Deck 11: Auditing the Revenue Cycle

Question 1

Risks associated with revenue recognition are such that auditors often consider the occurrence of revenues and the existence of receivables assertions to be a significant inherent risk.

Answer 1

True

Question 2

With respect to performing analytical procedures to understand total revenue, the auditor should understand _______.

A)revenue recognition methods of all firms within the industry
B)how the firm relates its cost of goods sold to revenue recognition
C)the entity's capacity, the maximum volume of sales that it could generate if it fully utilized its facilities and employees to manufacture and deliver products and services
D)how the client firm handles depreciation entries related to contra-revenue accounts

Answer 2

the entity's capacity, the maximum volume of sales that it could generate if it fully utilized its facilities and employees to manufacture and deliver products and services

Question 3

An audit must be customized each year because inherent risk factors for a client _______.

A)will vary from year to year
B)should be invariant throughout the industry
C)should be fixed over time
D)should be discussed with regulatory agencies

Answer 3

will vary from year to year

Question 4

If discounts are given for early payment, _______.

A)sales discounts are recorded when recording the cash receipt and reducing a customer's receivable
B)the customer's account payable balance should be decreased accordingly
C)the company should credit the Sales Discount account
D)an increase in equity will result from a customer taking the discount

Question 5

To which part of the revenue cycle does the assertion of valuation at historical cost and at net realizable value pertain?

A)Account balances
B)Transaction classes
C)Disclosures
D)All of these answer choices are correct

Question 6

A primary account balance in the revenue cycle is _______.

A)accounts payable
B)accounts receivable
C)cost of goods sold
D)gross profit

Question 7

A debit memo is a form stating the particulars of a credit to accounts receivable, including the specific items returned, prices, and amount credited to a customer's account.

Question 8

Understanding how the entity earns and recognizes revenue assists the auditor in developing an expectation of total revenues by understanding the client's capacity, market place, and customers.

Question 9

When rights of return exist, or are likely to be accepted, _______.

A)the firm should simply expense them as incurred
B)should restrict cash to cover any potential right of return or warranty claim
C)a reasonable estimate of refunds should be made when revenue is recognized.
D)a company should consult with other firms in the industry with respect to best practices

Question 10

For companies that sell goods or services on account, there is significant interaction between sales and accounts receivable.

Question 11

Management often has more incentives to understate revenues than to overstate revenues.

Question 12

Gross sales refers to _______.

A)total revenues before any deductions, such as deductions for sales returns and allowances.
B)total revenues, net of deductions for sales returns and allowances
C)earnings before interest and taxes
D)operating income

Question 13

The cash receipts function, which includes the process of receipts from cash and credit sales, involves the following subfunctions: (1) disbursing cash, (2) depositing cash, and (3) recording the receipts.

Question 14

Key factors for the auditor to consider regarding the entity and its environment in the revenue process are _______.

A)corporate governance and related party transactions
B)regulatory oversight of the profession
C)recent actions of competitors inside and outside the industry
D)the client's maintenance of an attorney on retainer

Question 15

In the revenue cycle, which of the following assertions does not apply to the relevant account balances in the revenue cycle?

A)Existence
B)Completeness
C)Valuation
D)Classification

Question 16

Analytical procedures are an optional part of every audit as part of audit planning.

Question 17

For companies that sell goods or services on account, if revenue is recognized prematurely, what would be overstated: sales or accounts receivable?

A)Both sales and accounts receivable
B)Sales, not accounts receivable
C)Accounts receivable, not sales
D)Neither sales nor accounts receivable

Question 18

There is significant interaction between cash receipt transactions and accounts receivable because _______.

A)the creation of an account receivable indicates receipt of cash
B)a misstatement of cash receipts will result in a misstatement of accounts receivable.
C)a misstatement of cash receipts will result in a misstatement of interest payments
D)the settlement of an account receivable will result in a decrease to the cash account

Question 19

The effectiveness of IT controls usually depends on both effective entity level controls and effective IT general controls.

Question 20

Most auditors plan to test controls in the revenue cycle because of the relatively low volume of routine transactions in this cycle.

Question 21

If a reasonable estimate of potential refunds cannot be made, _______.

A)the firm should simply disregard any expense and handle on a case-by-case basis
B)revenue should not be recognized until the material uncertainty is resolved
C)a portion of the revenue should recognized immediately upon sale
D)no revenue recognition should occur during the life of the refund obligation

Question 22

Recognizing revenues without shipping would lead to ________ gross margins and _______ accounts receivable turnover in days.

A)increased; low
B)decreased; low
C)increased; high
D)decreased; high

Question 23

The uncollectible accounts expense to net credit sales ratio is useful in evaluating the reasonableness of __________.

A)uncollectible accounts expense
B)total revenues
C)gross margins
D)prior period's uncollectible accounts expense

Question 24

If receivables are growing faster than sales, it may be an indication that the company is _________.

A)accomplishing sales growth by taking on increased credit risk
B)accomplishing sales growth by taking steps to reduce credit risk
C)slowing down sales growth by taking on increased credit risk
D)slowing down sales growth by taking steps to reduce credit risk

Question 25

The fraud risk assessment is an important part of the audit that the auditor needs to approach with _______.

A)due diligence
B)professional skepticism
C)the assistance of the internal audit function
D)careful consideration

Question 26

A common scheme to conceal the misappropriation of cash receipts ________.

A)is known as lapping
B)is known as kiting
C)is usually committed by senior management and members of the board of directors
D)should be handled by the internal audit function, not the external auditors

Question 27

After evaluating inherent risk and control risk, the auditor ________.

A)is in a position to begin the audit work
B)can conclude the audit and issue an audit opinion
C)should confirm with management to ensure the auditors findings are agreed with
D)is in a position to evaluate fraud risk

Question 28

Understanding how the entity earns and recognizes revenue assists the auditor in ________.

A)determining control risk related to accounts payable
B)discussing the audit with the predecessor auditor
C)developing an expectation of total revenues by understanding the client's capacity, market place, and customers
D)developing an expectation of total revenues by understanding the capacities of the client's key competitors

Question 29

Among analytical procedures commonly used to audit the revenue cycle, what is the audit significance of the sales to capacity ratio?

A)Assessing the reasonableness of total revenues
B)Comparing manufacturing to other asset-based companies
C)Evaluating the reasonableness of uncollectible accounts expense
D)Evaluating the reasonableness of prior period's uncollectible accounts expense

Question 30

An example of a sales-related factor that would increase inherent risk would be ________.

A)significant legal compliance issues when making sales
B)a history of complying with all laws and regulations
C)strong oversight of management by the board of directors
D)revenue recognition is relatively straightforward, with no significant accounting issue

Question 31

The accounts receivable growth to sales growth ratio = _________.

A)((Accounts Receivable _t ÷ Accounts Receivable _{t − 1}) - 1) ÷ ((Sales _t ÷ Sales _{t −1}) - 1)
B)((Accounts Receivable _t ÷ Accounts Receivable _{t − 1}) + 1) ÷ ((Sales _t ÷ Sales _{t − 1}) + 1)
C)((Accounts Receivable _t ÷ Accounts Receivable _{t + 1}) - 1) ÷ ((Sales _t ÷ Sales _{t + 1}) - 1)
D)((Accounts Receivable _t ÷ Accounts Receivable _{t + 1}) + 1) ÷ ((Sales _t ÷ Sales _{t + 1}) + 1)

Question 32

Which of the following ratios, when small, may indicate an inadequate estimation process?

A)Uncollectible accounts expense to accounts receivable write-offs
B)Uncollectible accounts expense to net credit sales
C)Accounts receivable growth to sales growth
D)Accounts receivable turnover in days

Question 33

The classification of the transaction as a sale or a borrowing may be incorrect when _________.

A)factoring receivables with recourse
B)estimating the likelihood of collection within the next year
C)writing off customers' balances as uncollectible
D)debating over the timing and amount of revenue to be recognized

Question 34

The purpose of a disclosure committee _______.

A)is to supervise the internal audit function
B)is to handle all communications with firm attorneys
C)is to work with the CFO or controller to review disclosures
D)is to ensure that the firm receives a 'clean' audit opinion

Question 35

An example of a sales-related factor that would decrease inherent risk would be ________.

A)complicated revenue recognition policies
B)lax oversight of management by the board of directors
C)nominal legal compliance issues when making and collecting sales
D)existence of excessive sales goals/targets

Question 36

The market share ratio is useful in assessing the reasonableness of ________.

A)both total revenues and gross margins
B)total revenues, not gross margins
C)gross margins, not total revenues
D)None of these answer choices are correct.

Question 37

It is particularly important in growth companies for auditors to monitor the entity's collection period because any growth in sales is usually accompanied by ________.

A)growth in accounts receivables that consume operating cash
B)increase in premium gross margins
C)decrease in the client's collection period
D)increase in the market share for the client's product

Question 38

The starting point for every audit test is _______.

A)agreeing fee schedules and compensation
B)contact with the predecessor auditor
C)is obtaining an understanding of the business and industry
D)agreement with the client as to what kind of audit opinion they can expect

Question 39

Which of the following may occur in a transaction between a manufacturer and a wholesaler when the seller retains title to inventory in the wholesaler's possession, and the sale is completed when the wholesaler sells the inventory forward?

A)Consignment sales
B)Bill and hold transactions
C)Refund rights
D)Write-off of accounts receivable

Question 40

What is the nature of a sale under refund rights?

A)The sale is made with the right to return the goods for a full refund, even if the goods are not defective.
B)The sale is made with the right to return the goods for a full refund, if the goods are defective.
C)The sale is made with no right to return the goods for a refund, even if the goods are defective.
D)The sale is made with no right to return the goods for a refund, even if the goods are not defective.

Question 41

In the performance of which transaction(s) does segregation of duties serve as an important internal control?

A)Cash receipts, not credit sales
B)Credit sales, not cash receipts
C)Both cash receipts and credit sales
D)None of these answer choices are correct.

Question 42

Recording cash receipts involves ________.

A)journalizing cash received by a bank
B)receiving cash over-the-counter
C)recording cash received via mail receipt
D)all the above

Question 43

Which of the following computer actions is a control for the classification assertion of the sales and receivables?

A)Starts with the population of daily sales invoices and compares the date on the sales invoice with the date on the underlying bill of lading.
B)Starts with the population of daily sales invoices and compares customer numbers with the sales order, specifically addressing customer account coding errors.
C)Starts with the population of daily sales invoices and compares quantities with the underlying packing slips, compares prices to the underlying sales order, and checks the mathematical accuracy of the sales invoice.
D)Starts with the population of daily sales invoices and develops a one for one match with underlying shipping documents to ensure that each sales invoice is supported by a bill of lading.

Question 44

Which of the following represents the start of the transaction trail of documentary evidence?

A)Sales order
B)Credit approval
C)Sales journal
D)Bill of lading

Question 45

A lockbox system ________.

A)is only used by large companies that can afford to pay for this service
B)deals with cash being received at a post office box that is controlled by the company's bank
C)increases a company's inherent risk, as the firm is now more susceptible to fraud and error
D)enables a firm to completely eliminate/outsource its accounts receivable function

Question 46

A credit sale should always include debits to accounts receivable and cost of goods sold, and credits to ________.

A)sales discounts and allowances
B)sales and inventory
C)sales and sales discounts
D)sales discounts and inventory

Question 47

What is a remittance advice?

A)A document prepared by the bank showing the details of electronic funds transfers received by the bank from customers
B)A receipt from the bank showing the total amount deposited to the client's account at the bank
C)A document received from the customer showing the details of payments made by the customer
D)A daily report showing cash recorded in the cash receipts journal identifying customers making payments on account and the amounts received

Question 48

Which of the following is a control for the completeness (of cash receipts assertion)?

A)The computer compares each item on the underlying information in the bank remittance report to develop a one for one match with recorded cash receipts in the daily remittance report.
B)The computer starts with the population of daily cash receipts recorded in the daily remittance report and develops a one for one match with the underlying bank remittance report.
C)The computer starts with the population of daily cash receipts recorded in the daily remittance report and it compares the dollar amount of each recorded cash receipt with the underlying bank remittance report.
D)The computer starts with the population of daily cash receipts recorded in the daily remittance report and compares the date recorded in the daily remittance report with the date received and deposited by the bank.

Question 49

What do over-the-counter receipts devices such as a cash register or point-of-sale terminal provide?

A)All of these answer choices are correct.
B)Immediate visual display for the customer of the amount of the cash sale and the cash tendered
C)An internal record of the transaction on a computer file or a tape locked inside the register
D)Printed control totals of the day's receipts processed on the device

Question 50

At the warehouse, when goods are pulled from inventory, which of the following is normally produced to detail the items that will be shipped to the customer and the quantity of each item shipped?

A)Packing slip
B)Sales order
C)Sales invoice
D)Bill of lading

Question 51

As a control for cash receipts, which assertion is addressed when the computer starts with the population of daily cash receipts recorded in the daily remittance report (or cash receipts journal) and develops a one for one match with the underlying bank remittance report

A)Accuracy
B)Classification
C)Occurrence
D)Completeness

Question 52

Which of the following provides the basis for recording a sale in the sales journal?

A)Sales invoice
B)Packing slip
C)Bill of lading
D)Master price file

Question 53

During which of the following functions is the auditor primarily concerned that sales invoices are recorded accurately and in the proper period?

A)Recording sales
B)Shipping sales orders
C)Filling sales orders
D)Accepting customer orders

Question 54

A walkthrough is important as _________.

A)different companies often have different documents and transaction flows
B)the volume of routine transactions in the revenue cycle is very high
C)companies with dominant market shares often obtain premium gross margins
D)any growth in sales is usually accompanied by receivable growth that consumes operating cash

Question 55

Which of the following is a receipt from the bank showing the total amount deposited to the client's account at the bank?

A)Remittance advice
B)Remittance report from the bank
C)Monthly statements of receivable balances
D)Bank deposit slip

Question 56

As an important control for the occurrence assertion related to sales, the computer starts with the population of daily sales invoices and develops a one for one match with underlying shipping documents to ensure that each sales invoice is supported by a ________.

A)bill of lading
B)packing slip
C)sales order
D)sales invoice

Question 57

A major risk in processing cash receipts transactions ________.

A)is that the bank often erroneously double-counts entries
B)is the possible theft of cash before or after a record of the receipt is made
C)is the possible theft of cash only before record of the receipt is made
D)relates to inaccuracies caused by only one person counting the cash receipts

Question 58

Which of the following risks is addressed by preparing periodic independent bank reconciliations?

A)Errors being made in journalizing cash receipts
B)Receipts being posted to the wrong customer account
C)Cash sales may not be recorded.
D)Cash not being deposited intact daily

Question 59

As a control for the assertion of cutoff of cash receipts, a daily exception report is generated for which of the following?

A)Any cash receipts recorded in the incorrect time period
B)Any recorded values of cash received not supported by an underlying remittance report
C)Any recorded cash receipts not supported by the bank remittance report
D)Any cash receipts posted to the incorrect customer

Question 60

The process used for developing an audit strategy for various assertions begins with _________.

A)understanding the flow of transactions in a given transaction cycle
B)identifying what can go wrong from initiating the transaction to the recording in the general ledger
C)assessing whether controls exist to mitigate what can go wrong
D)identifying relevant controls, performing tests of controls, and evaluating results

Question 61

Good internal controls over the write-off of uncollectible accounts ________.

A)are optional if the company is smaller in size
B)are typically expensive and cumbersome to implement
C)are important to prevent write-offs from being used to conceal fraud in processing cash receipts
D)are less important if accounts receivable are outsourced

Question 62

The auditor will usually test the effectiveness of computer general controls as part of testing _______ level controls.

A)entity
B)division
C)transaction
D)function

Question 63

What is a credit memo?

A)A form stating the particulars of a credit to accounts receivable, including the specific items returned, prices, and amount credited to a customer's account
B)A document used to record adjustments such as a provision for bad debt expense or an accounts receivable write-off in the general ledger
C)A report prepared on the receipt of goods from customers showing the kinds and quantities of goods received
D)A form showing the description, quantity, and other data pertaining to goods the customer is authorized to return

Question 64

An example of a factor that provides the incentive for management to misstate revenue cycle assertions would be ________.

A)realistic sales targets within the firm
B)strong support from top management of an ethical culture
C)pressures to overstate revenues to achieve revenue or profitability targets that were not achieved
D)pressures to accurately report revenues to achieve revenue or profitability targets that were achieved

Question 65

While examining internal control weaknesses, the auditor may need to change the timing of planned substantive tests related to an assertion from interim testing to testing ________ balances.

A)year-end
B)end-of-quarter
C)month-end
D)None of these answer choices are correct.

Question 66

Which of the following is a form showing the description, quantity, and other data pertaining to goods the customer is authorized to return?

A)Sales return authorization
B)Authorization for accounts receivable write-off
C)Cash receipts journal
D)Journal entry

Question 67

Segregation of duties ________.

A)should always be considered an important internal control
B)should be of primary concern to larger, more complex companies
C)should be instituted by the auditor
D)refers to ensuring employees take on as many tasks as possible, to save labor costs

Question 68

Many clients build in redundant controls such that if one control does not detect a misstatement, ________.

A)no other control will find the same misstatement
B)an exception report is generated
C)another control will detect the problem
D)the control should immediately be eliminated

Question 69

With respect to understanding the client's revenue process, it is particularly important that the auditor ________.

A)makes some preliminary inquiries with the client's attorney
B)be knowledgeable about the entity, how the entity earns revenues, and particular revenue recognition issues that may be relevant to the entity
C)examines other firms within the client's industry to determine acceptable practices
D)uses accounting standards as an optional guide to determining what the client should be recording

Question 70

Public company auditors test controls in order to ________.

A)determine if they should be eliminated
B)support an opinion on internal controls
C)decide if responsibility for internal control should be reassigned from management to the internal auditors
D)determine their audit opinion without regard to substantive testing

Question 71

Good internal controls over the write-off of uncollectible accounts include appropriate review of ________ by management to ensure the appropriateness of the transaction.

A)journal entries
B)debit memos
C)receiving reports
D)cash receipts journal

Question 72

Which of the following is an act of fraud?

A)Lapping
B)Lockbox
C)Walkthrough
D)Disclosure

Question 73

Control activities useful in reducing the risk of fraud focus on establishing the validity and occurrence of such transactions and include ________.

A)a portion of sales returns should be authorized by sales management
B)all sales returns should be authorized by sales management
C)the computer should match the debit memo information with the sales order
D)ensuring top management approves all credit memos before agreeing to a reduction in accounts receivable

Question 74

Auditing the cutoff assertion pertaining to cash receipts is important because ________.

A)the auditor needs to ensure expenses are being matched with revenues
B)the bank may have recorded cash receipts in incorrect period
C)the client should have recorded cash receipts in the correct period
D)the recording of revenue and the corresponding receipt of cash should always be in the same fiscal period

Question 75

An analytical procedure related to substantive testing of revenue would be ________.

A)developing an understanding of the client's system of internal control
B)ensuring that all efficiency audits conducted by the internal audit function are properly planned
C)to check revenue and the related accounts payable accounts on a sample basis
D)to analyze ratio results relative to expectations based on prior years

Question 76

If the client relies on computer controls and the auditor plans to assess control risk as low for revenue cycle assertions, the auditor will usually ________.

A)test the effectiveness of general controls
B)perform substantive testing, to increase the confidence level
C)test the whole population as opposed to a sample
D)drastically increase the sample size

Question 77

Which of the following serves as the basis for initiating the sales return and internal processing of the customer return by the seller?

A)Cash receipts journal
B)Sales return authorization
C)Credit memo
D)Receiving report

Question 78

The document that serves as the basis for initiating the sales return and internal processing of the customer return by the seller is referred to as a ________.

A)credit memo
B)receiving report
C)sales return authorization
D)debit memo

Question 79

If the auditor's expectations regarding effective controls are not confirmed, ________.

A)the auditor should proceed with testing of controls
B)the auditor will need to evaluate the significance of the weaknesses noted and determine if the client has a compensating control in place that the auditor might rely on.
C)the auditor will need to evaluate the significance of the weaknesses noted and simply document this
D)the auditor should withdraw from the engagement

Question 80

The auditor often makes inquiries of personnel responsible for clearing exceptions ________.

A)to determine that all exceptions have been automatically approved
B)to ensure that no employees that handle exception reports are lapping
C)to determine their awareness of the types of misstatements that might appear on exception reports
D)to ensure that it is always one type of misstatement that will appear on the report