200

CHAPTER9
RevenueandCollectionCycle
LEARNINGOBJECTIVES
Review
Checkpoints

Exercises
andProblems

Cases

1. Describetherevenueand
collectioncycle,including
typicalsourcedocumentsand
controls.

1,2,3,4,
7

50,51

29,30

2. Giveexamplesofdetailtestof
controlsproceduresforauditing
controlovercustomercredit
approval,delivery,accounts
receivableaccounting,cash
receiptsaccounting,andbank
statementreconciliation.

5,6,8,9,
10,11

52

31,32,64,
65

3. Describesomecommonerrors,
irregularities,andfraudsinthe
revenueandcollectioncycle,and
designsomeauditand
investigationproceduresfor
detectingthem.

12,13,14,
15,16,17

53,54

61,62,63,
64,65

4. Explaintheimportanceofthe
existenceassertionfortheaudit
ofcashandaccountsreceivable
balances,anddescribesome
proceduresforobtainingevidence
abouttheexistenceofassets.

18,19

55,56,60

64,65

5. Identifyanddescribe
considerationsforusing
confirmationsintheauditofcash
andaccountsreceivable.

20,21,22,
23,24,25

58,59,60

33,65

6. Designandperformsubstantive
auditproceduresfortheauditof
abankstatementreconciliation,
andtellhowauditorscansearch
forlappingandkiting.

26,27,28

57

62

POWERPOINTSLIDES
PowerPointslidesareincludedonthewebsite.Pleasetakespecialnoteof:
*

RevenueandCollectionCycle

SOLUTIONSFORREVIEWCHECKPOINTS
9.1

Thebasicsequenceofactivitiesandaccountinginarevenueandcollection

201
cycleis:
1.
Receivingandprocessingcustomerorders.Enteringdatainanorder
systemandobtainingacreditcheck.
2.
Deliveringgoodsandservicestocustomers.Authorizingreleasefrom
storekeepingtoshippingtocustomer.Enteringshippinginformationin
theaccountingsystem.
3.
Billingcustomers,producingsalesinvoices.Accountingforcustomer
tradeaccountsreceivable.
4.
Collectingcashanddepositingitinthebank.Accountingforcash
receipts.
5.
Reconcilingbankstatements.
9.2

Whendocumentssuchassalesorders,shippingdocuments,andsalesinvoices
areprenumbered,someonecanlateraccountforthenumericalsequenceand
determinewhetheranytransactionshavefailedtoberecorded.(Completeness
controlobjective.)

9.3

Accesstocomputerterminalsshouldbecontrolledsoonlyauthorizedpersons
canenterorchangetransactiondata.Accesstomasterdatafilesis
importantbecausechangesinthemaffectautomaticcomputercontrols,suchas
creditcheckingandaccurateinventorypricing.

9.4

Itmightbeeasierjusttosendthecashtotheaccountsreceivable
accountants,but(1)thatwoulddelaythebankdepositandthecompanywould
loseinterestincome,and(2)adishonestaccountantcouldstealcashwhile
stillgivingthecustomercredit(toforestallcomplaints).Theaccountant
couldcoverthetheftbymakingfalsedebitentriestosuchaccountsas
allowancefordoubtaccounts(accountwriteoffs)ordiscountsandallowances
expense.

9.5

Auditorscouldexaminethesefilesforevidenceof:
Unrecordedsalespendingordermasterfile,
Inadequatecreditcheckscreditdata/checkfiles
Incorrectproductunitpricespricelistmasterfile

9.6

9.7

Withasampleofcustomeraccountsreceivable
(1)

Findthesupportfordebitentriesinthesalesjournalfile.Expectto
findevidence(copy)ofasalesinvoice,shippingdocument,andcustomer
order.Thesalesinvoiceshowingrecordingontheshippingdate.

(2)

Findthesupportforcreditentriesinthecashreceiptsjournalfile.
Expecttofindaremittanceadvice(entryonlist),whichcorrespondsto
detailonadepositslip,onadepositactuallyinabankstatementfor
thedaypostedinthecustomers'accounts.

Theaccountbalancesinarevenueandcollectioncycleinclude:
Cashinbank
Accountsreceivable
Allowancefordoubtfulaccounts
Baddebtexpense
Salesrevenue
Salesreturns,allowances,discounts

9.8

Thesespecificcontrolpoliciesandprocedures(inadditiontoseparationof
dutiesandresponsibilities)shouldbeinplaceandoperatinginacontrol

202
structuregoverningrevenuerecognitionandcashaccounting:
(1)
(2)
(3)
(4)
(5)

(6)

(7)
(8)

nosalesordershouldbeenteredwithoutacustomerorder
acreditcheckcodeormanualsignatureshouldberecordedbyan
authorizedmeans
accesstoinventoryandtheshippingareashouldberestrictedto
authorizedpersons
accesstobillingterminalsandblankinvoiceformsshouldberestricted
toauthorizedpersonnel
accountantsshouldbeunderorderstorecordsalesandaccounts
receivablewhenallthesupportingdocumentationofshipmentisin
order,andcareshouldbetakentorecordsalesandreceivablesasof
thedategoodsandserviceswereshipped,andcashreceiptsonthedate
thepaymentsarereceived
customerinvoicesshouldbecomparedwithbillsofladingandcustomer
orderstodeterminethatthecustomerissentthegoodsorderedatthe
properlocationfortheproperpricesandthatthequantitybeingbilled
isthesameasthequantityshipped
pendingorderfilesshouldbereviewedtimelytoavoidfailuretobill
andrecordshipments
bankstatementsshouldbereconciledindetailmonthly.

9.9

Ina"walkthrough"ofasalestransaction,auditorstakeasingleexampleof
asalestransactionandtraceitfromtheinitialcustomerorderthrough
creditapproval,billing,anddeliveryofgoods,totheentryinthesales
journalandsubsidiaryaccountsreceivablerecords,thenitssubsequent
collectionandcashdeposit.Sampledocumentsarecollectedandemployeesin
eachdepartmentarequestionedabouttheirspecificduties.Theinformation
gainedfromdocumentsandemployee;canbecomparedtoanswersobtainedonan
internalcontrolquestionnaire.Thepurposeofthe"walkthrough"isto
obtainanunderstandingofthetransactionflow,thecontrolprocedures,and
thepopulationsofdocumentsthatmaybeutilizedintestofcontrols
auditing.

9.10

Thetwoimportantcharacteristicsofadetailtestofcontrolprocedureare
(1)identificationofthedatapopulationfromwhichasampleofitemswill
beselectedforaudit,and(2)anexpressionoftheactionthatwillbetaken
toproducerelevantevidence.Ingeneral,theactionsindetailtestof
controlauditproceduresinvolvevouching,tracing,observing,scanning,and
recalculating.

9.11

Dualdirectiontestofcontrolssamplingreferstoproceduresthattestfile
contentsintwo"directions"thevaliditydirectionandthecompleteness
direction.Thevaliditydirectionisasamplefromtheaccountbalance(e.g.
salesrevenue)vouchedtosupportingsalesandshippingdocumentsfor
evidenceofvalidity.Thecompletenessdirectionisasamplefromthe
populationthatrepresentsallsales(e.g.shippingdocumentfiles)tracedto
thesalesjournalorsalesaccountforevidencethatnotransactions
(shipments,sales)wereomitted.

9.12

Thegoalsofdualdirectionsamplingrelatetothefirsttwoobjectivesof
internalcontrol:(1)recordedsales(accountsreceivable)arevalidand
documentedand(2)validsalestransactions(accountsreceivable)are
recordedandnoneomitted.Onedirectionistoensurethatallrecorded
debitstoaccountsreceivablerepresentvalidcreditsalesthatactually
occurredtherelevantpopulationforsamplingtoachievethisgoalisfrom
recordedreceivabledebitswhichshouldbevouchedtosupportingdocuments,

203
suchassalesinvoices.Likewise,asampleofrecordedcreditstoaccounts
receivableshouldbevouchedtocashreceiptsdocumentssuchasremittance
advicesanddeposits.
Theotherdirectionistoensurethatallcreditsalesandcashreceiptsthat
occurredwererecordedinthereceivablerecords.Therelevantpopulations
forsamplingtoachievethisgoalare:(1)evidenceofcreditsalessuchas
shippingdocuments,thentracethesetothereceivableaccounts,and(2)
evidenceofcashreceiptssuchasremittanceadvices,thentracethesetothe
receivableaccounts.
9.13

Inthe"CannyCashier,"ifsomeoneotherthattheassistantcontrollerhad
reconciledthebankstatementandcomparedthedetailsofbankdepositslips
tocashremittancereports,thediscrepanciescouldhavebeennotedand
followedup.Thediscrepancieswerethatcustomersandamountsonthetwodid
notmatch.

9.14

Topreventthecashreceiptsjournalandrecordedcashsalesfromreflecting
morethantheamountshownonthedailydepositslip,theinternalcontrol
systemshouldprovidethatreceiptsberecordeddailyandintact.Acareful
bankreconciliationbyanindependentpersoncoulddetectsucherrors.

9.15

Confirmationstotaxpayerswhohadactuallypaidtheirtaxeswouldhave
producedexceptions,complaints,andpeoplewiththeircounterreceipts.
Theseresultswouldhaverevealedtheembezzlement.

9.16

Auditorsmighthaveobtainedthefollowinginformation:
Inquiries:Personneladmittingthepracticesofbackdatingshippingdocuments
ina"billandhold"tactic,orpersonneldescribingthe60daywaitfora
specialjournalentrytorecordcustomerdiscountstaken.
Detailtestofcontrols:Thesampleofcustomerpaymentcashreceiptswould
haveshownnodiscountcalculationsandauthorizations,leadingtoinquiries
aboutthemannerandtimingofrecordingthediscounts.
Observation:Whenobservingthephysicalinventorytaking,specialnotice
shouldbetakenofanygoodsonthepremisesbutexcludedfromtheinventory.
Theseareoftensignsofsalesrecordedtooearly.
Confirmationsofaccountsreceivable:Customerswhohadnotyetbeengiven
creditfortheirdiscountscanbeexpectedtotakeexceptiontoabalancetoo
large.

9.17

TheauditorswouldhaveknownaboutthenormalFridayclosingofthebooks
forweeklymanagementreports,andtheycouldhavebeenalertedtothe
possibilitythattheaccountingemployeesoverlookedtheonceayear
occurrenceoftheyearenddateduringtheweek.

9.18

Itisimportanttoplaceemphasisontheexistenceandrightsassertions
becauseauditorshaveoftengotintomalpracticetroublebygiving
unqualifiedreportsonfinancialstatementsthatoverstatedassetsand
revenuesandunderstatedexpenses.Forexample,creditsalesrecordedtoo
early(fictitioussales?)resultinoverstatedaccountsreceivableand
overstatedsalesrevenue;failuretoamortizeprepaidexpenseresultsin
understatedexpensesandoverstatedprepaidexpenses(currentassets).

9.19

Theseproceduresareusuallythemostusefulforauditingtheexistenceand
rightsassertions:

204
Recalculation.Expiredprepaidexpensesarerecalculated,usingauditors'
vouchingofbasicdocuments,suchasloanagreements(prepaidinterest),rent
contracts(prepaidrent),andinsurancepolicies(prepaidinsurance).
Goodwillanddeferredexpensesarerecalculatedusingoriginalacquisition
andpaymentdocumentinformationandterm(usefullife)estimates.Abank
reconciliationisaspecialkindofcalculation,andthecompany's
reconciliationcanbeaudited.PhysicalObservation.Inventoriesandfixed
assetscanbeinspectedandcounted.Titlestoautos,land,andbuildingscan
bevouched,sometimesusingpublicrecordsinthecountyclerk'soffice.
Pettycashandundepositedreceiptscanbeobservedandcounted.Securities
heldasinvestmentscanbeinspectedifheldonthecompany'spremises.
Confirmation.Lettersofconfirmationcanbesenttobanksandcustomers,
askingforareportofthebalancesowedthecompany.Likewise,ifsecurities
heldasinvestmentsareinthecustodyofbanksorbrokeragehouses,the
custodianscanbeaskedtoreportthenames,numbers,andquantityofthe
securitiesheldforthecompany.Insomecases,inventoriesheldinpublic
warehousesoroutonconsignmentcanbeconfirmedwiththeotherparty.
VerbalInquiry.Inquiriestomanagementusuallydonotprovidevery
convincingevidenceaboutexistenceandownership.However,inquiriesshould
alwaysbemadeaboutthecompany'sagreementstomaintaincompensatingcash
balances(maynotbeclassifiableas"cash"amongthecurrentassets),about
pledgeorsalewithrecourseofaccountsreceivableinconnectionwith
financings,andaboutpledgeofotherassetsascollateralforloans.
ExaminationofDocuments(Vouching).Evidenceofownershipcanbeobtainedby
studyingthetitledocumentsforassets.Examinationofloandocumentsmay
yieldevidenceoftheneedtodiscloseassetspledgedasloancollateral.
Scanning.Assetsaresupposedtohavedebitbalances.Acomputercanbeused
toscanlargefilesofaccountsreceivable,inventory,andfixedassetsfor
uncharacteristiccreditbalances.Thenamesofdebtorscanbescannedfor
officers,directors,andrelatedparties,amountsforwhichneedtobe
reportedseparatelyordisclosedinthefinancialstatements.
AnalyticalProcedures.Comparisonsofassetandrevenuebalanceswithrecent
historymighthelpdetectoverstatements.Relationshipssuchasreceivables
turnover,grossmarginratioandsales/assetratioscanbecomparedto
historicaldataandindustrystatisticsforevidenceofoverall
reasonableness.Accountinterrelationshipsalsocanbeusedinanalytical
review.Forexample,salesreturnsandallowancesandsalescommissions
generallyvarydirectlywithdollarsalesvolume,baddebtexpenseusually
variesdirectlywithcreditsalesvolume,andfreightexpensevarieswiththe
physicalsalesvolume.Accountsreceivablewriteoffsshouldbecomparedwith
earlierestimateofdoubtfulaccounts.
9.20

Thefollowinginformationisrequestedinabankconfirmation:
ForDepositAccounts:
Accountname
Accountnumber
Interestrate
Balanceasoftheconfirmationdate
ForDirectLiabilities:
Accountnumberordescription

205
Balancedue
Datedue
Interestrate
Datethroughwhichinterestispaid
Descriptionofcollateral
9.21

A"positive"confirmationisarequestforaresponsefromanindependent
partywhotheauditorhasreasontoexpectisabletoreply.A"negative"
confirmationisarequestforaresponsefromtheindependentpartyonlyif
theinformationisdisputed.Negativeconfirmationsshouldalsobesentonly
iftherecipientcanbeexpectedtodetecterrorandreplyaccordingly.

9.22

Theresponserateforpositiveconfirmationsistheproportionofthenumber
ofconfirmationsreturned(totheauditor)tothenumbermailed.The
detectionrateistheproportionofexceptionsreportedtotheauditorsto
thenumberofaccounterrorsintentionallymadeinthestatementsmailedto
customers(inresearchstudiesregardingconfirmations).

9.23

Responseratecanbeincreasedby:
1.
2.
3.
4.

Sendingapostcardinadvance,notifyingthecustomeraconfirmationis
coming.
Sendingconfirmationsbyspecialdeliverymail.
Usingafirstclasspostagestampratherthanmeteredmailpostage.
Markingtheenvelope"ConfirmationEnclosed:PleaseExamineCarefully."

9.24

Justificationsforthedecisionnottouseconfirmationsfortradeaccounts
receivableinaparticularauditinclude:(1)receivablesarenotmaterial,
(2)confirmationswouldbeineffective,basedonprioryears'experienceor
knowledgethatresponsescouldbeunreliable,and(3)analyticalprocedures
andothersubstantivetestofdetailsproceduresprovidesufficient,
competentevidence.

9.25

Specialcareinexaminingsourcesofaccountsreceivableconfirmation
responses:
Auditorsneedtocontroltheconfirmations,includingtheaddressestowhich
theyaresent.Experienceisfullofcaseswhereconfirmationsweremailedto
companyaccomplices,whoprovidedfalseresponses.Theauditorsshould
carefullyconsiderfeaturesofthereplysuchaspostmarks,FAXandtelegraph
responses,letterhead,electronicmail,telephone,orothercharacteristics
thatmaygivecluestoindicatefalseresponses.Auditorsshouldfollowup
electronicandtelephoneresponsestodeterminetheirorigin(forexample,
returningthetelephonecalltoaknownnumber,lookinguptelephonenumbers
todetermineaddresses,orusingacrisscrossdirectorytodeterminethe
locationofarespondent).

9.26

Thecutoffbankstatementisabankstatementsentbythebankdirectlyto
theauditor,anditisusuallyforafifteenortwentydayperiodfollowing
thereconciliationdate.Thebasicuseofthestatementbytheauditoristo
determinewhetheroutstandingcheckswereactuallymailedbeforethe
reconciliationdateandoutstandingdepositsintransitwereactually
receivedinatimelymannerbythebank.

9.27

Theterm"lapping"referstoanemployee'sstealingthecashreceiptsofa
companyandthencoveringtheamountwithafollowingday'spaymentreceived
foranothercustomer'saccount.A"lapping"operationispossiblewhena
singleemployeehasaccesstobothcashandaccountsreceivablerecords.

206
Theauditorisalertedtothepossibilityofa"lapping"operationwhenthere
isnotaproperseparationofduties.Surpriseconfirmationistheprimary
meanswhichanauditorcanusetouncoversuchactivity.Also,detailsof
depositslipsandcashremittancereportscanbecomparedtodetect
discrepancies.
9.28

Chequekitingisthepracticeofbuildingupapparentbalancesinoneormore
bankaccountsbasedonuncollected(float)chequesdrawnagainstsimilar
accountsinotherbanks.Kitinginvolvesdepositingmoneyfromonebank
accounttoanother,usingahotcheque.Kitingisthedeliberatefloatingof
fundsbetweentwoormorebankaccounts.Bythismethod,abankcustomer
utilizesthetimerequiredforcheckstocleartoobtainanunauthorizedloan
withoutanyinterestcharge.
Auditorscandetectsignsofkitingbyobservinginthebankstatements:
#
#
#
#
#
#
#
#
#
#
#
#

Frequentdepositsandchequesinsameamounts
Frequentdepositsandchequesinroundamounts
Frequentdepositswithchequesswrittenonthesame(other)banks
Shorttimelagbetweendepositsandwithdrawals
FrequentATMaccountbalanceinquiries
ManylargedepositsmadeonThursdayorFridaytotakeadvantageofthe
weekend
Largeperiodicbalancesinindividualaccountswithnoapparentbusiness
explanation
Lowaveragebalancecomparedtohighlevelofdeposits
Manychequesmadepayabletootherbanks
Bankwillingnesstopayagainstuncollectedfunds
"Cash"withdrawalswithdepositchequesdrawnonanotherbank
Chequesdrawnonforeignbankswithlaxbankinglawsandregulations

Ifthesecashtransfersarerecordedinthebooks,acompanywillshowthe
negativebalancesthatresultfromchequesdrawnoninsufficientfunds.
However,perpetratorsmaytrytohidethekitingbynotrecordingthe
depositsandcheques.Suchmaneuversmaybedetectableinabank
reconciliationaudit.
Ascheduleofinterbanktransferscanbeconstructedfromthecanceledchecks
andcleareddepositsinthebankstatements.Thisscheduleshowseachcheck
amount,thenameofthepayingbank(withthebookrecordingdateandthe
chequeclearingdate),thenameofthereceivingbank(withthebookdeposit
dateandthebankclearingdate).Thepurposeofthisscheduleistoseethat
bothsidesofthetransfertransactionarerecordedinthesameperiod(and
intheproperperiod).
SOLUTIONSFORKINGSTONCASEPROBLEMS
9.29

ICQItems:ObjectivesandErrorsfromControlWeaknesses
Question

PossibleErrororIrregularity

1
2

Cashcouldbewithheldandrevenueandexpensebothunderstated
Cashcanberemovedfromthedeposit,andthecashierand
accountsreceivablebookkeepercouldhidethetheftby
manipulatingtheaccounts.

207
3
4
5
6
7
8
9
10
11
12
13
14

15
9.30

Thecashiercanstealmoneyincustodyandcouldmanipulate
recordstohidethetheft.
Thecashiercanstealmoneyand,withaccesstotherecords,
couldmanipulatethemtohidethetheft.
Ifthereconciliationisdonebysomeonewithaccesstocashor
otherrecords,thereconciliationcouldbemanipulatedtohide
theftsorerrorsintheaccounts.
Erroneousentriescouldbemadeiftheamountsarenotcompared
anddifferencescorrected.
Failuretomakealistearlygivesupthechancetocapturea
controltotalforlatercomparisontoaccountingentries,and
mathmistakesandtheftscouldgoundetected.
Failuretousemachinetotals(cashregistersandpointofsale
computers)givesupthechancetouseacontroltotalasin#7.
Failuretouseandcheckprenumbereddocumentsletsdocumentsget
lost,notrecorded,andtheincompletenessgoundetected.
Failuretoapprovediscountsmaypermitdishonestemployeesto
accountfordiscountsandstealthemoney.
Theduplicatedepositretainedbyacontrolperson(internal
auditor)canbeusedtocomparetoaccountentries.Withoutit,
erroneousentriescannotbedetected.
Failuretocomparetheremittancelisttothedepositgivesup
thechancetodetecttheftsfromthemoneyreceived(the
remittancelistbeingacontroltotalasin#7).
Noaccountingmanualinstructionsforclassifyingcashentries
contributestoemployee'sclassificationmistakesand
inconsistencies.
Iftheaccountsreceivablesubsidiaryandcontroldonotbalance,
someentriesarenotthesameinboth,andfailuretomakethe
comparisongivesupthechancetodetectfailuretopostall
entries.
Failuretodatecashentriesthesamedateasthereceiptgives
upcontroloverpropercutoffofcashentries.

InternalControlQuestionnaireSalesTransactionProcessing
ObjectivesandQuestions
Environment:
1.
Isthecreditdepartmentindependentof
thesalesdepartment?
2.
Aresalesofthefollowingtypes
controlledbythesameprocedures
describedbelow?Salestoemployees,
CODsales,disposalsofproperty,cash
sales,andscrapsales.
ValidityObjective:
3.
Isaccesstosalesinvoiceblanks
restricted?
4.
Areprenumberedbillsofladingorother
shippingdocumentspreparedor
completedintheshippingdepartment?
CompletenessObjective:
5.
Aresalesinvoiceblanksprenumbered?

Yes,No,N/A
Comments
Yes.Creditmanagerin
Treasurer'soffice
Noavailableinformation

Yes.Keptinlockedcloset
Yes.Shippingdepartment

Yes

208
6.
7.

Isthesequencecheckedformissing
invoices?
Istheshippingdocumentnumerical
sequencecheckedformissingbillsof
ladingnumbers?

AuthorizationObjective:
8.
Areallcreditsalesapprovedbythe
creditdepartmentpriortoshipment?
9.
Aresalespricesandtermsbasedon
approvedstandards?
10. Arereturnedsalescreditsandother
creditssupportedbydocumentationas
toreceipt,condition,andquantity
andapprovedbyaresponsibleofficer?
AccuracyObjective:
11. Areshippedquantitiescomparedto
invoicequantities?
12. Aresalesinvoicescheckedforerrorin
quantities,prices,extensionsand
footing,andfreightallowances,and
checkedwithcustomers'orders?
13. Isthereanoverallcheckforerrorsin
arithmeticaccuracyofperiodsales
databyastatisticalorproductline
analysis?
14. Areperiodicsalesdatareported
directlytogeneralledgeraccounting
independentofaccountsreceivable
accounting?
ClassificationObjective:
15. Doestheaccountingmanualcontain
instructionforclassifyingsales?
AccountingObjective:
16. Aresummaryjournalentriesapproved
beforeposting?
ProperPeriodObjective:
17. Doestheaccountingmanualcontain
instructionstodatesalesinvoiceson
theshipmentdate?

9.31

Yes.Accountsreceivable
clerk
Noavailableinformation

Yes.Creditmanagerfile
Yes.Approvedpricefile
Noavailableinformation

Yes.Shippingdepartment
clerk
Yes.Accountsreceivable
clerk
Yes.Marketingvice
president
No

Yes.Lumberandhardware
analysis
Yes.Generalledger
supervisor(procedure
manual)
Yes.Generalledger
supervisor(procedure
manual)

BridgeWorkingPaperforCashReceipts
Preparedby__________
Date_________________
KINGSTONCOMPANY
Bridge:CashReceiptsControl
December31,2002

209

9.32

Strength/Weakness

AuditImplication

AuditProgram

S: Monthlybank
reconciliation

Errorsdetected
byclient

Reviewthebankreconciliations
(Thiscomplianceprocedurewill
indirectlyaudittheclient
comparisonofcashentriesand
depositslips)

W: Noremitlist
ormachine
control

Cashrecordsmay
beincomplete

ConfirmlargersampleofA/Rfor
evidenceofbalancespaidby
customersbutnotsoreflectedby
accounts.

S: Cashdiscounts
approved

Accuratecalcof
amounts

SelectsampleofA/R,vouch
discountapprovaltosignature

S: Acctmanual
directscash
creditclassif

Propercredit
classification

Scanjournalstoseewhetherall
cashentriesincludecredittoA/R

S: Reconcilessub
tocontrolA/R

Postingerrors
detected

Reviewfileofreconciliation
work,followupcorrections

S: Acctmanual
directscash
entrydating

Properdateson
cashentries

Selectsampleofcashreceiptsand
traceentrydatestoA/R,and
depositdatestobankdepositslip

MatchingICQQuestionstoTestofControlsAuditProgram
ICQ(Appendix9A3)
1
separationofduties
2
cashierseparation
3
collectionseparation
4
writtenoffA/R
5
separationofduties
6
NA
7
NA
8
monthlyA/Rmailing
9
internalconfirms
10 customercomplaints
11 returnedgoods
12 CMsprenumbered
13 creditapproval
14 writeoffs,etcapproval
15 NA
16 NA
17 NA
18 A/Rreconciliation

9.33

Procedures(Ex96)
A4,B3observepeoples'duties
B3observecashierwork
(nothingtotestbecauseofweakness)
reviewthememoledger
B4observepeopleatwork
C5observemonthlyA/Rmailing
(nothingtotestbecauseofweakness)
A4observewhohandlescomplaints
C3vouchreturnstoreceivingreports
(nothingtotestbecauseofweakness)
A3dvouchcreditapproval
C3areviewforproperapproval

(notinprogram)Reviewsubsidiarycontrol
accountreconciliationworkingpapers
preparedbyclient

AccountsReceivableConfirmation
a.

Therearetwoformsofaccountsreceivableconfirmationrequests:the
"positive"formandthe"negative"form.

210
Apositiveformasksthedebtortorespondwhetherornotthedebtoris
inagreementwiththeinformationontheconfirmationrequest.A
negativeformasksthedebtortorespondonlyifthedebtordisagrees
withtheinformationontheconfirmationrequest.Thepositiveform
generallyrequiresfollowupbytheauditorintheformofpracticable
alternativeproceduresthatareusedtoobtainnecessaryevidenceifa
replyisnotreceived.
Theuseofthepositiveformispreferablewhenindividualaccount
balancesarerelativelylarge,whenthereisreasontobelievethat
theremaybeasubstantialnumberofaccountsindispute,orwith
inaccuraciesorirregularities.
Thenegativeformisusefulwheninternalcontrolsurroundingaccounts
receivableisconsideredtobeeffective,andalargenumberofsmall
balancesisinvolved,andtheauditorhasnoreasontobelievethat
personsreceivingtherequestsareunlikelytogivethemconsideration.
b.

Theitemsthatcomprisethebalance(recentsalesdebitsandcash
receiptscredits)canbevouchedtosupportinginternaldocumentary
evidencesalesinvoicesandbillsofladingandcashentriesand
depositslips.Thisworkis"extendedprocedures"todetermine
internallytheinformationthecustomersdidnotprovideexternally.An
auditorcanalsovouchpaymentsreceivedinthesubsequentperiodas
evidencetovalidatetheexistenceofthereceivablebalance.

SOLUTIONSFORMULTIPLECHOICEQUESTIONS
9.34

c.

Nobodyinthecompanyhasaccesstocash,thereforeitcannotbestolen.

9.35

a.

Improprietyofwriteoffscanbecontrolledbythereviewandapproval
bysomeoneoutsidethecreditdepartment.

9.36

b.

Lesssalesrevenueandcorrectamountofcostofgoodssoldresultsin
lessgrossprofit,thereforetheratioofgrossprofittosaleswill
decrease.(Actually,thegrossprofitnumeratorwilldecreaseata
greaterratethanthesalesdenominatorintheratio,causingtheratio
todecrease.)

9.37

d.

Thedirectionofthetestestablishessupportforrecordedamounts.

9.38

d.

Abookkeepercouldstealmoneyand"writeoff"tounsuspecting
customer'sbalancewithafictitious"salesreturn."

9.39

c.

Thecashierwouldhavebothcustodyofcashandrecordkeeping
responsibility,hencecouldstealmoneyandfixtherecordswithout
interferencebyanyoneelse.

9.40

c.

Theageofaccountsisanindicationofcreditlosses.

9.41

b.

Falsesalesjournalentriesmadeneartheendoftheyearmayhave
shippingorotherdocumentsthatreveallaterdatesorshowlackof
sufficientdocumentation.

9.42

c.

Accountsreceivableconfirmationenablesrecipientstorespondthatthey
owethecompanyorthattheydisputeordisagreewiththeamountthe

211
companysaystheyowe.Aresponsewithoutexception,however,doesnot
necessarilymeanthatthedebtorwillactuallypaytheamount.
9.43

c.

Kitinginvolvesamismatchingofdatesofrecordingaroundyearend,and
thescheduleofbanktransfersisdesignedtoshowalltherelevant
datessotheauditorcanseethattheentriesareintheproperperiods.

9.44

c.

Correct.

Checkingthesequenceformissingnumbersidentifies
documentsnotyetfullyprocessedintherevenuecycle.

9.45

a.

Correct.

Theaccountsreceivabledebitsaresupposedtorepresent
salesthathavebeenorderedbycustomersandactually
shippedtothem.

9.46

b.

Correct.

d.
9.47

c.

9.48

9.49

Theexistenceassertionisveryimportantbecausethe
companyassertsthecashandaccountsreceivabletoexist.
Presentationanddisclosureassertionissecondbestchoiceamongthe
onesofferedinthequestion.
Correctmainlybecausetheotherthreechoicesarelistedasappropriate
worktodo.Also,automaticsendingof100%negativeconfirmations
ignoresthejudgmentindecidingthenature,timing,andextentofthe
workneeded.

a.
b.
c.
d.

Assessedlevel
ofcontrolrisk
relatingto
receivablesis
Low
Low
High
High

a.

Correct.

b.

Incorrect.

c.

Incorrect.

d.

Incorrect.

Numberof
small
balancesis
Many
Few
Few
Many

Proper
consideration
bythe
recipientis
Likely
Unlikely
Likely
Likely

Correct
Incorrect
Incorrect
Incorrect

Shipmentsaretracedtocustomerswereinvoiced.(Thisdoes
notimplythattheinvoiceswererecordedinthesales
journal.)
See(a)above.Theinvoicecopiesneedtobetracedtothe
salesjournalandgeneralledgertodeterminewhetherthe
shipmentswererecorded,andtheproceduredoesnotgothis
far.Shipmentstocustomerswererecordedassales.
Recordedsaleswereshippedisnotestablishedbecausethe
sampleselectionisfromshipments,notfromrecordedsales.
Invoicedsaleswereshipped(see(c)above).

SOLUTIONSFOREXERCISESANDPROBLEMS
9.50

CashReceiptsControlObjectivesandExamples
General
Validity

Specific
1.
Iftheremittanceadviceisnotreturned,theperson
openingthemailshouldprepareonesothateachcheck
receivedisrepresentedbyaremittanceadvice.

Complete

2.

Allcashreceiptsshouldbelistedfromremittance
advices.
Depositspreparedbyapersonseparatefromtheonewho
opensthemail.

212
Subsidiarycustomeraccountspostedfromremittance
advices.
Generalledgercontrolaccountpostedfromcashreceipts
journal.

Bankstatementreconciledindependentofotherfunctions.
Controlaccountreconciledtosubsidiaryledgermonthly.

9.51

Author

3.

(Authorizationisusuallynotaproblemforcashreceipts
onaccountsreceivable.)Cashreceiptsfromotherthan
merchandisesalesauthorizedonuniqueremittanceadvice
forms.

Accuracy

4.

Dailyremittancelistcomparedtoduplicatedepositslip
receivedfrombankbypersonindependentofeither
function.

Classif

5.

Cashreceiptsenteredproperlyincashreceiptsjournal
astotheoriginofthereceipts.Separatedepositsmade
fornonmerchandisesalescashreceipts.

Acctg

6.

Monthlyreconciliationofcontrolaccounttocustomers'
individualaccountsandbankstatementreconciled
promptly.

Properperiod

7.

Dailydepositofallcashreceipts.Cashreceipts
recordedasperiodofdateofreceipt.Accountspostedas
ofdatecashreceived.
UniversityBooks,Incorporated
REVOLVINGCASHFUND
INTERNALCONTROLQUESTIONNAIRE

Question

Yes

Isresponsibilityforthefundvestedinoneperson?
Isphysicalaccesstothefunddeniedtoallothers?
Isthecustodianindependentofotheremployeeswho
handlecash?
Isthecustodianbonded?
Isthecustodiandeniedaccesstoothercashfunds?
Arereceiptsunalterable?
Arereceiptsprenumbered?
Istheintegrityoftheprenumberedsequence
periodicallyaccountedfor?
Doesthesellersignreceipts?
Arereceiptsattachedtoreimbursementvouchers?
Arevouchersthataresubmittedforreimbursement
approvedbysomeoneotherthanthecustodian?
Arereimbursementvouchersandattachments(receipts)
cancelledafterreimbursement?
Isthefundusedexclusivelyfortheacquisitionof
books?
Isthefundperiodicallycountedandreconciledby
someoneotherthanthecustodian?
Isthefundmaintainedonanimprestbasis?
Question
Yes

No

No

Isthesizeofthefundappropriateforthepurpose
intended?
9.52

OtherAuditProcedures

ReasonforOtherAuditProcedures

1. Sourceofdebitentriesin
generalledgercashaccount,
otherthanfromcashreceipts
journal,shouldbeinvestigated
andsupportingdocuments
examined.

1. Sincetheauditor,usingstandard
procedures,onlyexaminedthe
cashreceiptsjournal,hemust
investigatethevalidityofall
othersourcesofcashreceipts
whicharenotrecordedinthese
journals.

2. Asurpriseexaminationofcash
receiptsshouldbeperformed.
Priortotheaccountsreceivable
clerkobtainingthecash
receipts,theauditorshould
makealistofthemwithoutthe
clerk'sknowledge.The
undepositedmailreceiptsshould
thenbecontrolledafter
completionoftheirpreparation
fordepositandpostingshave
beenmadetothesubsidiary
accountsreceivableledger.The
depositslipshouldbecompared
totheremittancesforaccuracy
andtotaled.Individualitemson
thedepositslipshouldbe
comparedtopostingstothe
subsidiaryaccountsreceivable
ledger.Theauditorshouldthen
supervisethemailingofthe
deposittothebank.Theauditor
shouldaskGutzlertoaskthe
banktosendthestatement
containingthisdepositdirectly
totheauditor.

2. Sincetherearenoinitial
controlsovercashreceipts
establishedpriortothetimethe
accountsreceivableclerkobtains
thecash,asurpriseexamination
istheonlymethodofdetermining
ifcashreceiptsarebeing
recordedanddepositedproperly.

3. Postingsfromthedepositslips
shouldbetracedtothe
subsidiaryaccountsreceivable
ledger.Also,entriesinthe
subsidiaryaccountsledger
shouldbetracedtodeposit
slip.

3. Sincethereisnoseparationof
dutiesbetweencashreceiptsand
accountsreceivable,theaccounts
receivableclerkmayhavebeen
carelessinperformingher
postingduties.Thisprocedure
mayalsodisclosewhetherthe
accountsreceivableclerkmay
havebeenlappingtheaccounts.

4. Reviewthesubsidiaryaccounts
receivableledgerandconfirm
accountsthathaveabnormal
transactionactivitysuchas
consistentlylatepayments.

4. SeeNo.3above.

5. IfGutzlerallowscustomersto
takediscounts,theamountof
suchdiscountsandthediscount
periodshouldbechecked.

5. Sincethereisnoseparationof
dutiesbetweencashreceiptsand
accountsreceivable,theaccount
receivableclerkmayhave
appropriateddiscountswhich
couldhavebeenbutwerenot
takenormayhavebeencareless
incheckingtheappropriateness
ofdiscountstaken.

6. Datesandamountsofdaily
depositsperbank
statementshouldbecompared
withentriesinthecash
receiptsjournal.

6. Sincetherearenoinitial
controlsovercashreceipts
establishedpriortothetimethe
accountsreceivableclerkobtains
thecash,shemayhavebecome
carelessaboutpromptdepositof
thedailyreceipts.

7. Aproofofcashworkingpaper
shouldbepreparedwhich
reconcilestotalcashreceipts
withcreditsperbankstatement.

7. Sinceinternalcontrolovercash
receiptsisweak,theauditor
shouldperformthisoverallcheck
tohelpsubstantiatethathehas
investigatedallmaterialitems
duringhisdetailtests.

8. Forthoseperiodsforwhichthe
aboveauditprocedureswerenot
performedandforaperiodafter
thebalancesheetdate,scanthe
cashreceiptsjournalandbank
statementsforunusualitems.

8. Sinceinternalcontrolovercash
receiptsisweak,theauditor
shouldperformthisreviewto
helpsubstantiatethathehas
investigatedallmaterialitems
notcoveredduringhisother
tests.

9.53

Memorandum
TO:
FROM:
DATE:
SUBJECT:

BoardofDirectors,ThePottstownArtLeague
(Student'sname)
ControlweaknessesrelatedtoCashAdmissionFees

Yourequestedareportwhichidentifiestheweaknessesintheexistingsystem
ofcashadmissionfeesandmyrecommendations.Belowaretheweaknessesthat
existandmyrecommendationsforproceduresthatovercometheseweaknesses.I
willbepleasedtodiscusstheseatthenextboardmeetingandofferfurther
explanationsthatmaybenecessary.
Weakness:Thereisnosegregationofdutiesbetweenpersonsresponsiblefor
collectingadmissionfeesandpersonsresponsibleforauthorizingadmission.
Recommendation:Oneclerk(hereafterreferredtoasthecollectionclerk)
shouldcollectadmissionfeesandissueprenumberedtickets.Theotherclerk
(hereafterreferredtoastheadmissionclerk)shouldauthorizeadmission
uponreceiptoftheticketorproofofmembership.
Weakness:Anindependentcountofpayingpatronsisnotmade.
Recommendation:Theadmissionclerkshouldretainaportionofthe
prenumberedadmissionticket(admissionticketstub).
Weakness:Thereisnoproofofaccuracyofamountscollectedbytheclerks.
Recommendation:Admissionticketstubsshouldbereconciledwithcash
collectedbythetreasurerdaily.
Weakness:Cashreceiptsrecordsarenotpromptlyprepared.
Recommendation:Thecashcollectionsshouldberecordedbythecollection
clerkdailyonapermanentrecordthatwillserveasthefirstrecordof
accountability.
Weakness:Cashreceiptsarenotpromptlydeposited.Cashshouldnotbeleft
undepositedforaweek.
Recommendation:Cashshouldbedepositedatleastonceeachday.
Weakness:Thereisnoproofofaccuracyofamountsdeposited.
Recommendation:Authenticateddepositslipsshouldbecomparedwithdaily
cashcollectionrecords.Discrepanciesshouldbepromptlyinvestigatedand
resolved.Inaddition,thetreasurershouldestablishapolicythatincludes
ananalyticalreviewofcashcollections.
Weakness:Thereisnorecordoftheinternalaccountabilityofcash.
Recommendation:Thetreasurershouldissueasignedreceiptofallproceeds
receivedfromthecollectionclerk.Thesereceiptsshouldbemaintainedand
shouldbeperiodicallycheckedagainstcashcollectionanddepositrecords.
9.54

ControlWeakness:Computer
Weaknesses

Recommendations

Lackofsegregationofduties

Computeroperations,programchanges,and
maintenanceoflogsshouldbeperformed
bydifferentpeople.

Nolibrarianfunction

Custodyandcontroloverdatabasesand
systemdocumentationshouldbeundera

Deficientrestrictedaccess

librarianfunctionandnotrotated.
Programmersshouldnothavefreeaccess
tothecomputerroom(equipment).

Deficientdocumentation

Needdocumentationofflowcharts,program
changes,systemssoftware,testing.

Lackofcontroltotals

Errorcheckingvalidationsneedcontrol
totalsforeffectiveoperation.

Nocomputerpricelist

Formanualentryprocess,clerkshould
notneedtoenterthesalesprice.It
shouldbeinadatabase.

Numericalsequence

Thecomputershouldbeusedtocheck
numericalsequence.

Controltotal

Thebillingclerk'scontroltotalof
salesshouldbeusedtocomparetototal
salesprocessedbythecomputer.

Customeraccounts

Thecomputersystemshouldbeprogrammed
tomaintaincustomeraccountsinsteadof
usingamanualopeninvoicefile.

b.

Shippingclerkscouldenterthedate,customeridentification,shipment
quantities,andproductidentificationnumbersinaterminal.Thenthe
computersystemcouldautomaticallyproduceasalesinvoice.Controls
include:
Autoclockdatechecking
Selfcheckingcustomeridentificationnumbers
Selfcheckingproductidentificationnumbers
TerminalbatchhashtotalofcustomerIDnumbers
Automaticnumberingofsalesinvoices
Authorizedpricelistindatabase
ControltotalcomparisonofhashIDnumbersinruntoruntotals

9.55

BankReconciliation
CASH
Basicauditproceduresthatshouldbeperformedingatheringevidencein
supportofeachoftheitems(a)through(f)oftheCYNTHIACOMPANYbank
reconciliationareasfollows:
(a)
*

Balanceperbank
Confirmationbydirectwrittencommunicationwithbank(seeStandard
BankConfirmation).
ObtainandinspectaJanuarycutoffbankstatementobtaineddirectly
fromthebank(examineopeningbalance).

(b)Depositintransit
*
VerifythatthedepositwaslistedintheJanuarycutoffbankstatement
onatimelybasis.
*
Tracetothecashreceiptsjournal.
*
Inspecttheclient'scopyofthedepositslipforthedateofthe
deposit.

(c)Outstandingchecks
*
ExaminechecksaccompanyingtheJanuarycutoffbankstatementandtrace
all1999,orprior,checkstotheoutstandingchecklist.
*
Traceoutstandingcheckstothecashdisbursementsjournal.
*
Examineallsupportingdocumentsforthoseoutstandingchecksthatwere
notreturnedwiththecutoffbankstatement.
*
Ascertainwhychecknumber837hasbeenoutstandingforsolong.
(d)NSFcheckreturn
*
FollowupontheultimatedispositionoftheNSFcheck.
*
Examineallsupportingdocuments.
(e)Notecollected
*
Examinethebankcreditmemo.
*
Tracetoaccountingrecords.
(f)Balanceperbooks
*
Footthebankreconciliationtothistotalandcomparewiththegeneral
ledgerbalance.
9.56

a.

ThePA'stestofthesalescutoffatJune30shouldincludethe
followingsteps:
1.
2.
3.
4.
5.
6.

b.

1.

2.

DeterminewhatHouston'scutoffpolicyis,reviewthepolicyfor
reasonableness,andcompareittotheprioryearforconsistency.
Selectasampleofsalesinvoices(includingthelastserial
invoicenumber)fromthoserecordedinthelastfewdaysofJune
andthefirstfewdaysofJuly.
Tracethesesalesinvoicestoshippingdocumentsanddeterminethat
saleshavebeenrecordedintheproperperiodinaccordancewith
companycutoffpolicy.
Determinethatthecostofgoodssoldhasbeenrecordedinthe
periodofsale.
Selectasampleofshippingdocumentsforthesameperiodandtrace
thesetothesalesinvoice.Determinethatthesaleandthecostof
goodssoldhavebeenrecordedintheproperperiod.
Reviewthecutoffforsalesreturnsandallowances,determinethat
ithasbeenbaseduponaconsistentpolicyandthattherehavenot
beenabnormalsalesreturnsandallowancesinJuly;thismight
indicateeitheranoverstatementofsalesduringtheauditperiod
ortheneedforavaluationaccountatJune30toprovidefor
futurereturnsandallowances.
ThePAwillusetheJuly10cutoffbankstatementinhisreviewof
theJune30bankreconciliationtodeterminewhether:
(a) Theopeningbalanceonthecutoffbankstatementagreeswith
the"balanceperbank"ontheJune30reconciliation.
(b) TheJune30bankreconciliationincludesthosecancelledchecks
thatwerereturnedwiththecutoffbankstatementandaredated
orbearbankendorsementspriortoJuly1.
(c) Depositsintransitclearedwithinareasonabletime.
(d) Interbanktransfershavebeenconsideredproperlyin
determiningtheJune30adjustedbankbalance.
(e) OtherreconcilingitemswhichhadnotclearedthebankatJune
30(suchasbankerrors)clearduringthecutoffperiod.
ThePAmayobtainotherauditinformationby:
(a) Investigatingunusualentriesonthecutoffbankstatement.
(b) Examiningcancelledchecks,particularlynotingunusualpayees

(c)
9.57

a.

orendorsements.
Reviewingotherdocumentationsupportingthecutoffbank
statement.

Cashbalance,perbooksNovember30
Add:Creditbybank
Adjustedcashbalance(onhandand
inbank)
Lessadjustedbankbalance:
Bankbalance,November30
Lessoutstandingchecks,
6500
$116.25
7126
150.00
7815
253.25
8621
190.71
8623
206.80
8632
145.28

$18,901.62
100.00
$19,001.62
$15,550.00

1,062.29

14,487.71

Cashwhichshouldbeonhandfordeposit
Cashdepositreported

$4,513.91
3,794.41

Amountoftheft

$719.50

Theminimumamountofthetheftis$719.50ifthecashreportedas
"undepositedreceipts"($3,794.41)wasactuallyonhand,represented
Novemberreceipts,andwasdepositedintactinDecember.Ifthe
$3,794.41wasnotavailabletodepositorrepresentedDecemberreceipts,
themaximumlosscouldbe$4,513.91(719.50+3,794.41)forNovember.
Suchashortage(minimumormaximum)forNovemberandtheattemptto
concealtheshortagewouldalerttheauditorstoexaminethebank
reconciliationsthroughouttheyearforotherconcealedshortages.
b.

Heattemptedtoconcealhistheftby:
1.
Notlistingalloutstandingchecks.
2.
Miscalculatingtheoutstandingchecksshownonthereconciliation.
3.
Subtractinganitemfromthebankbalancethatshouldbeaddedto
bookbalance.

c.

1.
2.

d.

9.58

Nooneotherthanthecashierisresponsiblefortracingcash
receiptstothedepositsinthebank.
Thecashierisalsoresponsibleforpreparingthebank
reconciliation.

ThefollowingauditingproceduresonDecember5woulduncoverthetheft
iftheOctober31reconciliationisknowntobecorrect:
1.
ComparechecksreturnedsinceOctober31withchecksoutstandingat
thattimeandwithcheckregisterforNovemberinorderto
ascertainoutstandingchecks.
2.
TracecashonhandatOctober31aswellasreceiptsduring
Novembertodepositsinbank,ascertainingundepositedcashat
November30.
3.
CountcashonhandonDecember5,andbyaddingdepositssince
November30andsubtractingreceiptssinceNovember30todevelop
cashonhandatNovember30.
4.
Compareadjustedcashonhanddevelopedincount(Step3)with
undepositedcashascertainedintracing(Step2).

Auditingproceduresotherthanconfirmationwhichmaybeusedtoverifyan

accountreceivableinclude:
1.

Examinationofevidenceofsubsequentpaymentoftheaccountincluding:
a.
Thecustomer'sremittanceadviceaccompaniedbythepayment.
b.
Thechecksentinbythecustomer.
c.
Anauthenticatedbankdepositticketlistingadepositedcheckfor
theoutstandingaccount.
d.
Anentryinthecashreceiptsbook.
e.
Acreditpostedtothecustomer'saccount.

2.

Examinationofotherevidenceincluding:
a.
Shippingdepartment'snoticeofshipment,accompaniedpossiblybya
receiptedcopyofthebilloflading,thecustomer'spurchase
order,salesinvoices,andanycorrespondencereferringtothe
shipmentofthegoods.
b.
Entriesremovingthegoodsfrominventory.
c.
Timerecordsandworkorders,ifappropriate.

3.

Externalinquiriesastotheexistenceandcreditratingofthedebtor.

4.

Discussionoftheaccountwiththeclient'screditmanager,examination
ofcreditdepartmentrecords,andrecordsofmerchandisereturned,and
suchotherinvestigationasmayleadtobetterunderstandingofthe
natureoftheaccountanditscollectibility.

Theauditormightalsoconsiderfurtherdiscussionorcorrespondencewiththe
debtortodeterminewhetheralternativemethodsmightbeusedtoconfirmthe
account(e.g.,byfurnishingthedebtormoredetailconcerningtheinvoices
inthebalance.
9.59

Theprocedurefollowedappearstobeappropriateexceptthattheexamination
ofdetailtransactionsforthreemonthsmightbeconsideredtobeexcessive
inviewoftheexceptionallygoodinternalcontrol.Alightertestofsuch
transactions,designedtotesttheeffectivenessofthecontrolprocedures,
mightbedevised.
Theproceduresfollowedshouldbesupplementedbythefollowing:
1.

2.
3.

4.
5.
9.60

Reviewthecompany'smethodofsalescutoffatyearendandtest
billingsandshipments(includingreturns)foranadequateperiodbefore
andafteryearendtoestablishthatcutoffprocedureshavebeen
adheredto.
Examinecollectionsinearlypartofsubsequentperiodtodetermineifa
substantialportionofthereceivableshasbeencollected.
Examineagreementsenteredintowiththedistributors.Ifprice
protectionclausesareincluded,reviewthecurrentpricepositionand
distributorinventorypositionstodeterminewhetherareserveforsuch
protectionisneeded.
Whenacompanydealswithalimitednumberofcustomers,itisdependent
uponthecontinuedsolvencyofallsuchcustomers.
Obtainarepresentationletterfromappropriatecompanyofficials
coveringthereceivables.

ToauditthescheduleofRentReconciliationpreparedbythecontrollerof
CLAYTONREALTYCORPORATION,youwouldperformthefollowingproceduresfor
thoseitemsmarkedbyanasterisk:
Tosubstantiatethevalidityofgrossapartmentrents,youwould

Physicallyexaminetherentalpropertyorreviewarchitectural
blueprintstoascertainthetotalnumberofrentalunits.
Comparethetotalnumberofvalidatedrentalunitswiththetotalnumber
ofrentchargesonthescheduleofgrossapartmentrents(ScheduleA).
Foroccupiedunits,vouchtheindividualapartmentrentalchargesper
leaseagreementstotheindividualrentalchargesonScheduleA.
Forunoccupied(vacant)units,ascertainthereasonablenessofthe
scheduledrent(byreferencetothelastrentpaid,byreferenceto
comparablerentchargesforsimilarunits,etc.).
Footthegrossapartmentrentschedule(ScheduleA)andcomparethe
totalwiththefigureindicatedontherentreconciliation.

Tosubstantiatethevalidityofthevacancies,youwould
*
Physicallyexaminetheapartmentsthatwerevacantduringthemonth.
*
Comparetherentalcharge(validatedinthegrossapartmentrents
proceduresabove)foreachvacantapartmentwiththescheduleof
vacancies(ScheduleB)
*
Footthescheduleofvacancies(ScheduleB)andcomparethetotalwith
thetotalindicatedontherentreconciliation.
TosubstantiatethevalidityofunpaidJanuaryrents,youwould
*
Traceunpaidrentsfromindividualtenantapartmentledgercardsto
ScheduleC.
*
Foottheunpaidrentsschedule(ScheduleC)andcomparethetotalwith
theamountshownontherentreconciliation.
*
Examinethecollectionfileforevidenceofcollectionattempts.
*
RequestwrittenconfirmationsfromtenantswithaccountsinJanuary
arrears.
Tosubstantiatethevalidityoftheprepaidrentcollected,youwould
*
Tracethereceipttotheindividualtenantapartmentledgercard.
*
Comparetheamountcollectedwiththeleaseterms.
Tosubstantiatethevalidityofthecashcollected,youwould
*
Foottheclientpreparedrentreconciliation.
*
Reconcilethecashreceiptspertherentreconciliationwiththebooks
andrecords.
*
Confirmandreconcilethespecialbankaccountbalance.
SOLUTIONSFORDISCUSSIONCASE
9.61
a) This question involves matching the type of audit procedure and type of evidence
it creates to a described audit activity, vouching subsequent receipts
b) Knowledge of accounting system components, such as the names of books and records
use to record cash receipts can be applied
9.62
a) The importance and reliability of the audit evidence obtained from confirming
zero balances needs to be considered against the cost of the procedure
b) Key risk is omitting to record sales, specific controls procedures to address
this risk can be described
9.63

The case presents a situation where the company management has incentives to meet
certain financial statement targets and this may motivate them to take actions or
make accounting choices that have an impact on their financial statements. The
auditor is looking for objective evidence to support the financial statement numbers
that management has prepared. Points that can be discussed include the following.
a) Rosella is applying a knowledge of the business operation to perform analysis
procedures. In particular, the knowledge of the business indicates certain operating
factors that determine what results are reasonable and attainable (maximums). She is
also trying to support the sales figure by analyzing monthly data trends, and making
comparisons to prior periods and to related amounts such as gross profit and
engineers travel expenses. These procedures can provide evidence about validity and
completeness of sales.
b) The findings suggest that the company has experienced a large increase in orders
and is attempting to meet these orders with its current production capacity.
Alternately, given the debt covenants and bonuses, management may be trying to push
sales out the door before they are finished so they can recognize revenue in the
current year to avoid missing key targets. This can distort gross profit since not
all costs have been incurred at the time of shipment, and since the costs are not a
usual part of production there may be no procedures in place to identify and accrue
for them. Various conclusions are possible depending on the interpretation of the
case facts, any assumptions made and how this is all analyzed.
c) With this recognition policy it is possible that the facts support revenue
recognition. It appears machines were loaded and titled transferred to customer
before year end. In any case, this can be verified with examination of relevant
documents and confirmation of customer receivables. The possibility of current
income being overstated still exists, but this may be due to a problem of
completeness of liabilities (i.e., warranty costs of getting the machines working
at the customers premises) rather than validity of sales. Other valid points can be
discussed.
9.64
This could occur if the companys record keeping is inadequate or it lacks internal
controls over cash.
9.65
The case requires one to consider risks in a stock brokerage business and evaluate
the appropriateness of negative confirmations as audit evidence. A possible approach
to the analysis is as follows.
a) The main inherent risk is failing to record a customer stock transaction
correctly, or omitting recording it. This would result in invalid or incomplete
information in the customers account. Given that marketable securities are
involved, there is also a fairly high risk of fraud by misappropriation of customer
funds or investments. Regulatory non-compliance is another consideration. Given the
types of inherent risks to be controlled, strong controls are required over
authorization/ownership, completeness and validity of customer trades and account
balances. There is also the risk that customers will provide incorrect information
and the need to keep records of customer telephone orders and instructions, issue
confirmations, and verify customer account details regularly. The external audit in
this situation can complement internal controls by providing a further check on
validity, completeness and authorization/ownership.

b) Negative confirmations are relatively inexpensive and a large percentage of the

customer population can be queried. While a weakness is the low response rate, and
the inability to know if non-responses would have indicated errors, they do get at
the key concern that customer assets have been misappropriated by the stock
brokerage firm since customers are more likely to respond when their accounts are
incomplete.
9.66

1.

SituationsencounteredintheauditofTrinityCompany'sfinancial
statementsthatmayindicateanattemptedconcealmentofdefalcation:
1.

UnderfootedSalesJournalTheJulysalesjournalwasunderfooted
by$4,500.Becausetheunderstatedmonthlytotalwaspostedasa
debittoAccountsReceivable,accountabilityforfuturereceivable
collectionswasalsounderstatedby$4,500.Thiscouldpermit
someonetointerceptcustomerremittanceswithoutanapparent
shortageresulting.

2.

FalseDebitPostingThefirstsituationdealtwiththetheftof
cashforwhichaccountabilityhadnotbeenestablished.The
establishmentofrecordedaccountability,however,willnot
necessarilypreventtheperpetrationandconcealmentofa
defalcation.
Forexample,apersonwithaccesstoacompany'ssupplyofblank
checksmaystealbyissuingachecktohimselforherself.
Concealingsuchatheftwouldalsorequireaccesstocertain
accountingrecords.Apersonwhopoststhegeneralledgercould
concealthetheftby:
*
reducingtherecordedaccountabilityforcashinthechecking
account.ThiscouldbeaccomplishedbypostingacredittoCash
thatdidnotcomefromanyprecedingrecord;
*
transferringtheresultingshortfalltoanexpenseaccount.
Situation2indicatesonewaythismightbedoneenteringan
unsupporteddebitpostinginanexpenseaccount.Later,to
completetheconcealment,itmightbenecessarytoremovethe
returnedcheckfromthenextbankstatementbeforethechecking
accountisreconciled.

3.

UncancelledSupportingDocumentsUncancelledsupportingdocuments
canberemovedfromavoucherandusedagainassupportfora
fraudulentvoucher.Thisfraudulentvouchercouldbeenteredintoa
company'spurchase/disbursementsystem,resultinginanimproper
disbursement.

4.

OmittedOutstandingCheckAmisappropriationofcashsimilarto
thatdescribedinSituation2mighthaveoccurred.Theresulting
cashshortagecouldbeconcealedbymanipulatingthebank
reconciliationatmonthend.Anunrecorded,improperlyissuedcheck
wouldreducethebankbalance,butwouldnotreducethebook
balance.soaproperlypreparedbankreconciliationwouldnot
reconcile,andthecashshortagewouldberevealed.
However,thepersonwhoreconcilesthebankstatementcouldconceal
theshortagebyunderstatingtheamountsubtractedforoutstanding
checks.forexample,acheckthatshouldhavebeenlistedas
outstandingmightbeomittedfromthelistasdescribedin
Situation4orthelistmightbeunderfooted.Alternatively,
concealmentcouldbeattemptedbyoverstatingdepositsintransit.

2.

a.

Thereisanimportantdistinctionbetweenthetypeofconcealment
discussedinSituation4andthosediscussedpreviously.The
concealmentinSituation4istemporarybecausetheperpetrator
mustrepeattheconcealmentateachsubsequentreconciliationdate.
Defalcationcanbepermanentlyconcealedbyreducing(crediting)
cashsothatitagreeswiththeshortageasadebittosomeincome
statementaccount.Theoffsettingdebittoanincomestatement
accountwillresultineitheranunderstatedrevenue(Situation1)
oranoverstatedexpense(Situation2and3).Suchconcealmentsare
"permanent"becausenofurtheractionbytheperpetratoris
required.

b.

Acarefulconsiderationofthewaysconcealmentsmightbeattempted
isanimportantfactorindeterminingappropriatedirectionsfor
substantivetestsofdetails.Forexample,whenauditingabank
reconciliation,auditorsshouldauditdepositsintransitfor
overstatementandoutstandingchecksforunderstatement.(Seealso
SAS39,AU350.)
Todetectpermanentconcealmentsofmaterialdefalcations,auditors
mightplantheirsubstantiveauditprocedurestoauditrevenuesfor
understatementandexpensesforoverstatement.Thesedirectionsare
oppositetothoseoftenassociatedwithauditingformanagement
inspireddistortionsoffinancialdata;suchdistortionshave
usuallyexaggeratedreportedprofitsbyoverstatingrevenuesor
understatingexpenses.

c.

Throughthefoursituationspresented,onecanseethatthe
perpetrationandconcealmentofadefalcationusuallyrequiresboth
accesstoanasset(forperpetration)andaccesstorelated
accountingrecords(forconcealment).Therefore,agoodinternal
controlsystemshouldbedesignedsothatoneemployeedoesnot
havebothtypesofaccess.
However,allcontrolsystemshaveinherentlimitationsthatprevent
auditorsfromplacingcompleterelianceonthem.Therefore,
auditorsshouldnotrelyexclusivelyongoodcontrolproceduresto
fulfilltheirresponsibilitytosearchformaterialdefalcations.
Somesubstantiveproceduresshouldbeperformed,althoughthe
extentofsuchsubstantiveproceduresmaybeappropriatelyreduced
wheneffectivecontrolproceduresarepresent(SAS39,AU350).

d.

Substantiveauditproceduresincludeanalyticalreviewprocedures
andtestsofdetails,whichcanbeappliedinanycombinationthe
auditorsdeemappropriate.Forthepurposeofdetectingmaterial
defalcations,analyticalreviewproceduresmaybeespecially
effectiveinsituationswheredefalcationshavebeencleverly
concealedthroughelaborateandcollusivefalsificationof
supportingdocuments.
However,itispossiblethatmaterialandrecurringdefalcations
involvingsimilaramountsmayhaveoccurredoveranextended
period.Becausethecontinuationofsuchdefalcationsmaynotcause
unusualfluctuations,analyticalreviewproceduresmaynotdetect
thedefalcations.Accordingly,auditorsshouldcarefullyweighthe
riskthatrecurringandmaterialdefalcationsmayhaveoccurred
whentheymakedecisionsabouttheappropriatemixofanalytical

reviewanddetailedprocedurestobeperformed.
9.67

InterbankTransfers
NotetoInstructors:Check#1799($10,000payabletoCitizenNationalBank)
drawnonthe1stNationalBankaccountwasnotrecordedinEverReady'scash
disbursementsjournal.Thisisthereasonitisnotinthescheduleof
interbanktransfersinExhibit9.621.Theauditorsobtainedtheinitial
informationfromthecashreceiptsandcashdisbursementsjournals,and#1799
wasnotinthem.
a.

CompletetheScheduleofInterbankTransfers(workingpaperC5)by
enteringthenewinformation.

EXHIBIT9.621
ScheduleofInterbankTransfers
C5

EVERREADYCORPORATION
SCHEDULEOFINTERBANKTRANSFERS
December31,2002

DisbursingAccount
Check
No.

Bank

2220
4050
1417
4051
2221
4052
1601
4053
1799
2222
4054
1982

Chase
Commerce
1stN.C.
Commerce
Chase
Commerce
1stN.C.
Commerce
N.C.
Chase
Commerce
N.C.

Amount
11,000
10,000
10,463
12,000
15,000
12,000
11,593
14,000
10,000
12,000
20,000
9,971

ReceivingAccount

Dateper Dateper
Books
Bank
28Dec
29Dec
24Dec 24Dec
31Dec
05Jan
05Jan
31Dec 31Dec
07Jan
08Jan
12Jan
13Jan
08Jan 08Jan

Prepared__________
Date__________
Reviewed__________
Date__________

Bank

Dateper Dateper
Books
Bank

Commerce
NorthCountry
NorthC.payroll
Chase
Commerce
NorthCounty
N.C.payroll
Chase
Commerce
Commerce
NorthCountry
N.C.payroll

22Dec
23Dec
24Dec 24Dec
28Dec
30Dec
30Dec
31Dec 31Dec
04Jan
05Jan
07Jan
08Jan
08Jan 08Jan

Tracedfromcashdisbursementsjournal.
Checkproperlylistedasoutstandingonbankreconciliation.
Vouchedtocheckclearedinbankstatement.
Tracedfromcashreceiptsjournal.
Voucheddepositclearedinbankstatement.
Note:Wescannedthecashdisbursementsandcashreceiptsjournalsforchecks
toanddepositsfromotherbankaccounts.Foundnoneotherthanthosenoted
inthisworkpaper.
b.

Whatistheactualcashbalanceforthefourbankaccountscombined,
consideringonlytheamountsgiveninthiscaseinformation,asof
December31,2002(beforeanyoftheDecember31payrollchecksare
cashedbyemployees)?AsofJanuary8,2003(beforeanyoftheJanuary8
payrollchecksarecashedbyemployees)?(Hint:Prepareascheduleof
"apparentbalances"and"actualbalances"illustratedinChapter18to
explaincheckkiting.)

SCHEDULEOFAPPARENTBALANCESANDACTUALBALANCES
CumulativeRecordofBankBalances
ChaseBank

NorthCountry Payroll

Dec22(Tu)
Apparentbalance
Actualbalance

0
(11,000)

11,000
0

Dec23(W)
Apparentbalance
Actualbalance

0
(11,000)

11,000
1,000

10,000
10,000

Dec24(Th)
Apparentbalance
Actualbalance

0
(11,000)

11,000
1,000

537
537

9,463
9,463

Dec28(M)
Apparentbalance
Actualbalance

1,000
1,000

11,000
(11,000)

537
537

0*
0*

9.68

Commerce

Combined

Payrollchecksassumedcashedbyemployees.

Dec29(Tu)
Apparentbalance
Actualbalance

1,000
1,000

1,000
(11,000)

537
537

Dec30(W)
Apparentbalance
Actualbalance

1,000
(14,000)

16,000
(8,000)

12,537
12,537

Dec31(Th)
Apparentbalance
Actualbalance

1,000
(14,000)

4,000
(8,000)

944
944

11,593
11,593

Jan4(M)
Apparentbalance
Actualbalance

15,000
0

4,000
(22,000)

944
944

0*
0*

Jan5(Tu)
Apparentbalance
Actualbalance

0
0

2,000
(12,000)

944
(9,056)

Jan7(Th)
Apparentbalance
Actualbalance

0
(12,000)

0
0

944
(9,056)

Jan8(F)
Apparentbalance
Actualbalance

0
(12,000)

0
(20,000)

973
973

9,971
9,971

(9,463)

(21,056)

ManipulatedBankReconciliation
Yes,somethingiswrong,andittakesacarefuleyetodetectit.Thebank
statementinExhibit193hasbeenaltered.Clearedcheck#2233for$5,000
hasbeenerased,andthebankbalancehasbeenchangedfrom$2,374.93to
$7,374.93.Thebankbalanceisactually$5,000lowerthanthereconciliation

shows.Sincetheproblemsays:"allchecksenteredinCaulco'scash
disbursementsjournalthroughFebruary29haveeitherclearedthebankorare
listedasoutstandingchecksintheFebruarybankreconciliation,"the
conclusionisthatthis$5,000checkwasnotrecorded.
Studentscanfindthealterationseveralways.(1)Theycannoticethecheck
inExhibit192(!)andfindthatitisnotonthebankstatement,even
thoughitisdatedandclearedinFebruary,(2)theycanaddthechecks
listedintheFebruarybankstatementandfindthatthetotalis$5,838.29,
notthe$10,838.29shownonthebankstatement,(3)theycanaddtheprevious
balancetothedepositandsubtractthewithdrawalstofindabalanceof
$2,374.93insteadofthealtered$7,374.93,and(4)theycannoticetheskip
inthenumericalsequencenotnotedbythebank'sdoubleasterisk(**)usedto
indicateaskip(thisistheplacethepaidcheckwaserased).
CAULCO,INC.
BankReconciliation(Corrected)
February29,1998
Balanceperbank

$2,374.93

Depositintransit

1,097.69

OutstandingChecks:
Number
Date
Payee

Amount

2239
2240

500.00
254.37

Feb26
Feb29

AlphaSupply
L.C.Stateman

TotalOutstanding

9.69

(754.37)

Reconciledbalance
GeneralledgerbalanceFeb29,1998

$2,718.25
$7,718.25

Cashoverstatement,Check#2233notrecorded

$5,000.00

EmployeeEmbezzlementviaCashReceiptsandPaymentofPersonalExpenses
Objective:Obtainevidencetodeterminewhetherexpensespaidfromtheextra
bankaccountwereforlegitimateschoolbusiness.Auditorscannotignore
informants'tales.
Control:Cashdisbursementsshouldbeauthorizedbyresponsibleofficersof
theorganizationtobeforvalidbusinesspurposes.Itisnotunusualfora
businessmanagertohavetheauthorizationresponsibility.Tightcontrol
wouldcallfordisbursementreview(attimeofchecksignature)byanother
responsibleperson(superintendent),andthiscontrolwasnotalways
observed.Cashreceiptsshouldbelistedbythepersoninitiallyincontrol
(cafeteriamanager),depositedbyanotherperson(businessmanager),anda
responsibleperson(superintendent,internalauditor,externalauditor)
shouldcomparetheinitialcontrolrecordtothedeposittonoteany
differences.
TestofControls:Forewarnedbytheinformant,theauditorscouldmake
inquiry:"Doestheschooldistricthaveafundforwhichindividual
disbursementsarenotapprovedbytheschoolboard?"and"Doesthebusiness
managerhaveresponsibilityforthisfund?"Answerstobothquestions
directedtothesuperintendentwouldbe"yes,"andtheauditorscanthen

concentrateinitialattentionontheparticularaccountrecords.
Thenextquestionis:"Doesthecafeteriamanagermakearecordofthedaily

receipts?"Answerbythesuperintendent:"Idon'tknow,askher."Luckily,it
turnedoutthatthecafeteriamanager,withoutdirectinstructions,made
notesonacalendaroftheamountofmoneysentforwardtothebusiness
managerfordeposit.Procedure:Comparetheamountsfromthecafeteria
manager'scalendartothedepositsintheaccount.
AuditofBalance:The"balances"beingauditedaretheexpenseaccountsthat
receivedthedebitsfromtheextrabankaccount.However,itisefficientto
gotothebankaccountrecordsasastartingpointfortheinvestigation.
Obtainthebankstatementsandsupportingdocumentsforcashdisbursements.
Studythemforevidenceof(1)improperlyauthorizedpayments,(2)payments
ofpersonalexpensesontheschooldistrict'sVISAaccount,and(3)payments
tounauthorizedpersons(including"cash"withnosupportingdocuments).
DiscoverySummary:AfterfindingpaymentstoAmericanExpressandVISA,
auditorsaskedthesuperintendentaboutthecreditcardusedbytheschool
andlearnedthattheschoolusedonlyVISA.InquiryatAmericanExpress
revealedthebusinessmanagerastheowneroftheaccountnumberfoundon
receiptsinthesupportingdocuments.(Actually,bythistimethebusiness
managerhadconfessed,butidentificationoftheaccountmighthavebeen
harder.)StudyoftheitemsanddatesontheVISAchargeslipsshoweditems
(e.g.hosiery)notusedattheschoolanddatesthatdidnotmatchbusiness
periods.Reviewofthechecksidentifiedsomeunsupportedchecksto"cash."
Duringthisreview,theauditorsfoundchecksdatedoutofnumericalsequence
andamissingblockinthemostcurrentmonth.Thiswasasignofhaving
blankcheckssigned,sothesuperintendentwasasked,andheadmitteddoing
so.Themissingblockwasinadeskdrawer,alreadysigned.
Comparingthecafeteriamanager'snotesofcashreceiptsshowedshortagesin
numerousdeposits.Thebusinessmanageradmittedtakingthecash.
9.70

RINGAROUNDTHEREVENUE:OverstatedSalesandAccountsReceivable
ThiscaseisatakeoffontheMattel,Inc.financialstatementsmisstatement
case.
AUDITAPPROACH
Objective:Obtainevidencetodeterminewhethersaleswererecordedinthe
properperiodandwhethergrossaccountsreceivablerepresentedtheamounts
duefromcustomersatyearend.
Control:Salestermsshouldbeproperlydocumented.Accountingtreatment,
includingbillingatagreeduponprices,shouldfollowthetermsofthesale.
Iftherisksandrewardsofownershiphavenotbeentransferredtothe
customer,orthepricehasnotbeenreliablydetermined,orthe
collectibilityoftheamountisseriouslyindoubtornotestimable,an
accrualsaleshouldnotberecognized.Recordedsalesshouldbesupportedby
customerordersandagreements.Shippingdocumentsshouldbesufficientto
showactualshipmentoralegitimatefieldwarehousingarrangement.
TestofControls:Questionnairesandinquiriesshouldbeusedtodetermine
thecompany'saccountingpolicies.Iftheauditorsdonotknowabout"bill
andhold"practices,theyshouldlearnthedetails.Fordetailprocedures:
Selectasampleofrecordedsales,andexaminethemforanysignsofunusual
salesterms.Vouchthemtocustomerordersandothersalesagreements,if
any.Vouchthemtoshippingdocuments,andexaminethedocumentsforexternal
validityrecognizingblankspaces(carriername,date)andcompany

representative'ssignature(twoplaces,bothcompanyandcarrier).Compare
pricesaskedincustomers'orderstopriceschargedoninvoices.Thesetests
followthevouchingdirectionstartingwithdatathatrepresentthefinal
recorded
transactions(sales)andgoingbacktofindoriginatingsupportingsource
documents.Theseproceduresmightrevealsometransactionsoftheproblem
typesbillandhold,andoverbilling.Thelastmonthofthefiscalyear
(althoughatypicalseasonallowmonth)couldbetargetedforgreater
attentionbecausethesalesaremuchhigherthanthepreviousJanuaryand
becausetheauditorswanttopayattentiontosalescutoffinthelast
month.
Selectasampleofshippingdocuments,tracethemtocustomerorders,and
tracethemtoinvoicesandtorecordingintheaccountsreceivablewith
properamountsontheproperdate.Thesetestsfollowthetracingdirection
startingwithdatathatrepresentthebeginningoftransactions(orders,
shipping)andtracingthemthroughthecompany'saccountingprocess.Ifextra
attentionisgiveninJanuaryforcutoffreasons,thissamplemightreveal
someoftheproblemtransactions.
AuditofBalance:Confirmasampleofcustomeraccounts.Followupexceptions
notedbycustomersrelatingtobillandholdterms,excessiveprices,and
doublebilling.Evenafewexceptionsraiseredflagsforthepopulationof
receivables.
Useanalyticalcomparisononcomparativemonth'ssales.Investigateany
unusualfluctuations(e.g.JanuarythisyearmuchlargerthanJanuarylast
year,thereversalmonthnextyearwithnegativesales).TheJanuary
comparativeincreaseinsalesshouldcauseauditorstoextenddetail
proceduresonsomeofthemonth'stransactions.
DiscoverySummary:Theauditorsperformedadetailsalescutoffteston
Januarysales,selectingasampleofrecordedsales.However,theydidnot
noticethesignificanceof"billandhold"markedontheinvoices,andthey
didnotfigureoutthemeaningoftheblankspacesandduplicatecompany
employeesignaturesontheshippingdocuments.
Inthefollowingyear'saudit,theytestedsalestransactionsinamonthwhen
theprioryear'sbillandholdsaleswerereversed.Theynoticedthe
discrepancybutweretoldthatitinvolvedvariousbillingerrors.Theydid
notconnectitwithreversaloftheprioryear'ssales.
Theauditorsconfirmedajudgmentsampleoflargeaccountsreceivable
balances.Twelvereplieswerereceivedon103confirmations.Sixofthe
replieswerefrom"billandhold"customerswholisteddiscrepancies.The
auditorsfollowedupthesixbyexaminingsalesinvoicesandshipping
documents.Theydidnotgraspthesignificanceofthe"billandhold"stamps
orthefeaturesoftheshippingdocumentsdescribedearlier.Three
confirmationresponsesindicatedthecustomersdidnotowetheamounts.The
auditorsreliedonMattoxinternaldocumentstodecidethatthecustomers
werewrong.Theydidnotexaminethesalesordersthatindicatedthatthese
customershadarightofcancellation.
Theauditorsdidnotperformmonthbymonthanalyticalsalescomparisonswith
theprioryear.Thustheydidnotrecognizethesignificantfluctuationsin
thecomparativeJanuarysales.Inthenextyear'saudit,theydidnot
recognizethesignificantcomparativedecreaseinmonth'ssalesforthe
monthswhentheprioryearbillandholdsaleswerereversed.

9.71

a.

Thepurposeofacutofftestistoverifythattransactions
(particularlythoseoccurringonandaroundthebalancesheetdate)are
recordedintheproperaccountingperiod.Suchtestsrelateto
managementsassertionsaboutvaluationandallocation(thatis,amounts
areappropriatelyvaluedandallocatedtothecorrectperiod).

b.

Inorderforthosefinancialstatementswhichmeasureflows(thatis,
thestatementofincomeandretainedearnings,andthestatementof
changes
infinancialposition)tobecorrect,thetransactioncutoffsatboth
thebeginningandendofthefiscalyearmustbecorrect.Thus,inan
initialengagement,anauditormusttestbothtransactioncutoffs.

c.

i)
ii)

iii)

iv)

9.72

Reviewtheclientsproceduresforensuringthatapropercutoff
ofsalestransactionsandanysalesreturnsandallowancesismade.
Ifaprenumberedshippingdocumentisused,obtainthenumberof
thelastshipmentinthefiscalyear.Comparethisnumberto
salestransactionsrecordedinthecurrentandthesubsequent
period.
Ifthereisnoprenumberedshippingdocument,selectasampleof
salesrecordedduringthelastfewdaysofthecurrentyearandthe
firstfewdaysofthenextyear.Examineshippingdatestoverify
recordingintheproperperiod.
Selectasampleofcreditmemorandaissuedneartheendofthe
currentfiscalyearandatthebeginningofthenextfiscalyear
andexaminesupportingdocuments,includingreceivingreportsfor
anyreturnedgoods.Verifythatcreditmemosarerecordedinthe
sameperiodastherelatedsalestransactions.

d.

Thecutoffofcashreceiptsistestedbytracingcashreceipt
transactionsrecordedneartheendofthefiscalyeartoadeposit
recordedbythebank.Anydepositsintransitattheendoftheperiod
shouldbetracedtoacutoffbankstatement(coveringthefirstfew
daysofthenextfiscalyear)sentdirectlybythebanktotheauditor.
Anunreasonabledelayintherecordingofadepositbythebankcould
indicateacutofferror.

a.

i)

b.

No,theprocedureofopeningeachroutebooktwice,atrandom,would
notproduceastatisticallyvalidrandomsample.Sincethereare

Thereisnoapparentaccountingcontroloverthelinenscarriedby
driversforsaletocustomers.Specifically,nooneseemsto
reconcilethenatureandquantityoflinenssold,tocustomers
chargesasrecordedbythedriver.
ii) Thereisalackofsegregationoffunctionsinthatdrivershave
controloverassetsbothlinensandcashaswellasrecordsof
thoseassets(theroutebook).
iii) Thereisalackofadequatecashreceiptrecords.Specifically,no
receiptforcashreceivedisgivenbythedrivertothecustomer.
iv) Nooneseemstoaccountforcompletenessofthenumericalsequence
ofsalesinvoicespreparedattheplant.Thussalesinvoices
mightbepreparedbutnotenteredintheroutebooks.
v)
Regularmonthlystatementsarenotsenttocustomers.
vi) Thereareapparentlynoproceduresforfollowuponoverdue
accounts.
vii) Therearenoindependentinternalverificationprocedures,for
example,byaninternalauditor.

differentnumbersofaccountsonthevariousroutes(from25to40),
customersonasmallroute(25)haveagreaterprobabilityofselection
thancustomersonalargeroute(40).Thisviolatestheequal
probabilityofselectionrequirementforarandomsample.Inaddition,
openingtheroutebookatrandomisahaphazardprocedurewhichcan
easilybebiased(forexample,thebooktendstoopenmostreadilyto
certainpages).

c.

Sincetheinternalcontrolsinthissituationarequitepoor,theuseof
positiveaccountsreceivableconfirmationsismostappropriate.That
is,theauditorshouldrequestthatcustomersrespondwhetherofnot
theyagreewiththerecordedbalance.Moreover,positiveconfirmations
shouldbeusedsincethereisaconsiderableriskoffraudbythe
drivers,whocontrolboththerecordsandcashcollections.

d.

Dollarunitsamplingismosteffectiveandefficientwhentheauditoris
concernedprimarilywiththeriskthatanaccountbalancemaybe
overstated,andtheexpectederrorrateinthepopulationislow.
Neitherconditionislikelytobepresentinthiscase.Sincethereisa
riskoffraudbythedriverswhichcouldresultinunrecorded
receivablesandsales,theaccountsreceivablebalancesmaybe
understated.Inaddition,sinceinternalcontrolsarenotgood,thereis
likelytobeafairlyhigherrorrateintheaccounts.Thus,dollarunit
samplingshouldprobablynotbeusedinthissituation.