An auditor has determined that a client's accounts receivable balance has increased because of a general weakness in local economic

conditions. What would the auditor likely do? In this circumstance, an auditor would most likely expand the substantive tests of collectability. The auditor's primary reason to evaluate collectability is to corroborate the valuation assertion. If collectability is in doubt, the auditor may want to suggest that the client increase the provision in the Allowance for Doubtful Accounts account. An auditor generally computes the accounts receivable turnover. How is that statistic determined? Accounts receivable turnover is calculated as the net credit sales for the reporting period divided by the average amount of receivables for the reporting period. A high number indicates that receivables are collected fairly quickly (perhaps credit terms are too strict), whereas a lower number indicates that receivables are collected more slowly (perhaps collection efforts need to be improved). Which management assertion is being evaluated when the auditor analyzes the aging schedule (the aged trial balance) of accounts receivable? The accounts receivable aging schedule is one indication as to the collectability of the accounts receivable. The auditor is evaluating the overall valuation of the accounts receivable balance, including the provision for the allowance of bad debts. In auditing accounts receivable and revenue, what are some potential problems that could exist that would create material misstatements? Potential problems involving accounts receivable and revenue include: 1. Fictitious sales transactions are posted near yearend in order to enhance the reported profitability of the entity. 2. A specific account receivable is collected, but the cash is stolen. Later, the account is written off as uncollectible to cover the theft. 3. Lapped accounts receivable: money is stolen from one or more than one account and then future collections of other accounts are used to cover the original theft. 4. Incorrect year-end cutoff. 5. Incorrectly billed customers. 6. Undisclosed sales to related parties. 7. Shipments of goods on consignment recorded as actual sales.

Why would a company report sales transactions that are false? Recording sales transactions that are false increases reported revenues and net income, at least in the short run. There are many reasons why a company might want to increase reported revenues and net profits: 1. Actual company revenues and net income are below forecasts and market expectations, and reported company financial performance is important for maintaining credibility in investor circles. 2. Employee income is based on bonuses, which in turn are based on reported company profitability. 3. The company plans to issue equity or debt securities. Hence, each of these pressures and incentives would be fraud risk factors, increasing the auditor's assessment of the possibility of fraud and financial statement misstatement. What departments are involved when a company receives an order from a customer for an item of inventory and then that same company ships the merchandise and records the transaction? Departments involved: 1. Sales or Order department - Takes the order and records all needed information. 2. Credit department - Verifies that the customer should be given credit. 3. Warehouse or Finished Goods department Gathers merchandise and delivers it to Shipping department. 4. Shipping department - In charge of sending goods to the customer. 5. Billing department - Reconciles documentation and sends sales invoices to customer. 6. Accounts receivable - Maintains subsidiary ledger indicating customer balance. 7. Collections department - Follows up on invoice by sending account balance reminders to customer. This department will also prepare documentation for any account to be written off. What documents are generated by each of the following departments? 1. Sales department. 2. Credit department. 3. Shipping department. 4. Billing department. 1. The sales department generates the sales confirmation and possibly the internal order to record all pertinent information about the order. This department or the order department may prepare the internal order documentation necessary to process the customer's order. 2. The credit department generally does not create

a new document, but instead marks approval (if appropriate) on the internal customer order. 3. The shipping department generates the bill of lading to record merchandise being shipped out. 4. The billing department compares and matches all applicable documents and prepares a sales invoice. An auditor takes a sample of sales transactions recorded three or four days after year-end for a portion of this subsequent period audit review. The auditor verifies that these transactions are being reported in the proper period. Which assertion is the auditor testing? When an auditor reviews transactions that were not recorded in the period being audited and tests whether they should have been recorded, the auditor is testing the completeness assertion. The completeness assertion is applicable when the auditor seeks to determine whether any transactions have been left out of the reporting period recording process. Just because the transactions are being reported in the subsequent period doe not mean they should not have been reported in the period being audited. When an independent auditor sends out confirmations of accounts receivable balances, what management assertion is being tested? Accounts receivable confirmations are primarily used to help substantiate the existence, the occurrence, and the rights and obligations assertions. The auditor is basically seeking evidence that a reported balance does exist, the the sales transaction did occur, and that the entity has a right to collect the still unpaid debt for the transaction. This confirmation could also be a test of the valuation assertion: whether or not the correct amount of accounts receivable is shown as an asset of the entity. he subsequent period is the time period between the end of the reporting entity's fiscal year and the last day of audit field work. What testing of accounts receivable should be performed during this time period? During the subsequent period, the auditor should look for the following, which might impact the reporting of the year-end accounts receivable balance: 1. Cash collections or receivables reported at yearend corresponding to balances that were reported. This step may alert the auditor to possible accounts receivable adjustments, including account writeoffs.

2. Accounts actually written off as being uncollectible. 3. Sales returns and allowances on year-end accounts receivable items. The auditor should also be alert for any adverse news about significant customers which might indicate an inability to pay open amounts in accounts receivable. The auditor is testing accounts receivable. The auditor selects a sample of sales orders and traces them through the entire accounting information system, form receipt of the customer's sales order to its final recording or impact in the general ledger. Which management assertion is being tested when the auditor starts with transactions at their inception? Why is this activity sometimes referred to as a dualpurpose test? When tracing one or more documents through the entire accounting information system, the auditor is generally ensuring that all transactions and events that should have been recorded have been recorded and that amounts and other data relating to the recorded transactions and events have recorded appropriately. Thus, the auditor is testing the completeness and accuracy assertions. This particular type of test is known as a dualpurpose test because it is used in the substantive testing of the customer's account and in the assessment of control risk. When following the document through the entire accounting information system, the auditor is also checking to see if various control procedures are operating as designe The auditor is testing accounts receivable and selects a number of customer balances within the accounts receivable ending balance and seeks documentation to corroborate (or support) each of these figures. What management assertion is being tested when an auditor starts with a reported account balance and seeks substantiation for it? When an auditor is seeking substantiation for a reported account balance, the auditor is testing the existence and the rights and obligations assertions. The auditor wants to confirm that the reported amount actually does exist and that the entity holds or controls the rights to this asset. During an audit, which document(s) should be used to determine when an accounts receivable item and a sales transaction should be recorded? The sales invoice, which should be supported by the customer's purchase order, provides the free-on-

board (FOB) shipping point, and the bill of lading document indicates the date that the order was shipped. Confirmations are mailed out and a number of them are returned to the auditor with exceptions noted. What are some reasons that these exceptions might have been returned with exceptions, which may require investigation and resolution by the auditor? If confirmations with noted exceptions are returned to the auditor, further investigation and possible adjustments to the accounts receivable balance may be necessary because: 1. Payment was made by the customer prior to the end of the reporting period, but was never recorded by the reporting entity. 2. Shipment of the merchandise was not made until after the end of the reporting period, or shipment of certain merchandise has not actually occurred. 3. Goods have been shipped on consignment so no actual sales transaction has actually occurred. 4. The actual accounts receivable balances is in dispute. Confirmations are mailed out and a number of them are returned to the auditor with exceptions noted. What are some reasons that some of these confirmations with exceptions might not require adjustment? Receivable confirmations could be returned for certain reasons that once resolved do not necessitate the recording of an adjustment to the account balance: 1. Payment was made by the customer, but it was not received by the reporting entity until after the end of the reporting period. 2. The goods were shipped to the customer free-onboard (FOB) shipping point and were in transit at the end of the year. 3. The account was temporarily in dispute until certain information was sent to the customer. This information has now been sent, and the account balance is no longer in dispute. 4. A sales transaction was posted to an incorrect customer's account due to a reporting entity error. This matter has since been resolved. What management assertion is being tested when the auditor reviews a client's credit approval process, which normally takes place before goods are either manufactured or picked and shipped to a customer?

The auditor is testing the credit approval process, which assists in an evaluation of the appropriateness of the accounts receivable allowance for doubtful accounts balance. This is a test of the valuation assertion. Confirmation is a traditional audit test, especially in substantiating accounts receivable. What are the different types of confirmations? The different types of confirmations include: 1. Positive confirmation - Generally provides a balance as of a particular date and asks the customer to indicate whether the balance is correct or not. Positive confirmations can also be a blank confirmation format that simply asks the recipient to fill in an amount or other information and return the document. An invoice confirmation may only show invoice numbers, rather than amounts. 2. Negative confirmation - Provides a balance as of a particular date and asks the customer to respond only if that balance is not correct. 3. Standard bank confirmation - A form approved by the AICPA for use as a convenience to auditors, as well as to bankers, who are the individuals requested to fill out these forms. A bank cut-off statement is another conveniencetype form that is mailed to the bank by the auditor and is then returned to the auditor. When completed, this form verifies the reconciling items on the client's year-end bank reconciliations with evidence that is not accessible to the client An auditor is deciding between using positive confirmations and negative confirmations. How is this decision made? Positive confirmations require more effort and are more costly. However, positive confirmations provide better quality evidence because the customer is asked to respond in every case. Therefore, positive confirmations are more likely to be used when there is additional risk (high inherent or control risk), material (significant) balances, and/or older balances. Conversely, negative confirmations are used when risk levels are low and when balances are small and relatively new. Often, the auditor uses a combination of positive and negative confirmations. When would an auditor place less reliance on confirmations in the testing of accounts receivable?

The auditor's choice of confirmation falls along a continuum, from no confirmations in some circumstances, to using only negative confirmations, to using both negative and positive confirmations, to using only those that are positive. Confirmation of accounts receivable is less critical when the overall receivable balance is small or when it is felt that the customers will not respond to the request: For example, governmental bodies often will not respond to confirmation requests. confirmation is also less important if payment has already been made to the reporting entity. Also, confirmation of receivables may be ineffective if the auditor is hired after the end of the year. In that case, the auditor must substantiate the receivables by some other means. An auditor is hired after the end of the fiscal year and is unable to confirm the accounts receivable amount reported on the client's balance sheet. What alternative methods can the auditor apply that may provide satisfactory audit evidence? If the confirmation of accounts receivable is not possible because of the auditor being hired late, satisfactory evidence about year-end receivables may be obtained in several alternative ways: 1. The auditor can review cash collections after year-end. Collections of amounts owed as of the end of the year provide some evidence that the various accounts receivable balances did exist at year-end. 2. Review of all documentation that was created in connection with the receivable can also provide evidence. In addition, the auditor may want to compare the amount due at the end of the current fiscal year with previous fiscal year-end balances to verify comparability and/or reasonableness. What should the auditor do if positive confirmations are not returned? When positive confirmations are not returned, the auditor should be concerned that perhaps the customer does not exist and that the receivables are fictitious, perhaps in an attempt by the entity to increase not only revenues, but also net income. The auditor can do several things if this situation occurs: 1. Mail a second confirmation to the customer, perhaps this time by registered mail. 2. Call the customer directly. 3. Review the credit file to make sure that there is adequate documentation of the customer's existence.

4. Review subsequent cash payments and the documentation generated in connection with those recent transactions. In an audit, when is the confirmation of receivables normally performed? The confirmation process usually takes a relatively long time. Therefore, it is often begun early in the audit process. The most reliable evidence from confirmations is obtained when they are sent as close to the balance sheet date as possible. However, as a means of completing the audit on a timely basis, it is often necessary to confirm the accounts at an interim date. This action is permissible if internal controls are adequate and inherent risk is reasonably low. A roll-forward schedule is generally used in this process. Assume that a reporting company's accounts receivable turnover figure declines during the current year. What problems might this indicate? If a reporting company's accounts receivable turnover figure has declined during the current reporting year, it is possible that either the reported sales are misstated (i.e., too low) or the reported receivables are misstated (i.e., too high). Possible problems include: 1. Uncollectible accounts are not being recognized and written off. 2. Cash collections are not being reported or are not being recorded on a timely basis. 3. Sales have perhaps remained at the same level or have started to decline, but a higher percentage of customers are now buying on credit or are not paying on a timely basis for one reason or another.