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Flashcards in Chapter 7 Deck (74)
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1
Q

An unexplained decrease in the ratio of gross profit to sales may suggest which of the following possibilities?
a) Unrecorded purchases
b) Unrecorded sales
c) Merchandise purchases being charged to SG&A
d) Fictitious sales

A

Correct answer: b) Unrecorded sales

a) COGS too low
c) COGS too low
d) sales too high

Sales – COGS = Gross Profit
10-5=5 (5/10=.5)
8-5=3 (3/8=.375) decreased sales causes a decrease in ratio of gross profit

2
Q

When a sample of customer AR is selected for vouching debits, auditors will vouch them to?
a) Sales invoices with shipping documents and customer sales orders.
b) Records of AR write-offs
c) Cash remittance lists and bank deposit slips.
d) Credit files and reports.

A

a) Sales invoices with shipping documents and customer sales orders.

3
Q

What assertion does the error in sales process map to?

Sales recorded, goods not shipped

A

Existence/occurence

4
Q

What assertion does the error in sales process map to?

Goods shipped, sales not recordedC

A

Completeness

5
Q

What assertion does the error in sales process map to?

Goods shipped to bad credit risk customer

A

Valuation/accuracy

6
Q

What assertion does the error in sales process map to?

Sales billed at the wrong price or wrong quantity

A

Valuation/accuracy

7
Q

What assertion does the error in sales process map to?

Product A sales recorded as Product Line B

A

Presentation/disclosure

Want to be in the correct segment for segmented revenue schedule

8
Q

What assertion does the error in sales process map to?

Failure to post charges to customers for sales

A

Completeness

9
Q

What assertion does the error in sales process map to?

January sales recorded in December

A

Cutoff

10
Q

Is there such thing as a typical revenue and collection cycle?

A

No

11
Q

If shipping, when is revenue recognized?

A

Upon shipping the good

12
Q

Customer Sales Order

A

Details of the type/quantity of products/services ordered by the customer

13
Q

Credit Approval Form

A

Document if credit was granted

14
Q

Open-Order Report

A

Shows all orders that aren’t complete

15
Q

Shipping Document

A

generally serves as the bill of lading

16
Q

Sales Invoice

A

The bill

17
Q

Sales Journal

A

information for sales on credit NOT ALL SALES!! Only capturing when the debit is to A/R. Not capturing cash sales.

18
Q

Bill of Lading

A

a receipt that the carrier gives to the company… consigning goods to shipper temporarily

19
Q

Customer Statement

A

mailed to the customer and contains details of all sales, cash receipts, and credit memorandum transactions

20
Q

Accounts Recievable Subsidiary Ledger

A

can see individual customer accounts

21
Q

Aged Trial Balance of Accounts Receivable

A

for valuation of A/R. How late are payments, what is owed?

22
Q

Remittance Advice

A

what account is the payment for?

23
Q

Cash Receipts Journal

A

Shows cash received

24
Q

Credit Memorandum

A

used to record credits for the return of goods

25
Q

Write-off Authorization

A

authorizes final write-off of AR (generally authorized by the treasurer)

26
Q

Sales Transactions

A

Accounts Receivable (Debit)
Sales (Credit)
Allowance for uncollectible accounts (Credit)
Bad debt expense (Debit)

27
Q

Cash Receipts Transactions

A

Cash (Debit)
Accounts receivable (Credit)
Cash discounts (Debit)

28
Q

Sales returns and allowance transactions

A

Sales returns (Debit)
Sales allowances (Debit)
Accounts Receivable (Credit)

29
Q

When is an assertion considered relevant?

A

if there is a reasonable possibility it could contain a material misstatement

30
Q

Revenue Cycle Inherent Risks

A
  • Inflate revenue to increase profitability
  • Returns and allowances
  • Collectability of receivables
31
Q

Inherent risks of revenue are mostly related to inflating revenue… there is an exception

A

Cookie Jar Reserves – incentive to pull back revenue and time things so they can put revenue into the next period

32
Q

Revenue relevant assertions

A
  • Occurance
  • Completeness
  • Cutoff
33
Q

Accounts receivable relevant assertions

A
  • existence
  • completeness
  • valuation
34
Q

Revenue - Occurrence/Existence

What could go wrong?

A

Management may overstate sales by adding fictitious transactions.

35
Q

Revenue - Occurrence/Existence

Internal Control

A

System requires a shipping document prior to recording revenue.

36
Q

Revenue - Occurrence/Existence

Possible Test of Control

A

Review system control and evidence that it has been in place for entire period. Also, determine who can override the system control. Key thing: needs to be in place for the entire year…

37
Q

Revenue - Occurrence/Existence

Possible substantive test

A

Randomly select sample of sales in sales detail file. Vouch to supporting shipping documents, invoice, customer order. From sales detail file BACK through to the shipping documents.

38
Q

Revenue - Completeness

What could go wrong?

A

Not all sales are recorded.

39
Q

Revenue - Completeness

Internal Control

A

System records revenue upon receiving a shipping document.

40
Q

Revenue - Completeness

Possible Test of Control

A

Review system control and evidence that it has been in place for entire period. Also, determine who can override the system control.

41
Q

Revenue - Completeness

Possible Substantive Test

A
  • Randomly select sample of shipping documents. Trace to recording in sales detail file. (Exactly opposite of the occurrence substantive test.)
  • Randomly select a sample of days and trace total for all shipping documents on those days to sales journal.

Different levels of precision

42
Q

Accounts Receivable - Existence

What could go wrong?

A

Accounts receivable are overstated due to fictitious transactions.

43
Q

Accounts Receivable - Existence

Internal Control

A

System requires a shipping document prior to recording accounts receivable.

44
Q

Accounts Receivable - Existence

Possible Test of Control

A

Review system control and evidence that it has been in place for entire period. Also, determine who can override the system control.

45
Q

Accounts Receivable - Existence

Possible Substantive Test

A

Randomly select sample of customer accounts in accounts receivable subsidiary file. Confirm these accounts receivable.

46
Q

What are confirmations useful for verifying?

A

Existence

(also provides evidence for rights and obligations)

47
Q

What are factors that are likely to affect the reliability of confirmations?

A
  • Intended recipient of the confirmation
  • Type of information being confirmed (entire balance versus individual transactions)
  • Type of confirmation being sent
48
Q

Cash confirmations

A

Confirming with the bank - typically electronic confirmations

49
Q

Accounts receivable confirmations

A

Higher probability you see paper confirmations

50
Q

Why are confirmations not great for verifying valuation?

A

(incentive on behalf of the confirming party) – If the company messes up and says you only owe $80 when you actually owe $100… I have incentive to say oh yeah, I only owe $80.

51
Q

________ essentially requires confirmations to be used.

A

PCAOB

52
Q

Positive Confirmation

A

Asks whether the balance is correct / incorrect

53
Q

When are positive confirmations used?

A
  • Small number of accounts are involved
  • Large number of errors are anticipated
54
Q

Blank confirmations

A

Should be used if the recipient is likely to return a positive confirmation without verifying the accuracy of the information get the customer to fill it in

55
Q

Negative Confirmations

A

Asks for a response only if something is wrong

56
Q

When should negative confirmations be used?

A
  • the assessed level of risk of material misstatement is low
  • a large number of small balances is involved materiality will not be affected by small balances most likely
  • the client’s customers can be expected to consider the confirmations properly
57
Q

Which provides more assurance… positive or negative confirmation?

A

Positive confirmations

(you don’t know if a negative confirmation is a real response or if they just aren’t responding because they don’t know how to appropriately deal with the confirmation)

58
Q

“Please examine the data below carefully and either confirm its accuracy or report any differences directly to our auditors using the enclosed reply envelope.”

A

Positive confirmation letter

59
Q

“Please examine the data below carefully and compare them to your records of your account with us. If the information is not in agreement with your records, please state any differences below and return directly to our auditors in the return envelope provided, fi the information is correct, no reply is necessary.”

A

Negative confirmation letter

60
Q

Responses to positive confirmations provide _______ _________ evidence than negative nonresponses.

A

more reliable

61
Q

Recipients of account receivable confirmations might not…

A

report understatements

62
Q

Auditors must have heightened professional skepticism for…

A

unexpected responses

63
Q

What are some examples of unexpected responses?

A
  • responses via fax or email instead of mail
  • All confirmations returned by the post office as non-deliverable must be investigated. The address is incorrect, the PO tries to deliver it, but it is sent back to be if they fail at delivering it. Is it a fake customer? Why does the client not know the customer’s address?
64
Q

What should auditors do about non-response to positive confirmation requests?

A
  • Follow up with second and sometimes third requests
  • A lower-than-expected response rate could be indicative of fictitious customer accounts
  • Follow-up on all exceptions
  • Alternative procedures (special audit term) at a certain point you have to do something else that you didn’t plan to do, the original plan didn’t provide the evidence that they wanted it to provide
65
Q

What is the trade-off between positive and negative confirmations?

A

Depends on the magnitude and risk associated with the receivables portfolio, as well as the likelihood of getting responses.

66
Q

What is a common strategy for sending positive and negative confirmations?

A

send positive confirmations on individually significant balances and negative confirmations for a sample of other accounts.

67
Q

What are some confirmation alternative procedures?

A
  • Vouch to subsequent cash collections
  • Examine shipping documents
  • Examine supporting documentation, such as sales orders, invoices, and shipping documents
  • Inspect correspondence files for past due accounts
68
Q

Vouching to subsequent cash collections is usually sufficient evidence of what?

A

Existence and valuation
Why would someone pay money if they didn’t owe that money?

69
Q

What shipping documents should be examined as an alternative procedure?

A

Bill of lading (third party evidence)

70
Q

Examining supporting documentation, such as sales orders, invoices, and shipping documents depends on what?

A

Internal controls: if the company has really good controls this would provide really good evidence (if not… not as reliable)

71
Q

Accounts Receivable - Valuation

What could go wrong?

A

The uncollectible portion of accounts receivable is not properly estimated.

72
Q

Accounts Receivable - Valuation

Internal Control

A

Management evaluates the collectability of delinquent receivables on a timely basis.

73
Q

Accounts Receivable - Valuation

Possible Test of Control

A

Inspect documentation for evidence of timely evaluation.

74
Q

Accounts Receivable - Valuation

Possible Substantive Test

A
  • Compare write-offs to estimates of doubtful accounts (Substantive analytical procedure).
  • Randomly select sample of customer accounts more than 90 days overdue. - - - Inspect evidence of collectability and inquire of credit manager.
    Recalculate allowance and bad debt expense.