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1.

An auditor has determined that a client's accounts receivable balance has increased because of a general weakness in
local economic conditions.
What would the auditor likely do?: In this circumstance, an auditor would most likely expand the substantive tests of collectability.
The auditor's primary reason to evaluate collectability is to corroborate the valuation assertion. If collectability is in doubt, the auditor may
want to suggest that the client increase the provision in the Allowance for Doubtful Accounts account.
2. An auditor generally computes the accounts receivable turnover.
How is that statistic determined?: Accounts receivable turnover is calculated as the net credit sales for the reporting period divided by
the average amount of receivables for the reporting period.
A high number indicates that receivables are collected fairly quickly (perhaps credit terms are too strict), whereas a lower number indicates
that receivables are collected more slowly (perhaps collection efforts need to be improved).
3. Which management assertion is being evaluated when the auditor analyzes the aging schedule (the aged trial balance) of
accounts receivable?: The accounts receivable aging schedule is one indication as to the collectability of the accounts receivable. The
auditor is evaluating the overall valuation of the accounts receivable balance, including the provision for the allowance of bad debts.
4. In auditing accounts receivable and revenue, what are some potential problems that could exist that would create
material misstatements?: Potential problems involving accounts receivable and revenue include:
1. Fictitious sales transactions are posted near year-end in order to enhance the reported profitability of the entity.
2. A specific account receivable is collected, but the cash is stolen. Later, the account is written off as uncollectible to cover the theft.
3. Lapped accounts receivable: money is stolen from one or more than one account and then future collections of other accounts are used to
cover the original theft.
4. Incorrect year-end cutoff.
5. Incorrectly billed customers.
6. Undisclosed sales to related parties.
7. Shipments of goods on consignment recorded as actual sales.
5. Why would a company report sales transactions that are false?: Recording sales transactions that are false increases reported
revenues and net income, at least in the short run. There are many reasons why a company might want to increase reported revenues and
net profits:
1. Actual company revenues and net income are below forecasts and market expectations, and reported company financial performance is
important for maintaining credibility in investor circles.
2. Employee income is based on bonuses, which in turn are based on reported company profitability.
3. The company plans to issue equity or debt securities.
Hence, each of these pressures and incentives would be fraud risk factors, increasing the auditor's assessment of the possibility of fraud and
financial statement misstatement.
6. What departments are involved when a company receives an order from a customer for an item of inventory and then
that same company ships the merchandise and records the transaction?: Departments involved:
1. Sales or Order department - Takes the order and records all needed information.
2. Credit department - Verifies that the customer should be given credit.
3. Warehouse or Finished Goods department - Gathers merchandise and delivers it to Shipping department.
4. Shipping department - In charge of sending goods to the customer.
5. Billing department - Reconciles documentation and sends sales invoices to customer.
6. Accounts receivable - Maintains subsidiary ledger indicating customer balance.
7. Collections department - Follows up on invoice by sending account balance reminders to customer. This department will also prepare
documentation for any account to be written off.
CPA Audit - Accounts Receivable and Revenues
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7. What documents are generated by each of the following departments?
1. Sales department.
2. Credit department.
3. Shipping department.
4. Billing department.: 1. The sales department generates the sales confirmation and possibly the internal order to record all pertinent
information about the order. This department or the order department may prepare the internal order documentation necessary to process
the customer's order.
2. The credit department generally does not create a new document, but instead marks approval (if appropriate) on the internal customer
order.
3. The shipping department generates the bill of lading to record merchandise being shipped out.
4. The billing department compares and matches all applicable documents and prepares a sales invoice.
8. An auditor takes a sample of sales transactions recorded three or four days after year-end for a portion of this
subsequent period audit review. The auditor verifies that these transactions are being reported in the proper period.
Which assertion is the auditor testing?: When an auditor reviews transactions that were not recorded in the period being audited and
tests whether they should have been recorded, the auditor is testing the completeness assertion. The completeness assertion is applicable
when the auditor seeks to determine whether any transactions have been left out of the reporting period recording process. Just because the
transactions are being reported in the subsequent period doe not mean they should not have been reported in the period being audited.
9. An auditor takes a sample of sales transactions recorded during the three or four days before year-end and verifies that
these transactions were reported in the proper period.
Which assertion is the auditor testing?: When an auditor looks at transactions that have been recorded in the period being audited
and tests as to whether they should have been recorded, the auditor is testing both the occurrence and cutoff assertions. The occurrence
assertion is applicable when the auditor seeks to determine whether certain recorded transactions have actually occurred and pertain to the
entity. The cutoff assertion pertains to whether or not transactions have been recorded in the correct accounting period.
10. What is the first procedure that the sales department (or order department) does when it receives a customer's order?:
The sales department prepares a confirming sales order form with the following attributes:
1. Quantity ordered.
2. Price of each item ordered.
3. Description of items ordered.
4. Terms of sale.
5. Address of customer and address where order is to be shipped.
6. Name/ signature of individual processing the customer's order.
11. What does the sales department (or order department) do after the sales order document is completed?: When a document
is completed in any transaction system, the next steps are as follows:
1. Have the document reviewed and authorized or approved by an appropriate party.
2. Record the essential information on the document, if needed. In an IT environment, this step is probably not necessary, as this work has
already taken place via the computer program.
3. File a copy of the document in case follow-up is needed later.
4. Forward the remaining copies of the document to the necessary parties or departments.
12. When an independent auditor sends out confirmations of accounts receivable balances, what management assertion is
being tested?: Accounts receivable confirmations are primarily used to help substantiate the existence, the occurrence, and the rights and
obligations assertions. The auditor is basically seeking evidence that a reported balance does exist, the the sales transaction did occur, and
that the entity has a right to collect the still unpaid debt for the transaction. This confirmation could also be a test of the valuation assertion:
whether or not the correct amount of accounts receivable is shown as an asset of the entity.
13. How does the credit department judge whether or not to approve open account credit for a particular sales order?: A
credit file is normally maintained for each credit customer either online or in a hardcopy location. The credit file maintains some or all of
the following;
1. Payment history of the customer.
2. Current balance and age of the customer's open (unpaid) sales orders.
3. Credit report.
4. References.
5. Financial statements.
6. Credit limits.
Based on this information and any other more recent information deemed necessary, such as an updated credit report, the decision is made
as to whether or not credit for the new sales order will be granted.
14. Which department receives the approved customer order?
What action is taken?: The approved customer order is physically or electronically transmitted to the warehouse or finished goods
department where the appropriate merchandise is gathered for delivery to the shipping department.
15. The warehouse delivers merchandise to the shipping department so that it can be sent to the customer.
At the time of delivery to the shipping department, what three events should occur?: Whenever an asset is conveyed from one
location to another, the recipient should:
1. Count the goods.
2. Check that the condition of the goods is appropriate.
3. Verify that the goods agree with the description listed in the related documentation (the approved customer order, in this case).
Whenever an asset is conveyed form one location to another, the party making the conveyance should receive a signed receipt or electronic
acknowledgement. Here, the appropriate party within the shipping department should sign one copy of the approved customer order
document and return it to the warehouse personnel.
In the age of computers and application software that is designed to handle customer order fulfillment activity, much of this activity can be
easily accommodated by electronic means. The basic steps discussed above are still appropriate to consider, however.
16. When goods are being shipping, what should the shipping department do?: The shipping department should prepare the
appropriate shipping documentation. One very important document is referred to as a bill of lading.
17. Who receives copies of the shipping documents when the customer's order is shipped?: When the customer's order is
shipped, the following receives copies of the shipping document:
1. A copy of the bill of lading is sent with the merchandise.
2. A copy of the bill of lading may also be mailed to the customer directly.
3. A copy of the shipped customer order is forwarded to inventory control in order to update any perpetual inventory records.
4. A copy of the customer order is retained in the shipping department files.
5. A copy of the customer order and bill of lading is forwarded to the billing department to serve as information for preparing the sales
invoice.
18. Which department receives a copy of all customer orders and shipping documents for reconciliation and invoicing
purposes?: The billing department receives all of the customer order documents. The department reconciles all of these documents,
verifies appropriate order approvals, and prepares a sales invoice.
19. Once a sales invoice is prepared, what activity takes place next in the billing department?: Each sales invoice becomes an
entry in the sales journal. At the end of the day, account totals are derived form the sales journal, and a daily sales summary is prepared or
automatically transmitted to the general ledger. Automated accounting information systems can handle most, if not all, of these steps in an
integrated fashion.
20. Who receives a copy of the sales invoice?: Recipients of a copy of the sales invoice or record of the sales transaction include:
1. The customer.
2. The billing department.
3. Accounts receivable.
21. What are the major functions of the accounts receivable department?: The accounts receivable department will:
1. Keep a record of the individual amounts owed by each individual customer.
2. Keep a record of the age of each customer's account. Oftentimes, this function is handled automatically by the accounts receivable
software program.
3. Send notices to accounts if accounts are overdue.
4. Secure authorization to turn slow-paying customer accounts over to the collections department.
22. If the collections department deems a specific customer account to be noncollectable, what activity occurs?: Both the
collections department and the accounts receivable department assemble information to indicate actions that have been taken in an attempt
to collect the accounts receivable. This information is normally reviewed by an independent party before final write-off of the account
balance is approved.
23. The subsequent period is the time period between the end of the reporting entity's fiscal year and the last day of audit
field work.
What testing of accounts receivable should be performed during this time period?: During the subsequent period, the auditor
should look for the following, which might impact the reporting of the year-end accounts receivable balance:
1. Cash collections or receivables reported at year-end corresponding to balances that were reported. This step may alert the auditor to
possible accounts receivable adjustments, including account writeoffs.
2. Accounts actually written off as being uncollectible.
3. Sales returns and allowances on year-end accounts receivable items.
The auditor should also be alert for any adverse news about significant customers which might indicate an inability to pay open amounts in
accounts receivable.
24. The auditor is testing accounts receivable. The auditor selects a sample of sales orders and traces them through the
entire accounting information system, form receipt of the customer's sales order to its final recording or impact in the
general ledger. Which management assertion is being tested when the auditor starts with transactions at their
inception?
Why is this activity sometimes referred to as a dual-purpose test?: When tracing one or more documents through the entire
accounting information system, the auditor is generally ensuring that all transactions and events that should have been recorded have been
recorded and that amounts and other data relating to the recorded transactions and events have recorded appropriately. Thus, the auditor is
testing the completeness and accuracy assertions.
This particular type of test is known as a dual-purpose test because it is used in the substantive testing of the customer's account and in the
assessment of control risk. When following the document through the entire accounting information system, the auditor is also checking to
see if various control procedures are operating as designed.
25. The auditor is testing accounts receivable and selects a number of customer balances within the accounts receivable
ending balance and seeks documentation to corroborate (or support) each of these figures.
What management assertion is being tested when an auditor starts with a reported account balance and seeks
substantiation for it?: When an auditor is seeking substantiation for a reported account balance, the auditor is testing the existence and
the rights and obligations assertions. The auditor wants to confirm that the reported amount actually does exist and that the entity holds or
controls the rights to this asset.
26. During an audit, which document(s) should be used to determine when an accounts receivable item and a sales
transaction should be recorded?: The sales invoice, which should be supported by the customer's purchase order, provides the free-on-
board (FOB) shipping point, and the bill of lading document indicates the date that the order was shipped.
27. Confirmations are mailed out and a number of them are returned to the auditor with exceptions noted.
What are some reasons that these exceptions might have been returned with exceptions, which may require
investigation and resolution by the auditor?: If confirmations with noted exceptions are returned to the auditor, further investigation
and possible adjustments to the accounts receivable balance may be necessary because:
1. Payment was made by the customer prior to the end of the reporting period, but was never recorded by the reporting entity.
2. Shipment of the merchandise was not made until after the end of the reporting period, or shipment of certain merchandise has not
actually occurred.
3. Goods have been shipped on consignment so no actual sales transaction has actually occurred.
4. The actual accounts receivable balances is in dispute.
28. Confirmations are mailed out and a number of them are returned to the auditor with exceptions noted.
What are some reasons that some of these confirmations with exceptions might not require adjustment?: Receivable
confirmations could be returned for certain reasons that once resolved do not necessitate the recording of an adjustment to the account
balance:
1. Payment was made by the customer, but it was not received by the reporting entity until after the end of the reporting period.
2. The goods were shipped to the customer free-on-board (FOB) shipping point and were in transit at the end of the year.
3. The account was temporarily in dispute until certain information was sent to the customer. This information has now been sent, and the
account balance is no longer in dispute.
4. A sales transaction was posted to an incorrect customer's account due to a reporting entity error. This matter has since been resolved.
29. What management assertion is being tested when the auditor reviews a client's credit approval process, which normally
takes place before goods are either manufactured or picked and shipped to a customer?: The auditor is testing the credit
approval process, which assists in an evaluation of the appropriateness of the accounts receivable allowance for doubtful accounts balance.
This is a test of the valuation assertion.
30. Confirmation is a traditional audit test, especially in substantiating accounts receivable.
What are the different types of confirmations?: The different types of confirmations include:
1. Positive confirmation - Generally provides a balance as of a particular date and asks the customer to indicate whether the balance is
correct or not. Positive confirmations can also be a blank confirmation format that simply asks the recipient to fill in an amount or other
information and return the document. An invoice confirmation may only show invoice numbers, rather than amounts.
2. Negative confirmation - Provides a balance as of a particular date and asks the customer to respond only if that balance is not correct.
3. Standard bank confirmation - A form approved by the AICPA for use as a convenience to auditors, as well as to bankers, who are the
individuals requested to fill out these forms.
A bank cut-off statement is another convenience-type form that is mailed to the bank by the auditor and is then returned to the auditor.
When completed, this form verifies the reconciling items on the client's year-end bank reconciliations with evidence that is not accessible to
the client.
31. An auditor is deciding between using positive confirmations and negative confirmations.
How is this decision made?: Positive confirmations require more effort and are more costly. However, positive confirmations provide
better quality evidence because the customer is asked to respond in every case. Therefore, positive confirmations are more likely to be used
when there is additional risk (high inherent or control risk), material (significant) balances, and/or older balances.
Conversely, negative confirmations are used when risk levels are low and when balances are small and relatively new.
Often, the auditor uses a combination of positive and negative confirmations.
32. When would an auditor place less reliance on confirmations in the testing of accounts receivable?: The auditor's choice of
confirmation falls along a continuum, from no confirmations in some circumstances, to using only negative confirmations, to using both
negative and positive confirmations, to using only those that are positive. Confirmation of accounts receivable is less critical when the
overall receivable balance is small or when it is felt that the customers will not respond to the request: For example, governmental bodies
often will not respond to confirmation requests. confirmation is also less important if payment has already been made to the reporting
entity.
Also, confirmation of receivables may be ineffective if the auditor is hired after the end of the year. In that case, the auditor must substantiate
the receivables by some other means.
33. An auditor is hired after the end of the fiscal year and is unable to confirm the accounts receivable amount reported on
the client's balance sheet.
What alternative methods can the auditor apply that may provide satisfactory audit evidence?: If the confirmation of
accounts receivable is not possible because of the auditor being hired late, satisfactory evidence about year-end receivables may be obtained
in several alternative ways:
1. The auditor can review cash collections after year-end. Collections of amounts owed as of the end of the year provide some evidence that
the various accounts receivable balances did exist at year-end.
2. Review of all documentation that was created in connection with the receivable can also provide evidence.
In addition, the auditor may want to compare the amount due at the end of the current fiscal year with previous fiscal year-end balances to
verify comparability and/or reasonableness.
34. What are the steps in the accounts receivable confirmation process?: 1. Either the auditor or the reporting company prepares the
confirmation forms. If the company prepares them, the auditor should review the confirmations for accuracy before they are mailed (by the
auditor).
2. A representative of the reporting company must sign the confirmations, requesting that the customer provide the information requested to
the auditor.
3. The auditor mails the confirmations, which request that all responses be returned directly to the auditor. Usually, a self-addressed (i.e.,
the auditor's address) postage-paid envelope is included with the confirmation request.
4. The auditor reviews all returned responses and decides what to do in situations where there are exceptions noted.
35. Confirmation requests are mailed out to a company's customers. Once customer sends the confirmation back to the
auditor via the company's fax, instead of postal mail.
What should happen next?: Normally, the auditor contacts the customer and asks that the confirmation be returned by postal mail, as
indicated on the confirmation. In that way, the auditor has a copy of the document directly from the customer. Of course, if the item being
confirmed is not material to the auditor's need for evidence concerning the year-end accounts receivable balance, a confirming balance
telephone call to the customer by the auditor may suffice.
36. An auditor sends a number of positive confirmation requests to the customers of a reporting entity. Several of these
requests are not returned.
What is the auditor concerned about in connection with these particular receivables?
What should the auditor do if positive confirmations are not returned?: When positive confirmations are not returned, the
auditor should be concerned that perhaps the customer does not exist and that the receivables are fictitious, perhaps in an attempt by the
entity to increase not only revenues, but also net income.
The auditor can do several things if this situation occurs:
1. Mail a second confirmation to the customer, perhaps this time by registered mail.
2. Call the customer directly.
3. Review the credit file to make sure that there is adequate documentation of the customer's existence.
4. Review subsequent cash payments and the documentation generated in connection with those recent transactions.
37. In an audit, when is the confirmation of receivables normally performed?: The confirmation process usually takes a relatively
long time. Therefore, it is often begun early in the audit process. The most reliable evidence from confirmations is obtained when they are
sent as close to the balance sheet date as possible. However, as a means of completing the audit on a timely basis, it is often necessary to
confirm the accounts at an interim date. This action is permissible if internal controls are adequate and inherent risk is reasonably low. A
roll-forward schedule is generally used in this process.
38. Assume that a reporting company's accounts receivable turnover figure declines during the current year. What
problems might this indicate?: If a reporting company's accounts receivable turnover figure has declined during the current reporting
year, it is possible that either the reported sales are misstated (i.e., too low) or the reported receivables are misstated (i.e., too high).
Possible problems include:
1. Uncollectible accounts are not being recognized and written off.
2. Cash collections are not being reported or are not being recorded on a timely basis.
3. Sales have perhaps remained at the same level or have started to decline, but a higher percentage of customers are now buying on credit or
are not paying on a timely basis for one reason or another.