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Flashcards in 11.6 Deck (18):
1

In the confirmation of accounts receivable, the auditor would most likely

Request confirmation of a sample of the inactive accounts.

When the risk of material misstatement at the relevant assertion level is at an acceptably low level, the auditor will confirm only a sample of receivables. The sample should include inactive or past due accounts. If such accounts are to be regarded as assets, acknowledgment of the debts must be obtained. Confirming inactive accounts may also detect lapping or establish what amounts are in dispute.

2

For the fiscal year ending December 31 of the previous year and for the current year, Justin Co. has net sales of $1,000,000 and $2,000,000; average gross receivables of $100,000 and $300,000; and an allowance for uncollectible accounts receivable of $30,000 and $50,000, respectively. If the accounts receivable turnover and the ratio of allowance for uncollectible accounts receivable to gross accounts receivable are calculated, which of the following best represents the conclusions to be drawn?

Accounts receivable turnovers are 10.0 and 6.7, and the ratios of uncollectible accounts receivable to gross accounts receivable are 0.30 and 0.17, respectively. Examine allowance for possible understatement of the allowance.

The accounts receivable turnover equals sales divided by average gross receivables. Thus, it equals 10.0 ($1,000,000 ÷ $100,000) and 6.7 ($2,000,000 ÷ $300,000) for the prior year and current year, respectively. The ratio of allowance for uncollectible accounts receivable to gross accounts receivable is .30 ($30,000 ÷ $100,000) for the prior year and .17 ($50,000 ÷ $300,000) for the current year. The gross accounts receivable tripled in the second year, yet the allowance for uncollectible accounts receivable increased by only 67%. This could be an indication that the allowance for uncollectible accounts receivable is understated.

3

An independent auditor asked a client’s internal auditor to assist in preparing a standard financial institution confirmation request for a payroll account that had been closed during the year under audit. After the internal auditor prepared the form, the controller signed it and mailed it to the bank. What was the major flaw in this procedure?

The form was mailed by the controller.

The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used for specific deposits and loans. A confirmation is signed (requested) by the client, but it should be sent by the auditor. Thus, the auditor should control confirmation requests and responses. Control means direct communication between the intended recipient and the auditor to minimize possible bias of the results because of interception and alteration of the requests or responses.

4

To reduce the risks associated with accepting fax responses to requests for confirmations of accounts receivable, an auditor most likely would

Verify the sources and contents of the faxes in telephone calls to the senders.

Because establishing the source of a fax is often difficult, the auditor should ensure that the confirmations returned by fax are genuine. One way is to verify the sources by following up with telephone calls to the senders.

5

An audit client sells 15 to 20 units of product annually. A large portion of the annual sales occur in the last month of the fiscal year. Annual sales have not materially changed over the past 5 years. Which of the following approaches would be most effective concerning the timing of audit procedures for revenue?

The auditor should inspect transactions occurring in the last month of the fiscal year and review the related sale contracts to determine that revenue was posted in the proper period.

Tests of the details of transactions at year end are most effective given that total sales consist mostly of a few transactions. Also, because most occur in the last month of the year, the auditor should establish that management made a proper cutoff.

6

Cooper, CPA, is auditing the financial statements of a small rural municipality. The receivable balances represent residents’ delinquent real estate taxes. Internal control at the municipality is ineffective. To determine the existence of the accounts receivable balances at the balance sheet date, Cooper would most likely

Send positive confirmation request.

The presumption that the auditor will request confirmation of receivables cannot be overcome unless (1) the receivables are not material, (2) external confirmation requests are unlikely to be effective, (3) the assessed risks of material misstatement are low, and (4) other planned substantive procedures apply to the assessed risks. None of these conditions apply. Thus, the auditor should confirm the receivables. However, negative confirmation requests are not used unless the assessed risks of material misstatement are low. Because the municipality’s internal control is ineffective, the auditor should send positive confirmation requests.

7

Which of the following sets of information does an auditor usually confirm on one form?

Cash in bank and collateral for loans.

The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used by auditors to confirm the deposit balance held by the bank for a client. In addition, this confirmation requests loan information, such as a description of the collateral securing the loan.

8

The most effective audit procedure for determining the collectibility of an account receivable is the

Review of the subsequent cash collections.

Collectibility pertains to the assertion of valuation. It is the principal issue with regard to the adequacy of the allowance for doubtful accounts. The best way to determine collectibility is to learn whether the receivable was subsequently collected. A confirmation provides evidence that a contract exists and that the debtor acknowledges the debt, but the subsequent collection of the receivable is the only means of gaining complete assurance that the amount will be paid.

9

To establish illegal “slush funds,” corporations may divert cash received in normal business operations. An auditor would encounter the greatest difficulty in detecting the diversion of proceeds from

Scrap sales.

Because scrap sales often provide little documentary evidence to corroborate cash receipts, it is difficult to detect abstraction of proceeds from unrecorded sales.

10

An auditor is required to confirm accounts receivable if the accounts receivable balances are

Material to the financial statements.

Confirmation of accounts receivable is a generally accepted auditing procedure. The auditor should confirm accounts receivable unless (1) they are immaterial, (2) confirmation would be ineffective, or (3) the RMM based on other procedures is judged to be sufficiently low.

11

Which of the following procedures would be appropriate to test the existence assertion during an audit of accounts receivable?

Sending confirmations to customers.

The existence assertion about account balances at period end is that assets (e.g., accounts receivable), liabilities, and equity interests exist. Thus, external confirmation of accounts receivable by sending requests to customers tests for existence. They must be confirmed unless (1) they are immaterial, (2) confirmation would be ineffective, or (3) the assessed risk of material misstatement is low and other procedures address the risk.

12

An auditor suspects that a client’s cashier is misappropriating cash receipts for personal use by lapping customer checks received in the mail. In attempting to uncover this embezzlement scheme, the auditor most likely would compare the

Dates checks are deposited per bank statements with the dates remittance credits are recorded.

Lapping involves recording current cash payments on accounts receivable as credits to prior customers’ accounts to conceal a theft of cash. Comparing the date that a customer’s check was deposited with the date a record was made to reduce the balance determines whether the deposit was made prior to the recording date.

13

Tracing bills of lading to sales invoices provides evidence that

Shipments to customers were invoiced.

Comparing the seller’s copies of shipping documents (such as bills of lading) with billing documents (sales invoices) provides evidence that the amounts shipped were billed to customers. The absence of invoices for goods shipped would suggest that the related sales were unrecorded at the balance sheet date.

14

An auditor most likely would limit substantive audit tests of sales transactions when the risks of material misstatement are assessed as low for the existence and occurrence assertions concerning sales transactions and the auditor has already gathered evidence supporting

Cash receipts and accounts receivable.

Cash receipts and accounts receivable have a direct relationship with sales. A cash sale results in a debit to cash and a credit to sales. A sale on account results in a debit to accounts receivable and a credit to sales. Thus, evidence related to cash receipts and accounts receivable provides assurances about sales.

15

An entity’s financial statements were misstated over a period of years because large amounts of revenue were recorded in journal entries that involved debits and credits to an illogical combination of accounts. The auditor could most likely have been alerted to this fraud by

Scanning the general journal for unusual entries.

The general journal is a book of original entry used for transactions not suitable for recording in the special journals (sales, purchases, cash receipts, cash disbursements). Entries involving unusual combinations of accounts are more likely to appear in the general journal than in one of the special journals, which are designed to record large numbers of similar items. For example, credit sales (debit accounts receivable, credit sales) are entered in the sales journal.

16

During the process of confirming receivables as of December 31, Year 1, a positive confirmation was returned indicating the “balance owed as of December 31 was paid on January 9, Year 2.” The auditor would most likely

Verify that the amount was received.

Responses to confirmation requests that involve significant differences are investigated by the auditor. Others are delegated to client employees with a request that explanations be given to the auditor. Such differences often arise because of recent cash payments. In that event, the auditor should trace remittances to verify that stated amounts were received.

17

The best evidence regarding year-end bank balances is documented in the

Bank reconciliations.

A bank reconciliation verifies the agreement of the bank statements obtained directly from the institution and the amount of cash reported in the financial statements. These amounts should be equal after adjustment for deposits in transit, outstanding checks, bank charges, etc. Thus, a bank reconciliation documents direct (primary) evidence of the year-end bank balance.

18

The standard AICPA form directed to financial institutions requests all of the following except

The principal amount paid on a direct liability.

The principal amount paid on a direct liability is not listed on the Standard Form to Confirm Account Balance Information with Financial Institutions. The auditor is not concerned with the amount of a liability already paid. The form confirms account number/description, balance, due date, interest rate, date through which interest is paid, and description of collateral.