Boynton SM CH 14

CHAPTER 14
AUDITING
THE
REVENUE CYCLE
Learning Check
14-1.
a. The revenue cycle includes the activities involved in the

exchange of goods and services with customers and the
realization of the revenue in cash.
b.
The
classes
of
transactions
in
this
cycle
for
merchandising company are sales, sales adjustments,

and cash receipts. The primary accounts affected by
these transactions are sales, accounts receivable, cost of
sales, inventory, cash, sales discounts, sales returns and
allowances,
bad debts expense, and allowance for
uncollectable accounts
14-2.
a. Specific audit objectives for the revenue cycle are derived

from the five categories of management's financial
statement assertions.
b.
Specific audit objectives for credit sales transactions
include the following:

Specific Audit Objectives
Transaction Objectives
Occurrence. Recorded sales transactions represent
Solutions Manual to Modern Auditing: Copyright
2005, John Wiley and Sons, Inc.
14-1
goods shipped or services provided during the period.

Recorded cash receipt transactions represent cash
received during the period.
Recorded sales adjustment transactions during the
period represent authorized discounts, returns and
allowances, and uncollectable accounts.
Completeness.
All sales cash receipts and sales
adjustments made during the period were recorded.
Accuracy.
All sales and cash receipts and sales
adjustments are accurately valued using GAAP and
correctly journalized, summarized and posted.
Cutoff. All sales, cash receipts and sales adjustments
have been recorded in the correct accounting period.
Classification.
All sales, cash receipts, and sales
adjustments
have
been
recorded
in
the
proper
accounts.
Balance Objectives
Existence. Accounts receivable representing amounts
owed by customers exists at the balance sheet date.
Completeness. Accounts receivable include all claims
on customers at the balance sheet date.
Rights and Obligations. Accounts receivable at the
balance sheet date represent legal claims of the entity
on customers for payment.
Valuation and Allocation.
Accounts
receivable
represents gross claims on customers at the balance

sheet date and agrees with the sum of the accounts
receivable subsidiary ledger.
uncollectable
accounts
The allowance for
represents
reasonable
14-2
estimate of the difference between gross receivables

and their net realizable value.
Disclosure Objectives
Occurrence and Rights and Obligations.
Disclosed
revenue cycle events and transactions have occurred

and pertain to the entity.
Completeness.
All revenue cycle disclosures that
should have been included in the financial statements
have been included.
Understandability.
Revenue cycle information is
appropriately presented and information in disclosures
is understandable to users.
Accuracy and Valuation. Revenue cycle information is
disclosed accurately and at appropriate amounts.
14-3.
Following are a few examples of differences between how
the auditor might use the knowledge of the entity and its
environment for a computer company v. a hotel.
a.
Certain balance sheet accounts like accounts receivable

and inventories are going to be very significant for the
computer manufacturer, but relatively immaterial for the
hotel.
The computer company is also likely to have a
higher ratio of sales to fixed assets, or sale to total assets,

than the hotel.
b.
The computer company auditor will have significant

issues associated with the risk of misstatement with
14-3
respect to the existence of receivables and inventories

that are not present for the hotel. The computer company
auditor will also have to address valuation and allocation
issues associated with the collectability of receivables
and lower of cost or market of inventories that are
insignificant for the hotel.
The hotel will have a potential
risk of material misstatement in terms of how it accounts

for revenues from properties that it manages for others,
as opposed to properties that it owns.
14-4.
Factors that might motivate management to deliberately
misstate revenue cycle assertions include:

Pressures to overstate revenues in order to report achieving
announced revenue or profitability targets or industry norms
that were not achieved in reality owing to such factors as
global, national, or regional economic conditions, the impact
of
technological
developments
on
the
entity's
competitiveness, or poor management.

Pressures to overstate cash and gross receivables or
understate the allowance for doubtful accounts in order to
report a higher level of working capital in the face of
liquidity problems or going concern doubts.
Factors that might contribute to unintentional misstatements
in revenue cycle assertions include:
14-4
The volume of sales, cash receipts, and sales adjustments

transactions
is
often
high,
resulting
in
numerous
opportunities for errors to occur.

The timing and amount of revenue to be recognized may be
contentious owing to factors such as ambiguous accounting
standards, the need to make estimates, the complexity of
the calculations involved, and purchasers' rights of return.
14-5. a. Following are example analytical procedures that the

auditor might use to estimate total revenue for a
household appliance manufacturer and for an airline.
Industry
Household
Possible Analytical Procedures

Appliance Use past ratio of net sales to
Mfg.
capacity with adjustments for

capacity changes.
Use a combination of past

ratios of market share with
adjustments
changes
in
Requires
knowledge
total
Airline
of
market
market
size
current
share.
of
the
in
the
industry.
Estimate net revenues using
information on utilization of
capacity (airline seat miles)
14-5
and average revenue per seat.

b.
Two analytical procedures that the auditor might use to

estimate gross margin for company might include.
Analytic Procedure
Audit Significance
Compare
historical Companies with
trends
in
share
and
margin
with
market market shares often are able to

gross obtain larger gross margins.
current
unaudited data.
Evaluate
percentage
commanding
the Companies
with
high
of proportion of revenues from new
revenues coming from products

new products.
may
earn
premium
gross margins due to the ability

to innovate.
c.
Two analytical procedures that the auditor might use to

estimate net receivables and the allowance for doubtful
accounts for company might include.
Analytic Procedure
Audit Significance
Accounts
receivable Understanding
a
turn days
companys
history of accounts and sales

volume can assist the auditor in
evaluating net receivables and
the adequacy of the allowance
14-6
for doubtful accounts.

Evaluate the entities This procedure is
history
primarily
of related to the adequacy of the
uncollectable
allowance
accounts expense to accounts.
for
uncollectable
The above history of
net credit sales, with accounts receivable turn days

adjustment
for would
economic conditions
be
evaluating
most
useful
estimating
for
gross
receivables given sales.

14-6.
Several control environment factors and their applicability
to revenue cycle assertions are:

Integrity
and
ethical
values
reduction
of
risk
of
overstatement of revenues and receivables by eliminating

incentives to dishonest reporting.
Commitment to competence - by chief financial officers and
accounting personnel.
Management's
philosophy
and
operating
style
conservatism in developing such accounting estimates as

the allowance for uncollectable accounts and allowance for
sales returns.
Human
resource
policies
and
practices
bonding
of
employees who handle cash

14.7.The following table summarizes the functions that apply to
credit sales transactions, the department that performs the
14-7
functions, and the principal documents or records produced in

performing the function.
Department
Function
Initiating
that Principal
documents
and
produced
in
performs function
records
Sales department

Documents
credit
Customer Order
sales
Credit department
Sales Order
Computer Files and Records
Customer Master File (with
credit
information)
and
Accounts Receivable Master

File.
Perpetual Inventory
Authorized Price List
Open Order File
Delivering
good
Warehousing
and Documents
and shipping
services
Shipping documents
department
goods.
Line
for Reports
of
unfilled
orders
and back orders

operating Computer Files and Records
departments
services.
for Open Order File

Perpetual Inventory
Shipping File
14-8
Department
Function
that Principal
documents
and
produced
in
performs function
records
Recording
Accounting

Documents
sales
(Billing)
Sales Invoice
Sales
Reports
and
Sales
Journal
Various Exception Reports
Monthly
Customer
Statements
Computer Files and Records
Sales Transaction File
Accounts Receivable Master
File
14-8.
In order to assess control risk as low based on programmed
control procedures the auditor should test the following.

Control
Programmed
Importance
to
Control
Risk
Assessment
control If a programmed control procedure in
procedures
critical
to
low
control
risk
assessment then the auditor should

Computer
directly test the control procedure.

general In order to obtain assurance that the
control procedures
programmed
control
procedure
14-9
functions effectively throughout the

period the auditor also needs to these
the effectiveness of computer general
Manual
control procedures.
follow-up Programmed controls usually report
procedures.
exceptions noted when performing

the control. As a result auditors also
need to test the effectiveness of
manual controls that follow-up on
reported exceptions.
14-9.
The following tables describes programmed controls for a

typical manufacturing company.
Potential
Programmed
Misstatement Control
a. Sales
The
CAATs (Assuming Test
Data)
computer Submit test data for a
invoices may compares entries in transaction that has

not
recorded.
be the
sales
with
journal shipping information,
underlying both with and without
shipping
information.
supporting
sales
All invoice.
shipping
documents must be
matched
with
sales invoice.
b. Sales invoice The
computer Submit test data with
may
recorded
be compares dates on dates

in the
sales
on
sales
invoice invoices that both do

14-10
Potential
Programmed
the
wrong with
dates
accounting
shipping

Data)
on and do
not
match
with dates on related
period.
documents.
shipping files.
c. A
fictitious The computer will Submit test data with
sales invoice, not prepare a sale sales
or
sales invoice
transaction
for
without information that both
underlying
is
which information
revenue
invoice
shipping files.
should not be
and
is
not
on supported
by
underlying
shipping
information.
recognized, is
recorded.
d. Sales
are The
computer Submit test data for
made without searches a field for sales orders that both

credit
appropriate
approval.
authorization
credit are
and
are
supported
not
by
before an order is appropriate
credit
placed on an open authorization.

e. A
order file.
sales The
invoice
incorrect
has matches quantities sales
that
on a sales invoices both do and do not
quantities or with
prices.
invoices
underlying match
shipping
shipping
information
underlying
information
and and authorized price
matches prices with lists.

14-11
Potential
Programmed
Data)
an authorized price
f.
list.
The
Sales
invoices may checks

run-to-run batches
that
not be posted totals of beginning complete

or
may
with
and
not accounts receivable incomplete data sets
be
balances, plus sales in terms of completed
journalized
transactions,
the
with transactions.
ending
receivable
balances.
The
computer Submit test data with
g. Sales
invoices may matches
customer underlying
be posted to information on the information that both

the
wrong sales invoice with does and does not
customers
the
master match
with
accounts.
customer file, the information

sales order, and the previously
14-10.
common
shipping
sales
documents.
shipping files.
management
control
order
involves
on
created
and
having
managers with responsibility for sales to review daily or weekly

sales reports to assess the reasonableness of recorded sales.
Further management responsible for warehousing and shipping
should review daily or weekly sales and inventory movement
14-12
reports to assess the reasonableness of recorded sales and

inventory removed from the perpetual inventory.
14-11.
The sub-functions involved in cash receipts include (1)
receiving cash receipts, (2) depositing cash in bank, and (3)

recording the cash receipts.
14-12. a. Two important controls pertaining to cash sales and the
transaction class audit objectives to which they relate
are:
The customer's expectation of a printed receipt and
supervisory surveillance of over the counter sales
transactions helps to ensure that all cash sales are
processed through the cash registers or terminals completeness.
Independent check by supervisor on the accuracy of
cash count sheets, and verification of agreement of
cash on hand with totals printed by a cash register or
terminal - existence or occurrence and valuation or
allocation.
b.
Two important controls pertaining to the initial handling of

mail receipts are (1) immediate restrictive endorsement
of checks received and (2) preparation of a multi-copy
listing (prelist) of mail receipts.
14-13
14-13. a. A lockbox is a post office box that is controlled by the

company's bank. The bank picks up the mail daily, credits
the company for the cash, and sends the remittance
advices to the company for use in updating accounts
receivable. This system eliminates the risk of diversion of
the receipts by company employees and failure to record
the receipts.
b.
Depositing receipts intact daily means that all receipts

are deposited; that is, cash disbursements should not be
made out of undeposited receipts. This control reduces
the risk that receipts will not be recorded (completeness),
and the resulting bank deposit record establishes the
existence or occurrence of the transactions.
14-14. Four controls that can aid in preventing or detecting errors

or
irregularities
in
recording
cash
receipts are summarized below along with potential tests of

controls:
Control
Independent
agreement
check
of
Test of Control
of Inspect a sample of daily cash
validated summaries
deposit slip with daily cash evidence

summary.
Computer
validated
check
and
of
examine
agreement
deposit
slip
with
by
responsible employee.
of Use CAATs to test computer
14-14
information included in the matching

cash receipts journal with cash
information from prelist.
of
information
receipts
journal
from
with
electronic prelist. Also follow-up

on how exceptions are reported
and
examine
evidence
or
correction of errors reported on

Preparation
of
exception reports.
periodic Examine a sample of periodic
independent
bank bank
reconciliations.
Mailing
of
reconciliations.
inquiries
about
reconciliation
procedures
Make
bank
and
test accuracy on a sample basis.

monthly Observe the mailing of monthly
statements to customers.
statements to customers. Make

inquiries
about
procedures
to
follow-up on issues raised by

customers, and examine reports
or other evidence of follow-up.
14-15. a. The
functions
pertaining
to
sales
adjustments
transactions are: granting cash discounts; granting sales

returns and allowances; and determining uncollectable
accounts.
b.
The following three types of controls pertaining to sales

adjustments transactions have as their common focus
14-15
establishing the validity, or existence of occurrence, of

such transactions:
Proper
authorization
of
all
sales
adjustments
transactions.
The
use
of
appropriate
documents
and
records,
particularly the use of an approved credit memo for

granting credit for returned or damaged goods, and an
approved write-off authorization memo for writing off
uncollectable customer accounts.
Segregation of duties for authorizing sales adjustment
transactions and handling and recording cash receipts.
14-16. a. The accounts receivable balance is a function of the
transactions that are posted to the account, namely credit
sales, cash receipts, and sales adjustments.
A sound
system of internal controls over these three transaction

cycles that ensure the completeness and accuracy of
these transactions, should also ensure the completeness
and accuracy of account receivable.
b.
The primary control over the balance involves sending

monthly
statements
to
customers
and
having
an
independent function to receive and follow-up on any

issues raised by customers.
14-16
c.
The
rights
and
obligations
assertion
for
accounts
receivable involves selling, or factoring, cash receipts.
If
an
entity
sells
its
receivables,
it
should
keep
documentary record of the receivables that have been

sold or pledged, and have a process for following up on
collection of those receivables and the reduction of the
related liability to the factoring agent.
These records
should be compared with monthly statements received

from a bank or factoring agent.
d.
Public companies normally control establish controls over

the presentation and disclosure assertion and related
audit objectives through an effective and independent
disclosure committee. The disclosure committee should
have individuals who are knowledgeable about GAAP and
the transactions being processed.
14-17. The following table provides example controls and tests of

controls for each assertion (and transaction level audit
objective) related to credit sales and cash receipts. Examples
emphasize programmed control procedures where appropriate.
Student should note that tests of controls should also
emphasize
testing
computer
general
controls,
observing
exception reports, and testing manual follow-up of items that

appear on exception reports.
14-17
Credit Sales
Assertion
(Audit Control
Objective)
Existence
Test of Controls
and Computer matches Submit test data where
Occurrence
sales
invoice invoice data does not
(Occurrence)
information
with match with underlying
underlying
shipping information.
shipping
Completeness
information.
Computer prints a Submit test data with
(Completeness)
report of all goods shipments that have not

shipped
but
billed.
not been
billed
to
test
accuracy of report of all

good shipped but not
Existence
Occurrence
billed.
of Submit test data with
and Comparison
/ invoice date with shipments in one period
Completeness
the
(Cutoff)
period when goods subsequent period.
Valuation
accounting and
billing
in
the
were shipped.
and Computer matches Submit test data with
Allocation
sales
prices
(Accuracy)
authorized
with invoice prices that do

price not
match
the
list and sales order. authorized price list or

Presentation
sales order.
and Computer matches Submit test
Disclosure
customer
(Classification)
on
sales
data
the
number customer information on

invoice the sales invoice does
14-18
with
customer not
number
on
match
the
sales underlying sales order.
order.
and If an entity sells its Observe and reperform
Rights
Obligations
receivables,
it procedures
should
a documenting
keep
documentary
record
for
receivables
of
that
have
the been factored or sold.
receivables
that
have been sold and

it should compare
that
record
with
monthly
statements
received
from
factoring company.
Cash Receipts
Assertion
Objective)
Existence
(Audit Control
Test of Controls
and Independent check Observe and reperform
Occurrence
of
agreement
(Occurrence)
cash
and
with
cash
of manual
checks check
to
independent
count check of the prelist with
sheets and prelist.
controls
the
cash
receipts
14-19
Completeness
journal.
Independent check Observe and reperform
(Completeness)
of
agreement
cash
and
with
cash
of manual
checks check
Occurrence
Completeness
(Cutoff)
Valuation
independent
the
cash
receipts
journal.
of Observe and test the
and Preparation
/ periodic
accuracy of independent
independent
bank bank reconciliations.
reconciliations.
and Independent check Observe and reperform
Allocation
of
(Accuracy)
cash
and
with
cash
agreement
of manual
controls
checks check
independent
the
cash
receipts
journal.
of Make inquiries
and Mailing
Disclosure
statements
(Classification)
customers.
to
sheets and prelist.

Presentation
to
sheets and prelist.

Existence
controls
to mailing
of
about
monthly
statements
to
customers.
Observe
notes
and
procedures
used to follow-up upon

questions
Rights
Obligations
raised
by
customers.
and If an entity sells its Observe and reperform
receivables,
it procedures
should
a documenting
keep
for
14-20
documentary
record
receivables
of
receivables
that
have
the been factored or sold.

that
have been sold and

it should compare
that
record
with
monthly
statements
received
from
factoring company.
14-18. a. The transaction classes that should be considered in

assessing control risk for accounts receivable assertions
are: credit sales, cash receipts, and sales adjustments.
b.
In assessing control risk for the existence or occurrence

account balance assertion for accounts receivable, the
following transaction
class control risk assessments
should be considered:
Existence or occurrence for sales transactions that
increase accounts receivable.
Completeness for cash receipts and sales adjustments
transactions that decrease accounts receivable.
14-21
c.
A revised acceptable level of detection risk for tests of

details and a revised level of substantive tests must be
determined for an assertion when the relevant final or
actual
inherent
risk
assessments,
control
risk
assessments, and analytical procedure risk assessments,

differ from the planned assessed levels.
14-22
14-19.
The following table explains some example preliminary
audit strategies for each financial statement assertion in the

context of the audit risk model.
Assertion
Inherent
Control
Analytic
Test of Details
Risk
Risk
Procedures
Risk
Low
Risk
if Moderate
Existence
Maximum
and
due
Occurrence
revenue
controls
recognitio
over
occurrence
problems.
of sales are expectation the
to internal
to
high which will allow
depending
the on
strong.
Moderate
for
smaller
sample
reliability of and
model.
sizes
changing
timing
of
confirmations
of receivables.
It
will
reduce
also
the
extent of cutoff
Completenes
Moderate.
Not
Low
if Moderate
a internal
to
significant
controls
inherent
over
risk.
occurrence
allow
reliability of sizes
model.
for
smaller sample
of sales are expectation changing

strong.
to
high high which will
depending
the on
tests.
Moderate
and
the
timing
of
confirmations
14-23
of receivables.
It
will
also
reduce
the
extent of cutoff
Rights
and Moderate
Obligations
to
Moderate
high to
high to
depending depending
on
Moderate
high confirming with
depending
the on internal on
entitys
controls.
ability
to However,
tests.
Low: Consider
factoring agent
and search for
reliability of large
unusual
expectation cash receipts.
generate
control are model.
operating
more
cash flow.
nonroutine
than
Valuation and High

Allocation
routine.
or Moderate
maximum
due
high to
to depending
subjective
nature
to
Moderate
of controls
high can
depending
on internal on
The
auditor
test
accuracy
of
receivables
at
reliability of gross
allowance. over
the
value
expectation with
collection
model.
confirmation.
of
The
receivables
should
consider
auditor
extensive tests
14-24
of
the
allowance after
Presentation
Inherent
and
risk
Disclosure
usually
high
Moderate
is to
Maximum:
high Analytical
depending
procedures
or on internal are
maximum. controls
over
year-end.
Maximum
High.
often
to
It
is
cost
not effective
to
directed at substantively
testing
test disclosures
disclosures. disclosures. which are not

complex
for
receivables.
14-20.
In vouching recorded accounts receivable transactions to
supporting documentation, a sample of debits to customers'

accounts is compared to data on supporting sales invoices and
matching shipping documents, sales orders, and customer
orders. The evidence obtained pertains primarily to specific
audit objectives derived from the existence or occurrence,
rights and obligations, and valuation or allocation assertions
for accounts receivable.
14-21.
Both the sales cutoff test and the cash receipts cutoff test
pertain to accounts receivable. The sales cutoff test involves:
14-25
Examining shipping documents for several days before and

after the cutoff date to determine the date and terms of
shipment.
Tracing shipping documents to sales and inventory records
to establish that the entries were made in the correct
accounting period.
Inspecting invoices for a period of time before and after the
cutoff date to ascertain the validity and propriety of the
shipments and corresponding entries.
Inquiring of management about any direct shipments by
outside
suppliers
to
customers
and
determining
the
appropriateness of related entries.

In performing a cash receipts cutoff test, the auditor may be
present at the balance sheet date to personally observe the
promptness of the cutoff. In particular, the auditor determines
that all collections received prior to the close of business are
included in cash on hand or in deposits in transit and are
credited to accounts receivable. Alternatively, the auditor may
review the daily cash summary and validated deposit slip for
the last day of the year.
Both cutoff tests relate to the occurrence and completeness
audit objectives for accounts receivable.
14-22. a. It may not be necessary to confirm accounts receivable
when:
14-26
The balance is immaterial to the financial statements.

The use of confirmations would be ineffective as an
audit procedure.
The auditor's combined assessment of inherent risk
and control risk is low, and that assessment, made in
conjunction with the evidence expected to be provided
by analytical procedures or other substantive tests of
details, is sufficient to reduce audit risk to an
acceptably
low
level
for
the
applicable
financial
b.
Factors to be considered in choosing the form of

confirmation request are (1) the acceptable level of
detection risk and (2) the composition of the customer
balances. The positive form is used when detection risk is
low or individual customer balances are relatively large.
The negative form should be used only when all three of
the following conditions apply:
The acceptable level of detection risk for the related
assertions is moderate or high.
A large number of small balances is involved.
The auditor has no reason to believe that the recipients
of the requests are unlikely to give them consideration.
c.
When no response is received after the second or third

positive confirmation request to a customer, the auditor
14-27
should
apply
such
alternative
procedures
as
(1)
examining subsequent collections and (2) vouching open

invoices comprising the customer's balance. Alternate
procedures may be omitted when both of the following
conditions apply:
There are no unusual qualitative factors or systematic
characteristics related to the nonresponses, such as
that all nonresponses pertain to year-end transactions.
The nonresponses, projected as 100% misstatements
to the population and added to the sum of all other
unadjusted differences, would not affect the auditor's
decision about whether the financial statements are
materially misstated
14-23. a. The aged trial balance is used primarily in assessing the
adequacy of the allowance for uncollectable accounts.
b.
Procedures applied to the aged trial balance include (1)

footing and crossfooting the aged trial balance and
comparing the total to the general ledger balance for
accounts receivable and (2) testing the aging of the
amounts shown in the aging categories by examining
supporting documentation such as dated sales invoices.
c.
After testing the accuracy of the aged trial balance the

auditor should perform the following procedures to draw a
14-28
conclusion about the fair presentation of the allowance

for doubtful accounts.
Examine
past
due
accounts
for
evidence
of
collectability such as correspondence with customers

and outside collection agencies, credit reports, and
customers financial statements.
Discuss collectability of accounts with appropriate
management personnel.
Evaluated managements process for estimated the
allowance for doubtful accounts using hindsight.
Evaluate
the
adequacy
of
the
allowance
given
information about industry trends, aging trends, and

collection history for specific customers.
d.
Hindsight allows auditors to evaluate the reasonableness

of managements process for estimating the allowance for
doubtful accounts.
The reliability of managements
process for developing this accounting estimate can be

gauged by evaluating estimates in prior periods and the
degree to which those estimates accurately estimated
subsequent uncollectable accounts.
14-24.
GAAP disclosure for accounts receivable include:
Disclosure of receivables from employees, officers, affiliated

companies and other related parties.
Appropriate classification of material credit balances.
14-29
Appropriate
classification
of
current
and
noncurrent
receivables.
Disclosure of pledging, assigning, or factoring receivables.
Comprehensive Questions
14-25.
(Estimated Time: 15 Minutes)
The auditor should consider separately audit the revenues

associated with the 27 owned properties and the 40 managed
properties.
Revenues for the 27 owned properties represent direct
revenues of the motel chain.
The auditor might consider
evaluating the summer season separate from the balance of

the year as the auditor will expect occupancy to be high during
that time of year and the auditor will also expect that revenues
should reflect higher rates. The auditor would also expect that
for the balance of the year occupancy should be lower and
revenues per night will be reduced due to significant price
competition.
Knowledge of the industry will be particularly
helpful in gauging the reasonableness of occupancy rates and

revenues per unit.
Revenues for the 40 managed hotels will likely be related to
management fees based on revenues earned for absentee
14-30
owners.
The auditor needs to consider the same issues as
above, but also need to determine the appropriateness of the

management fee based on the contract with absentee owners.
14-26.
1.
(Estimated time - 25 minutes)

The
following
table
provides
the
solutions
to
the
quantitative requirements in parts a through g.
2.
Receivables are growing faster than sales.
In addition,
Sales price per unit has gone up and the ratio of sales to
total assets has increased.
This might be evidence of
problems with revenue recognition.
In addition, during
14-31
this period of accounts receivable growth, accounts

receivable turn days increased during the last year, and
the uncollectable account expense to account receivable
write-off has gone down.
The auditor should also
consider whether the allowance for doubtful accounts is

adequate.
14-27.
Internal Control Questionnaire

Question
Yes No
1. Are cash registers or point-of-sale devices used for over-thecounter sales?

2. Is there periodic surveillance of cash sales procedures?
3. Are customers who pay by check required to provide
identification?
4. Are checks restrictively endorsed on receipt?
5. Is a receipt produced by the cash register given to each
customer?
6. Is an independent check made of agreement of cash and
checks
on
hand
with
cash count sheets and cash register readings?

7. Is cash deposited intact daily?
8. Is an independent check made of agreement of daily cash
register
summaries
with validated deposit slips?
14-32
9. Is an independent check made of agreement of amounts

journalized
with
daily
cash register summaries and validated deposit slips?

10. Are periodic independent bank reconciliations made?
11. Are employees who handle cash bonded?
14-28. (Estimate Time: 30 Minutes)
Weakness
Recommended Improvement
Financial secretary exercises To extent possible, financial
too
much
control
over secretary's
collections.
responsibilities
should be confined to record

keeping.
Finance
committee
exercising
its
is
not Finance
assigned assume
responsibility for collections.
The
auditing
function
committee
a
more
should
active
supervisory role.
has An audit committee should be
been assigned to the finance appointed to perform periodic

committee, which also has auditing procedures or engage
responsibility
for
the outside auditors to perform
administration of the cash the procedures.

function.
Moreover,
the
finance committee has not

performed
the
auditing
14-33
Weakness
function.
The head
usher
has
sole The
number
of
counters
access to cash during the should be increased to at least

period
of
the
count.
One two, and cash should remain
person should not be left under joint surveillance until

alone with the cash until the counted and recorded so that
amount has been recorded or any
discrepancy
will
be
should
be
control established in some brought to attention.

other way.
The collection is vulnerable to The
robbery
while
it
is
collection
being deposited in the bank's night
counted and from the church depository immediately after

safe prior to its deposit in the the
bank.
count.
Physical
safeguards, such as locking

and bolting the door during
the period of the count, should
be instituted. Vulnerability to
robbery will also be reduced
by increasing the number of
counters.
The head usher's count lacks The financial secretary should
usefulness
standpoint
from
control receive
because
copy
of
the
he collection report for posting to
surrenders custody of both the financial records. The head

the cash and the record of usher should maintain a copy
the count.
of the report for use by the

audit committee.
14-34
Weakness
Contributions
not Contributions
should
be
are
deposited intact. There is no deposited

assurance
that
withheld
by
secretary
the
for
intact.
If
it
is
amounts considered necessary for the

financial financial secretary to make
expenditures cash expenditures, she should
will be properly accounted be

for.
provided
with
cash
working fund. The fund should

be replenished by check based
upon
properly
reimbursement
approved
request
and
satisfactory support.
Members are asked to draw Members should be asked to
checks
to
"cash",
thus make checks payable to the
making
the
checks church. At the time of the
completely
negotiable
and count, ushers should stamp
vulnerable
to the
misappropriation.
endorsement
Only)
No
mention
is
church's
made
on
involved
disbursing
instructions
(For
the back
Deposit
of the
check.
of Key employees and members
bonding.
Written
restrictive
in
receiving
cash
should
and
be
bonded.
for Because much of the work in
handling
cash cash collections is performed
collections apparently
have by unpaid, untrained church
not been prepared.

members, often on a short2005, John Wiley and Sons, Inc.
14-35
Weakness
term basis, detailed written
instructions
should
be
prepared.
14-29. (Estimated Time: 30 minutes)
a.
Consolidated
Electricity
Company:
Cash
Receipts
Flowchart
Documentary
Key Reports
Computer
Programs and Files

Audit Trail
Customer
Payment
Remittance
Advice
Accounts
Receivable
File
Data
Entry
at
CRT
Deposit
Slip
CASH RECEIPTS
PROGRAM:
Updates AR Master
File and Daily
Transaction Tape.
Also Produces
Deposit Slip for
Cash Received
rece
Cash
Receipts
Transaction
File
14-36
b.
Yes, the new cash receipts procedures have created some

systems and internal control problems. These problems
include the following:
There are some potential control problems in the data
entry
procedures.
The
CRT
operator
should
be
restricted to cash receipts processing activities. There

should
be
safeguards
to
detect
or
prevent
unauthorized entries to the system.

The old master file records are destroyed in the update
process. The company should keep a backup of the
accounts receivable file in case the file is destroyed.
This can be accomplished by periodically dumping the
accounts receivable file on magnetic tape or another
disk
There is no assurance that all cash receipts have been
entered correctly into the system. There should be
some independent computation of batch and/or hash
totals involving the remittance advices and the number
14-37
of transactions so that a comparison at the conclusion

of processing would reveal omissions or errors
The remittance advices The remittance advices are
destroyed the next day, which probably is too soon.
Any errors or operator alterations not discovered by the
end of the next business day would be difficult to trace
and correct.
14-30. (Estimated Time 25 Minutes)
a. Substantive Test
b.
Financial c.
Statement
Vouch
aged
Type
of
Evidence
Assertion
trial Valuation
or Documentary
balance to supporting allocation

documentation
Apply
analytical Existence
procedures
or Analytical
occurrence,
completeness,
valuation
Vouch
allocation
recorded Existence
receivables
or
or Documentary
to occurrence,
supporting
rights
documentation
obligations,
valuation
allocation
Perform sales cutoff Existence
and
or
or Documentary
14-38
a. Substantive Test
b.
Financial c.
Statement
Type
of
Evidence
Assertion
occurrence,
test
completeness
accounts All
except Confirmation
Confirm
receivable
Vouch
presentation
and
disclosure.
trial Valuation
aged
or Documentary
balance to supporting allocation

documentation
Vouch
recorded Existence
receivables
or Documentary
to occurrence,
supporting
rights
documentation
obligations,
and
valuation
Verify
accuracy
accounts
trial
general
allocation
of Valuation
or Mathematical
receivable allocation
balance
agreement
or
and
with
ledger
control
Examine subsequent Existence
collections
allocation
Confirm
receivable
or Documentary
or occurrence,
completeness,
valuation
accounts All
presentation
except Confirmation
and
14-39
a. Substantive Test
b.
Financial c.
Statement
presentation
of
Evidence
Assertion
disclosure
statement Presentation
Compare
Type
and Documentary
with disclosure
GAAP
Perform cash receipts Existence
cutoff test
or Documentary
occurrence,
completeness
14-31. (Estimated Time 20 minutes)

Schedule of Adjustments
Cost
Transaction
of
Sales
Unde Over
Goods Sold
Unde Over
4,00
2,40
0
10,0
0
5,60
00
6,00
0
8,00
Total
0
14,0
14,0
5,60
00
00
14-40
Adjusting Entry
Inventory
DR
5,60
CR
0
5,60
0
14-32.
a.

King might justify omitting the confirmation of Cycle's
accounts receivable when:
The balance is immaterial to the financial statements.
The use of confirmations would be ineffective as an
audit procedure.
The auditor's combined assessment of inherent risk
and control risk is low, and that assessment, made in
conjunction with the evidence expected to be provided
by analytical procedures or other substantive tests of
details, is sufficient to reduce audit risk to an
acceptably
low
level
for
the
applicable
financial
b.
In designing confirmation requests, the auditor considers

the acceptable level of detection risk needed to be
achieved, the composition of the client's customer balances,
and the likelihood that the customers will conscientiously
respond. The positive form is used when detection risk is
low or individual customer balances are relatively large.
14-41
The negative form should be used only when all three of

the following conditions apply:
The acceptable level of detection risk for the related
assertions is moderate or high.
A large number of small balances is involved.
The auditor has no reason to believe that the recipients
of the requests are unlikely to give them consideration.
c.
When no response is received after the second or third

positive confirmation request to a customer, the auditor
should apply such alternative procedures as (1) examining
subsequent collections and (2) vouching open invoices
comprising the customer's balance. Alternate procedures
may be omitted when both of the following conditions
apply:
There are no unusual qualitative factors or systematic
characteristics related to the nonresponses, such as
that all nonresponses pertain to year-end transactions.
The nonresponses, projected as 100% misstatements
to the population and added to the sum of all other
unadjusted differences, would not affect the auditor's
decision about whether the financial statements are
materially misstated.
Case
14-42
s
14-33. (Estimated Time 30 Minutes)
Accounts Receivable Gros s

Allowance for Uncollectable Accounts
Net Receivables
Total Assets
Total Revenues
Uncollectable Accounts Expense
Writeoff of Accounts Receivable
Year 5
Unaudited
535,000
($14,500)
520,500
2,200,000
2,700,000
33,750
22,600
Yar 4
Unaudited
295,000
($6,400)
288,600
1,800,000
2,050,000
25,625
24,500
Year 3
Unaudited
265,000
($5,275)
259,725
1,500,000
1,750,000
21,875
22,500
Year 2
Unaudited
207,500
($5,900)
201,600
1,200,000
1,400,000
17,500
17,000
a. Selected Ratios
Sales to average total as sets
Industry Median
Difference
1.35
1.25
0.10
1.24
1.23
0.01
1.30
1.29
0.01
1.27
1.26
0.01
AR Growth to Sales Growth
2.53
0.65
1.15
1.13
55
47
8
49
48
1
48
47
1
48
47
1
AR collection period
Industry Median
Difference
Uncollectable account expense to net credit sales
Industry Median
Difference
Uncollectable account expense to bad debt writeoffs
b.
1.25%
1.50%
-0.25%
1.25%
1.30%
-0.05%
1.25%
1.25%
0.00%
1.25%
1.25%
0.00%
1.493
1.046
0.972
1.029
Year 1
Unaudited
175,000
($5,400)
169,600
1,000,000
1,200,000
15,000
14,000
The unaudited figures for Aurora Manufacturing, Inc. show the
following:
There was a significant increase in sales compared to total
assets, particularly when compared to industry averages.
This is an indication of possible existence and occurrence
problems as past history of the ratio of total assets to sales
would predict lower sales levels. The auditor should expand
the scope of accounts receivable confirmations.
14-43
The collection period is increasing relative to industry

averages and past history. Further, accounts receivable are
growing faster than sales.
The Aurora continues to use a
historical rate of 1.25% of credit sales to provide for

uncollectable accounts while industry trends show an
increase in the rate of bad debts to credit sales. The is an
indication of possible problems of associated with the net
realizable value of receivables. The auditor needs to expand
the scope of tests of collection of current receivables, the
allowance for uncollectable accounts, and the provision for
bad debt expense.
Comprehensive Cases
14-34. See separate file with answers to the comprehensive case
related to the audit of Mt. Hood Furniture that is included with
this chapter.
this chapter.
this chapter.
14-44
14-45
Professional Simulation
Analytical
Procedure
s
Situatio
Internal
Risk
Audit
Controls
Assessme
Procedure
nt
n
To:
Audit File
Re: Analytical procedures

From:
CPA Candidate
Ratio
Unaudited Ratio Auditors
Accounts
Range
42 days 48 days
Receivable 54 days
Turn Days
Sales and
Accounts Sales
Receivable
Growth 7%
Rates
Expectation
Growth: Sales Growth: 6% - 9%

Accounts
Accounts
Receivable
Growth: 6% - 9%
Receivable
Sales
to
Net
Growth: 14%
Fixed 10.0
6.0 8.0
Assets
14-46
The above analytical procedures show that receivables are growing

faster than sales, the ratios of accounts receivable turn day and
sales to net fixed assets are both significantly larger than the
auditors expectation.
The most likely misstatement due to the
potential overstatement of both sales and receivables relates to the

occurrence of sales and the existence of receivables due to revenue
recognition problems.
The increase in accounts receivable turn
days also points to possible problems with the valuation of

receivables at net realizable value due to the understatement of the
allowance for doubtful accounts.
14-47
Internal
Controls
Analytical
Risk
Audit
Situatio
Procedure
Assessme
Procedure
nt
Assertion
A.
Existence and Occurrence
B.
Completeness
C.
Rights and Obligations
D.
Valuation and Allocation
E.
Presentation and Disclosure
Identify the appropriate assertion for each of the following internal

controls. Check all that apply.
Internal Control
1.
The computer prints a report of
(A)
(B)
(C)
(D)
(E)
the sale invoice with prices on the
master price list.

The
computer
all
2.
shipments
that
have
not
resulted in a sales invoice.

The computer matches the date
on the bill of lading with the
accounting period when the sales
3.
4.
invoice is recorded.
The computer matches prices on
matches
the
14-48
customer number on the sales

invoice with the customer number
5.
on the master customer file.

The computer compares control
totals
on
shipping
documents
with corresponding control totals
Risk
Assessme
nt
Analytical
Internal
Audit
Situatio
Procedure
Controls
Procedure
To:
Audit File
Re: Control Risk Assessment

From:
CPA Candidate
Based on the following assessments the auditor should assess

control risk as moderate for the purpose of considering the controls
over the accounts receivable balance.
Accounts receivable is
affected by the existence and occurrence assertion for credit sales

(low in this case) and the completeness control related to cash
receipts (moderate in this case) and sales return (low in this case).
A conservative risk assessment would be to use a moderate risk
14-49
assessment for control risk when planning the confirmation of

accounts receivable.
Control Risk
Control
Assessment
The computer matches sales invoice information with Low
underlying shipping information.
The computer matches sales
prices
with
the Low
authorized price list.

A prelist is prepared for cash receipts and compared Moderate
with deposit slips.
The computer prepares a daily report of authorized Low
sales returns that have not resulted in a receiving
report or a credit memo.
Audit
Procedure
s
Analytical
Internal
Risk
Situatio
Procedure
Controls
Assessme
nt
Audit procedure
A.
Select a sample of recorded sales transactions from several

days before and after year-end and examining supporting sale
invoices and shipping documents to determine that sales were
recorded in the proper period.
14-50
B.
Trace beginning balance for accounts receivable to the prior

years working papers.
C.
Send positive confirmations for accounts receivable and followup on disputed confirmations.
D.
Trace a sample of revenue transactions from shipments to

recorded sales invoices in the sale journal.
E.
Determine
whether
there
are
credit
balances
that
are
significance in the aggregate that should be reclassified as

liabilities.
F.
Send confirmations to entities that have purchased accounts

receivable.
G.
Compare uncollectable accounts expense to net credit sales.
H.
Review activity in the general ledger account for accounts

receivable and investigate entries that appear unusual in
amount or source.
I.
Use generalized audit software to recompute the aging of

accounts receivable and investigate the credit history of
accounts that are over 60 days past due.
J.
Observe that all cash received through the close of business on

the last day of the fiscal year is include in cash on hand or
deposits in transit and that now receipts of the subsequent
period are included.
Determine the audit procedure that best addresses the following

risks.
Risk
(A)
(B)
(C)
(D)
14-51
(E)
(F)
(G)
(H)
(I)
(J)
3.
value.
All sales during the period may not
4.
be recorded.
All legal claims
5.
receivable are adequately disclosed.

Accounts receivable information
may not be appropriately classified
and
1.
Recorded sales may not represent
2.
goods shipped during the year.

The allowance for doubtful accounts
may not reasonably estimate the
difference
between
gross
receivables and their net realizable
presented
in
on
the
accounts
financial
statements.
14-52

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CHAPTER 14

a. The revenue cycle includes the activities involved in the

merchandising company are sales, sales adjustments,

bad debts expense, and allowance for

a. Specific audit objectives for the revenue cycle are derived

Specific audit objectives for credit sales transactions

include the following:

2005, John Wiley and Sons, Inc.

goods shipped or services provided during the period.

represents gross claims on customers at the balance

Solutions Manual to Modern Auditing: Copyright

The allowance for

2005, John Wiley and Sons, Inc.

estimate of the difference between gross receivables

revenue cycle events and transactions have occurred

Following are a few examples of differences between how

Certain balance sheet accounts like accounts receivable

The computer company is also likely to have a

higher ratio of sales to fixed assets, or sale to total assets,

The computer company auditor will have significant

Solutions Manual to Modern Auditing: Copyright

2005, John Wiley and Sons, Inc.

respect to the existence of receivables and inventories

The hotel will have a potential

risk of material misstatement in terms of how it accounts

Factors that might motivate management to deliberately

misstate revenue cycle assertions include:

competitiveness, or poor management.

Solutions Manual to Modern Auditing: Copyright

2005, John Wiley and Sons, Inc.

The volume of sales, cash receipts, and sales adjustments

opportunities for errors to occur.

14-5. a. Following are example analytical procedures that the

Possible Analytical Procedures

capacity with adjustments for

Use a combination of past

Solutions Manual to Modern Auditing: Copyright

2005, John Wiley and Sons, Inc.

and average revenue per seat.

Two analytical procedures that the auditor might use to

market market shares often are able to

of proportion of revenues from new

revenues coming from products

gross margins due to the ability

Two analytical procedures that the auditor might use to

history of accounts and sales

Solutions Manual to Modern Auditing: Copyright

2005, John Wiley and Sons, Inc.

for doubtful accounts.

of related to the adequacy of the

accounts expense to accounts.

The above history of

net credit sales, with accounts receivable turn days

receivables given sales.

Several control environment factors and their applicability

to revenue cycle assertions are:

overstatement of revenues and receivables by eliminating

conservatism in developing such accounting estimates as

employees who handle cash

Solutions Manual to Modern Auditing: Copyright

2005, John Wiley and Sons, Inc.

functions, and the principal documents or records produced in

performing the function.