Question 1

In the planning phase, Denis conducted an analytical procedure to compare the allowance for doubtful accounts balance to the accounts receivable balance. In the prior years, the allowance for the doubtful accounts/accounts receivable ratio was between 2.5% to 3.5%. This year, the number is 1.25%. What should Denis do?
A) Change the assessed inherent risk
B) Conduct additional testing to justify the lower bad debt.
C) Advise management that they should increase the allowance for doubtful accounts provision.
D) Document this difference and continue with audit work to see if this is pervasive bias of management.

Accepted Answer

The answer of In the planning phase, Denis conducted an...

Question 2

You have just been assigned to manage the audit of Cheap Music Downloads Inc. (CMD), a new large client of your firm. CMD is a subsidiary of a client of your firm that manufactures audio and video equipment for international distribution. CMD has been in operation for two years.
CMD runs a website that allows customers to order songs using their credit card. There are tens of thousands of small transactions daily. Once the credit card has been authorized by the credit card processing intermediary, CMD's web sales system generates a 16-digit sequential code that the customer uses to access the song via the website. CMD then records both the sale and the royalty for the song.
Quarterly, CMD remits royalties to artists based on the number of copies of each song that has sold if the accumulated royalty exceeds $25 for that artist. Artist royalties that do not exceed $25.00 will be paid every two years if there has not been a payment during that time.
All contracted royalty rates, artist names, and song titles are recorded in CMD's database tables.
Required:
Describe three internal controls that should exist over sales or royalty transactions or over the database tables. For each control:
1. State the control.
2. Describe (not just state) the audit assertion associated with the control (or state the purpose of the control).
3. Provide an audit test that you could use to test the control.

Accepted Answer

The answer of You have just been assigned to manage...

Question 3

Office Design Inc. (ODI) has been your audit client for five years. ODI designs and sells office furniture such as desks, cabinets, and couches used in office reception areas. ODI has sales in Canada and the U.S., with five distribution locations where furniture is available to prospective purchasers to try out before purchasing. These locations are in Toronto, Montreal, Halifax, New York, and Chicago. The company uses custom-designed software for its order processing and sales, which is kept current by one of the five information systems personnel.
The Vice President of Finance is new. Executive management is paid a salary and a bonus based on the annual net income of ODI. Unfortunately, the accounting staff at the head office (in Montreal) has been downsized from ten people to six due to a recent slowdown in sales. Your review of the aged accounts receivable trial balance revealed that one third of the accounts have been outstanding for more than one year. ODI's profits have declined substantially from last year. Its line of credit and bank loans are at their maximum and the company is considering selling its U.S. operations to provide cash flow.
Prior year working papers revealed few errors and indicate that you considered management integrity to be good. However, due to segregation issues, you did not rely on the internal controls in the prior year.
Required:
A) What issues in corporate governance and in the control environment affect your assessment of internal controls for revenue? How does this affect the decision to conduct substantive testing (i.e. exclusion of tests of controls)?
B) What is the likely assessment of computer general controls? How does this affect the type of audit testing conducted at ODI?

Accepted Answer

The answer of Office Design Inc. (ODI) has been your...

Question 4

At every audit engagement the auditor is required to consider that there could be significant risks of misstatement for revenue recognition. At ABC Ltd., the auditor has concluded that, yes, there are material risks of misstatement associated with revenue recognition. How does this affect the extent of testing for accounts receivable?
A) Audit risk will be increased.
B) Inherent risks will be decreased.
C) Decreased control testing is required.
D) Increased substantive testing is required.

Accepted Answer

When there are significant risks of misstatement regarding revenue recognition, the auditors are supposed to perform increased substantive testing to obtain evidence of these transactions to ensure that financial statements are not materially misstated. Therefore, the extent of testing for accounts receivable will be increased to address the risk of misstatement.

Question 5

Tests of details of balances relate to which part of the Audit Risk Model?
A) control risk
B) inherent risk
C) substantive risk
D) planned detection risk

Accepted Answer

The answer of Tests of details of balances relate to...

Question 6

One of the key internal controls to prevent transactions in the sales and collection cycle to fictitious customers is to
A) have the bank reconciliation done by someone who is independent of the treasury function.
B) account for the integrity of the numerical sequence of sales orders.
C) compare customer numbers entered to the customer master file.
D) include the sales price list of all products in the computer files.

Accepted Answer

Comparing customer numbers entered to the customer master file is a direct method to ensure that sales transactions are made to legitimate, existing customers, thereby preventing transactions with fictitious customers. This control helps in verifying the authenticity of the customer by matching the entered customer information against the pre-approved and validated data in the customer master file.

Question 7

You and your audit team went to a local mall for your lunch break. While there, you dropped off a roll of film at a photo store, and planned to pick it up after work that day. You strike up a conversation with your supervisor about digital versus film photography and your supervisor says, "Next week, you are going to be working at a client that just happens to be a group of photography stores. Tell me, what controls do you think should be programmed into the store cash registers to help ensure that sales transactions are accurate and complete?"
Required:
Answer your supervisor's question.

Accepted Answer

The answer of You and your audit team went to...

Question 8

Your audit client is a large retail chain with its own credit card. It has annual sales of about $100 million. On December 31, there were approximately 40 000 open accounts with total receivables of approximately $18.5 million. Very few customer balances exceed $1000. The company's general office maintains the accounts receivable records. The large volume of transactions processed by the company has necessitated extensive segregation of duties and frequent balancing of data during processing. Accordingly, the company's general and system controls are considered to be very good. A complete record of each customer's account is stored on a relational database and includes the following information:
Description of field contents
Type of account (personal, corporate) Customer account number
Customer name and address Credit limit (code for 8 credit levels)
Status code (active, inactive, bad debt) Number of transactions this month
Current month's charges Current month's payments
Total outstanding balance Aged balance over 30 days
Aged balance over 60 days Aged balance over 90 days
Aged balance over 120 days Year account opened
Year last active Total purchases this year to date
Total returns this year to date Number of months active
Total purchases last year Number of months active last year
Source transactions are store purchase invoices, payments, and adjustments. Daily, all the orders are received, entered into the computer, and processed against the customer master file. Each account is updated and automatically analyzed to determine whether the transactions just processed have created a condition that should be brought to the attention of the authorization or collection departments. Exception reports are automatically printed and forwarded to these groups.
The company sends monthly statements to customers on a cyclical basis. About 2000 statements are mailed each billing day.As the accounts are updated, the day's transactions are accumulated and added to the starting control figure for each cycle. The new control figures are balanced with the sum of all the individual accounts in the cycle (accumulated as each account is processed). In addition, a detailed transaction and cycle control report is prepared, providing an audit trail in customer account number sequence.
Required:
Describe the audit procedures you would perform in your year-end audit work for this company's accounts receivable. For each audit test, state the relevant audit assertion(s). Be sure to include different types of tests as necessary (e.g. manual or computer-assisted audit techniques), and clearly identify those tests that can be completed using CAATs.

Accepted Answer

The answer of Your audit client is a large retail...

Question 9

A) State the five specific transaction-related audit objectives for sales and describe one common test of controls for each objective.
B) Describe three tests of controls commonly used to test the accuracy objective for sales.

Accepted Answer

The answer of A) State the five specific transaction-related audit...

Question 10

An effective procedure to test for unbilled shipments is to trace from the
A) sales history file to the shipping documents.
B) shipping documents to the sales history file.
C) sales history file to the accounts receivable ledger.
D) sales history file to the general ledger sales account.

Accepted Answer

To test for unbilled shipments, it is best to trace from the shipping documents to the sales history file. This will allow for verification of all shipments and ensure that they have been properly recorded in the sales history file. Tracing from the sales history file to the shipping documents does not guarantee that all shipments have been properly recorded, as there may be missing or incomplete shipping documents. Tracing to the accounts receivable ledger or general ledger sales account would not provide specific information about unbilled shipments.

Question 11

A risk of material misstatement in accounts receivable associated with the allocation balance-related audit objective is that "long-term service revenue is recorded as current revenue or in the wrong period, overstating revenue and accounts receivable." Which of the following tests of detail of balances would respond to this risk?
A) Read customer contracts and audit the criteria used to allocate revenue to components of the sales contract.
B) Check cash received after the year end and trace to accounts receivable master file.
C) Read the notes to the financial statements and compare to audited financial information.
D) Enquire with management about the process used to make sure that revenue is recorded in the correct period.

Accepted Answer

Reading customer contracts and auditing the criteria used to allocate revenue to components of the sales contract would help identify any instances where long-term service revenue has been recorded as current revenue or in the wrong period. This test would allow the auditor to verify that revenue has been allocated correctly and in accordance with accounting standards. The other choices do not directly address the risk associated with the allocation balance-related audit objective.

Question 12

Outline the key areas that the auditor would review as part of general controls.

Accepted Answer

The answer of Outline the key areas that the auditor...

Question 13

Gonzo is an online dating agency. Gonzo has been in business for 5 years and was able to reach revenues of $1 million last year. Given its recent expansion, Gonzo's shareholders have required that the company's financial statements be audited for the first time this year. You have been assigned to the audit team for this mandate.
The senior manager has asked you to review the process description for the sales of Gonzo. You need to identify the controls in place that could be tested and used for the audit and also identify any controls that might be missing and briefly explain the impact on the audit.
Gonzo's CEO has provided you with the following description of the company's processes and activities for the past year.
Sales
Gonzo's website is operational 24 hours per day. All of the sales for Gonzo are completed online when a customer opens a profile. Each customer pays $50 to open a profile and then pays $10 per month to keep his or her profile active. Most customers pay online with their credit cards and the sale is automatically recorded in Gonzo's sales ledger at the time of payment.
Gonzo also had a promotion for the last 3 months of the year: If a new customer subscribed for one year, they could pay $100 up front to keep their profile active for the full year instead of paying $10 each month for 12 months. This proved to be a popular sales tactic as customers enjoyed the $20 savings.
Website Security
In the past year, one hacker managed to compromise the website and stole the credit card information of 25 Gonzo customers. To ensure quality of customer service, Gonzo reimbursed a total of $10 000 to the customers to compensate them for the amounts that were stolen as a result of the intrusion on their website. Since then, Gonzo hired a third party, Mindster Box, to improve the security of their website. Mindster Box performs monthly updates to the security features and monitors any intrusion attempts. Gonzo has not had any website security problems since hiring Mindster.
Collection and Reconciliation
As most of the sales are done by credit card, Gonzo receives money from large credit card companies on a by-weekly basis. When money is received, Jo-Ann, the accounting manager at Gonzo, reconciles the details of the payments received from the credit card company to the sales ledger of Gonzo. Jo-Ann has often complained that this is nearly impossible to do since Gonzo's accounting system keeps track of the payment by the website user name, which is often very different from the actual name of the person as stated on the detailed report provided by the credit card company. Jo-Ann therefore mostly relies on the statement of the credit card company to record and adjust revenues reported by Gonzo.

Accepted Answer

The answer of Gonzo is an online dating agency. Gonzo...

Question 14

Following are three different situations with respect to the audit of accounts receivable and sales. For each, specify the evidence mix that you would use (tests of control, substantive tests, type of confirmation/timing), and explain why.
A) The client is in a volatile industry, selling products that can quickly become obsolete. Total accounts receivable is $65 million with a bad debt allowance of $7 million. The company has recently laid off three accounting staff to save money.
B) A small company has 45 different customers with balances ranging from $500 to $25 000 per customer. There is one accountant on staff and a professional accountant comes in once per week for three hours to review the staff accountant's work and prepare journal entries. Bad debts are rare, as the owner is actively involved in accounts receivable collection.
C) Big Department Store Finance Corporation has fifty staff in the accounting department, a sophisticated software package, and about $250 million in accounts receivable. The corporation manages the department store's credit cards. About 100 000 credit card customers have balances less than $300 on their accounts, while the balances for the remaining customers range up to a maximum of $5000.

Accepted Answer

The answer of Following are three different situations with respect...

Question 15

You are the audit senior responsible for a large photofinishing centre and camera store. The store uses automated cash registers tied to inventory (also known as point-of-sale devices). The point-of-sale devices take advantage of automated procedures and controls that can be programmed to reduce errors and improve controls over completeness of transactions.
Required:
Provide examples of interdependent controls that should be used to complement the programmed controls.

Accepted Answer

The answer of You are the audit senior responsible for...

Question 16

State the five specific balance-related audit objectives as applied to accounts receivable.

Accepted Answer

The answer of State the five specific balance-related audit objectives...

Question 17

Proper accounting requires that an account receivable must be written off by the client when
A) the client company concludes that an amount is no longer collectible.
B) the customer files for bankruptcy.
C) a collection agency cannot inspire the customer to pay the debt.
D) the account is at least six months old.

Accepted Answer

Account receivable should be written off by the client when they conclude that an amount is no longer collectible.

Question 18

The document that is used to prepare and reconcile the deposit of cash and improve control over the custody of assets (cash) is the
A) sales invoice.
B) credit memo.
C) remittance advice.
D) cash receipts journal.

Accepted Answer

Remittance advice is a document sent by a customer to a supplier to inform the supplier that their invoice has been paid. It is used in the process of reconciling the deposit of cash, as it helps businesses track which invoices have been paid and improve control over the custody of cash assets by providing a record of payment.

Question 19

After the auditor has identified the key internal controls and weaknesses and assessed control risk, it is appropriate to decide whether
A) substantive tests will be increased sufficiently to justify the cost of performing tests of controls.
B) substantive tests will be reduced sufficiently to justify the cost of performing tests of controls.
C) tests of controls will be increased sufficiently to justify the cost of performing substantive tests.
D) tests of controls will be reduced sufficiently to justify the cost of performing substantive tests.

Accepted Answer

After identifying key internal controls and weaknesses and assessing control risk, the auditor decides whether the reduction in substantive tests, due to reliance on those controls, justifies the cost of performing tests of controls. If controls are strong, the auditor may perform tests of controls to justify reducing substantive testing, which can save time and resources.

Question 20

Certain internal controls satisfy more than one objective. It is desirable to consider
A) each objective separately.
B) the objectives together.
C) the objectives that can be tested.
D) only the controls that satisfy more than one objective.

Accepted Answer

The answer of Certain internal controls satisfy more than one...

Quiz 12: Audit of the Revenue Cycle

Tests of details of balances relate to which part of the Audit Risk Model?

One of the key internal controls to prevent transactions in the sales and collection cycle to fictitious customers is to

A) State the five specific transaction-related audit objectives for sales and describe one common test of controls for each objective. B) Describe three tests of controls commonly used to test the accuracy objective for sales.

An effective procedure to test for unbilled shipments is to trace from the

Outline the key areas that the auditor would review as part of general controls.

State the five specific balance-related audit objectives as applied to accounts receivable.

Proper accounting requires that an account receivable must be written off by the client when

The document that is used to prepare and reconcile the deposit of cash and improve control over the custody of assets (cash) is the

After the auditor has identified the key internal controls and weaknesses and assessed control risk, it is appropriate to decide whether

Certain internal controls satisfy more than one objective. It is desirable to consider