with the sales manager whether any sales allowances have been granted after the
statement of financial position date that may apply to the current period.
3. Add the columns on the aged trial balance and compare the total with the general ledger.
4. Observe whether the controller make an independent comparison of the total in the general
ledger with the trial balance of accounts receivable.

Requirement:

a. For each procedures, identify the applicable type of audit evidence.

b. For each procedures, identify which of the following it is:
1. Test of controls
2. Substantive test of transactions
3. Analytical procedures
4. Test of details of balances
c. For those procedures you identified as a test of control or substantive test of transactions, what
internal control objective of objectives are being satisfied.
d. For those procedures you identified as a test of details of balances, what audit objectives or
objectives are being satisfied.
Answer:
2. a. Inquiry
b. Test of details of balances
c. The sales transactions are reported in a timely manner.

3. a. Mechanical accuracy
b. Test of details of balances
c. Mechanically, accounts receivable are correct.

4. a. Observation
b. Test of control
c. Mechanically, accounts receivable are correct.