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Chapter 14

Audit of the Sales and Collection Cycle:


Tests of Controls and Substantive
Tests of Transactions

 Review Questions
14-1 a. The bill of lading is a document prepared at the time of shipment of
goods to a customer indicating the description of the merchandise, the
quantity shipped, and other relevant data. Formally, it is a written
contract of the shipment and receipt of goods between the seller and
carrier. It is also used as a signal to bill the client. The original is sent
to the customer and one or more copies are retained.
b. A sales invoice is a document indicating the description and quantity
of goods sold, the price including freight, insurance, terms, and other
relevant data. It is the method of indicating to the customer the
amount owed for the sale and the due date of the payments. The
original is sent to the customer and one or more copies are retained.
The sales invoice is the document for recording sales in the
accounting records.
c. The credit memo is a document indicating a reduction in the amount
due from a customer because of returned goods or an allowance
granted. It often takes the same general form as a sales invoice, but it
reduces the customer's accounts receivable balance rather than
increasing it.
d. The remittance advice is a document that accompanies the sales
invoice mailed to the customer and can be returned to the seller with
the payment. It is used to indicate the customer name, sales invoice
number, and the amount of the invoice when the payment is received.
A remittance advice is used to permit the immediate deposit of cash
receipts as a means of improving control over the custody of assets.
e. The monthly statement to customers is the document prepared
monthly and sent to each customer indicating the beginning balance
of that customer's accounts receivable, the amount and date of each
sale, cash payments received, credit memos issued, and the ending
balance due. It is, in essence, a copy of the customer's portion of the
accounts receivable master file.
14-2 Proper credit approval for sales helps minimize the amount of bad debts
and the collection effort for accounts receivable by requiring that each sale be
evaluated for collection potential.
Adequate controls in the credit function enable the auditor to place more
reliance on the client's estimate of uncollectible accounts. Without these controls,
the auditor would have to make his or her own credit checks on the customers in
order to be convinced that the allowance for uncollectible accounts is reasonable.

14-1
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14-3 The sales journal contains the record of each sales transaction that includes
the customer name, date, amount, and the account classification for each
transaction. The sales journal generally represents the record of each individual
transaction. Typically, the sales journal accumulates transactions for a period of
time, which is often monthly. Transactions recorded in the sales journal are then
posted to the general ledger, and if the transaction is for sales on account the
accounts receivable master file is updated for each transaction.
The accounts receivable master file is used to record individual sales, cash
receipts, and sales returns and allowances for each customer and to maintain
customer account balances. The master file is updated using data from the sales
journal, sales return journal, cash receipts journal. The total in the accounts receivable
master file equals the total in the accounts receivable general ledger account.

14-4 BestSellers.com could integrate its online ordering system with its inventory
system so that a book shipment is made only after the customer’s credit card
company approves the customer’s purchase. Because credit card issuers often
transfer funds electronically almost immediately after a sale, BestSellers.com could
also set up their system to ship books only after payment has been received by the
credit card issuer. Finally, BestSellers.com could arrange with an online credit
service bureau to run credit checks on customers purchasing over a preset
minimum amount. Although BestSellers.com sells its goods through the Internet, the
company should still record sales revenue when the books are shipped to
customers.

14-5

TRANSACTION-RELATED
AUDIT OBJECTIVE KEY INTERNAL CONTROLS
1. Recorded sales are for  Recording of sales is supported by authorized
shipments actually made shipping documents and approved customer
to existing customers orders.
(occurrence).  Credit is authorized before shipment takes
place.
 Sales invoices are prenumbered and properly
accounted for.
 Only customer numbers existing in the
computer data files are accepted when they
are entered.
 Monthly statements are sent to customers;
complaints receive independent follow-up.
2. Existing sales  Shipping documents are prenumbered and
transactions are recorded accounted for.
(completeness).  Sales invoices are prenumbered and
accounted for.

14-2
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14-5 (continued)

TRANSACTION-RELATED
AUDIT OBJECTIVE KEY INTERNAL CONTROLS
3. Recorded sales are for the  Determination of prices, terms, freight, and
amount of goods shipped discounts is properly authorized.
and are correctly billed and  Internal verification of invoice preparation.
recorded (accuracy).  Approved unit selling prices are entered into
the computer and used for sales.
 Batch totals are compared with computer
summary reports.
4. Sales transactions are  Regular monthly statements sent to
properly included in the customers.
accounts receivable master  Internal verification of accounts receivable
file and are correctly master file contents.
summarized (posting and  Comparison of accounts receivable master file
summarization). or trial balance with general ledger balance.
5. Sales transactions are  Use of adequate chart of accounts.
properly classified  Internal review and verification of the account
(classification). classifications.
6. Sales are recorded on the  Procedures requiring billing and recording of
correct dates (timing). sales on a daily basis as close to the time of
occurrence as possible.
 Internal verification of timely recording of
transactions.

14-6

Tests of controls:

1. On a sample of sales invoices, examine proper authorization and


indication of internal verification of sales amounts.
2. Examine approved computer printout of unit selling prices.
3. Examine file of batch totals for initials of data control clerk; compare
totals to summary reports.

Substantive tests of transactions:

1. Recompute information on sales invoices.


2. Trace entries in sales journal to related sales invoices.
3. Trace detail on sales invoices to shipping documents, approved price
lists, and customers' orders.

14-3
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14-7 The most important duties that should be segregated in the sales and
collection cycle are:

1. Receiving orders for sales


2. Shipping goods
3. Billing customers and recording sales
4. Maintaining inventory records
5. Maintaining general accounting records
6. Maintaining detailed accounts receivable records
7. Processing cash receipts
8. Granting credit and pursuing unpaid accounts

Segregation of duties should be used extensively in the sales and collection


cycle for two reasons. First, cash receipts are subject to easy manipulation. Second,
the large number and nature of transactions within the cycle make the procedure of
cross-checking, where one employee's duties automatically serve to verify the
accuracy of another's, highly desirable.
If the asset-handling activities (shipping goods and processing cash
receipts) are combined with their respective accountability activities (maintaining
inventory, accounts receivable, and general accounting records), a serious deficiency
with respect to safeguarding those assets exists. It would be easy for an employee,
by either omitting or adding an entry, to use the company's assets for his or her own
purpose. If the credit granting function is combined with the sales function, there
may be a tendency of sales staff to optimize volume even at the expense of high
bad debt write-offs.

14-8 The use of prenumbered documents is meant to prevent the failure to bill or
record sales as well as to prevent duplicate billings and recordings. An example of a
useful control to provide reasonable assurance that all shipments are billed is for the
billing clerk to file a copy of all shipping documents in sequential order after a
shipment has been billed. Periodically, someone can account for all numbers in the
sequence and investigate the reason for missing documents. Computer programs
can be used to identify gaps and duplicates in the sequence. The same type of a
useful test in this area is to account for the sequence of duplicate sales invoices in
the sales journal, watching for omitted numbers, duplicate numbers, or invoices
outside the normal sequence. This test simultaneously provides evidence of both
the occurrence and completeness objectives.

14-4
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14-9 1. Credit is authorized before a sale takes place.

Test: Analyze the allowance for uncollectible accounts and write-offs


of accounts receivable during the period to determine the
effectiveness of the credit approval system.

2. Goods are shipped only after proper authorization.

Test: Review physical inventory shortages to determine the


effectiveness of inventory control.

3. Prices, including payment terms, freight, and discounts, are properly


authorized.

Test: Compare actual price charged for different products, including


freight and terms, to the price list authorized by management.

14-10 The purpose of footing and crossfooting the sales journal and tracing the
totals to the general ledger is to determine that sales transactions are properly
included in the accounts receivable master file and are correctly summarized. The
auditor will make a sample selection from the sales journal to perform tests of
controls and substantive tests of transactions, so he or she must determine that the
general ledger agrees with the sales journal.

14-11 The verification of sales returns and allowances is quite different from the
verification of sales for three primary reasons:

1. Sales returns and allowances are normally an insignificant portion of


operations and therefore receive little attention from the auditor.
2. The primary emphasis the auditor places on sales returns and
allowances is to determine that returns and allowances are properly
authorized and that sales are not overstated at year-end and
subsequently reversed by the issuance of returns.
3. The completeness objective cannot be ignored because unrecorded
sales returns and allowances can materially overstate net income.

14-12 Cash is the most liquid asset that a company owns and thus it is the most
likely target of misappropriation. The emphasis the auditor places on the possibility
of misappropriation of cash is not inconsistent with his or her responsibility, which is
to determine the fairness of the presentation of the financial statements. If material
fraud has occurred, and it is not fully disclosed in the financial statements, those
statements are not fairly presented.

14-5
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14-13

TRANSACTION-RELATED
AUDIT OBJECTIVE KEY INTERNAL CONTROLS
1. Recorded cash receipts are for  Separation of duties between
funds actually received by the handling cash and record keeping.
company (occurrence).  Independent reconciliation of bank
accounts.
2. Cash received is recorded in the  Separation of duties between
cash receipts journal handling cash and record keeping.
(completeness).  Use of remittance advices or a
prelisting of cash.
 Immediate endorsement of incoming
checks.
 Internal verification of the recording
of cash receipts.
 Regular monthly statements to
customers.
3. Cash receipts are deposited and  Same as 2 above.
recorded at the amounts received  Approval of cash discounts.
(accuracy).  Regular reconciliation of bank
accounts.
 Batch totals are compared with
computer summary reports.
4. Cash receipts are properly included  Regular monthly statements to
in the accounts receivable master customers.
file and are correctly summarized  Internal verification of accounts
(posting and summarization). receivable master file contents.
 Comparison of accounts receivable
master file or trial balance totals with
general ledger balance.
5. Cash receipts transactions are  Use of adequate chart of accounts.
properly classified (classification).  Internal review and verification.
6. Cash receipts are recorded on the  Procedure requiring recording of
correct dates (timing). cash receipts on a daily basis.
 Internal verification.

14-6
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14-14 Audit procedures that the auditor can use to determine whether all cash
receipts were recorded are:

 Discussion with personnel and observation of the separation of duties


between handling cash and record keeping.
 Account for numerical sequence of remittance advices or examine
prelisting of cash receipts.
 Observe immediate endorsement of incoming checks.
 Examine indication of internal verification of the recording of cash
receipts.
 Observe whether monthly statements are sent to customers.
 Trace from remittance advices or prelisting to cash receipts journal.

14-15 Proof of cash receipts is a procedure to test whether all recorded cash
receipts have been deposited in the bank account. In this test, the total cash
receipts recorded in the cash receipts journal for a period of time, such as a month,
are reconciled to the actual deposits made to the bank during the same time period.
The procedure is not useful to discover cash receipts that have not been recorded in
the journals or time lags in making deposits, but it is useful to discover recorded
cash receipts that have not been deposited, unrecorded deposits, unrecorded loans,
bank loans deposited directly into the bank account, and similar misstatements.

14-16 Lapping is the postponement of entries for the collection of receivables to


conceal an existing cash shortage. The fraud is perpetrated by someone who records
cash in the cash receipts journal and then enters them into the computer system.
The person defers recording the cash receipts from one customer and covers the
shortage with receipts from another customer. These in turn are covered by the
receipts from a third customer a few days later. The employee must either continue
to cover the shortage through lapping, replace the stolen money, or find another way
to conceal the shortage.
This fraud can be detected by comparing the name, amount and dates
shown on remittance advices to cash receipts journal entries and related duplicate
deposit slips. Since the procedure is relatively time-consuming, auditors ordinarily
perform the procedure only where there is a specific concern with fraud because of
internal control deficiencies discovered.

14-17 The audit procedures most likely to be used to verify accounts receivable
charged off as uncollectible and the purpose of each procedure are as follows:

 Examine approvals by the appropriate persons of individual accounts


charged off. The purpose is to determine that charge-offs are approved.
 Examine correspondence in client's files that indicates the uncollectibility
of the accounts for a selected number of write-offs. The purpose is to
determine that the account appears to be uncollectible.
 Examine Dun and Bradstreet credit records as an indication of the
uncollectibility of an account. The purpose is the same as the previous
procedure.

14-7
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14-17 (continued)
 Consider the reason for the charge-off compared to the company policy
for writing off uncollectible accounts. The purpose is to determine
whether or not company policy is being followed.
14-18 The primary objective of the tests of controls and substantive tests of
transactions for sales and cash receipts is to determine whether or not the auditor
may rely on internal controls to produce accurate information. If it is determined
through tests of controls and substantive tests of transactions that the system
provides reliable information as to accounts receivable balances, the auditor may
reduce the sample size for the confirmation of accounts receivable and adjust the
type of confirmation and timing of the tests. If the system is not considered effective
because of deficiencies in internal control, the sample size must be increased,
positive confirmations will probably be necessary, and the confirmations will most
likely be as of the balance sheet date.
14-19 It is often acceptable to perform tests of controls and substantive tests of
transactions at an interim date. The auditor may decide it is necessary to test the
untested period at year-end. It is acceptable to perform tests of controls and
substantive tests of transactions for sales and cash receipts at an interim date and
not perform additional tests of the system at year-end under the following
circumstances:
 The auditor believes that internal controls are effective.
 The auditor does not anticipate significant changes in the internal
controls during the remaining period.
 The transactions normally occurring between the completion of the
tests of controls and substantive tests of transactions and the end of
the year are similar to the transactions prior to the test date.
 The remaining period is not too long.
14-20 Generally, successful tests of controls and substantive tests of transactions
allow for a reduction of tests of details of balance at year-end. However, Diane
Smith chose the month of March, which only represents one-twelfth of the year, as
her test period. With such a short test period, Diane cannot conclude that she has
selected a representative sample from the total population; therefore, without testing
additional months (consensus of several CPA firms requires at least nine months
coverage), Diane should not change the scope of her tests of details of balances at
year-end.

 Multiple Choice Questions From CPA Examinations


14-21 a. (4) b. (4) c. (3)
14-22 a. (4) b. (3) c. (1) d. (1)
14-23 a. (4) b. (4) c. (2)

14-8
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 Discussion Questions and Problems

14-24 1. a. Recorded sales are for the amount of goods ordered and are
correctly billed and recorded. (Accuracy)
b. Examine indication of internal verification on sales documents.
c. Incorrect prices may be charged, the customer may be billed
for the wrong quantity, or the total amount may be computed
incorrectly.
d. Recompute information on the sales invoices. Trace details on
sales invoices to shipping records, price lists, and customers'
orders.
2. a. Recorded sales and credit transactions are for shipments
actually made and existing sales transactions are recorded.
(Occurrence and Completeness)
b. Account for the numerical sequences of sales orders, invoices,
and credit memoranda.
c. Shipments or returns are not recorded. Orders from customers
are misplaced and not filled.
d. Examine correspondence concerning credit memoranda to
assure that they were properly issued. Trace sample of shipping
documents to related sales invoices and entries into the sales
journal and accounts receivable master file. Confirm accounts
receivable.
3. a. Existing transactions are recorded; recorded transactions exist.
(Completeness and Occurrence)
b. The auditor should observe the employees and discuss the
procedures with personnel.
c. Sales could be made and not recorded, with the employee
keeping the proceeds of the sale.
d. Trace selected shipping documents to related duplicate sales
invoices, the sales journal, and accounts receivable master file.
4. a. Existing transactions are recorded. (Completeness)
b. Online shipping documents are prenumbered and accounted
for weekly.
c. Online sales could be made but not recorded.
d. Select a sample of online shipments (using the prenumbered
online shipping documents), and trace to a sales invoice, sales
journal or listing, and the accounts receivable master file.
5. a. Existing transactions are recorded. (Completeness)
b. The auditor should observe the activities of those employees
and discuss the procedures with personnel.
c. These unusual sales could be made but not recorded and the
proceeds kept from the company.
d. Examine sales documents for these sales and trace the entries
into the cash receipts journal.

14-9
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14-24 (continued)

6. a. Existing transactions are recorded and recorded sales are


for the amount of goods ordered and are correctly billed.
(Completeness and Accuracy)
b. The auditor should observe the activities of employees and
discuss the procedures with personnel.
c. A receivable might intentionally not be recorded, allowing the
cash to be kept from the company.
d. Trace from the shipping records to the sales invoice, to the
accounts receivable master file, and to the cash receipts journal.

7. a. Sales and cash receipts transactions are properly included in


the accounts receivable master file and are correctly summarized.
(Posting and summarization)
b. Observation of procedures and examination of indication of
internal verification.
c. Unintentional errors could be posted in the control accounts
and left undetected for long periods of time.
d. Perform tests of clerical accuracy―foot journals and trace
postings from journal to general ledger and accounts receivable
master file.

8. a. Existing cash receipts transactions are recorded. (Completeness)


b. Observation and discussion of procedures with employees.
c. Cash could be received, not recorded, and kept from the
company by an employee or lost prior to deposit.
d. Trace receipts recorded on a list such as from a prelisting of
cash to the books of original entry. Confirm accounts receivable.

9. a. Transactions are recorded on the correct dates. (Timing)


b. Compare date per books to the date that the deposit appears
on the bank statement.
c. Cash receipts might be recorded in the wrong accounting
period, lost, or stolen.
d. Trace cash recorded on a list, such as a prelisting of cash, to
the cash receipts journal and to the bank statement.

14-25 1. a. Test of control


b. Existing sales transactions are recorded. (Completeness)
c. Documentation

2. a. Test of control
b. Recorded sales are for shipments actually made to existing
customers. (Occurrence)
c. Documentation

14-10
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14-25 (continued)

3. a. Substantive test of transactions


b. Recorded sales are for the amount of goods shipped. (Accuracy)
c. Documentation

4. a. Substantive test of transactions


b. Sales transactions are properly included in the accounts
receivable master file and are correctly summarized. (Posting
and summarization)
c. Reperformance

5. a. Test of control
b. Recorded sales returns are for returns from existing customers.
(Occurrence)
c. Documentation

6. a. Test of control
b. (1) Cash received is recorded in the cash receipts journal.
(Completeness)
(2) Cash receipts are recorded on the correct dates. (Timing)
c. Observation or documentation

7. a. Substantive test of transactions


b. (1) Recorded receipts are for funds actually received by the
company. (Occurrence)
(2) Cash received is recorded in the cash receipts journal.
(Completeness)
(3) Cash receipts are deposited at the amount received.
(Accuracy)
(4) Cash receipts are recorded on the correct dates. (Timing)
c. Documentation

14-26 a. Objective 1 A given sale is recorded more than once, or a sale is


recorded for which a shipment was not made.
Objective 2 A shipment took place for which no sale was recorded.
Objective 3 A sales journal was incorrectly footed, or a sales
transaction was posted to the incorrect customer
account.

b. The first objective deals with overstatement of sales resulting from


recording sales for which no shipment had occurred. The second
objective concerns understatement of sales. It results from a shipment
that has not been recorded.

c. Procedures 2, 3, and 4 are tests of controls. Procedures 1, 5, and 6


are substantive tests of transactions.

14-11
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14-26 (continued)

d.

(3)
(1) (2) POSTING AND
OCCURRENCE COMPLETENESS SUMMARIZATION
SUBSTANTIVE Procedure Procedure Procedure
TEST OF 6 1 5
TRANSACTIONS
TEST OF Procedure Procedure Procedure
CONTROL 2 4 3

e.

NATURE OF
MISSTATEMENT
PROCEDURE CONTROL BEING TESTED TRYING TO PREVENT
2 A shipping document is To prevent billing to a
attached to each duplicate customer or recording a
sales invoice. sale for which no shipment
has been made.
3 An independent person Preventing misstatements
traces from the sales journal in failure to post to the
to the accounts receivable accounts receivable master
master file. A tick mark is file, posting to the wrong
shown in the margin of the customer, at the wrong
sales journal after a amount, or at the wrong
transaction is traced. date.
4 At the time of billing, the The failure to bill
duplicate sales invoice customers for shipments
number is written on the actually made.
bottom left-hand corner of
each shipping document.
Periodically, the entire
sequence of shipping
documents is accounted for
and each is examined to
make certain there is an
invoice number, which
indicates that a given
shipment has been billed.

14-27 a. (4) b. (2) c. (3)

14-12
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14-28

TEST OF CONTROL
OR SUBSTANTIVE TRANSACTION-
TEST OF RELATED AUDIT
TRANSACTIONS OBJECTIVE(S) SUBSTANTIVE TEST
1. S T of T Accuracy Not applicable
2. S T of T Posting and Not applicable
summarization
3. T of C Accuracy Compare unit selling prices on
duplicate sales invoices to the
approved price list.
4. T of C Classification Examine a sample of sales
transactions to determine if
each one is correctly classified
in the sales journal.
5. S T of T Classification Not applicable
6. S T of T Completeness Not applicable
Accuracy
Timing
Posting and
summarization
7. S T of T Occurrence Not applicable
Completeness
Accuracy
Timing
8. T of C Accuracy Recalculate the cash
discounts for a sample of
remittances and determine
whether each one was
consistent with company
policy.
9. T of C Completeness Trace from a sample of
remittance advices to the cash
receipts journal to determine if
the related cash is recorded.

14-13
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14-29

POSSIBLE ERROR OR FRAUD CONTROL


1. Invoices for goods sold are posted c. Monthly statements are mailed to
to incorrect customer accounts. all customers with outstanding
balances.
2. Goods ordered by customers are g. Shipping documents are
shipped, but not billed to anyone. compared with sales invoices
when goods are shipped.
3. Invoices are sent for shipped f. Daily sales summaries are
goods, but are not recorded in the compared with sales invoices
sales journal. when goods are shipped.
4. Invoices are sent for shipped k. Control amounts posted to the
goods and are recorded in the accounts receivable ledger are
sales journal, but are not posted to compared with the control totals
any customer account. of invoices.
5. Credit sales are made to i. Customer orders are compared
customers with unsatisfactory to an approved customer list.
credit ratings.
6. Goods are removed from inventory b. Approved sales orders are
for unauthorized orders. required for goods to be removed
from the warehouse.
7. Goods shipped to customers do d. Shipping clerks compare goods
not agree with goods ordered by received from the warehouse
customers. with approved sales orders.
8. Invoices are sent to colluding h. Sales invoices are compared
parties in a fraudulent scheme and with shipping documents and
sales are recorded for fictitious approved customer orders before
transactions. invoices are mailed.

14-14
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14-30 a.

DEFICIENCY RECOMMENDED IMPROVEMENT


1. Financial secretary exercises too To extent possible, financial
much control over collections. secretary's responsibilities should
be confined to record keeping.
2. Finance committee is not Finance committee should assume
exercising its assigned a more active supervisory role.
responsibility for collection.
3. The finance committee is An audit committee should be
responsible for the auditing appointed to perform periodic
function and administration of the auditing procedures or engage
cash function. Moreover, the outside auditors.
finance committee has not
performed the auditing functions.
4. The head usher has sole access to The number of counters should be
cash during the period of the count. increased to at least two, and cash
One person should not be left should remain under joint
alone with the cash until the surveillance until counted and
amount has been recorded or recorded so that any discrepancies
control established in some other will be brought to attention.
way.
5. The collection is vulnerable to The collection should be deposited
robbery while it is being counted in the bank's night depository
and from the church safe prior to its immediately after the count.
deposit in the bank. 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.
6. The head usher's count lacks The financial secretary should
usefulness from a control receive a copy of the collection
standpoint because he surrenders report for posting to the financial
custody of both the cash and the records. The head usher should
record of the count. maintain a copy of the report for
use by the audit committee.

14-15
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14-30 (continued)

DEFICIENCY RECOMMENDED IMPROVEMENT


7. Contributions are not deposited Contributions should be deposited
intact. There is no assurance that intact. If it is considered necessary
amounts withheld by the financial for the financial secretary to make
secretary for expenditures will be cash expenditures, he should be
properly accounted for. provided with a petty cash fund. The
fund should be replenished by a
check based upon a properly
approved reimbursement request
and satisfactory support.

8. Members are asked to draw Members should be asked to make


checks to "cash," thus making the checks payable to the church. At the
checks completely negotiable and time of the count, ushers should
vulnerable to misappropriation. stamp the church's restrictive
endorsement (For Deposit Only) on
the back of the check.
9. No mention is made of bonding. Key employees and members
involved in receiving and disbursing
cash should be bonded.
10. Written instructions for handling Especially because much of the
cash collections apparently have work involved in cash collections is
not been prepared. performed by unpaid, untrained
church members, often on a short-
term basis, detailed written
instructions should be prepared.
11. The envelope system has not been The envelope system should be
encouraged. Control features that it encouraged. Ushers should indicate
could provide have been ignored. on the outside of each envelope the
amount contributed. Envelope
contributions should be reported
separately and supported by the
empty collection envelopes.
Prenumbered envelopes will permit
ready identification of the donor by
authorized persons without general
loss of confidentiality.

14-16
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14-31

a. b. c.
TRANSACTION
STRENGTH OR RELATED
INTERNAL CONTROL DEFICIENCY AUDIT OBJECTIVE NATURE OF DEFICIENCY
1. Credit is granted by a Strength Occurrence of sales.
credit department.
2. Sales returns are Deficiency Prenumbered receiving reports should be
presented to a sales prepared by receiving department clerks
department clerk who immediately upon receipt of returned goods.
prepares a written, A duplicate copy of the receiving report should be
prenumbered receiving sent to the credit department for approval and
report. preparation of a credit memorandum that is then
forwarded to accounting to record the sales
return.
14-17

3. Statements are sent Strength • Occurrence of sales


monthly to customers. • Accuracy of sales
• Posting and
summarization of sales
• Completeness of
cash receipts
• Accuracy of cash
receipts
• Posting and
summarization of
cash receipts
4. Write-offs of accounts Deficiency This is an inappropriate segregation of duties.
receivable are approved The controller has recordkeeping responsibilities.
by the controller. The write-off of accounts involves authorization
responsibilities. The write-offs should be
approved by the credit department, not the
controller.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com

14-31 (continued)

a. b. c.
TRANSACTION
STRENGTH OR RELATED
INTERNAL CONTROL DEFICIENCY AUDIT OBJECTIVE NATURE OF DEFICIENCY
5. Cash receipts received in Strength Completeness of cash
the mail are received by a receipts.
secretary with no record-
keeping responsibility.
6. Cash receipts received in Deficiency This represents inadequate segregation of duties
the mail are forwarded because it gives custody of the cash to those in
unopened with remittance accounting who are responsible for recordkeeping
advices to accounting. activities. Personnel in accounting could
misappropriate cash receipts and alter accounting
records to hide the fraud.
7. The cash receipts journal Deficiency The cash receipts journal represents the primary
is prepared by the accounting record for all cash received. It should
14-18

treasurer’s department be prepared by personnel within the accounting


function, not the treasury function. The treasury
function has primarily responsibilities surrounding
the custody of cash. Thus, they should not have
any recordkeeping responsibilities.
8. Cash is deposited weekly. Deficiency Cash should be deposited at least daily to prevent
loss or theft of cash.
9. Once shipment occurs and Strength Completeness of sales.
is recorded in the sales
journal, all shipping
documents are marked
“recorded” by the
accounting staff.
10. The bank reconciliation is Strength • Occurrence of cash
prepared by individuals receipts
independent of cash • Completeness of cash
receipts recordkeeping. receipts
• Accuracy of cash receipts
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com

14-32

TRANSACTION-
RELATED
AUDIT POTENTIAL FINANCIAL STATEMENT
CONTROL OBJECTIVE MISSTATEMENT IF CONTROL IS ABSENT
1. Occurrence Sales may be recorded for invalid or non-
existent products.

Accuracy Sales may be processed based on


inaccurate price information.
2. Occurrence Sales may be recorded for non-existent
products.

Accuracy Sales may be processed for existing


products using quantities ordered, even
when ordered quantities are not on hand.
3. Occurrence Sales may be processed for customers who
are unable to pay.
4. Occurrence Shipments may be made to persons making
an unauthorized credit card purchase (e.g.,
with a stolen credit card).
5. Accuracy Sales may be processed inaccurately (e.g.,
wrong product, wrong price, wrong quantity).
6. Occurrence Sales may be recorded even though
shipment has not occurred.

Timing Sales may be recorded in the wrong time


period.

14-19
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com

■ Case
14-33 a.

Objective Key Controls Test of Controls Substantive Test


of Transactions
Recorded credit Controller handles Review credit Select credit memos
memos are made to all requests (C1). memos for proper from the sales
non-fictitious Controller reviews authorizations journal and trace to
customers all credit memos original sale. Verify
(occurrence) (C2). original customer
Credit memos are and sale.
authorized by a
second party (C3).
Credit memos are All credit memos Review that log is Review credit memo
complete are documented in prepared and log and test to
(completeness) a log. requests are actual credit memo
All credit memos forwarded to the to ensure credit
are forwarded to the Controller. memo is recorded.
Controller.

b. Adequacy of Sales Return Allowance can be tested through


1. Analytical Procedures – develop independent estimate and compare.
2. Comparison to Sales.
3. Comparison to A/R.
4. Compare to actual bad debt write offs and sales returns.

c. The fact that the A/R Allowance has not changed in the data table, even though the
total revenue has increased suggests 1) collections have improved or 2) A/R allowance
has not been evaluated with respect to new balance in A/R. As an auditor, you would
pay special attention to adequacy of A/R Allowance during fieldwork.

14-20
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com

 Integrated Case Application

14-34 a., b., c., and d.


PINNACLE MANUFACTURING―Part IV

a. b. c. d.
Key Transaction Related Test of Substantive Test
# Internal Control Audit Objectives Control of Transaction
1. Segregation of the Recorded acquisitions are for goods and Discuss Trace entries in the acquisitions
purchasing, receiving, services actually received (occurrence). segregation of journal to related vendors'
and cash Recorded cash disbursements are for duties with invoices, receiving reports, and
disbursements goods and services actually received personnel and purchase orders.
functions. (occurrence). observe activities.

2. Independent Existing cash disbursement transactions Examine file Reconcile recorded cash
reconciliation of the are recorded (completeness). of completed disbursements with the cash
14-25

monthly bank Recorded cash disbursement bank disbursements on the bank


statements. transactions are stated at the correct reconciliations. statement (proof of cash
amounts (accuracy). disbursements).

3. Use of prenumbered Existing acquisition transactions are Account for Trace from a file of vendors'
voucher packages, recorded (completeness). a sequence invoices to the acquisitions journal.
properly accounted of voucher
for. packages.
4. Use of prenumbered Existing cash disbursement transactions Account for Reconcile recorded cash
checks, properly are recorded (completeness). a sequence disbursements with the cash
accounted for. of checks. disbursements on the bank
statement (proof of cash
disbursements).
5. Use of prenumbered Existing acquisition transactions are Account for a Trace from a file of receiving
receiving reports, recorded (completeness). sequence of reports to the acquisitions journal.
properly accounted receiving reports.
for.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com

14-34 (continued)
a., b., c., and d.

a. b. c. d.
Key Transaction Related Test of Substantive Test
# Internal Control Audit Objectives Control of Transaction
6. Internal verification • Recorded acquisitions are for goods Examine Examine supporting documents
of document package and services actually received document for propriety and recompute
before check (occurrence). package for information on the supporting
preparation. • Recorded acquisitions are stated at indication of documents.
the correct amounts (accuracy). internal
• Acquisition transactions are properly verification.
included in the master files, and are
properly summarized (posting and
summarization).
• Acquisitions are properly classified
(classification).
• Acquisitions are recorded on the
14-26

correct dates (timing).


7. Review of supporting Recorded cash disbursements are for Examine checks Trace the cancelled check to the
documents and goods and services actually received for signature. related acquisitions journal entry
signing of checks (occurrence). and examine for payee name and
by an independent, amount.
authorized person.
8. Cancellation of Recorded acquisitions are for goods and Examine Examine the acquisitions journal
documents prior to services actually received (occurrence). indication of for duplicate entries to a vendor.
signing of the check. cancellation.
9. Monthly reconciliation • Acquisition transactions are properly Inquire of client Foot acquisitions and cash
of the accounts included in the master files, and are about monthly disbursements journals and trace
payable master file properly summarized (posting and reconciliation postings to the general ledger and
with the general summarization). procedures. accounts payable and inventory
ledger. • Cash disbursement transactions are master files.
properly included in the master file,
and are properly summarized (posting
and summarization).
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com

14-34 (continued)

e.

Acquisitions Substantive Tests of Transactions


Note: More than one audit procedure is listed for certain objectives even though the requirement is for only one procedure.

TRANSACTION-RELATED
AUDIT OBJECTIVES SUBSTANTIVE AUDIT PROCEDURES
Occurrence • Compare prices on vendor invoices with approved price limits established by
management.
• Review the acquisitions journal, general ledger, and accounts payable master file
for large or unusual amounts.
Completeness • Trace a sample of receiving reports to the acquisitions journal.
14-27

• Trace from a file of vendors' invoices to the acquisitions journal.


• Trace from additions in perpetual inventory records to recorded acquisitions.
Accuracy • Compare amounts for entries in acquisitions journal to related vendors' invoices,
purchase orders and receiving reports.
• Recompute information on vendor invoices.
• Compare prices on vendor invoices with approved price limits established by
management.
Posting and • Trace individual entries in accounts payable master file to acquisitions journal.
Summarization
Classification • Examine vendors' invoices for proper classification.
• Compare classification with chart of accounts by reference to vendors' invoices.
Timing • Compare dates of receiving reports and vendors' invoices with dates in the
acquisitions journal.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com

14-34 (continued)

f.

Cash Disbursements Substantive Tests of Transactions


Note: More than one audit procedure is listed for certain objectives even though the requirement is for only one procedure.

TRANSACTION-RELATED
AUDIT OBJECTIVES SUBSTANTIVE AUDIT PROCEDURES
Occurrence • Trace cancelled check numbers in the cash disbursements journal to related
cancelled checks and examine for payee, name, and amount.
• Examine cancelled check for authorized signature, proper endorsement, and
cancellation
by the bank.
• Review the cash disbursements journal, general ledger, and accounts payable master
file for large or unusual amounts.
14-28

• Trace cancelled check to the related acquisitions journal entry and examine for payee
name and amount.
Completeness • Trace entries in acquisitions journal to subsequent payment in cash disbursements
journal.
Accuracy • Compare cancelled checks with the related acquisitions journal and cash
disbursements journal entries.
• Recompute cash discounts.
Posting and • Trace individual entries in accounts payable master file to cash disbursements journal.
Summarization
Classification • Compare classification with chart of accounts by reference to vendors' invoices and
acquisitions journal.
Timing • Compare dates on cancelled checks with cash disbursements journal.
• Compare dates on cancelled checks with the bank cancellation date.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com

14-34 (continued)

g. Note: Student answers will depend on answers in requirements b


through f.

General

1. Discuss the following items with client personnel and observe


activities:
a. Segregation of duties
b. Monthly reconciliation of accounts payable master file
with the general ledger.
2. Test journal summarization and posting for a test month:
a. Foot acquisition journal and trace postings to the general
ledger and accounts payable and inventory master files.
b. Foot cash disbursements journal and trace postings to
general ledger and accounts payable master file.
3. Examine file of completed bank reconciliations.
4. Account for a sequence of cancelled checks.
5. Reconcile recorded cash disbursements with cash disbursements
on the bank statement.
6. Review the acquisitions journal, cash disbursements journal,
general ledger, and accounts payable master file for large or
unusual amounts.
7. Examine underlying documents (vendors’ invoices, receiving
reports, purchase orders, and purchase requisitions) for
indication of cancellation and reasonableness.

Acquisitions

8. Trace entries in the acquisitions journal to related vendors’


invoices, receiving reports, and purchase orders.
a. Examine indication of internal verification of dates,
unit costs, prices, extensions and footings, account
classification, recording in the journal, and posting and
summarization.
b. Examine supporting documents for propriety.
c. Compare prices on vendors’ invoices with approved
price limits established by management.
d. Recompute information on vendors’ invoices.
e. Examine vendors’ invoices for proper classification.
f. Compare dates on recorded acquisitions with dates on
receiving reports and vendors’ invoices.
g. Examine document package for indication of internal
verification.

14-25
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com

14-34 (continued)

9. Account for a sequence of receiving reports and voucher


packages.

10. Trace a sample of receiving reports and vendors’ invoices to


the acquisitions journal.

Cash Disbursements

11. Select a sample of cancelled checks and:


a. Trace cancelled check to the related cash disbursements
journal entry and acquisitions journal entry and examine
for payee, name, amount, and date.
b. Examine check for signature, proper endorsement, and
cancellation by the bank.
c. Compare date on cancelled check with bank cancellation
date.
d. Recompute cash discounts.

14-35 – ACL Problem

a. There are 112 transactions in the month of September, 2002. The


total amount of these transactions is $127,941.13 (Filter expression is
DATE1 >= ‘20020901’ AND DATE1 <= ‘20020930’; Count command;
then Total command).
b. Type “IN” has the highest count. See the following report created
using the Summarize command:

Page 1 04/10/2009 12:09:18


Produced with ACL by: ACL Educational Edition -
Not For Commercial Use

TYPE AMOUNT COUNT


AA -533.59 1
CN -9025.02 108
IN 525259.16 588
PM -45281.38 71
TR -1538.48 4
468880.69 772

c. There are 588 sales invoices (IN), totaling $525,259.16. The largest
single invoice amount is $5,549.19 and the average invoice amount is
$893.30. (Filter by invoice type = IN; then use Statistics command on
the Amount column.)

14-26
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com

14-35 – ACL Problem (continued)

d. Leaving the filter from part c intact, create a computed field with the
following expression: DUE – DATE1 and then add this column to the
table view. Several of the invoices have negative results, which
means that possibly the wrong year was used for the due date. Also,
some are 90 days old, which indicates potential collection problems.
e. See the following printout:, which is the result of using the Stratify
command after a filter is applied to isolate “IN” transactions greater
than or equal to $300.

 Internet Problem Solution: Point of Sales Systems Controls

14-1 Consider the many economic transactions in which you participate on a


daily basis. You may purchase a cup of coffee at a coffee shop; pay your telephone
bill; purchase stamps at the post office, and so forth. In many cases, the transaction
is documented using a “point of sale” system. Using the Internet, find the definition
of a point of sale system and read about the controls that have been established by
the University of Toronto related to these systems to answer the following questions
[http://www.internalaudit.utoronto.ca/resources/controls.htm#B3] :

1. What is a point of sale system?

Answer:
A point of sale system is one that allows the entering of transactions
details and the printing of sales invoices/receipts as transactions occur.

14-27
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com

Internet Problem 14-1 (continued)

2. In your opinion, does a point of sale system increase or decrease the


likelihood that cash will be stolen by employees?

Answer:
If a point of sale system is properly implemented and monitored there
should be a reduced likelihood that employees could steal cash. So,
the system must be properly used and controlled if it is to be effective.

3. What are the key controls around point of sale systems implemented
by the University of Toronto?

Answer:
The University of Toronto’s Internal Audit website [http://www.internal
audit.utoronto.ca/resources/controls.htm#B3] includes the following:

These controls are designed to prevent the loss of assets due to error
or misappropriation and to protect customers from misuse of their
credit cards or breaches of their confidentiality.

• Point-of-sale systems are configured to require a supervisor/


manager password authorization to process refunds and void
transactions
• Credit card refunds are processed only by crediting the original
card so that service charges are recovered
• Credit/debit card sales transactions are reconciled to point-of-
sale system totals report(s) at least daily by a supervisor who
does not process transactions
• Point-of-sale system daily totals reports are reconciled to FIS
Statement of Accounts or Management Reports at least
monthly by a supervisor/manager independent of transaction
processing
• Point-of-sale system terminals are kept in a secure location
and staff log off when away from them
• All records containing credit card details are kept in a secure
area with access restricted to only those employees who
require it

(Note: Internet problems address current issues using Internet sources. Because
Internet sites are subject to change, Internet problems and solutions may change. Current
information on Internet problems is available at www.pearsonglobaleditions.com/arens.)

14-28