Selly Kurniawati 041611333072

Ervina Dilasanti 041611333107

Dewi Renitasari 041611333123
Alvin Ilham N 041611333262

CASE 14-33

The Kwan Pharmaceutical Company

1. All customers requests for credits are documented in a log and are forwarded
to the controller.
2. The controller review each credit request for reasonableness and discusses it
with the appropriate personnel related to the initial sale.
3. The controller documents the credit memo on a form explaining the reason for
the credit and the amount on credit.
4. The controller and the CFO both physically sign the credit memo paperwork.
5. The credit is issued by a separate department prior to the reduction of the A/R
Allowance for the Costumer, or is refunded by check.
6. The controller updates the accounting software for the credit memo.
7. On a quarterly basis, the controller evaluates the adequacy of the A/R
Allowance.

a. Audit Program for Sales Returns

No Transaction Related Key Existing Test of Controls Substantive Tests of

Audit Objectives Controls /TOC Transactions/ STOT
1 The recorded sales are 1. All 1. Check return Review journal and
those that are actually customer requests master transaction files
sent to non fictitious request for regarding for unusual
customers (occurrence) credits are return transactions and
documented approval. amounts.
in a log and 2. 2. Check
are request Browse back and forth
forwarded documents journal entries and AR
to the whether to supporting
controller. permitted or documents (credit
(C1) not. memo).
2. The 3. Check
controller whether all
review each return requests
credit have been
request for recorded
 reasonablen
ess and
discusses it
with the
appropriate
personnel
related to
the initial
sale. (C3)
3. All
customer
request for
credits are
documented
in a log and
are
forwarded
to the
controller.
(C4).
4. All
customer
request
for credits
are
documented
in a log and
are
forwarded
to the
controller.
(C5)
5. The
controller
documents
the credit
memo on a
form
explaining
the reason
for the
credit and
 the amount
on credit.
(C6)

2 The existing A / R 1. All 1. Check the Searching for sample

Allowance & Sales customer order of the credit memos has been
Return transactions have request for return request inputted into the main
been recorded credits are document journal and file.
(Completeness) documented number in
in a log and order or not.
are 2. Check
forwarded whether the
to the return request
controller. document
(C1) already has
2. All permission
customer and has been
request for authorized.
credits are 3. Is the latest
documented accounting
in a log and software able
are to access all
forwarded existing or not
to the existing
controller. accounts.
(C2)
3. All
customer
request for
credits are
documented
in a log and
are
forwarded
to the
controller.
(C4)
4. The
controller
documents
the credit
memo on a
 form
explaining
the reason
for the
credit and
the amount
on credit.
(C6)

3 The A / R Allowance & 1. All 1. What is the 1. Browse the

Sales Return recorded is customer reason given journal entry to
the amount of the items request for for return the credit
returned and set aside credits are requests is memo.
and correctly recorded documented correct or not.
(Accuracy) in a log and 2. Are the 2. Recalculate the
are numbers amount stated
forwarded entered in in the credit
to the returns are in memo.
controller. accordance
(C2) with the 3. Browse the
2. The returns in the return details to
controller account. credit memos
review each 3. Is the memo and customer
credit that has been return requests.
request for signed by the
reasonablen authorization 4. Check the
ess and party is checking
discusses it difficult account for
with the according to refund
appropriate or not with a
personnel memo each
related to return.
the initial 4. Has the
sale. (C3) updated
3. All accounting
customer software
request for reached the
credits are goal of the
documented software in
in a log and each account
are 5. Have the
Forwarded receivables set
 to the aside been
controller. recorded with
(C5) the numbers
4. The considered by
controller the relevant
documents department.
the credit
memo on a
form
explaining
the reason
for the
credit and
the amount
on credit.
(C6)

4. Return Transactions are 1. All 1. Whether the Trace sample memo

correctly entered into customer amount of the set returns to the return /
the parent file A / R request for aside that has been credit master file and
Allowance & Sales credits are deducted has been test the credit memo
Return and summarized documented posted in the correct number, date and
correctly (Posting & in a log and account. number.
Summarizing) are
forwarded
to the
controller.
(C5)
2. The
controller
documents
the credit
memo on a
form
explaining
the reason
for the
credit and
the amount
on credit.
(C6)
5. Transactions A / R 1. All 1. whether returns that Check copies of credit
Allowance & Sales customer have been given memos for the right
Return are classified request for authorization have classification of
correctly credits are been included in the accounts.
(Classification) documented proper classification
in a log and of accounts.
are
forwarded 2. whether the control
to the assessment on the
controller. quarter of the month
(C4) is feasible or not on
2. On a the receivables set
quarterly aside.
basis, the
controller
evaluates
the
adequacy of
the A/R
Allowance.
(C7)
6. A / R Allowance & On a quarterly Has the feasibility Compare the date of
Sales Return is recorded basis, the controller control assessment return recording in the
on the correct date evaluates the been done with the journal with the ladder
(Timing) adequacy of the right time in the A / R in the credit memo.
A/R Allowance. Allowance account

b. Test for evaluating the sufficiency of sales returns allowances :

- Perform analytical tests related to sales accounts and sales returns allowances
by comparing the number of accounts in the audit year with the previous
year.
- Check the amount of returns from sales each year.
- Pay attention to the mutations from the previous year on the two accounts,
whether significant or not and the value of their plausibility.
- If it is significant and is considered unreasonable, ask for an explanation from
the client.

c. The allowance for immovable uncollectible receivables from last year indicates
that the company paid little attention to the reserves of its receivables. To
conduct an examination of the allowance for uncollectible accounts:
a. Obtain information on how to calculate / determine the reserves of
uncollectible accounts
b. Obtain information about the age of the company's receivables
c. Calculate the allowance for accounts receivable
 CASE 16-35

QUESTIONS

You are auditing the sales and collection cycle for the Smalltown Regional
Hospital, a small not-for-profit hospital. The hospital has a reputation for excellent
medical services and deficient record keeping. The medical people have a tradition of
doing all aspects of their job correctly, but because of a shortage of accounting
personnel, there is not time for internal verification or careful performance. In
previous years, your CPA firm has found quite a few misstatements in billings, cash
receipts, and accounts receivable. As in all hospitals, the two largest assets are
accounts receivable and property, plant,and equipment.
The hospital has several large loans payable to local banks,and the two banks
have told management that they are reluctant to extend morecredit, especially
considering the modern hospital that is being built in a nearby city. In the past,
county taxes have made up deficits, but in the past year, the county has also been
incurring deficits because of high unemployment.
In previous years, your response from patients to confirmation requests has
been frustrating at best. The response rate has been extremely low, and those who did
respond did not know the purpose of the confirmations or their correct outstanding
balance. You have had the same experience in confirming receivables at other
hospitals.
You conclude that control over cash is excellent and the likelihood of fraud is
extremely small. You are less confident about unintentional errors in billing,
recording sales, cash receipts, accounts receivables, and bad debts.

A. Identify the major factors affecting client business risk and acceptable audit
risk for this audit.
B. What inherent risks are you concerned about?
C. In this audit of the sales and collection cycle,which types of tests are you
likely to emphasized?
D. For each of the following, explain whether you plan to emphasize the test and
give reasons:
1. Tests of controls
2. Substantive tests of transactions
3. Analytical procedures
4. Tests of details of balances

ANSWER
 a. There are four major factors affecting acceptable audit risk for the audit
of Smalltown Regional Hospital.
1. There are several large loans to two local banks, both which
have said they are reluctant to extend more credit.
2. A modern hospital is being built in a nearby city, which affects
the competitive environment, and therefore the likelihood of
financial failure.
3. The hospital has been incurring significant deficits in the past.
4. County taxes may not be able to make up the deficits, as they
have in the past.

Considering the combined effect of these factors, the auditor should set a low
acceptable audit risk.

b. The following are major inherent risks:

1. In the audit of accounts receivable and property, plant and
equipment, the amounts are highly material.
2. Misstatements are common in billings, cash receipts, accounts
receivable balances, and bad debts.
3. Due to the high unemployment rate, there is a significant risk of
increased bad debts.

c. The major difficulty the auditor faces is the ineffective controls over
sales and the unreliability of confirmations because of the nature of the
customers. The auditor should therefore plan to emphasize substantive
tests of transactions for sales and alternative procedures, especially
subsequent cash receipts. The controls over cash receipts are such that it
is practical to reduce assessed control risk after a proper understanding
is obtained of internal control and tests of controls are performed. A
likely approach is the following:
1. Test internal controls over cash receipts using tests of controls to
make sure that the controls are effective to prevent fraud.
2. Do substantive tests of transactions for revenues, with emphasis
on tests for unrecorded revenues, billing misstatements, and
recording misstatements. The sample for sales should be traced
to subsequent cash receipts to test whether each receipt has been
correctly recorded. One important test is to select a sample of
patient charts and trace transactions through to the revenue
journal. The patient chart is a reliable indicator of services
provided to patients.
3. The accounts receivable aged trial balance should be tested for
detail tie-in. Minimal confirmations should be sent, with
 emphasis on large or unusual balances. The emphasis should be
on subsequent cash receipts.
4. A careful evaluation of all older, outstanding accounts is
essential due to the likelihood of bad debts. The high
unemployment rate in the community increases the likelihood of
a material misstatement of the allowance for uncollectible
accounts.

d. The following emphasis is appropriate for each type of test:

TYPE OF TEST EMPHASIS REASON

Test of controls None, except control Controls are deficient in all areas
of cash receipts. except cash receipts.

Substantive test of Extensive - Tests of details of

transactions balances evidence
(confirmation) is not
reliable, therefore
substantive tests of
transactions are the most
important evidence.
- Substantive tests of
transactions are even
more important because
of potential for
misstatement for the
completeness objective.
- Tests of details of
balances are unlikely to
uncover any existing
misstatements for this
objective.

Analytical Extensive An indication of misstatements

procedure may result from these tests.
Tests of details of Reasonably - Confirmations are not
balances extensive, except emphasized because of the
confirmations which lack of reliability in the
should be minimal. situation.
- Tests of details of balances
are used most extensively
for bad debts and the
allowance for
uncollectible accounts.