200
CHAPTER 9
Revenue and Collection Cycle
LEARNING OBJECTIVES
Review
Checkpoints
Exercises
and Problems
Cases
1. Describe the revenue and collection
cycle, including typical source
documents and controls.
1, 2, 3, 4,
7
50, 51
29, 30
2. Give examples of detail test of
controls procedures for auditing
control over customer credit
approval, delivery, accounts
receivable accounting, cash
receipts accounting, and bank
statement reconciliation.
5, 6, 8, 9,
10, 11
52
31, 32, 64,
65
3. Describe some common errors,
irregularities, and frauds in the
revenue and collection cycle, and
design some audit and
investigation procedures for
detecting them.
12, 13, 14,
15, 16, 17
53, 54
61, 62, 63,
64, 65
4. Explain the importance of the
existence assertion for the audit
of cash and accounts receivable
balances, and describe some
procedures for obtaining evidence
about the existence of assets.
18, 19
55, 56, 60
64, 65
5. Identify and describe
considerations for using
confirmations in the audit of cash
and accounts receivable.
20, 21, 22,
23, 24, 25
58, 59, 60
33, 65
6. Design and perform substantive
audit procedures for the audit of
a bank statement reconciliation,
and tell how auditors can search
for lapping and kiting.
26, 27, 28
57
62
POWERPOINT SLIDES
PowerPoint slides are included on the website. Please take special note of:
*
Revenue and Collection Cycle
SOLUTIONS FOR REVIEW CHECKPOINTS
9.1
The basic sequence of activities and accounting in a revenue and collection
cycle is:
1.
Receiving and processing customer orders. Entering data in an order
201
2.
3.
4.
5.
system and obtaining a credit check.
Delivering goods and services to customers. Authorizing release from
storekeeping to shipping to customer. Entering shipping information in
the accounting system.
Billing customers, producing sales invoices. Accounting for customer
trade accounts receivable.
Collecting cash and depositing it in the bank. Accounting for cash
receipts.
Reconciling bank statements.
9.2
When documents such as sales orders, shipping documents, and sales invoices
are prenumbered, someone can later account for the numerical sequence and
determine whether any transactions have failed to be recorded. (Completeness
control objective.)
9.3
Access to computer terminals should be controlled so only authorized persons
can enter or change transaction data. Access to master data files is important
because changes in them affect automatic computer controls, such as credit
checking and accurate inventory pricing.
9.4
It might be easier just to send the cash to the accounts receivable
accountants, but (1) that would delay the bank deposit and the company would
lose interest income, and (2) a dishonest accountant could steal cash while
still giving the customer credit (to forestall complaints). The accountant
could cover the theft by making false debit entries to such accounts as
allowance for doubt accounts (account write-offs) or discounts and allowances
expense.
9.5
Auditors could examine these files for evidence of:
Unrecorded sales -- pending order master file,
Inadequate credit checks -- credit data/check files
Incorrect product unit prices -- price list master file
9.6
9.7
With a sample of customer accounts receivable
(1)
Find the support for debit entries in the sales journal file. Expect to
find evidence (copy) of a sales invoice, shipping document, and customer
order. The sales invoice showing recording on the shipping date.
(2)
Find the support for credit entries in the cash receipts journal file.
Expect to find a remittance advice (entry on list), which corresponds to
detail on a deposit slip, on a deposit actually in a bank statement for
the day posted in the customers' accounts.
The account balances in a revenue and collection cycle include:
Cash in bank
Accounts receivable
Allowance for doubtful accounts
Bad debt expense
Sales revenue
Sales returns, allowances, discounts
9.8
These specific control policies and procedures (in addition to separation of
duties and responsibilities) should be in place and operating in a control
structure governing revenue recognition and cash accounting:
(1)
no sales order should be entered without a customer order
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(2)
(3)
(4)
(5)
(6)
(7)
(8)
a credit-check code or manual signature should be recorded by an
authorized means
access to inventory and the shipping area should be restricted to
authorized persons
access to billing terminals and blank invoice forms should be restricted
to authorized personnel
accountants should be under orders to record sales and accounts
receivable when all the supporting documentation of shipment is in order,
and care should be taken to record sales and receivables as of the date
goods and services were shipped, and cash receipts on the date the
payments are received
customer invoices should be compared with bills of lading and customer
orders to determine that the customer is sent the goods ordered at the
proper location for the proper prices and that the quantity being billed
is the same as the quantity shipped
pending order files should be reviewed timely to avoid failure to bill
and record shipments
bank statements should be reconciled in detail monthly.
9.9
In a "walk through" of a sales transaction, auditors take a single example of
a sales transaction and trace it from the initial customer order through
credit approval, billing, and delivery of goods, to the entry in the sales
journal and subsidiary accounts receivable records, then its subsequent
collection and cash deposit. Sample documents are collected and employees in
each department are questioned about their specific duties. The information
gained from documents and employee; can be compared to answers obtained on an
internal control questionnaire. The purpose of the "walk through" is to obtain
an understanding of the transaction flow, the control procedures, and the
populations of documents that may be utilized in test of controls auditing.
9.10
The two important characteristics of a detail test of control procedure are
(1) identification of the data population from which a sample of items will be
selected for audit, and (2) an expression of the action that will be taken to
produce relevant evidence. In general, the actions in detail test of control
audit procedures involve vouching, tracing, observing, scanning, and
recalculating.
9.11
Dual direction test of controls sampling refers to procedures that test file
contents in two "directions" -- the validity direction and the completeness
direction. The validity direction is a sample from the account balance (e.g.
sales revenue) vouched to supporting sales and shipping documents for evidence
of validity. The completeness direction is a sample from the population that
represents all sales (e.g. shipping document files) traced to the sales
journal or sales account for evidence that no transactions (shipments, sales)
were omitted.
9.12
The goals of dual-direction sampling relate to the first two objectives of
internal control: (1) recorded sales (accounts receivable) are valid and
documented and (2) valid sales transactions (accounts receivable) are recorded
and none omitted. One direction is to ensure that all recorded debits to
accounts receivable represent valid credit sales that actually occurred--the
relevant population for sampling to achieve this goal is from recorded
receivable debits which should be vouched to supporting documents, such as
sales invoices. Likewise, a sample of recorded credits to accounts receivable
should be vouched to cash receipts documents such as remittance advices and
deposits.
The other direction is to ensure that all credit sales and cash receipts that
occurred were recorded in the receivable records. The relevant populations for
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sampling to achieve this goal are: (1) evidence of credit sales such as
shipping documents, then trace these to the receivable accounts, and (2)
evidence of cash receipts such as remittance advices, then trace these to the
receivable accounts.
9.13
In the "Canny Cashier," if someone other that the assistant controller had
reconciled the bank statement and compared the details of bank deposit slips
to cash remittance reports, the discrepancies could have been noted and
followed up. The discrepancies were that customers and amounts on the two did
not match.
9.14
To prevent the cash receipts journal and recorded cash sales from reflecting
more than the amount shown on the daily deposit slip, the internal control
system should provide that receipts be recorded daily and intact. A careful
bank reconciliation by an independent person could detect such errors.
9.15
Confirmations to taxpayers who had actually paid their taxes would have
produced exceptions, complaints, and people with their counter receipts. These
results would have revealed the embezzlement.
9.16
Auditors might have obtained the following information:
Inquiries: Personnel admitting the practices of backdating shipping documents
in a "bill and hold" tactic, or personnel describing the 60-day wait for a
special journal entry to record customer discounts taken.
Detail test of controls: The sample of customer payment cash receipts would
have shown no discount calculations and authorizations, leading to inquiries
about the manner and timing of recording the discounts.
Observation: When observing the physical inventory-taking, special notice
should be taken of any goods on the premises but excluded from the inventory.
These are often signs of sales recorded too early.
Confirmations of accounts receivable: Customers who had not yet been given
credit for their discounts can be expected to take exception to a balance too
large.
9.17
The auditors would have known about the normal Friday closing of the books for
weekly management reports, and they could have been alerted to the possibility
that the accounting employees overlooked the once-a-year occurrence of the
year end date during the week.
9.18
It is important to place emphasis on the existence and rights assertions
because auditors have often got into malpractice trouble by giving unqualified
reports on financial statements that overstated assets and revenues and
understated expenses. For example, credit sales recorded too early (fictitious
sales?) result in overstated accounts receivable and overstated sales revenue;
failure to amortize prepaid expense results in understated expenses and
overstated prepaid expenses (current assets).
9.19
These procedures are usually the most useful for auditing the existence and
rights assertions:
Recalculation. Expired prepaid expenses are recalculated, using auditors'
vouching of basic documents, such as loan agreements (prepaid interest), rent
contracts (prepaid rent), and insurance policies (prepaid insurance). Goodwill
and deferred expenses are recalculated using original acquisition and payment
document information and term (useful life) estimates. A bank reconciliation
is a special kind of calculation, and the company's reconciliation can be
204
audited. Physical Observation. Inventories and fixed assets can be inspected
and counted. Titles to autos, land, and buildings can be vouched, sometimes
using public records in the county clerk's office. Petty cash and undeposited
receipts can be observed and counted. Securities held as investments can be
inspected if held on the company's premises.
Confirmation. Letters of confirmation can be sent to banks and customers,
asking for a report of the balances owed the company. Likewise, if securities
held as investments are in the custody of banks or brokerage houses, the
custodians can be asked to report the names, numbers, and quantity of the
securities held for the company. In some cases, inventories held in public
warehouses or out on consignment can be confirmed with the other party. Verbal
Inquiry. Inquiries to management usually do not provide very convincing
evidence about existence and ownership. However, inquiries should always be
made about the company's agreements to maintain compensating cash balances
(may not be classifiable as "cash" among the current assets), about pledge or
sale with recourse of accounts receivable in connection with financings, and
about pledge of other assets as collateral for loans.
Examination of Documents (Vouching). Evidence of ownership can be obtained by
studying the title documents for assets. Examination of loan documents may
yield evidence of the need to disclose assets pledged as loan collateral.
Scanning. Assets are supposed to have debit balances. A computer can be used
to scan large files of accounts receivable, inventory, and fixed assets for
uncharacteristic credit balances. The names of debtors can be scanned for
officers, directors, and related parties, amounts for which need to be
reported separately or disclosed in the financial statements.
Analytical Procedures. Comparisons of asset and revenue balances with recent
history might help detect overstatements. Relationships such as receivables
turnover, gross margin ratio and sales/asset ratios can be compared to
historical data and industry statistics for evidence of overall
reasonableness. Account interrelationships also can be used in analytical
review. For example, sales returns and allowances and sales commissions
generally vary directly with dollar sales volume, bad debt expense usually
varies directly with credit sales volume, and freight expense varies with the
physical sales volume. Accounts receivable write-offs should be compared with
earlier estimate of doubtful accounts.
9.20
The following information is requested in a bank confirmation:
For Deposit Accounts:
Account name
Account number
Interest rate
Balance as of the confirmation date
For Direct Liabilities:
Account number or description
Balance due
Date due
Interest rate
Date through which interest is paid
Description of collateral
9.21
A "positive" confirmation is a request for a response from an independent
party who the auditor has reason to expect is able to reply. A "negative"
confirmation is a request for a response from the independent party only if
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the information is disputed. Negative confirmations should also be sent only
if the recipient can be expected to detect error and reply accordingly.
9.22
The response rate for positive confirmations is the proportion of the number
of confirmations returned (to the auditor) to the number mailed. The detection
rate is the proportion of exceptions reported to the auditors to the number of
account errors intentionally made in the statements mailed to customers (in
research studies regarding confirmations).
9.23
Response rate can be increased by:
1.
2.
3.
4.
Sending
coming.
Sending
Using a
Marking
a postcard in advance, notifying the customer a confirmation is
confirmations by special delivery mail.
first class postage stamp rather than metered mail postage.
the envelope "Confirmation Enclosed: Please Examine Carefully."
9.24
Justifications for the decision not to use confirmations for trade accounts
receivable in a particular audit include: (1) receivables are not material,
(2) confirmations would be ineffective, based on prior years' experience or
knowledge that responses could be unreliable, and (3) analytical procedures
and other substantive test of details procedures provide sufficient, competent
evidence.
9.25
Special care in examining sources of accounts receivable confirmation
responses:
Auditors need to control the confirmations, including the addresses to which
they are sent. Experience is full of cases where confirmations were mailed to
company accomplices, who provided false responses. The auditors should
carefully consider features of the reply such as postmarks, FAX and telegraph
responses, letterhead, electronic mail, telephone, or other characteristics
that may give clues to indicate false responses. Auditors should follow up
electronic and telephone responses to determine their origin (for example,
returning the telephone call to a known number, looking up telephone numbers
to determine addresses, or using a criss-cross directory to determine the
location of a respondent).
9.26
The cutoff bank statement is a bank statement sent by the bank directly to the
auditor, and it is usually for a fifteen or twenty day period following the
reconciliation date. The basic use of the statement by the auditor is to
determine whether outstanding checks were actually mailed before the
reconciliation date and outstanding deposits in transit were actually received
in a timely manner by the bank.
9.27
The term "lapping" refers to an employee's stealing the cash receipts of a
company and then covering the amount with a following day's payment received
for another customer's account. A "lapping" operation is possible when a
single employee has access to both cash and accounts receivable records.
The auditor is alerted to the possibility of a "lapping" operation when there
is not a proper separation of duties. Surprise confirmation is the primary
means which an auditor can use to uncover such activity. Also, details of
deposit slips and cash remittance reports can be compared to detect
discrepancies.
9.28
Cheque kiting is the practice of building up apparent balances in one or more
bank accounts based on uncollected (float) cheques drawn against similar
accounts in other banks. Kiting involves depositing money from one bank
206
account to another, using a hot cheque. Kiting is the deliberate floating of
funds between two or more bank accounts. By this method, a bank customer
utilizes the time required for checks to clear to obtain an unauthorized loan
without any interest charge.
Auditors can detect signs of kiting by observing in the bank statements:
#
#
#
#
#
#
#
#
#
#
#
#
Frequent deposits and cheques in same amounts
Frequent deposits and cheques in round amounts
Frequent deposits with chequess written on the same (other) banks
Short time lag between deposits and withdrawals
Frequent ATM account balance inquiries
Many large deposits made on Thursday or Friday to take advantage of the
weekend
Large periodic balances in individual accounts with no apparent business
explanation
Low average balance compared to high level of deposits
Many cheques made payable to other banks
Bank willingness to pay against uncollected funds
"Cash" withdrawals with deposit cheques drawn on another bank
Cheques drawn on foreign banks with lax banking laws and regulations
If these cash transfers are recorded in the books, a company will show the
negative balances that result from cheques drawn on insufficient funds.
However, perpetrators may try to hide the kiting by not recording the deposits
and cheques. Such maneuvers may be detectable in a bank reconciliation audit.
A schedule of interbank transfers can be constructed from the canceled checks
and cleared deposits in the bank statements. This schedule shows each check
amount, the name of the paying bank (with the book recording date and the
cheque clearing date), the name of the receiving bank (with the book deposit
date and the bank clearing date). The purpose of this schedule is to see that
both sides of the transfer transaction are recorded in the same period (and in
the proper period).
SOLUTIONS FOR KINGSTON CASE PROBLEMS
9.29
ICQ Items: Objectives and Errors from Control Weaknesses
Question
Possible Error or Irregularity
1
2
Cash could be withheld and revenue and expense both understated
Cash can be removed from the deposit, and the cashier and accounts
receivable bookkeeper could hide the theft by manipulating the
accounts.
The cashier can steal money in custody and could manipulate
records to hide the theft.
The cashier can steal money and, with access to the records, could
manipulate them to hide the theft.
If the reconciliation is done by someone with access to cash or
other records, the reconciliation could be manipulated to hide
thefts or errors in the accounts.
Erroneous entries could be made if the amounts are not compared
and differences corrected.
Failure to make a list early gives up the chance to capture a
control total for later comparison to accounting entries, and math
mistakes and thefts could go undetected.
Failure to use machine totals (cash registers and point-of-sale
3
4
5
6
7
8
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9
10
11
12
13
14
15
9.30
computers) gives up the chance to use a control total as in # 7.
Failure to use and check prenumbered documents lets documents get
lost, not recorded, and the incompleteness go undetected.
Failure to approve discounts may permit dishonest employees to
account for discounts and steal the money.
The duplicate deposit retained by a control person (internal
auditor) can be used to compare to account entries. Without it,
erroneous entries cannot be detected.
Failure to compare the remittance list to the deposit gives up the
chance to detect thefts from the money received (the remittance
list being a control total as in # 7).
No accounting manual instructions for classifying cash entries
contributes to employee's classification mistakes and
inconsistencies.
If the accounts receivable subsidiary and control do not balance,
some entries are not the same in both, and failure to make the
comparison gives up the chance to detect failure to post all
entries.
Failure to date cash entries the same date as the receipt gives up
control over proper cutoff of cash entries.
Internal Control Questionnaire - Sales Transaction Processing
Objectives and Questions
Environment:
1.
Is the credit department independent of
the sales department?
2.
Are sales of the following types
controlled by the same procedures
described below? Sales to employees,
COD sales, disposals of property, cash
sales, and scrap sales.
Validity Objective:
3.
Is access to sales invoice blanks
restricted?
4.
Are prenumbered bills of lading or other
shipping documents prepared or
completed in the shipping department?
Completeness Objective:
5.
Are sales invoice blanks prenumbered?
6.
Is the sequence checked for missing
invoices?
7.
Is the shipping document numerical
sequence checked for missing bills of
lading numbers?
Authorization Objective:
8.
Are all credit sales approved by the
credit department prior to shipment?
9.
Are sales prices and terms based on
approved standards?
10. Are returned sales credits and other
credits supported by documentation as
Yes, No, N/A
Comments
Yes. Credit manager in
Treasurer's office
No available information
Yes. Kept in locked closet
Yes. Shipping department
Yes
Yes. Accounts receivable
clerk
No available information
Yes. Credit manager file
Yes. Approved price file
No available information
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to receipt, condition, and quantity
and approved by a responsible officer?
Accuracy Objective:
11. Are shipped quantities compared to
invoice quantities?
12. Are sales invoices checked for error in
quantities, prices, extensions and
footing, and freight allowances, and
checked with customers' orders?
13. Is there an overall check for errors in
arithmetic accuracy of period sales
data by a statistical or product-line
analysis?
14. Are periodic sales data reported
directly to general ledger accounting
independent of accounts receivable
accounting?
Classification Objective:
15. Does the accounting manual contain
instruction for classifying sales?
Accounting Objective:
16. Are summary journal entries approved
before posting?
Yes. Marketing vice
president
No
Yes. Lumber and hardware
analysis
Yes. General ledger
supervisor (procedure
manual)
Proper Period Objective:
17. Does the accounting manual contain
instructions to date sales invoices on
the shipment date?
9.31
Yes. Shipping department
clerk
Yes. Accounts receivable
clerk
Yes. General ledger
supervisor (procedure
manual)
Bridge Working Paper for Cash Receipts
Prepared by__________
Date_________________
KINGSTON COMPANY
Bridge: Cash Receipts Control
December 31, 2002
Strength/Weakness
Audit Implication
Audit Program
S: Monthly bank
reconciliation
Errors detected by
client
Review the bank reconciliations
(This compliance procedure will
indirectly audit the client
comparison of cash entries and
deposit slips)
W: No remit list
or machine
control
Cash records may
be incomplete
Confirm larger sample of A/R for
evidence of balances paid by
customers but not so reflected by
accounts.
S: Cash discounts
Accurate calc of
Select sample of A/R, vouch
209
approved
9.32
amounts
discount approval to signature
S: Acct manual
directs cash
credit classif
Proper credit
classification
Scan journals to see whether all
cash entries include credit to A/R
S: Reconciles sub
to control A/R
Posting errors
detected
Review file of reconciliation
work, followup corrections
S: Acct manual
directs cash
entry dating
Proper dates on
cash entries
Select sample of cash receipts and
trace entry dates to A/R, and
deposit dates to bank deposit slip
Matching ICQ Questions to Test of Controls Audit Program
ICQ
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
9.33
(Appendix 9A-3)
separation of duties
cashier separation
collection separation
written off A/R
separation of duties
NA
NA
monthly A/R mailing
internal confirms
customer complaints
returned goods
CMs prenumbered
credit approval
writeoffs,etc approval
NA
NA
NA
A/R reconciliation
Procedures (Ex 9-6)
A4, B3 observe peoples' duties
B3 observe cashier work
(nothing to test because of weakness)
review the memo ledger
B4 observe people at work
C5 observe monthly A/R mailing
(nothing to test because of weakness)
A4 observe who handles complaints
C3 vouch returns to receiving reports
(nothing to test because of weakness)
A3d vouch credit approval
C3a review for proper approval
(not in program) Review subsidiary-control
account reconciliation working papers
prepared by client
Accounts Receivable Confirmation
a.
There are two forms of accounts receivable confirmation requests: the
"positive" form and the "negative" form.
A positive form asks the debtor to respond whether or not the debtor is
in agreement with the information on the confirmation request. A negative
form asks the debtor to respond only if the debtor disagrees with the
information on the confirmation request. The positive form generally
requires follow-up by the auditor in the form of practicable alternative
procedures that are used to obtain necessary evidence if a reply is not
received.
The use of the positive form is preferable when individual account
balances are relatively large, when there is reason to believe that there
may be a substantial number of accounts in dispute, or with inaccuracies
or irregularities.
The negative form is useful when internal control surrounding accounts
receivable is considered to be effective, and a large number of small
210
balances is involved, and the auditor has no reason to believe that
persons receiving the requests are unlikely to give them consideration.
b.
The items that comprise the balance (recent sales debits and cash
receipts credits) can be vouched to supporting internal documentary
evidence--sales invoices and bills of lading and cash entries and deposit
slips. This work is "extended procedures" to determine internally the
information the customers did not provide externally. An auditor can also
vouch payments received in the subsequent period as evidence to validate
the existence of the receivable balance.
SOLUTIONS FOR MULTIPLE CHOICE QUESTIONS
9.34
c.
Nobody in the company has access to cash, therefore it cannot be stolen.
9.35
a.
Impropriety of write-offs can be controlled by the review and approval by
someone outside the credit department.
9.36
b.
Less sales revenue and correct amount of cost of goods sold results in
less gross profit, therefore the ratio of gross profit to sales will
decrease. (Actually, the gross profit numerator will decrease at a
greater rate than the sales denominator in the ratio, causing the ratio
to decrease.)
9.37
d.
The direction of the test establishes support for recorded amounts.
9.38
d.
A bookkeeper could steal money and "write off" to unsuspecting customer's
balance with a fictitious "sales return."
9.39
c.
The cashier would have both custody of cash and recordkeeping
responsibility, hence could steal money and fix the records without
interference by anyone else.
9.40
c.
The age of accounts is an indication of credit losses.
9.41
b.
False sales journal entries made near the end of the year may have
shipping or other documents that reveal later dates or show lack of
sufficient documentation.
9.42
c.
Accounts receivable confirmation enables recipients to respond that they
owe the company or that they dispute or disagree with the amount the
company says they owe. A response without exception, however, does not
necessarily mean that the debtor will actually pay the amount.
9.43
c.
Kiting involves a mismatching of dates of recording around year-end, and
the schedule of bank transfers is designed to show all the relevant dates
so the auditor can see that the entries are in the proper periods.
9.44
c.
Correct.
Checking the sequence for missing numbers identifies
documents not yet fully processed in the revenue cycle.
9.45
a.
Correct.
The accounts receivable debits are supposed to represent
sales that have been ordered by customers and actually
shipped to them.
9.46
b.
Correct.
d.
The existence assertion is very important because the company
asserts the cash and accounts receivable to exist.
Presentation and disclosure assertion is second best choice among the
211
ones offered in the question.
9.47
c.
9.48
9.49
Correct mainly because the other three choices are listed as appropriate
work to do. Also, automatic sending of 100% negative confirmations
ignores the judgment in deciding the nature, timing, and extent of the
work needed.
a.
b.
c.
d.
Assessed level
of control risk
relating to
receivables is
Low
Low
High
High
a.
Correct.
b.
Incorrect.
c.
Incorrect.
d.
Incorrect.
Number of
small
balances is
Many
Few
Few
Many
Proper
consideration
by the
recipient is
Likely
Unlikely
Likely
Likely
Correct
Incorrect
Incorrect
Incorrect
Shipments are traced to customers were invoiced. (This does
not imply that the invoices were recorded in the sales
journal.)
See (a) above. The invoice copies need to be traced to the
sales journal and general ledger to determine whether the
shipments were recorded, and the procedure does not go this
far. Shipments to customers were recorded as sales.
Recorded sales were shipped is not established because the
sample selection is from shipments, not from recorded sales.
Invoiced sales were shipped (see (c) above).
SOLUTIONS FOR EXERCISES AND PROBLEMS
9.50
Cash Receipts Control Objectives and Examples
General
Validity
Specific
1.
If the remittance advice is not returned, the person
opening the mail should prepare one so that each check
received is represented by a remittance advice.
Complete
2.
All cash receipts should be listed from remittance
advices.
Deposits prepared by a person separate from the one who
opens the mail.
Subsidiary customer accounts posted from remittance
advices.
General ledger control account posted from cash receipts
journal.
212
Bank statement reconciled independent of other functions.
Control account reconciled to subsidiary ledger monthly.
9.51
Author
3.
(Authorization is usually not a problem for cash receipts
on accounts receivable.) Cash receipts from other than
merchandise sales authorized on unique remittance advice
forms.
Accuracy
4.
Daily remittance list compared to duplicate deposit slip
received from bank by person independent of either
function.
Classif
5.
Cash receipts entered properly in cash receipts journal
as to the origin of the receipts. Separate deposits made
for nonmerchandise sales cash receipts.
Acctg
6.
Monthly reconciliation of control account to customers'
individual accounts and bank statement reconciled
promptly.
Proper period
7.
Daily deposit of all cash receipts. Cash receipts
recorded as period of date of receipt. Accounts posted as
of date cash received.
University Books, Incorporated
REVOLVING CASH FUND
INTERNAL CONTROL QUESTIONNAIRE
Question
Yes
Is responsibility for the fund vested in one person?
Is physical access to the fund denied to all others?
Is the custodian independent of other employees who
handle cash?
Is the custodian bonded?
Is the custodian denied access to other cash funds?
Are receipts unalterable?
Are receipts prenumbered?
Is the integrity of the prenumbered sequence periodically
accounted for?
Does the seller sign receipts?
Are receipts attached to reimbursement vouchers?
Are vouchers that are submitted for reimbursement
approved by someone other than the custodian?
Are reimbursement vouchers and attachments (receipts)
cancelled after reimbursement?
Is the fund used exclusively for the acquisition of
books?
Is the fund periodically counted and reconciled by
someone other than the custodian?
Is the fund maintained on an imprest basis?
Question
Yes
No
No
Is the size of the fund appropriate for the purpose
intended?
9.52
Other Audit Procedures
Reason for Other Audit Procedures
213
1. Source of debit entries in
general ledger cash account,
other than from cash receipts
journal, should be investigated
and supporting documents
examined.
1. Since the auditor, using standard
procedures, only examined the
cash receipts journal, he must
investigate the validity of all
other sources of cash receipts
which are not recorded in these
journals.
2. A surprise examination of cash
receipts should be performed.
Prior to the accounts receivable
clerk obtaining the cash
receipts, the auditor should
make a list of them without the
clerk's knowledge. The
undeposited mail receipts should
then be controlled after
completion of their preparation
for deposit and postings have
been made to the subsidiary
accounts receivable ledger. The
deposit slip should be compared
to the remittances for accuracy
and totaled. Individual items on
the deposit slip should be
compared to postings to the
subsidiary accounts receivable
ledger. The auditor should then
supervise the mailing of the
deposit to the bank. The auditor
should ask Gutzler to ask the
bank to send the statement
containing this deposit directly
to the auditor.
2. Since there are no initial
controls over cash receipts
established prior to the time the
accounts receivable clerk obtains
the cash, a surprise examination
is the only method of determining
if cash receipts are being
recorded and deposited properly.
3. Postings from the deposit slips
should be traced to the
subsidiary accounts receivable
ledger. Also, entries in the
subsidiary accounts ledger
should be traced to deposit
slip.
3. Since there is no separation of
duties between cash receipts and
accounts receivable, the accounts
receivable clerk may have been
careless in performing her
posting duties. This procedure
may also disclose whether the
accounts receivable clerk may
have been lapping the accounts.
4. Review the subsidiary accounts
receivable ledger and confirm
accounts that have abnormal
transaction activity such as
consistently late payments.
4. See No. 3 above.
214
5. If Gutzler allows customers to
take discounts, the amount of
such discounts and the discount
period should be checked.
5. Since there is no separation of
duties between cash receipts and
accounts receivable, the account
receivable clerk may have
appropriated discounts which
could have been but were not
taken or may have been careless
in checking the appropriateness
of discounts taken.
6. Dates and amounts of daily
deposits per bank
statement should be compared
with entries in the cash
receipts journal.
6. Since there are no initial
controls over cash receipts
established prior to the time the
accounts receivable clerk obtains
the cash, she may have become
careless about prompt deposit of
the daily receipts.
7. A proof-of-cash working paper
should be prepared which
reconciles total cash receipts
with credits per bank statement.
7. Since internal control over cash
receipts is weak, the auditor
should perform this overall check
to help substantiate that he has
investigated all material items
during his detail tests.
8. For those periods for which the
above audit procedures were not
performed and for a period after
the balance sheet date, scan the
cash receipts journal and bank
statements for unusual items.
8. Since internal control over cash
receipts is weak, the auditor
should perform this review to
help substantiate that he has
investigated all material items
not covered during his other
tests.
215
9.53
Memorandum
TO:
FROM:
DATE:
SUBJECT:
Board of Directors, The Pottstown Art League
(Student's name)
Control weaknesses related to Cash Admission Fees
You requested a report which identifies the weaknesses in the existing system
of cash admission fees and my recommendations. Below are the weaknesses that
exist and my recommendations for procedures that overcome these weaknesses. I
will be pleased to discuss these at the next board meeting and offer further
explanations that may be necessary.
Weakness: There is no segregation of duties between persons responsible for
collecting admission fees and persons responsible for authorizing admission.
Recommendation: One clerk (hereafter referred to as the collection clerk)
should collect admission fees and issue prenumbered tickets. The other clerk
(hereafter referred to as the admission clerk) should authorize admission upon
receipt of the ticket or proof of membership.
Weakness: An independent count of paying patrons is not made.
Recommendation: The admission clerk should retain a portion of the prenumbered
admission ticket (admission ticket stub).
Weakness: There is no proof of accuracy of amounts collected by the clerks.
Recommendation: Admission ticket stubs should be reconciled with cash
collected by the treasurer daily.
Weakness: Cash receipts records are not promptly prepared.
Recommendation: The cash collections should be recorded by the collection
clerk daily on a permanent record that will serve as the first record of
accountability.
Weakness: Cash receipts are not promptly deposited. Cash should not be left
undeposited for a week.
Recommendation: Cash should be deposited at least once each day.
Weakness: There is no proof of accuracy of amounts deposited.
Recommendation: Authenticated deposit slips should be compared with daily cash
collection records. Discrepancies should be promptly investigated and
resolved. In addition, the treasurer should establish a policy that includes
an analytical review of cash collections.
Weakness: There is no record of the internal accountability of cash.
Recommendation: The treasurer should issue a signed receipt of all proceeds
received from the collection clerk. These receipts should be maintained and
should be periodically checked against cash collection and deposit records.
9.54
Control Weakness: Computer
Weaknesses
Recommendations
Lack of segregation of duties
Computer operations, program changes, and
maintenance of logs should be performed by
different people.
No librarian function
Custody and control over databases and
system documentation should be under a
librarian function and not rotated.
216
Deficient restricted access
Programmers should not have free access to
the computer room (equipment).
Deficient documentation
Need documentation of flowcharts, program
changes, systems software, testing.
Lack of control totals
Error-checking validations need control
totals for effective operation.
No computer price list
For manual entry process, clerk should not
need to enter the sales price. It should
be in a database.
Numerical sequence
The computer should be used to check
numerical sequence.
Control total
The billing clerk's control total of sales
should be used to compare to total sales
processed by the computer.
Customer accounts
The computer system should be programmed
to maintain customer accounts instead of
using a manual open invoice file.
b.
Shipping clerks could enter the date, customer identification, shipment
quantities, and product identification numbers in a terminal. Then the
computer system could automatically produce a sales invoice. Controls
include:
Autoclock date checking
Self-checking customer identification numbers
Self-checking product identification numbers
Terminal batch hash total of customer ID numbers
Automatic numbering of sales invoices
Authorized price list in database
Control total comparison of hash ID numbers in run-to-run totals
9.55
Bank Reconciliation
CASH
Basic audit procedures that should be performed in gathering evidence in
support of each of the items (a) through (f) of the CYNTHIA COMPANY bank
reconciliation are as follows:
(a)
*
*
Balance per bank
Confirmation by direct written communication with bank (see Standard Bank
Confirmation).
Obtain and inspect a January cutoff bank statement obtained directly from
the bank (examine opening balance).
(b) Deposit in transit
*
Verify that the deposit was listed in the January cutoff bank statement
on a timely basis.
*
Trace to the cash receipts journal.
*
Inspect the client's copy of the deposit slip for the date of the
deposit.
(c) Outstanding checks
*
Examine checks accompanying the January cutoff bank statement and trace
217
*
*
*
all 1999, or prior, checks to the outstanding check list.
Trace outstanding checks to the cash disbursements journal.
Examine all supporting documents for those outstanding checks that were
not returned with the cutoff bank statement.
Ascertain why check number 837 has been outstanding for so long.
(d) NSF check return
*
Follow up on the ultimate disposition of the NSF check.
*
Examine all supporting documents.
(e) Note collected
*
Examine the bank credit memo.
*
Trace to accounting records.
(f) Balance per books
*
Foot the bank reconciliation to this total and compare with the general
ledger balance.
9.56
a.
The PA's test of the sales cutoff at June 30 should include the following
steps:
1.
2.
3.
4.
5.
6.
b.
1.
2.
Determine what Houston's cutoff policy is, review the policy for
reasonableness, and compare it to the prior year for consistency.
Select a sample of sales invoices (including the last serial invoice
number) from those recorded in the last few days of June and the
first few days of July.
Trace these sales invoices to shipping documents and determine that
sales have been recorded in the proper period in accordance with
company cutoff policy.
Determine that the cost of goods sold has been recorded in the
period of sale.
Select a sample of shipping documents for the same period and trace
these to the sales invoice. Determine that the sale and the cost of
goods sold have been recorded in the proper period.
Review the cutoff for sales returns and allowances, determine that
it has been based upon a consistent policy and that there have not
been abnormal sales returns and allowances in July; this might
indicate either an overstatement of sales during the audit period or
the need for a valuation account at June 30 to provide for future
returns and allowances.
The PA will use the July 10 cutoff bank statement in his review of
the June 30 bank reconciliation to determine whether:
(a) The opening balance on the cutoff bank statement agrees with
the "balance per bank" on the June 30 reconciliation.
(b) The June 30 bank reconciliation includes those cancelled checks
that were returned with the cutoff bank statement and are dated
or bear bank endorsements prior to July 1.
(c) Deposits in transit cleared within a reasonable time.
(d) Interbank transfers have been considered properly in
determining the June 30 adjusted bank balance.
(e) Other reconciling items which had not cleared the bank at June
30 (such as bank errors) clear during the cutoff period.
The PA may obtain other audit information by:
(a) Investigating unusual entries on the cutoff bank statement.
(b) Examining cancelled checks, particularly noting unusual payees
or endorsements.
(c) Reviewing other documentation supporting the cutoff bank
statement.
218
9.57
a.
Cash balance, per books November 30
Add: Credit by bank
Adjusted cash balance (on hand and
in bank)
Less adjusted bank balance:
Bank balance, November 30
Less outstanding checks,
6500
$116.25
7126
150.00
7815
253.25
8621
190.71
8623
206.80
8632
145.28
$18,901.62
100.00
$19,001.62
$15,550.00
1,062.29
14,487.71
Cash which should be on hand for deposit
Cash deposit reported
$ 4,513.91
3,794.41
Amount of theft
$
719.50
The minimum amount of the theft is $719.50 if the cash reported as
"undeposited receipts" ($3,794.41) was actually on hand, represented
November receipts, and was deposited intact in December. If the $3,794.41
was not available to deposit or represented December receipts, the
maximum loss could be $4,513.91 (719.50 + 3,794.41) for November. Such a
shortage (minimum or maximum) for November and the attempt to conceal the
shortage would alert the auditors to examine the bank reconciliations
throughout the year for other concealed shortages.
b.
He attempted to conceal his theft by:
1.
Not listing all outstanding checks.
2.
Miscalculating the outstanding checks shown on the reconciliation.
3.
Subtracting an item from the bank balance that should be added to
book balance.
c.
1.
2.
d.
9.58
No one other than the cashier is responsible for tracing cash
receipts to the deposits in the bank.
The cashier is also responsible for preparing the bank
reconciliation.
The following auditing procedures on December 5 would uncover the theft
if the October 31 reconciliation is known to be correct:
1.
Compare checks returned since October 31 with checks outstanding at
that time and with check register for November in order to ascertain
outstanding checks.
2.
Trace cash on hand at October 31 as well as receipts during November
to deposits in bank, ascertaining undeposited cash at November 30.
3.
Count cash on hand on December 5, and by adding deposits since
November 30 and subtracting receipts since November 30 to develop
cash on hand at November 30.
4.
Compare adjusted cash on hand developed in count (Step 3) with
undeposited cash ascertained in tracing (Step 2).
Auditing procedures other than confirmation which may be used to verify an
account receivable include:
1.
Examination of evidence of subsequent payment of the account including:
a.
The customer's remittance advice accompanied by the payment.
b.
The check sent in by the customer.
219
c.
d.
e.
An authenticated bank deposit ticket listing a deposited check for
the outstanding account.
An entry in the cash receipts book.
A credit posted to the customer's account.
2.
Examination of other evidence including:
a.
Shipping department's notice of shipment, accompanied possibly by a
receipted copy of the bill of lading, the customer's purchase order,
sales invoices, and any correspondence referring to the shipment of
the goods.
b.
Entries removing the goods from inventory.
c.
Time records and work orders, if appropriate.
3.
External inquiries as to the existence and credit rating of the debtor.
4.
Discussion of the account with the client's credit manager, examination
of credit department records, and records of merchandise returned, and
such other investigation as may lead to better understanding of the
nature of the account and its collectibility.
The auditor might also consider further discussion or correspondence with the
debtor to determine whether alternative methods might be used to confirm the
account (e.g., by furnishing the debtor more detail concerning the invoices in
the balance.
9.59
The procedure followed appears to be appropriate
of detail transactions for three months might be
view of the exceptionally good internal control.
transactions, designed to test the effectiveness
might be devised.
except that the examination
considered to be excessive in
A lighter test of such
of the control procedures,
The procedures followed should be supplemented by the following:
1.
2.
3.
4.
5.
9.60
Review the company's method of sales cutoff at year-end and test billings
and shipments (including returns) for an adequate period before and after
year-end to establish that cut-off procedures have been adhered to.
Examine collections in early part of subsequent period to determine if a
substantial portion of the receivables has been collected.
Examine agreements entered into with the distributors. If price
protection clauses are included, review the current price position and
distributor inventory positions to determine whether a reserve for such
protection is needed.
When a company deals with a limited number of customers, it is dependent
upon the continued solvency of all such customers.
Obtain a representation letter from appropriate company officials
covering the receivables.
To audit the schedule of Rent Reconciliation prepared by the controller of
CLAYTON REALTY CORPORATION, you would perform the following procedures for
those items marked by an asterisk:
To substantiate the validity of gross apartment rents, you would-*
Physically examine the rental property or review architectural blueprints
to ascertain the total number of rental units.
*
Compare the total number of validated rental units with the total number
of rent charges on the schedule of gross apartment rents (Schedule A).
*
For occupied units, vouch the individual apartment rental charges per
lease agreements to the individual rental charges on Schedule A.
*
For unoccupied (vacant) units, ascertain the reasonableness of the
220
*
scheduled rent (by reference to the last rent paid, by reference to
comparable rent charges for similar units, etc.).
Foot the gross apartment rent schedule (Schedule A) and compare the total
with the figure indicated on the rent reconciliation.
To substantiate the validity of the vacancies, you would-*
Physically examine the apartments that were vacant during the month.
*
Compare the rental charge (validated in the gross apartment rents
procedures above) for each vacant apartment with the schedule of
vacancies (Schedule B)
*
Foot the schedule of vacancies (Schedule B) and compare the total with
the total indicated on the rent reconciliation.
To substantiate the validity of unpaid January rents, you would-*
Trace unpaid rents from individual tenant apartment ledger cards to
Schedule C.
*
Foot the unpaid rents schedule (Schedule C) and compare the total with
the amount shown on the rent reconciliation.
*
Examine the collection file for evidence of collection attempts.
*
Request written confirmations from tenants with accounts in January
arrears.
To substantiate the validity of the prepaid rent collected, you would -*
Trace the receipt to the individual tenant apartment ledger card.
*
Compare the amount collected with the lease terms.
To substantiate the validity of the cash collected, you would -*
Foot the client-prepared rent reconciliation.
*
Reconcile the cash receipts per the rent reconciliation with the books
and records.
*
Confirm and reconcile the special bank account balance.
SOLUTIONS FOR DISCUSSION CASE
9.61
a) This question involves matching the type of audit procedure and type of evidence
it creates to a described audit activity, vouching subsequent receipts
b) Knowledge of accounting system components, such as the names of books and records
use to record cash receipts can be applied
9.62
a) The importance and reliability of the audit evidence obtained from confirming
zero balances needs to be considered against the cost of the procedure
b) Key risk is omitting to record sales, specific controls procedures to address
this risk can be described
9.63
The case presents a situation where the company management has incentives to meet
certain financial statement targets and this may motivate them to take actions or
make accounting choices that have an impact on their financial statements. The
auditor is looking for objective evidence to support the financial statement numbers
that management has prepared. Points that can be discussed include the following.
a) Rosella is applying a knowledge of the business operation to perform analysis
procedures. In particular, the knowledge of the business indicates certain operating
factors that determine what results are reasonable and attainable (maximums). She is
221
also trying to support the sales figure by analyzing monthly data trends, and making
comparisons to prior periods and to related amounts such as gross profit and
engineers’ travel expenses. These procedures can provide evidence about validity and
completeness of sales.
b) The findings suggest that the company has experienced a large increase in orders
and is attempting to meet these orders with its current production capacity.
Alternately, given the debt covenants and bonuses, management may be trying to push
sales out the door before they are finished so they can recognize revenue in the
current year to avoid missing key targets. This can distort gross profit since not
all costs have been incurred at the time of shipment, and since the costs are not a
usual part of production there may be no procedures in place to identify and accrue
for them. Various conclusions are possible depending on the interpretation of the
case facts, any assumptions made and how this is all analyzed.
c) With this recognition policy it is possible that the facts support revenue
recognition. It appears machines were loaded and titled transferred to customer
before year end. In any case, this can be verified with examination of relevant
documents and confirmation of customer receivables. The possibility of current
income being overstated still exists, but this may be due to a problem of
completeness of liabilities (i.e., ‘warranty’ costs of getting the machines working
at the customers’ premises) rather than validity of sales. Other valid points can be
discussed.
9.64
This could occur if the company’s record keeping is inadequate or it lacks internal
controls over cash.
9.65
The case requires one to consider risks in a stock brokerage business and evaluate
the appropriateness of negative confirmations as audit evidence. A possible approach
to the analysis is as follows.
a) The main inherent risk is failing to record a customer stock transaction
correctly, or omitting recording it. This would result in invalid or incomplete
information in the customer’s account. Given that marketable securities are
involved, there is also a fairly high risk of fraud by misappropriation of customer
funds or investments. Regulatory non-compliance is another consideration. Given the
types of inherent risks to be controlled, strong controls are required over
authorization/ownership, completeness and validity of customer trades and account
balances. There is also the risk that customers will provide incorrect information
and the need to keep records of customer telephone orders and instructions, issue
confirmations, and verify customer account details regularly. The external audit in
this situation can complement internal controls by providing a further check on
validity, completeness and authorization/ownership.
b) Negative confirmations are relatively inexpensive and a large percentage of the
customer population can be queried. While a weakness is the low response rate, and
the inability to know if non-responses would have indicated errors, they do get at
the key concern that customer assets have been misappropriated by the stock
brokerage firm since customers are more likely to respond when their accounts are
incomplete.
9.66
1.
Situations encountered in the audit of Trinity Company's financial
statements that may indicate an attempted concealment of defalcation:
1.
Underfooted Sales Journal--The July sales journal was underfooted by
$4,500. Because the understated monthly total was posted as a debit
to Accounts Receivable, accountability for future receivable
222
collections was also understated by $4,500. This could permit
someone to intercept customer remittances without an apparent
shortage resulting.
2.
False Debit Posting--The first situation dealt with the
cash for which accountability had not been established.
establishment of recorded accountability, however, will
necessarily prevent the perpetration and concealment of
defalcation.
theft of
The
not
a
For example, a person with access to a company's supply of blank
checks may steal by issuing a check to himself or herself.
Concealing such a theft would also require access to certain
accounting records. A person who posts the general ledger could
conceal the theft by:
*
reducing the recorded accountability for cash in the checking
account. This could be accomplished by posting a credit to Cash
that did not come from any preceding record;
*
transferring the resulting shortfall to an expense account.
Situation 2 indicates one way this might be done--entering an
unsupported debit posting in an expense account. Later, to
complete the concealment, it might be necessary to remove the
returned check from the next bank statement before the checking
account is reconciled.
2.
3.
Uncancelled Supporting Documents--Uncancelled supporting documents
can be removed from a voucher and used again as support for a
fraudulent voucher. This fraudulent voucher could be entered into a
company's purchase/disbursement system, resulting in an improper
disbursement.
4.
Omitted Outstanding Check--A misappropriation of cash similar to
that described in Situation 2 might have occurred. The resulting
cash shortage could be concealed by manipulating the bank
reconciliation at month-end. An unrecorded, improperly issued check
would reduce the bank balance, but would not reduce the book
balance. so a properly prepared bank reconciliation would not
reconcile, and the cash shortage would be revealed.
However, the person who reconciles the bank statement could conceal
the shortage by understating the amount subtracted for outstanding
checks. for example, a check that should have been listed as
outstanding might be omitted from the list as described in Situation
4 or the list might be underfooted. Alternatively, concealment could
be attempted by overstating deposits in transit.
a.
There is an important distinction between the type of concealment
discussed in Situation 4 and those discussed previously. The
concealment in Situation 4 is temporary because the perpetrator must
repeat the concealment at each subsequent reconciliation date.
Defalcation can be permanently concealed by reducing (crediting)
cash so that it agrees with the shortage as a debit to some income
statement account. The offsetting debit to an income statement
account will result in either an understated revenue (Situation 1)
or an overstated expense (Situation 2 and 3). Such concealments are
"permanent" because no further action by the perpetrator is
required.
b.
A careful consideration of the ways concealments might be attempted
223
is an important factor in determining appropriate directions for
substantive tests of details. For example, when auditing a bank
reconciliation, auditors should audit deposits in transit for
overstatement and outstanding checks for understatement. (See also
SAS 39, AU 350.)
To detect permanent concealments of material defalcations, auditors
might plan their substantive audit procedures to audit revenues for
understatement and expenses for overstatement. These directions are
opposite to those often associated with auditing for managementinspired distortions of financial data; such distortions have
usually exaggerated reported profits by overstating revenues or
understating expenses.
c.
Through the four situations presented, one can see that the
perpetration and concealment of a defalcation usually requires both
access to an asset (for perpetration) and access to related
accounting records (for concealment). Therefore, a good internal
control system should be designed so that one employee does not have
both types of access.
However, all control systems have inherent limitations that prevent
auditors from placing complete reliance on them. Therefore, auditors
should not rely exclusively on good control procedures to fulfill
their responsibility to search for material defalcations. Some
substantive procedures should be performed, although the extent of
such substantive procedures may be appropriately reduced when
effective control procedures are present (SAS 39, AU 350).
d.
Substantive audit procedures include analytical review procedures
and tests of details, which can be applied in any combination the
auditors deem appropriate. For the purpose of detecting material
defalcations, analytical review procedures may be especially
effective in situations where defalcations have been cleverly
concealed through elaborate and collusive falsification of
supporting documents.
However, it is possible that material and recurring defalcations
involving similar amounts may have occurred over an extended period.
Because the continuation of such defalcations may not cause unusual
fluctuations, analytical review procedures may not detect the
defalcations. Accordingly, auditors should carefully weigh the risk
that recurring and material defalcations may have occurred when they
make decisions about the appropriate mix of analytical review and
detailed procedures to be performed.
9.67
Interbank Transfers
Note to Instructors: Check #1799 ($10,000 payable to Citizen National Bank)
drawn on the 1st National Bank account was not recorded in EverReady's cash
disbursements journal. This is the reason it is not in the schedule of
interbank transfers in Exhibit 9.62-1. The auditors obtained the initial
information from the cash receipts and cash disbursements journals, and #1799
was not in them.
a.
Complete the Schedule of Interbank Transfers (working paper C-5) by
entering the new information.
224
EXHIBIT 9.62-1
Schedule of Interbank Transfers
C-5
EVERREADY CORPORATION
SCHEDULE OF INTERBANK TRANSFERS
December 31, 2002
Disbursing Account
Check
No.
Bank
2220
4050
1417
4051
2221
4052
1601
4053
1799
2222
4054
1982
Chase
Commerce
1st N.C.
Commerce
Chase
Commerce
1st N.C.
Commerce
N.C.
Chase
Commerce
N.C.
Amount
11,000
10,000
10,463
12,000
15,000
12,000
11,593
14,000
10,000
12,000
20,000
9,971
Receiving Account
Date per Date per
Books
Bank
28-Dec
29-Dec
24-Dec 24-Dec
31-Dec
05-Jan
05-Jan
31-Dec 31-Dec
07-Jan
08-Jan
12-Jan
13-Jan
08-Jan 08-Jan
Prepared__________
Date__________
Reviewed__________
Date__________
Bank
Date per Date per
Books
Bank
Commerce
North Country
North C. payroll
Chase
Commerce
North County
N.C.
payroll
Chase
Commerce
Commerce
North Country
N.C. payroll
22-Dec
23-Dec
24-Dec 24-Dec
28-Dec
30-Dec
30-Dec
31-Dec 31-Dec
04-Jan
05-Jan
07-Jan
08-Jan
08-Jan 08-Jan
Traced from cash disbursements journal.
Check properly listed as outstanding on bank reconciliation.
Vouched to check cleared in bank statement.
Traced from cash receipts journal.
Vouched deposit cleared in bank statement.
Note: We scanned the cash disbursements and cash receipts journals for checks
to and deposits from other bank accounts. Found none other than those noted in
this workpaper.
b.
What is the actual cash balance for the four bank accounts combined,
considering only the amounts given in this case information, as of
December 31, 2002 (before any of the December 31 payroll checks are
cashed by employees)? As of January 8, 2003 (before any of the January 8
payroll checks are cashed by employees)? (Hint: Prepare a schedule of
"apparent balances" and "actual balances" illustrated in Chapter 18 to
explain check kiting.)
225
SCHEDULE OF APPARENT BALANCES AND ACTUAL BALANCES
Cumulative Record of Bank Balances
Chase Bank
North Country Payroll
Dec 22 (Tu)
Apparent balance
Actual balance
-0(11,000)
11,000
-0-
Dec 23 (W)
Apparent balance
Actual balance
-0(11,000)
11,000
1,000
10,000
10,000
Dec 24 (Th)
Apparent balance
Actual balance
-0(11,000)
11,000
1,000
537
537
9,463
9,463
Dec 28 (M)
Apparent balance
Actual balance
1,000
1,000
11,000
(11,000)
537
537
-0-*
-0-*
*
9.68
Commerce
Combined
Payroll checks assumed cashed by employees.
Dec 29 (Tu)
Apparent balance
Actual balance
1,000
1,000
1,000
(11,000)
537
537
Dec 30 (W)
Apparent balance
Actual balance
1,000
(14,000)
16,000
( 8,000)
12,537
12,537
Dec 31 (Th)
Apparent balance
Actual balance
1,000
(14,000)
4,000
( 8,000)
944
944
11,593
11,593
Jan 4 (M)
Apparent balance
Actual balance
15,000
-0-
4,000
(22,000)
944
944
-0-*
-0-*
Jan 5 (Tu)
Apparent balance
Actual balance
-0-0-
2,000
(12,000)
944
(9,056)
Jan 7 (Th)
Apparent balance
Actual balance
-0(12,000)
-0-0-
944
(9,056)
Jan 8 (F)
Apparent balance
Actual balance
-0(12,000)
-0(20,000)
973
973
9,971
9,971
(9,463)
(21,056)
Manipulated Bank Reconciliation
Yes, something is wrong, and it takes a careful eye to detect it. The bank
statement in Exhibit 19-3 has been altered. Cleared check # 2233 for $5,000
has been erased, and the bank balance has been changed from $2,374.93 to
$7,374.93. The bank balance is actually $5,000 lower than the reconciliation
shows. Since the problem says: "all checks entered in Caulco's cash
226
disbursements journal through February 29 have either cleared the bank or are
listed as outstanding checks in the February bank reconciliation," the
conclusion is that this $5,000 check was not recorded.
Students can find the alteration several ways. (1) They can notice the check
in Exhibit 19-2 (!) and find that it is not on the bank statement, even though
it is dated and cleared in February, (2) they can add the checks listed in the
February bank statement and find that the total is $5,838.29, not the
$10,838.29 shown on the bank statement, (3) they can add the previous balance
to the deposit and subtract the withdrawals to find a balance of $2,374.93
instead of the altered $7,374.93, and (4) they can notice the skip in the
numerical sequence not noted by the bank's double asterisk (**) used to
indicate a skip (this is the place the paid check was erased).
CAULCO, INC.
Bank Reconciliation (Corrected)
February 29, 1998
Balance per bank
$ 2,374.93
Deposit in transit
1,097.69
Outstanding Checks:
Number
Date
Payee
Amount
2239
2240
500.00
254.37
Feb 26
Feb 29
Alpha Supply
L.C. Stateman
Total Outstanding
9.69
( 754.37)
Reconciled balance
General ledger balance Feb 29, 1998
$ 2,718.25
$ 7,718.25
Cash overstatement, Check #2233 not recorded
$ 5,000.00
Employee Embezzlement via Cash Receipts and Payment of Personal Expenses
Objective: Obtain evidence to determine whether expenses paid from the extra
bank account were for legitimate school business. Auditors cannot ignore
informants' tales.
Control: Cash disbursements should be authorized by responsible officers of
the organization to be for valid business purposes. It is not unusual for a
business manager to have the authorization responsibility. Tight control would
call for disbursement review (at time of check signature) by another
responsible person (superintendent), and this control was not always observed.
Cash receipts should be listed by the person initially in control (cafeteria
manager), deposited by another person (business manager), and a responsible
person (superintendent, internal auditor, external auditor) should compare the
initial control record to the deposit to note any differences.
Test of Controls: Forewarned by the informant, the auditors could make
inquiry: "Does the school district have a fund for which individual
disbursements are not approved by the school board?" and "Does the business
manager have responsibility for this fund?" Answers to both questions directed
to the superintendent would be "yes," and the auditors can then concentrate
initial attention on the particular account records.
The next question is: "Does the cafeteria manager make a record of the daily
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receipts?" Answer by the superintendent: "I don't know, ask her." Luckily, it
turned out that the cafeteria manager, without direct instructions, made notes
on a calendar of the amount of money sent forward to the business manager for
deposit. Procedure: Compare the amounts from the cafeteria manager's calendar
to the deposits in the account.
Audit of Balance: The "balances" being audited are the expense accounts that
received the debits from the extra bank account. However, it is efficient to
go to the bank account records as a starting point for the investigation.
Obtain the bank statements and supporting documents for cash disbursements.
Study them for evidence of (1) improperly authorized payments, (2) payments of
personal expenses on the school district's VISA account, and (3) payments to
unauthorized persons (including "cash" with no supporting documents).
Discovery Summary: After finding payments to American Express and VISA,
auditors asked the superintendent about the credit card used by the school and
learned that the school used only VISA. Inquiry at American Express revealed
the business manager as the owner of the account number found on receipts in
the supporting documents. (Actually, by this time the business manager had
confessed, but identification of the account might have been harder.) Study of
the items and dates on the VISA charge slips showed items (e.g. hosiery) not
used at the school and dates that did not match business periods. Review of
the checks identified some unsupported checks to "cash."
During this review, the auditors found checks dated out of numerical sequence
and a missing block in the most current month. This was a sign of having blank
checks signed, so the superintendent was asked, and he admitted doing so. The
missing block was in a desk drawer, already signed.
Comparing the cafeteria manager's notes of cash receipts showed shortages in
numerous deposits. The business manager admitted taking the cash.
9.70
RING AROUND THE REVENUE: Overstated Sales and Accounts Receivable
This case is a take-off on the Mattel, Inc. financial statements misstatement
case.
AUDIT APPROACH
Objective: Obtain evidence to determine whether sales were recorded in the
proper period and whether gross accounts receivable represented the amounts
due from customers at year end.
Control: Sales terms should be properly documented. Accounting treatment,
including billing at agreed-upon prices, should follow the terms of the sale.
If the risks and rewards of ownership have not been transferred to the
customer, or the price has not been reliably determined, or the collectibility
of the amount is seriously in doubt or not estimable, an accrual sale should
not be recognized. Recorded sales should be supported by customer orders and
agreements. Shipping documents should be sufficient to show actual shipment or
a legitimate field warehousing arrangement.
Test of Controls: Questionnaires and inquiries should be used to determine the
company's accounting policies. If the auditors do not know about "bill and
hold" practices, they should learn the details. For detail procedures: Select
a sample of recorded sales, and examine them for any signs of unusual sales
terms. Vouch them to customer orders and other sales agreements, if any. Vouch
them to shipping documents, and examine the documents for external validity-recognizing blank spaces (carrier name, date) and company representative's
signature (two places, both company and carrier). Compare prices asked in
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customers' orders to prices charged on invoices. These tests follow the
vouching direction--starting with data that represent the final recorded
transactions (sales) and going back to find originating supporting source
documents. These procedures might reveal some transactions of the problem
types--bill and hold, and overbilling. The last month of the fiscal year
(although a typical seasonal low month) could be targeted for greater
attention because the sales are much higher than the previous January and
because the auditors want to pay attention to sales cut-off in the last month.
Select a sample of shipping documents, trace them to customer orders, and
trace them to invoices and to recording in the accounts receivable with proper
amounts on the proper date. These tests follow the tracing direction--starting
with data that represent the beginning of transactions (orders, shipping) and
tracing them through the company's accounting process. If extra attention is
given in January for cut-off reasons, this sample might reveal some of the
problem transactions.
Audit of Balance: Confirm a sample of customer accounts. Follow up exceptions
noted by customers relating to bill and hold terms, excessive prices, and
double billing. Even a few exceptions raise red flags for the population of
receivables.
Use analytical comparison on comparative month's sales. Investigate any
unusual fluctuations (e.g. January this year much larger than January last
year, the reversal month next year with negative sales). The January
comparative increase in sales should cause auditors to extend detail
procedures on some of the month's transactions.
Discovery Summary: The auditors performed a detail sales cut-off test on
January sales, selecting a sample of recorded sales. However, they did not
notice the significance of "bill and hold" marked on the invoices, and they
did not figure out the meaning of the blank spaces and duplicate company
employee signatures on the shipping documents.
In the following year's audit, they tested sales transactions in a month when
the prior year's bill and hold sales were reversed. They noticed the
discrepancy but were told that it involved various billing errors. They did
not connect it with reversal of the prior year's sales.
The auditors confirmed a judgment sample of large accounts receivable
balances. Twelve replies were received on 103 confirmations. Six of the
replies were from "bill and hold" customers who listed discrepancies. The
auditors followed up the six by examining sales invoices and shipping
documents. They did not grasp the significance of the "bill and hold" stamps
or the features of the shipping documents described earlier. Three
confirmation responses indicated the customers did not owe the amounts. The
auditors relied on Mattox internal documents to decide that the customers were
wrong. They did not examine the sales orders that indicated that these
customers had a right of cancellation.
The auditors did not perform month-by-month analytical sales comparisons with
the prior year. Thus they did not recognize the significant fluctuations in
the comparative January sales. In the next year's audit, they did not
recognize the significant comparative decrease in month's sales for the months
when the prior year bill and hold sales were reversed.
9.71
a.
The purpose of a cut-off test is to verify that transactions
(particularly those occurring on and around the balance sheet date) are
recorded in the proper accounting period.
Such tests relate to
229
management’s assertions about valuation and allocation (that is, amounts
are appropriately valued and allocated to the correct period).
b.
In order for those financial statements which measure flows (that is, the
statement of income and retained earnings, and the statement of changes
in financial position) to be correct, the transaction cut-offs at both
the beginning and end of the fiscal year must be correct.
Thus, in an
initial engagement, an auditor must test both transaction cut-offs.
c.
i)
ii)
iii)
iv)
9.72
Review the client’s procedures for ensuring that a proper cut-off of
sales transactions and any sales returns and allowances is made.
If a prenumbered shipping document is used, obtain the number of the
last shipment in the fiscal year.
Compare this number to sales
transactions recorded in the current and the subsequent period.
If there is no prenumbered shipping document, select a sample of
sales recorded during the last few days of the current year and the
first few days of the next year.
Examine shipping dates to verify
recording in the proper period.
Select a sample of credit memoranda issued near the end of the
current fiscal year and at the beginning of the next fiscal year and
examine supporting documents, including receiving reports for any
returned goods.
Verify that credit memos are recorded in the same
period as the related sales transactions.
d.
The cut-off of cash receipts is tested by tracing cash receipt
transactions recorded near the end of the fiscal year to a deposit
recorded by the bank.
Any deposits in transit at the end of the period
should be traced to a cut-off bank statement (covering the first few days
of the next fiscal year) sent directly by the bank to the auditor. An
unreasonable delay in the recording of a deposit by the bank could
indicate a cut-off error.
a.
i)
There is no apparent accounting control over the linens carried by
drivers for sale to customers. Specifically, no one seems to
reconcile the nature and quantity of linens sold, to customers
charges as recorded by the driver.
ii) There is a lack of segregation of functions in that drivers have
control over assets--both linens and cash-- as well as records of
those assets (the route book).
iii) There is a lack of adequate cash receipt records. Specifically, no
receipt for cash received is given by the driver to the customer.
iv) No one seems to account for completeness of the numerical sequence
of sales invoices prepared at the plant.
Thus sales invoices might
be prepared but not entered in the route books.
v)
Regular monthly statements are not sent to customers.
vi) There are apparently no procedures for follow-up on overdue
accounts.
vii) There are no independent internal verification procedures, for
example, by an internal auditor.
b.
No, the procedure of opening each route book twice, “at random”, would
not produce a statistically valid random sample. Since there are
different numbers of accounts on the various routes (from 25 to 40),
customers on a small route (25) have a greater probability of selection
than customers on a large route (40). This violates the equal probability
of selection requirement for a random sample. In addition, opening the
route book “at random” is a haphazard procedure which can easily be
biased (for example, the book tends to open most readily to certain
pages).
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c.
Since the internal controls in this situation are quite poor, the use of
positive accounts receivable confirmations is most appropriate. That is,
the auditor should request that customers respond whether of not they
agree with the recorded balance. Moreover, positive confirmations should
be used since there is a considerable risk of fraud by the drivers, who
control both the records and cash collections.
d.
Dollar-unit sampling is most effective and efficient when the auditor is
concerned primarily with the risk that an account balance may be
overstated, and the expected error rate in the population is low. Neither
condition is likely to be present in this case. Since there is a risk of
fraud by the drivers which could result in unrecorded receivables and
sales, the accounts receivable balances may be understated. In addition,
since internal controls are not good, there is likely to be a fairly high
error rate in the accounts. Thus, dollar-unit sampling should probably
not be used in this situation.