Ch 11

Question 1

Sources of Accounts Receivable

Answer 1

Claims against customers from sale of goods or services.
Loans to officers or employees.
Loans to subsidiaries.
Claims against various other refunds.
Claims for tax refunds.
Advances to suppliers.

Question 2

AR is shown on the balance sheet at

Answer 2

Net realizable value

Question 3

What is the nature/what is contained in notes receivables?

Answer 3

Substantial loans to individuals or companies.

Installment note or contract can allow seller to hold lien on goods. Examples:
Sale of industrial machinery, or farm equipment.

Loans to subsidiaries or other types of related companies.

Loans to officers, employees.

Question 4

Audit risk is significant for receivables because:

Answer 4

Many incidences of fraud have involved overstatement of receivables and revenue.

Revenue recognition may be based on complex accounting rules.
Examples—long term contract accounting
multiple element arrangements

Receivables and revenues are usually subject to valuation using significant accounting estimates.

Question 5

What are the three “steps” to audit receivables and revenue?

Answer 5

1. Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to receivables and revenues.
2. Obtain an understanding of internal control over receivables and revenues.
3. Assess the risks of material misstatement and design tests of controls and substantive procedures that:

Question 6

Assess the risks of material misstatement and design tests of controls and substantive procedures that:

Answer 6

a. Substantiate the existence of receivables and the occurrence of revenue transactions.
b. Establish the completeness of receivables and revenue transactions.
c. Verify the cutoff of revenue transactions.
d. Determine that the client has rights to recorded receivables.
e. Establish the proper valuation of receivables and the accuracy of revenue transactions.
f. Determine that the presentation and disclosure of receivables and revenue are appropriate.

Question 7

In the control environment, internal control over AR and revenue is important because:

Answer 7

Important because of risk of intentional misstatement of revenue.
Commitment to integrity and ethical behavior.
Are estimates of allowance for doubtful accounts developed in a conscientious manner?

Independence of board and audit committee.

Appropriate structure and lines of responsibility.

Commitment to recruit, develop, and retain competent. employees.

Holding employees accountable.

Question 8

Risk assessment is important within internal control over AR and revenue because:

Answer 8

Risk of misstatement of revenue may be high based on its nature and complex rules regarding revenue recognition.

Question 9

Give examples of control activities:

Answer 9

Prepare sales order.
Approve credit.
Issue merchandise from stock.
Shipment.
Billing.
Invoice verification.
Maintenance of control accounts.
Maintenance of customers’ ledgers.
Approval of sales returns and allowances.
Authorization of write-offs of uncollectible accounts.

Question 10

Two examples of monitoring controls:

Answer 10

Management review controls.
Internal audits.

Question 11

Match each revenue cycle to its’ corresponding document: Customer purchasing

Answer 11

Purchase order

Question 12

Match each revenue cycle to its’ corresponding document: Sales

Answer 12

Sales order

Question 13

Match each revenue cycle to its’ corresponding document: Shipping

Answer 13

Bill of lading

Question 14

Match each revenue cycle to its’ corresponding document: Billing

Answer 14

Invoice

Question 15

Match each revenue cycle to its’ corresponding document: Receiving cash receipts.

Answer 15

Control listing

Question 16

Match each revenue cycle to its’ corresponding document: Authorizing adjustments to accounts receivable

Answer 16

Credit memo

Question 17

Match each revenue cycle to its’ corresponding control: Sales and collections

Answer 17

Segregation of duties

Question 18

Match each revenue cycle to its’ corresponding control: Matching of sales invoices and

Answer 18

shipping documents

Question 19

Match each revenue cycle to its’ corresponding control: clerical accuracy checks on

Answer 19

invoices

Question 20

Match each revenue cycle to its’ corresponding control: Credit approval for

Answer 20

sales transactions

Question 21

Match each revenue cycle to its’ corresponding control: mailing of

Answer 21

monthly statements

Question 22

Match each revenue cycle to its’ corresponding control: reconciliation of

Answer 22

bank accounts

Question 23

Match each revenue cycle to its’ corresponding control: use of control listing of

Answer 23

cash receipts

Question 24

Match each revenue cycle to its’ corresponding control: use of budgets and analysis of

Answer 24

variances

Question 25

Match each revenue cycle to its’ corresponding control: control over shipping and

Answer 25

billing documents

Question 26

Match each revenue cycle to its’ corresponding control: use of authorized

Answer 26

credit memoranda

Question 27

Match each revenue cycle to its’ corresponding control: use of chart of accounts and review of

Answer 27

account codings

Question 28

The custodian of notes receivable should not

Answer 28

have access to cash or to the general accounting records.

Question 29

The acceptance and renewal of notes are

Answer 29

authorized in writing by a responsible official who does not have custody of notes.

Question 30

The write-off of defaulted notes are

Answer 30

approved in writing by responsible officials and effective procedures adopted for subsequent follow-up of such defaulted notes.

Question 31

3 audit steps of AR

Answer 31

A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to receivables and revenue.
B. Obtain an understanding of internal control over receivables and revenue.
C. Assess the risks of material misstatement and design further audit procedures.

Question 32

Details on Understanding the Client Business

Answer 32

The types of products and services sold.
The classes and categories of the client’s customers.
Whether the business is affected by seasonal or cyclical demand.
Typical marketing policies for the client and its industry.
Policies regarding pricing, sales returns, discounts, extension of credit, and normal delivery and payment terms.
Compensation arrangements that are based on recorded revenue.
Typical revenue recognition principles used in the industry and their methods of application.

Question 33

Understand controls established by

Answer 33

management to control risks.

Question 34

Determine controls have been

Answer 34

implemented

Question 35

Response to risks. (as an auditor) 3

Answer 35

An overall effect on audit.
Alter the design of audit procedures.
Performing procedures to address risk of material misstatement due to management override of internal control.

Question 36

Go over the red and pink information on slides 15-16!

Question 37

D. Perform further audit procedures—tests of controls. Give examples

Answer 37

a. Test the controls over sales transactions by examining the process of recording the transactions.
b. Trace details of shipping documents to related sales invoices.
c. Review the use and authorization of credit memoranda.
d. Test controls over over-the-counter sales by reconciling cash register tapes or sales tickets with sales journals.
e. Test management review controls.
f. Test controls over accounting estimates related to revenues and receivables.

Question 38

Perform further audit procedures—substantive procedures for receivables and revenue.

Answer 38

Obtain an aged trial balance of trade accounts receivable and analyses of other accounts receivable and reconcile to ledgers.
Obtain analyses of notes receivable and related interest.
Inspect notes on hand and confirm those with holders.
Confirm receivables with debtors.
Review the year-end cutoff of sales transactions.
Perform analytical procedures for accounts receivable, notes receivable, and revenue.
Review significant year-end sales contracts for unusual terms.
Test the valuation of notes receivable, computation of interest income, interest receivable, and amortization of discount or premium.
Evaluate the propriety of the client’s accounting methods for receivables and revenue.
Evaluate accounting estimates related to revenue recognition.
Determine the adequacy of the client’s allowance for uncollectible accounts.
Ascertain whether any receivables have been pledged.
Investigate any transactions with or receivables from related parties.
Evaluate the business purpose of significant and unusual sales transactions.
Evaluate financial statement presentation and disclosure of receivables and revenue.

Question 39

Obtain aged listing of receivables and reconcile to ledgers.
Obtain analyses of notes receivable and related interest.

Answer 39

Valuation and accuracy

Question 40

Inspect notes on hand and confirm those not on hand.

Answer 40

Existence, occurrence, and rights

Question 41

Confirm receivables with debtors.

Answer 41

Existence, occurrence, and rights
Valuation and accuracy

Question 42

Perform analytical procedures or data analytics.
Review significant year-end sales contracts.

Answer 42

Existence, occurrence, and rights
Cutoff
Valuation and accuracy

Question 43

Review the year-end cutoff of sales transactions.

Answer 43

Existence, occurrence, and rights
Cutoff

Question 44

Verify interest earned on notes receivable.

Answer 44

Completeness

Question 45

Evaluate the propriety of client’s accounting for transactions. Evaluate accounting estimates related to revenues and receivables.

Answer 45

Valuation and accuracy

Question 46

Determine adequacy of allowance for uncollectible accounts.

Answer 46

Valuation

Question 47

Ascertain the existence of pledged receivables.
Investigate receivables from related parties.

Answer 47

Presentation and disclosure

Question 48

Evaluate the business purpose of significant and unusual sales transactions.

Answer 48

Valuation and accuracy Presentation and disclosure

Question 49

Evaluate financial statement presentation and disclosure.

Answer 49

Presentation and disclosure

Question 50

Receivables should be confirmed, unless:

Answer 50

Accounts receivable are immaterial,
The use of confirmations would be ineffective, or,
The auditors’ combined assessment of inherent and control risk is low, and audit risk can be reduced to acceptably low level with substantive tests,

Question 51

if client refuses to allow auditors to send confirmations to Customers —

Answer 51

could lead to qualified opinion or disclaimer of opinion

Same result could occur if auditors cannot get written responses

Question 52

Two methods of confirmation of receivables:

Answer 52

Positive confirmations – request addressed to the debtor asking for a reply.
- Ordinarily sent with balances due on them.
- Blank forms – leave amount blank (used less frequently).

Negative confirmations – ask debtor to advise the auditors only if the balance shown is incorrect.
- Low level of assessed risk of material misstatement.
- Large number of small balances.
- A low error rate is expected.
- No reason to believe the respondent will ignore the request.

Question 53

Make the flowchart for the confirmation sequence:

Answer 53

1. Develop audit objectives
2. Choose appropriate confirmation form
3. determine the timing and extent
4. Identify the information to be confirmed
5. Select the accounts for confirmation
6. Prepare and mail the requests
7. send 2nd requests for positive confirmations
8. perform alternative procedures for non-respondents
9. resolve exceptions
10. document the procedures and results

Question 54

Steps for recognition of revenue

Answer 54

Step 1: Identify the Contract. Step 2: Identify the Performance Obligations.
Step 3: Determine the Transaction Price.
Step 4: Allocate the Transaction Price to the Performance Obligations.
Step 5: Recognize Revenue When the Performance Obligations Are Satisfied.

Question 55

Potential Revenue Recognition Problems

Services/items that would have complex/unsual revenue stuff happening

Answer 55

Sales with unusual right to return.
Side agreements.
Franchise fees.
Bill and hold transactions.
Sales using notes with unusual interest rates.
Long-term construction contracts.
Multiple element agreements.

Question 56

Revenue recognition may involve significant accounting estimates.
Auditors can evaluate these estimates by:

Answer 56

Reviewing and testing management’s method of developing the estimates,

Developing their own estimates, or,

Reviewing subsequent transactions and other events that provide evidence about the accuracy of the estimates.

Question 57

The auditors are required to perform a retrospective review of the prior year’s significant

Answer 57

accounting estimates to determine whether they indicate bias on the part of management.

Question 58

Construction industry: compare prior year estimates of costs to ____. This may show ____. Use this information for ___.

Answer 58

complete projects with the actual costs incurred

may show bias on the part of management

use this information for current year audit of estimates

Question 59

What are the steps to audit of allowance for doubtful accounts

Answer 59

Review collections in subsequent period.

Develop estimate and evaluate reasonableness of management estimate.

Compare the details of the aging of accounts receivable to prior years’ aging.

Investigate the credit ratings for delinquent and unusually large accounts.

Review confirmation exceptions for an indication of amounts in dispute or other clues as to possible uncollectible accounts.

Summarize in a working paper those accounts whose collectability is doubtful based on the preceding procedures. List customer names, doubtful amounts, and reasons for considering these accounts doubtful.

Review with the credit manager the current status of significant doubtful accounts.

Compute relationships, such as the number-of-days’-sales in accounts receivable and the relationship of the valuation allowance to (1) accounts receivable and (2) net credit sales.

Question 60

Audit of Allowance for Doubtful Accounts: Review collections in

Answer 60

subsequent period

Question 61

Audit of Allowance for Doubtful Accounts: develop estimate and evaluate reasonableness of

Answer 61

management estimate

Question 62

Audit of Allowance for Doubtful Accounts: compare the details of the aging of AR to

Answer 62

prior years’ aging

Question 63

Audit of Allowance for Doubtful Accounts: investigate the credit ratings for

Answer 63

deliquent and unsually large accounts

Question 64

Audit of Allowance for Doubtful Accounts: review confirmation exceptions for an

Answer 64

indication of amounts in dispute or other clues as to possible uncollectible accounts

Question 65

Audit of Allowance for Doubtful Accounts: summarize in a wp those accounts whose

Answer 65

collectability is doubtful based on the preceding procedures. List customer names, doubtful amounts, and reasons for considering these accounts doubtful.

Question 66

Audit of Allowance for Doubtful Accounts: review with the credit management the current status of

Answer 66

significant doubtful accounts

Question 67

Audit of Allowance for Doubtful Accounts: compute relationships, such as the

Answer 67

number of days’ sales in AR and the relationship of the valuation allowance to 1. AR and 2. net credit sales

Question 68

To identify related party transactions, auditors should review:

Answer 68

Proxy and other filings with S E C or other regulatory agencies.

conflict-of-interest statements by management.

Transactions with unusual terms.

Accounting records for unusual balances or transactions particularly near year-end.

Question 69

Determine that related party transactions are appropriately ____.

Answer 69

disclosed

Question 70

Lead schedules for receivables and net revenue and Working papers. Give examples (generally know these)

Answer 70

Aged trial balance of A/R.
Analyses of other accounts receivable.
Analysis of notes receivable and related interest.
Analysis of allowance for doubtful accounts and notes.
Comparative analyses of revenue.
Documentation of internal control.
Risk analyses and audit plan (program).