Auditing Chapter 6, 7, ACCT 408 Exam #2 with 1005 correct answers 2024.

7.33 Revenues are normally considered to have been earned when a. All possibility of return has expired b. The company has substantially accomplished what it must to be entitled to the benefits. c. The cash is collected. d. Goods have been shipped. - answer-b. Correct The earning process is complete at this point. 7.34 Sales are normally recorded on the date of the a. Customer purchase order. b. Bill of lading. c. Sales invoice. d. Payment check - answer-c. Correct This is often the same as the bill of lading date. 7.35 When auditing the revenue and collection cycle, auditors normally select balances to confirm from the a. Sales journal. b. Accounts receivable listing. c. General ledger. d. Cash receipts listing. - answer-b. Correct This would have the balance for confirming 7.36 Which of the following accounts is NOT normally part of the revenue and collection cycle? a. Sales. b. Accounts Receivable. c. Cash. d. Purchases Returns and Allowances. - answer-d. Correct Even though this involves shipments, it is considered part of the expenditure and disbursement cycle. 7.37 The control Procedure "credit sales approved by credit department" is directed toward which assertion? a. Existence/Occurrence b. Completeness. c. Valuation/Accuracy. d. Cutoff. - answer-c. Correct Credit approval helps ensure that the sale will be collectible. 7.38 Which of the following would be best protection for a company that wishes to prevent the "lapping" of trade accounts receivable? a. Separate duties so that the bookkeeper in charge of the general ledger has no access to incoming mail. b. Separate duties so that no employee has access to both checks from customers and currency from daily cash receipts. c. Have customers send payments directly to the company's depository bank. d. Request that customer's payment checks be made payable to the company and addressed to the treasurer. - answer-c. Correct The cash is not in the same physical place as the employees; therefore it cannot be stolen. 7.39 Which of the following internal control activities will most likely prevent the concealment of a cash shortage by improperly writing off a trade account receivable? a. Write-offs must be approved by a responsible officer after review of credit department recommendations and supporting evidence. b. Write-offs must be supported by an aging schedule showing that only receivables overdue several months have been written off. c. Write-offs must be approved by the cashier who is in a position to know whether the receivables have, in fact, been collected. d. Write-offs must be authorized by company field sales employees who are in a position to determine customers' financial standing. - answer-a. Correct Impropriety of write offs can be controlled by the review and approval of someone outside the credit department. 7.40 Auditors sometimes use comparisons of ratios as audit evidence. An unexplained decrease in the ratio of gross profit to sales may suggest which of the following possibilities? a. Unrecorded purchases. b. Unrecorded Sales. c. Merchandise purchases being charged to selling and general expense. d. Fictitious sales. - answer-b. Correct 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.) 7.41 An audit team is auditing sales transactions. One step is to vouch a sample of debit entries from the accounts receivable subsidiary ledger back to the supporting sales invoices. The purpose of this audit procedure is to establish that a. Sales invoices represent bona fide sales. b. All sales have been recorded. c. All sales invoices have been properly posted to customer accounts. d. Entries in the accounts receivable subsidiary ledger were properly invoiced. - answer-d. Correct Vouching is used to establish support for recorded amounts. 7.42 An auditor noted that client sales increased 10% for the year. At the same time, COGS as a percentage of sales had decreases from 45% to 40% and year-end accounts receivable had increased by 8%. Based on this information, the audior is most likely concerned about a. Unrecorded costs. b. Improper credit approvals. c. Improper sales cutoff. d Fictitious sales. - answer-d. Correct Fictitious sales would increase sales. Because no actual product was shipped, COGS as a percent of sales would decrease. The most likely debit for fictitious sales is accounts receivable, causing accounts receivable to increase. 7.43 An auditor noted that client sales increased 10% for the year. At the same time, COGS as a percentage of sales had decreases from 45% to 40% and year-end accounts receivable had increased by 8%. Based on this information, the auditor interviewed the sales manager, who stated that the increase in sales without a corresponding increase in COGS was due to a price increase enacted by the company during the year. How would the auditor test the sales manager's representation? a. Perform additional inquiries with sales personnel. b. Obtain copies of all price lists in use during the year and vouch the prices to sales invoices. c. Send confirmations asking customers about unit prices paid for product. d. Vouch vender invoices to payments made after year-end. - answer-b. Correct Reviewing the changes in pricing during the year and ensuring that customers were charged the new prices provides sufficient, reliable evidence to support the sales manager's representation. 7.44 To conceal a theft involving receivables, a dishonest bookkeeper might charge which of the following accounts? a. Miscellaneous income. b. Petty cash. c. Miscellaneous expense. d. Sales returns. - answer-d. Correct Using the sales returns account would raise the least suspicion because this account is more commonly linked to accounts receivable. A bookkeeper could steal money and "write off" to unsuspecting customer's balance with a fictitious "sales return." 7.45 Which of the following responses to an accounts receivable confirmation at December 31 would cause an audit team the most concern? a. "This amount was paid on December 30." b. "We received this shipment on January 2." c. "These goods were returned for credit on November 15." d. "The balance does not reflect our sales discount for paying by January 5." - answer-c. Correct This should have been recorded as a reduction or credit to the receivable by 12/31. 7.46 The client has a separate sales group for its largest "preferred" customers, a select group of customers who normally make purchases in excess of $250,000 and often have accounts receivable balances in excess of $1 million. Which of the following audit procedures would the auditor most likely perform? a. Prepare a schedule of purchases and payments for these customers. b. Send out negative confirmations on a large sample of these customers c. Inquire of the sales manager regarding the accounts receivable terms. d. Send out positive confirmations on a large sample of these customers. - answer-d. Correct The most likely audit step when there are a few large accounts is to send out positive confirmations. 7.47 Audit documentation often includes a client-prepared, aged trial balance of accounts receivable as of the balance sheet date. The audit team uses this aging primarily to a. Evaluate internal control over credit sales. b. Test the accuracy of recorded charge sales. c. Estimate credit losses. d. Verify the existence of the recorded receivables. - answer-c. Correct The age of accounts is an indication of credit losses. 7.48 Which of the following might be detected by auditors' cutoff review and examination of sales journal entries for several days prior to the balance sheet date? a. Lapping year-end accounts receivable. b. Inflating sales for the year. c. Kiting bank balances. d. Misappropriating merchandise. - answer-b. Correct 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. 7.49 Confirmation of individual accounts receivable balances directly with debtors will, of itself, normally provide the strongest evidence concerning the a. Collectability of the balances confirmed. b. Ownership of the balances confirmed. c. Existence of the balances confirmed. d. Internal control over balances confirmed. - answer-c. Correct 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. 7.50 Which of the following is the best reason for prenumbering in numerical sequence documents such as sales orders, shipping documents, and sales invoices? a. Enables company personnel to determine the accuracy of each document. b. Enables personnel to determine the proper period recording of sales revenue and receivables. c. Enables personnel to check the numerical sequence for missing documents and unrecorded transactions. d. Enables personnel to determine the validity of recorded transactions. - answer-c. Correct Checking the sequence for missing numbers identifies documents not yet fully processed in the revenue cycle. It does not provide evidence about accuracy, cutoff, or occurrence. 7.51 When a sample of customer accounts receivable is selected for vouching debits, auditors will vouch them to a. Sales invoices with shipping documents and customer sales invoices. b. Records of accounts receivable write-offs. c. Cash remittance lists and bank deposit slips. d. Credit files and reports. - answer-a. Correct The accounts receivable debits are supposed to represent sales that have been ordered by customers and actually shipped to them. 7.52 In the audit of accounts receivable, the most important emphasis should be on the a. Completeness assertion. b. Existence assertion. c. Rights and obligations assertion. d. Presentation and disclosure assertion. - answer-b. Correct Financial statement users are more likely to be damaged if assets are found not to exist or assets are overstated. 7.53 When accounts receivable are confirmed at an interim date, auditors need not be concerned with a. Obtaining a summary of receivables transactions from the interim date to the year-end date. b. Obtaining a year-end trial balance of receivables, comparing it to the interim trial balance, and obtaining evidence and explanations for large variations. c. (Page 321) Sending negative confirmations to all customers as of the year-end date. d. Considering the necessity for some additional confirmations as of the balance sheet date if balances have increased materially. - answer-c. Correct This is mainly because the other three choices are listed as appropriate work to do. Also, customers are likely to ignore negative confirmations after earlier responding to positive confirmations. 7..54 The negative request form of accounts receivable confirmation is useful particularly when the Assessed Level of Risk of Material Misstatement Relating to Receivables Is, Number of Small Balances Is, Proper Consideration by the Recipient Is a. Low Many Likely b. Low Few Unlikely c. High Few Likely d. High Many Likely - answer-a. Correct Negative confirmations are most appropriate when the assessed level of risk is low, dollar balances on accounts are small, and the auditor believes recipients will give consideration to the confirmations. 7.55 When an audit team traces a sample of shipping documents to the related sales invoice copies, they are trying to find relevant evidence that a. Shipments to customers were invoiced. b. Shipments to customers were recorded as sales. c. Recorded sales were shipped. d. Invoiced sales were shipped - answer-a. Correct Shipments are traced to customers' invoices. (This does not imply that the invoices were recorded in the sales journal.) 7.56 Write-offs of doubtful accounts should be approved by a. The salesperson. b. The credit manager. c. The treasurer. d. The cashier. - answer-c. Correct The treasurer or another high-ranking manager should approve write-offs. 7.57 When an audit team does not receive a response on a positive accounts receivable confirmation, auditors should do all of the following except a. Send a second request. b. Do nothing for immaterial balances. c. Examine shipping documents. d. Examine client correspondence files. - answer-b. Correct Because the confirmations are a sample of the account balance, even immaterial items should be followed up as they represent other balances in the universe of receivables. 7.58 Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this defalcation and be least likely to be detected by an auditor? a. Understating the sales journal. b. Overstating the accounts receivable control account. c. Overstating the accounts receivable subsidiary ledger. d. Understating the cash receipts journal. - answer-a. Correct Not recording sales on account in the books of original entry is the most effective way to conceal a subsequent theft of cash receipts. The accounts will be incomplete but balanced, and procedures applied to the accounting records will not detect the defalcation. 7.59 Which of the following internal control activities most likely would deter lapping of collections from customers? a. Independent internal verification of dates of entry in the cash receipts journal with dates of daily cash summaries. b. Authorization of write-offs of uncollectable accounts by a supervisor independent of credit approval. c. Separation of duties between receiving cash and posting the accounts receivable ledger. d. Supervisory comparison of the daily cash summary with the sum of the cash receipts journal entries. - answer-c. Correct Lapping is the delayed recording of cash receipts to cover a cash shortage. Current receipts are posted to the accounts of customers who paid one or two days previously to avoid complaints (and discovery) when monthly statements are mailed. The best protection is for the customers to send payments directly to the company's depository bank. The next best procedure is to ensure that the accounts receivable clerk has no access to cash received by the mail room. Thus, the duties of receiving cash and posting the accounts receivable ledger are segregated. 7.60 (Page 322) The financial records of the Movitz Company show that R. Dennis owes $4,100 on an account receivable. An independent audit is being carried out, and the auditors send a positive confirmation to R. Dennis. What is the most likely reason as to why a positive confirmation rather than a negative confirmation was used here? a . Control risk was particularly low for accounts receivable. b. Inherent risk was particularly high for accounts receivable. c. Dennis's account was not yet due. d. Dennis's account was not with a related party. - answer-b. Correct Because detection risk is lower for positive confirmations than negative confirmations, a positive confirmation is more likely when inherent risk is high. 7.61 An audit client sells 15 to 20 units of product annually. A large portion of the annual sales occur in the last month of the fiscal year. Annual sales have not materially changed over the past five years. Which of the following approaches would be most effective concerning the timing of audit procedures for revenue? a. The auditor should perform analytical procedures at an interim date and discuss any changes in the level of sales with senior management. b. The auditor should inspect transactions occurring in the last month of the fiscal year and review the related sale contracts to determine that revenue was posted in the proper period. c. The auditor should perform tests of controls at an interim date to obtain audit evidence about the operational effectiveness of internal controls over sales. d. The auditor should review period-end compensation to determine whether bonuses were paid to meet earnings goal - answer-b. Correct Since a large portion of the sales occur in the last month the auditor needs to test end of year sales, specifically the determination of the timing of sales is important to ensure sales were recorded in the proper period. 7.62 An auditor is required to confirm accounts receivable if the accounts receivable balances are a. Older than the prior year. b. Material to the financial statements. c. Smaller than expected. d. Subject to valuation estimates. - answer-b. Correct Confirmation are generally reserved for accounts that are material to the balance being examined, in this case, accounts receivable. 7.63 During the confirmation of accounts receivable, an auditor receives a confirmation via the client's fax machine. Which of the following actions should the auditor take? a. Not accept the confirmation and select another customer's balance to confirm. b. Not accept the confirmation and treat it as an exception. c. Accept the confirmation and file it in the working papers. d. Accept the confirmation but verify the source and content through a telephone call to the respondent. - answer-d. Correct When a reply to a confirmation is received via fax the auditor must determine that the fax actually came from the appropriate person at the client. A telephone call to an appropriate person at the respondent's company is an acceptable method for verifying the legitimacy of the response. When auditing with "fraud awareness," auditors should especially notice and follow up employee activities under which of these conditions? a. The company always estimates the inventory but never takes a complete physical count. b. The petty cash box is always locked in the desk of the custodian. c. Management has published a company code of ethics and sends frequent communication newsletters about it. d. The board of directors reviews and approves all investment transactions. - answer-a. Correct Risk is high when the company always estimates the inventory but never takes a complete physical count. The best way to enact a broad fraud prevention program is to a. Install airtight control systems of checks and supervision. b. Name an "ethics officer" who is responsible for receiving and acting on fraud tips. c. Place dedicated hotline telephones on walls around the workplace with direct communication to the company ethics officer. d. Practice management "of the people and for the people" to help them share personal and professional problems. - answer-d. Correct Since "people" are essential to a fraud prevention program, Practice management "of the people and for the people" to help them share personal and professional problems is the best long run way to stop fraud. A good fraud prevention program should address employees' motivation to steal from the company. The best method for doing this is to a. Establish employee assistance programs. b. Require a fidelity bond on all employees. c. Require reconciliations of all accounts to be reviewed by a supervisor. d. Ensure that all accounts with high inherent risk of fraud are audited. - answer-a. Correct Problems due to debt, addictions, or family problems motivate employees to commit frauds. Establishing an employee assistance program addresses these issues and ultimately may reduce the motivation to commit fraud for some employees. A code of ethics is an important element of a fraud prevention program. Which of the following would diminish the effectiveness of a company's code of conduct? a. The establishment of a chief ethics officer. b. The establishment of a hotline for reporting unethical behavior. c. The violation of the code of ethics by senior management. d. The posting of the code of ethics in the company workplace. - answer-c. Correct The violation of the code of ethics by senior management would reduce the effectiveness of the code of ethics because the tone at the top would send the wrong message to employees that the code of ethics was not important. Which of the following is least indicative of fraudulent activity a. Numerous cash refunds have been made to different people at the same post office box address. b. Internal auditors cannot locate several credit memos to support reductions of customers' balances. c. Bank reconciliation has no outstanding checks or deposits older than 15 days. d. Three people were absent the day the auditors handed out the paychecks and have not picked them up four weeks later. - answer-c. Correct Bank reconciliations that do not have outstanding checks or deposits older than 15 days are generally positive signs and are not indicative of fraudulent activity. Which of the following combinations is a good way to conceal employee fraud but an ineffective means of perpetrating management (financial reporting) fraud? a. Overstating sales revenue and overstating customer accounts receivable balances. b. Overstating sales revenue and overstating bad debt expense. c. Understating interest expense and understating accrued interest payable. d. Omitting the disclosure information about related-party sales to the president's relatives at below-market prices. - answer-b. Correct Overstating sales revenue and overstating bad debt expense by the same amount does not overstate net income or total assets (which is often a goal of financial reporting fraud). However, this action would help to hide a manager's theft of assets (i.e., embezzlement). Allison Everhart, an employee in accounts payable, believes she can run a fictitious invoice through the accounts payable system and collect the money. She knows payments are subject to an audit. Which account would be the best place to hide the fraud? a. Inventory. b. Wage expense. c. Consulting service expense. d. Property tax expense. - answer-c. Correct Expense accounts are often good places to hide fraud because accounts are closed at the end of the year. Consulting expense is a particularly good place to hide a fraud because it provides no actual product that may be counted or compared to the expense. Which of these arrangements of duties could most likely lead to an embezzlement or theft? a. The inventory warehouse manager has responsibility for making the physical inventory observation and reconciling discrepancies to the perpetual inventory records. b. The cashier prepared the bank deposit, endorsed the checks with a company stamp, and delivered the cash and checks to the bank for deposit (no other bookkeeping duties). c. The accounts receivable clerk received a list of payments received by the cashier so he could make entries in the customers' accounts receivable subsidiary accounts. d. The financial vice president received checks made out to suppliers and the supporting invoices, signed the checks, and mailed the checks. - answer-a. Correct The inventory warehouse manager could steal inventory and then manipulate the records to cover up the theft. This arrangement would violate proper segregation of duties because the manager has custody of assets and access to the records. The manager can steal and then conceal! Which of the following would the auditor consider to be an incompatible operation if the cashier receives remittances? a. The cashier prepares the daily deposit. b. The cashier makes the daily deposit at a local bank. c. The cashier posts the receipts to the accounts receivable subsidiary ledger cards. d. The cashier endorses the checks. - answer-c. Correct The auditor would consider it incompatible because the cashier would have both custody of cash and record-keeping responsibility and, hence, could steal money and fix the records without interference by anyone else. The cashier could steal and then conceal! Which of the following is an effective audit procedure that an auditor might use to detect kiting between intercompany banks? a. Review the composition of authenticated deposit slips. b. Review subsequent bank statements. c. Prepare a schedule of the bank transfers. d. Prepare a year-end bank reconciliation. - answer-c. Correct Kiting involves a mismatching of dates of recording cash transactions 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 were made in the proper periods. Immediately upon receipt of cash, a responsible employee should a. Record the amount in the cash receipts journal. b. Prepare a remittance listing. c. Update the subsidiary accounts receivable records. d. Prepare a deposit slip in triplicate. - answer-b. Correct Effective control of cash requires that receipts be recorded promptly. For mail receipts, a listing of remittance advices by an employee not performing incompatible functions is a standard control activity. If the customer does not return the remittance advice, one should be prepared at the time the mail is opened. If remittance advices are not used, a list of receipts should still be made when the mail is opened. Each morning the controller gets the prior day's list of remittances, a copy of the payment report, and a copy of the deposit slip returned from the bank. When comparing these items, the controller would be able to determine that a. No checks were returned for insufficient funds. b. The cash received and remittance advice received were maintained in a single batch. c. The accounts receivable system has controls over unauthorized access. d. The assistant controller does not also reconcile the subsidiary accounts payable. - answer-b. Correct If the cash received was not deposited intact or remittances were not posted, the deposit slip amount would not match the remittances or the payments recorded. Upon receipt of customers' checks in the mail room, a responsible employee should prepare a remittance list that is forwarded to the cashier. A copy of the list should be sent to the a. Internal auditor to investigate the list for unusual transactions. b. Treasurer to compare the list with the monthly bank statement. c. Accounts receivable bookkeeper to update the subsidiary accounts receivable records. d. Entity's bank to compare the list with the cashier's deposit slip. - answer-c. Correct The individuals with record-keeping responsibility should not have custody of cash. Hence, those individuals should use either the remittance advices or a list of the remittances to make entries to the cash and accounts receivable control account and to the subsidiary accounts receivable records. Indeed, having different people make entries in the control account and in the subsidiary records is an effective control. Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this defalcation and be least likely to be detected by an auditor? a. Understating the sales journal. b. Overstating the accounts receivable control account. c. Overstating the accounts receivable subsidiary ledger. d. Overstating the sales journal. - answer-a. Correct Not recording sales on account in the books of original entry is the most effective way to conceal a subsequent theft of cash receipts. The accounts will be incomplete but balanced, and procedures applied to the accounting records will not detect the defalcation. Embezzlement is a type of fraud that involves a. An employee's misappropriating an employer's money or property not entrusted to him or her. b. A manager's falsification of financial statements for the purpose of misleading investors and creditors. c. An employee's mistaken representation of opinion that causes incorrect accounting entries. d. An employee misappropriating an employer's money or property entrusted to the employee's control in the employee's normal job. - answer-d. Correct This statement is the textbook and criminological definition of embezzlement. Which of the following control activities would best protect against the preparation of improper or inaccurate cash disbursements? a. All checks must be signed by an officer designated by the board of directors. b. All signed checks must be reviewed and compared with supporting documentation by the treasurer before mailing. c. All checks must be sequentially numbered and accounted for by internal auditors. d. All checks must be perforated or otherwise effectively canceled when they are returned with the bank statement. - answer-b. Correct A final review by the treasurer can catch mistakes made in the processing of the payment. This also involves a review of the supporting documentation, an important consideration as well. During an audit of cash, the auditor is most concerned with the management assertion of a. Existence. b. Rights and obligations. c. Valuation or allocation. d. Occurrence. - answer-a. Correct The existence of cash is always a relevant assertion for cash because an overstatement of cash might indicate that fraudulent revenue was recorded. In preparing for the audit of cash, the auditors perform analytical procedures concerning cash balances. Which of the following would be the best source of information for use in the estimate of cash? a. Prior-years' balances. b. Management inquiry. c. Cash budgets. d. Aged accounts receivable reports. - answer-c. Correct Budgets provided by management provide the best management estimates for the sources and uses of cash. Where cash receipts or cash expenditures vary from the budget by a material amount, a higher level of risk may be assessed. Which of the following control activities could prevent a paid disbursement voucher from being presented for payment a second time? a. Vouchers should be prepared by individuals who are responsible for signing disbursement checks. b. Disbursement vouchers should be approved by at least two responsible management officials. c. The date on a disbursement voucher should be within a few days of the date the voucher is presented for payment. d. The official signing the check should compare it with the voucher and should stamp "paid" on the voucher documents. - answer-d. Correct Cancellation of vouchers by stamping them PAID prevents the voucher from mistakenly being paid a second time. Fraud risk factors are events or conditions that indicate which of the following: a. An opportunity to carry out a fraud. b. An attitude or rationalization that justifies a fraudulent action. c. An incentive or pressure to perpetrate fraud. d. All of these are correct. - answer-d. Correct The three factors that are likely to be present when fraud occurs are opportunity, motive, and the rationalization, which are reflected in responses (a-c). If the auditor believes that a misstatement is or might be intentional and the effect on the financial statements could be material or cannot be readily determined, the auditor should do which of the following? a. Inquire of management as to the possibility of fraud. b. Discuss with the audit committee what should be done to prevent possible future misstatements. c. Perform procedures to obtain additional audit evidence to determine whether fraud has occurred or is likely to have occurred. d. Both a and b are correct. e. None of these is correct. - answer-c. Correct Since the auditor believes that a discovered misstatement is or might be intentional, he/she should first perform additional procedures to obtain additional evidence to determine whether fraud has actually occurred. In what way can audit procedures be modified to address assessed fraud risks? a. Obtain more reliable information. b. Perform procedures close to year-end. c. Apply computer-assisted techniques to all items. d. All of these are valid modifications. - answer-d. Correct All three responses reflected in (a-c) would be appropriate modifications to address assessed fraud risks. As a result, this is the correct response. Incorporating elements of unpredictability in the selection of audit procedures to be performed by auditors include all of the following except a. Varying the timing of the audit procedures. b. Selecting items for testing that have lower amounts or are otherwise outside customary selection parameters. c. Performing audit procedures on an unannounced basis. d. Sending attorney letters to every attorney listed under the legal expense account. e. None of these is correct. - answer-d. Correct Sending attorney letters to every attorney listed under the legal expense account is common as it is important for auditors to inquire about any possible loss contingency. Since it is a customary procedure, this would not be an example of incorporating unpredictability into the selection of auditing procedures and would be the correct answer. Fraud risk factors are events or conditions that indicate I. An incentive or pressure to perpetrate fraud. II. An opportunity to carry out the fraud. III. An attitude or rationalization that justifies the fraudulent action. Which of the following statements is true? a. I is a fraud risk factor. b. I and II are fraud risk factors. c. II and III are fraud risk factors. d. None of these is a fraud risk factor. e. I, II, and III are fraud risk factors. - answer-e. Correct An incentive or pressure to perpetrate fraud is a correct response. In addition, an opportunity to carry out the fraud is a correct response. Finally, an attitude or rationalization that justifies the fraudulent action is a correct response. As a result, this answer is correct. Cash definition - answer-Represents currency on hand and cash deposit in bank accounts, including certificates of deposits, and savings accounts cash equivalents - answer-- Short-term highly liquid investments that are readily convertible to cash or so near their maturity that there is little risk of change in their value - Examples: treasury bills or money market funds Most important assertion for cash: - answer-Existence!!!; If foreign currency is involved, auditors may also be concerned with valuation assertion Control Activities for cash receipts: START: Cash received - answer-- Typically, individual employee receives cash/checks and has custody of the assets for a short time - Control activities to consider: Immediately prepare a list of cash receipts, have 2 people open the mail containing customer receipts, restrictively endorse checks upon receipt, and separate cash receipt employees from record-keeping and cash disbursements Control Activities for cash receipts: NEXT: Cash should be sent to treasurer - answer-- Bank deposit is prepared -- immediately deposited - Money is sent to the bank daily and intact (no money should be withheld from the daily deposit) - List of deposits (or remittance advices) go to the accounts who record the cash receipts - ACCOUNTANT WHO RECORD CASH RECEIPTS AND CREDITS TO CUSTOMER ACCOUNTS SHOULD NEVER HANDLE THE CASH Control Activities for cash receipts: An independent employee should receive: - answer-- A copy of the check listing - A report of payments recorded in AR - A copy of the deposit slips from the bank - Employees outside of cash operations (recording and custody) should prepare reconciliation Segregation of duties: - answer-1. Recording: Entries made by someone who does not have the check-writing ability, journal entries to record made by somebody in accounting 2. Custody: Blank checks are secure and can only be signed by the treasurer 3. Authorization: Authorized by AP department (Purchase order, vendor invoice, and internal receiving report = voucher (obligation to pay)) 4. Reconciliation: Monitoring performed by employee outside cash operations Primary risks for cash: - answer-- Cash is stolen (and no one is aware of it) - Cash is intentionally overstated to cover up theft or improve the appearance of liquidity - Cash is misstated due to errors in the bank reconciliation - Cash is misstated due to improper cutoff To audit a cash account, the auditor should obtain: - answer-- From client: Cash receipts journal, cash disbursements journal, bank reconciliation (all not audit evidence) - From the Bank (best audit evidence): Confirmation requests, cutoff bank statement, and cancelled checks (copies of checks that have already been cashed/have been used) -- must get info directly from bank Positive confirmation - answer-- Requests that banks respond indicating whether the balance is appropriate Blank confirmation - answer-- Requests banks provide balance - Most common and provides the highest level of assurance, compares bank records to client records Negative confirmation - answer-- Requests that bank respond only if the balance shown is correct - Lower level of assurance; non-response can mean no one ever got it, ignored it, different person could've received it. Not used commonly Cutoff bank statements - answer-- A complete bank statement that includes all paid checks and deposit slips - Normally covers the 10 to 20 day period after the date on of the financial statements - Client requests that the bank sends it directly to the auditor The steps to bank reconciliation: - answer-1. Balance per Bank: Confirm directly with bank and agree to cutoff bank statement 2. Deposits in transit: Vouch from bank reconciliation to cutoff bank statement 3. Outstanding checks: Trace cleared checks from cutoff bank statement to bank reconciliation 4. Balance per books: Recalculate reconciliation and agree to trial balance Substantive analytical procedures for cash are limited to: - answer-- Comparisons with budgeted amounts - Comparisons with prior years' cash balance (Prior year numbers are less useful b/c of the variation in the cash balance) Lack of analytical procedures is normally offset by: - answer-1. Extensive tests of controls and/or substantive tests of transactions for cash receipts and disbursements 2. Extensive tests of the entity's bank reconciliation Additional procedures to test cash: - answer-- Prepare a schedule of interbank transfers around year-end (used to detect check kiting, which is the deliberate floating of funds between two or more banks to make it appear that there is more cash is present and available than is really the case) - Obtain management representation concerning restrictions on cash (restricted cash needs to be designated separately on the B/S, ex: windmill company had to keep $15M on hand to dismantle the windmills to restore the land properly when done using the land) Inherent risks of inventory - answer-- Often a large and complex balance - Management estimate: valuation is usually very subjective - Susceptibility to theft - Errors affect both the B/S and NI - Industry changes can have large impacts Reasons why inventory could be materially overstated: - answer-Due to improper recording (error), due to inventory obsolescences issues, or due to theft Reasons why inventory could be materially understated: - answer-Due to recording of fictitious sales (fraud) What are the substantive testing for inventory? - answer-- Physical inventory observation - Cut-off testing - Pricing and compilation tests - Inventory turnover Physical inventory observation - answer-- Best opportunity to detect errors and fraud - Observe the physical inventory count taken by company personnel (test of controls) - Client provides listing of all inventory counts and auditor decides which inventory count to attend (substantive test) Important assertions for inventory - answer-- Existence: see if the count of the physical inventory is in the MF to see if it exists - Completeness: trace physical inventory to the MF to verify that the list is complete (test 10 items on MF and see if you find them in warehouse and make sure they are correct) - Rights and obligations: See if the company actually has ownership of the inventory - Valuation and allocation: Inquire about obsolete or damaged goods. Test mathematical accuracy of inventory reports and perform price tests for a sample of items to see if they are appropriately valued Physical inventory observation audit procedures - answer-1. Review inventory count instructions used by the client personnel 2. Observe client personnel taking inventory count (test of controls) 3. Tour facility and look for obsolete items (valuation test) 4. Perform duel direction testing: Existence and completeness 5. Record the last 5 receiving reports and last 5 shipping documents and determine if the items were properly included or excluded from the count (cutoff test) Physical inventory observation Challenges/difficult circumstances - answer-- Physical inventory not in Year-End date - Auditor not present for inventory count - Inventory located off client premise Inventory cutoff - answer-Verify cut-off for purchases and sales. Examine receiving reports and vendor sales invoices, bills of lading and sales invoices. Agree to inclusion/exclusion from inventory Auditors should examine: - answer-- Reasonableness of COGS (gross margin percentage and simple trend analysis) - Reasonableness of ending inventory (inventory turnover and days' sales in inventory) Fraud red flags for inventory - answer-- Uncontrolled access to inventory - Large differences between counts and inventory records - Inventory shows signs of damage, obsolescence or excess quantities - Unusual interplant transfers during physical inventory or at year-end - Reluctance of client to move merchandise to allow inspection of additional items located behind Segregation of duties in inventory - answer-- Purchase Department (Pre-numbered purchase orders should be prepared and issued to accounting and receiving departments) - Receiving Department (Receipt of goods should be verified and compared to purchase order) - Warehouse Personnel (Goods received should be securely held) - Shipping Department (Executes shipment of goods after receiving sales order and authorization from the credit departments) Auditing revenue substantive testing procedures - answer-- Test of details: Focuses on individual transactions or disclosures - Analytical procedures: Used to examine trends and plausible relationships among revenue related accounts What is revenue in auditing? - answer-- Must be 1) realized (already collected) or realizable (collectable in the future) and 2) earned (service is already performed or items have already have been shipped - SEC guidance: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller's price to buyer is fixed or determinable, and collectability is reasonably assured - Revenue must be considered a FRAUD RISK Inherent Risks of Revenue cycle - answer-1) improper revenue recognition: Fictitious sales, cut-off (recognizing revenue too early or wrong period), bill and hold, and channel stuffing 2) returns and allowances 3) collectability of receivables Risks for revenue - answer-- Assertions when testing revenue: Existence and Valuation of AR and Occurrence of revenue - Completeness assertion is less important/lower risk The revenue cycle order - answer-1) Receiving and processing customer orders: customer orders and credit approval (before shipping) 2) Delivering goods/services to customers: bill of lading and packing slip 3) Billing customers and recording AR: Sales invoice after shipping 4) Collecting and depositing cash received: check and deposit slip Customer order - answer-Contains the details of the type and quantity of products or services ordered by the customer Credit approval form - answer-Client must have a formal procedure for investigating the creditworthiness of the customer Shipping documents - answer-Bill of lading is signed to verify goods have been shipped. Packing slip contains information on the type of product shipped, the quantity shipped, etc. Sales invoice - answer-Used to bill the customer; contains information on the type of product or service, that quantity, the price and the terms of trade Aged trial balance of AR - answer-Summarizes all the customer balances in the AR subsidiary ledger. Each account is classified as current or placed into one of several past due categories Credit Memo - answer-Used to record credits for the return of goods by a customer Sales Journal - answer-Records information about the sales transaction. Once a sales invoice has been issued, the sale needs to be recorded in the accounting records Cash Receipts Journal - answer-Records the cash receipts of the entity Write-off authorization - answer-Authorizes the write-off of an uncollectible account receivable Control/custody of cash - answer-A person who controls cash should not have access to write down in journal or else they could steal a payment from a customer and write-off the receivable so no one would look for it. Analytical procedures for revenue: sales revenue analytics - answer-- Comparisons with other account balances: COGS, sales returns, sales commission) - Comparisons with prior periods - Comparisons with industry trends - Develop expectation with production records and average sales price Revenue: Test of Details - answer-1) Sales Cut-off tests: Used to verify whether revenues are recorded in the proper period. Examine sales invoices and shipping documents 5-10 days before and after year-end. Review credit memos - sales returned after year-end. 2) Test of transactions: 3-way match (to see if it is a valid sales transaction using customer order, shipping documents and sales invoice). Select a sample of sales recorded in the sales journal and VOUCH to supporting order, shipping documents and invoice. AR Analytic procedures - answer-- AR: Days sales in AR ( = AR/Average sales per day), Is it higher or lower than prior year or industry average? - Allowance for Doubtful Accounts/Bad debt expense: Bad debt expense as a percentage of sales, Allowance for doubtful accounts as a percentage of gross receivables, and compare current year write-offs with prior year allowance. AR Confirmations - answer-Useful for verifying existence. It is how much people owe your client and does not tell when. Factors likely to affect the reliability of confirmations - answer-- Previous audit experience - Intended recipient of the confirmation - Type of information being confirmed - The auditor may confirm entire balance or individual transactions - Type of confirmation being sent Positive confirmation (requires response) - answer-- Used when: a small number of accounts are involved or a large number of errors are anticipated. - Blank confirmation should be used if the recipient is likely to return a positive confirmation without verifying the accuracy of the information Negative confirmation (respond only if issue) - answer-- Used when: Assessed level of inherent and control risk is low, a large number of small balances is involved or auditor has no reason to believe that the recipient of the request are unlikely to give them consideration Important alternative procedures: - answer-- Identify subsequent cash receipts (after the confirmation date) - Request sales order, invoice and shipping documents associated with receivable (make sure sale is legit) Auditing standards require the auditors to use AR confirmation UNLESS: - answer-- AR balance is immaterial (worried about overstatement) - Auditor considers confirmations ineffective evidence because response rates will likely be inadequate or unreliable - Risk of Material misstatement (combined level of inherent risk and control risk) is low and other substantive evidence can be accumulated to provide sufficient evidence AR-Allowance for Doubtful Accounts - answer-- Inspect customer files for collectability - Recalculate allowance and bad debt expense - Verify reasonableness of allowance and bad debt expense - Verify appropriateness of accounts written off: Authorization and attempts to collect receivables Test AR Aging (as of year-end date) - answer-- Inquire of management regarding assumptions used in calculating allowance - Vouch as sample of current amounts (0-30 days) in AR aging to sales invoices to determine if they should be classified as past due - Vouch cash receipts after balance sheet date - Obtain credit reports for customers with large overdue balance -- make sure they pay - Consider economic events, prior write-offs, total sales, etc. Assertions in AR - answer-1) Existence (and collectable): confirm a sample of AR and examine cash receipts after the balance sheet date. 2) Valuation and allocation: Examine aged trial balance, perform analytical procedures on allowance, compare current year write-offs to prior-year allowance, and examine cash receipts after the balance sheet date. SEC guidance (SAB 104): - answer-- Persuasive evidence of an arrangement exists? -- Audit evidence: Review of customer order: confirmation - Delivery has occurred or services have been rendered? -- Audit evidence: review of bill of lading - The seller's price to the buyer is fixed or determinable? -- Audit evidence: Sales invoice (agree quantity to packing slip and price to master file) - Collectibility is reasonably assured? -- Audit evidence: Subsequent payment: credit check; payment history Auditor walkthrough - verify that understand control activities in place - answer-- Follow a sale from the initial customer order through credit approval, billing, delivery of goods, entry in the sales journal Procedures used from the least persuasive to the most persuasive form of evidence: - answer-1. Inquiry of client personnel 2. Observation of the operation of the control 3. Inspections of documents and records 4. Reperformance of control activities What are some importance internal controls surrounding the revenue cycle? - answer-Controls surrounding revenue recognition, calculation of allowance, segregation of duties, etc. Pending order master file - answer-- Sales transactions that are initiated but not yet complete - Review for evidence of completeness of sales and AR Credit check/approval files - answer-- Credit information must be up-to-date AR aged trial balance - answer-- Controls should be in place to ensure this is up-to-date Price list master file - answer-- May automatically populate on invoice - Auditor must be aware of price changes throughout year Sales journal - answer-- Should be reviewed daily by company personnel - Auditor should match pending dates with shipment dates Sales analysis report - answer-- Auditor should examine trends by employee, region, etc. Cash receipts journal - answer-- Auditor should review adjusting or unusual entries Customer billing statements - answer-- Review customer statements for what has been recorded as billed/paid/outstanding 3 ways to recognize expenses - answer-1) Recognized when they can be matched with the related revenues and those revenues are recognized 2) Recognized in the period in which they are incurred (ex: pay roll exp.) 3) Allocated to the future periods benefited by a systematic and rational process (ex: depreciation exp.) Inherent risk of the purchasing cycle - answer-- Capitalizing expenses - Unrecorded liabilities - Non-cancelable purchase agreements What is the most important financial statement assertion? - answer-Completeness What happens to NI when you improperly capitalize expense? - answer-Overstatement of profit in the current year and understatement of profit in future years Purchasing cycle - answer-1) Purchase goods and services: purchase requisition and purchase order 2) receiving the goods or services: receiving report 3) Recording the asset or expense and related liabilities: vendor's invoice and voucher 4) Paying the invoice through the cash disbursement process: check copy Purchase requisition - answer-Request to purchase goods or services Purchase order (authorization) - answer-Prepared by purchasing department and includes description of goods or services being purchased Receiving reports (custody) - answer-Records the receipt of goods Vender invoice - answer-Bill from the vendor Voucher (Recording) - answer-- AP department attaches voucher to PO, invoice and receiving report - Shows authorization and outlines accounting entries Risk of understatement for liabilities - answer-- Invoices are usually received after goods or services have been received - Requires the company to "hold the books open" for a specified time after the period ends to properly record expenses in the right period - If the company's cut-off procedures and inadequate, liabilities could be recorded in the wrong period Assertion, Risk of material misstatement, and substantive procedures of liabilities - answer-- Assertion: Completeness (All payables that should have been recorded are recorded) - Risk of material misstatement: Liabilities are not recorded as of the date they were incurred - Substantive procedures: Perform search for unrecorded liabilities Segregation of duties in purchasing cycle - answer-- Authorization: purchasing department approves requests and prepares PO - Custody: receipt of goods when they are delivered - Recording: AP department records entry when Voucher Packet (PO, receiving report, invoice) is received - Custody: Treasury makes payment to vendor Search for unrecorded liabilities - answer-1) Inquire of client about procedures for identifying and recording liabilities 2) Scan open purchase order file for material purchase commitments 3) Examine all unmatched vendor invoices and determine when goods were received 4) Examine all unmatched receiving reports occurring near year-end 5) Review cash disbursements occurring after year-end determine if the liability was recorded in proper period (most important step) Cut-off tests for purchases - answer-- Similar to cut-off testing for revenue - Examine receiving reports and vendor sales invoices occurring around year-end to ensure inventory is included in the appropriate period Review bank cutoff statement - answer-- To determine whether receipts or disbursements are recorded on a timely basis, or to verify the appropriateness of reconciling terms - Typically, these procedures are done when auditing cash Confirmation of payables - answer-- Choose accounts most likely to be understated (small or zero balances for regular suppliers) - Use if: internal controls are weak, accounts include unusual transactions, bill paying is slow Analytical procedures for liabilities - answer-AP should increase when the company increases production volume or engages in inventory stockpiling Taxes payable should have consistent relationship with other accounts: - answer-- Sales taxes related to sales dollar total - Payroll taxes related to payroll expense/hours worked - Excise taxes to sales dollars or volume - Income taxes to net income Substantive testing for PPE - answer-1) Agree balances to prior year documentation 2) Test purchase of PPE 3) Test additions to PPE subsequent to acquisition 4) Test gain on disposals of PPE 5) Search for unrecorded disposals Testing Depreciation Expense - answer-- Recalculate using: useful life, salvage value, cost and depreciation method - Evaluate reasonableness of management's assumptions - Ensure consistency with company policy F/S assertion(s) for Cash - answer-Existence F/S assertion(s) for AR - answer-Existence and valuation and allocation F/S assertion(s) for Revenue - answer-Occurance F/S assertion(s) for AP - answer-Completeness F/S assertion(s) for PPE - answer-Existence, rights and obligations, and valuation and allocation F/S assertion(s) for Inventory - answer-Existence, completeness, rights and obligations, and valuation and allocation (all 4) Existence assertion - answer-- Test for overstatement - Testing procedures = vouching - Start with ledger and find supporting documentation Completeness assertion - answer-- Test for understatement - Testing procedures = Tracing - Start with source documents and trace into the ledger