9.401 auditing

9.401 Auditing

Chapters 12 to 14Chapters 12 to 14

Auditing Sales, Receivables and Auditing Sales, Receivables and ReceiptsReceipts

S/R/R: Activities and DocumentsActivityActivity DocumentsDocuments Books/ journalsBooks/ journals

Customer Customer orderorder

-vary-vary

Granting creditGranting credit -Credit approval-Credit approval -Customer master file-Customer master file

ShippingShipping -Bill of lading-Bill of lading

Cash SalesCash Sales -invoice/receipt-invoice/receipt -Sales Journal-Sales Journal

-Cash Receipts journal-Cash Receipts journal

-G/L-G/L

BillingBilling -Invoice-Invoice

-Monthly statements-Monthly statements

-Sales journal-Sales journal

-Customer master file-Customer master file

-G/L-G/L

-A/R trial balance-A/R trial balance


Customer Customer receiptsreceipts

-Remittance -Remittance adviceadvice

-bank deposit detail-bank deposit detail

-customer master file-customer master file


-cash receipts journal-cash receipts journal

-G/L-G/L

Charging off Charging off uncollectible uncollectible accountsaccounts

-Account -Account Authorization Authorization FormForm



-G/L-G/L

Providing for Providing for Bad DebtsBad Debts

-journal entry-journal entry -G/L-G/L


Sales returns Sales returns and allowancesand allowances

-credit memo-credit memo -customer master file-customer master file


-sales R&A journal-sales R&A journal

-G/L-G/L

Charging off Charging off uncollectible uncollectible accountsaccounts

-Account -Account Authorization Authorization FormForm



-G/L-G/L

Providing for Providing for Bad DebtsBad Debts

-journal entry-journal entry -G/L-G/L

How to rob your employer (just kidding)What to do:What to do: How it’s stoppedHow it’s stopped

Take cash at P.O.S.(even Take cash at P.O.S.(even though sale has been though sale has been recorded)recorded)

-segregation of duties-segregation of duties

-reconciliation of cash to -reconciliation of cash to receiptsreceipts

Take cash at P.O.S. and Take cash at P.O.S. and don’t record saledon’t record sale


-analytical review-analytical review

Take cash received from Take cash received from A/R (even though A/R (even though recorded)recorded)


-reconciliation of cash to -reconciliation of cash to receiptsreceipts

Take cash received from Take cash received from A/R and don’t record itA/R and don’t record it


-confirmation of A/R-confirmation of A/R


Take cash received from X Take cash received from X and record it came from Y. and record it came from Y. Apply Z’s cheque to X.Apply Z’s cheque to X.


-confirmation of A/R-confirmation of A/R

-enforce vacations-enforce vacations

Take cash and say goods Take cash and say goods were returned in that amt.were returned in that amt.


-follow up of customer -follow up of customer infoinfo

-inventory counts-inventory counts

-authorization of returns-authorization of returns

Take cash received from Take cash received from customer X, then say their customer X, then say their a/c was “written off”a/c was “written off”

-authorization of write offs-authorization of write offs



Take 2% of cash payment Take 2% of cash payment received from all received from all customers who pay after customers who pay after the discount period has the discount period has expired. Grant them the expired. Grant them the discount anyways.discount anyways.

-authorization of discounts-authorization of discounts


Control objectives in S/R/R Recorded sales occurred (ie. Shipment Recorded sales occurred (ie. Shipment

made)made) No sales recorded twiceNo sales recorded twice No shipments to non-existent customersNo shipments to non-existent customers Existing sales are recordedExisting sales are recorded Recorded sales accurately recordedRecorded sales accurately recorded Sales properly classified (eg. Receipt of a Sales properly classified (eg. Receipt of a

receivable is NOT a sale)receivable is NOT a sale) Sales recorded on correct datesSales recorded on correct dates Sales transactions properly posted to Sales transactions properly posted to

customer accountscustomer accounts

Control objectives in S/R/R All cash received is recordedAll cash received is recorded All receipts recorded actually occurredAll receipts recorded actually occurred Cash receipts are recorded and deposited in Cash receipts are recorded and deposited in

correct amountscorrect amounts Cash receipts properly classifiedCash receipts properly classified Cash receipts recorded on correct dates Cash receipts recorded on correct dates Cash receipts are properly posted to correct Cash receipts are properly posted to correct

A/R accountsA/R accounts

General Controls in S/R/R

Segregation of duties in S/R/RSegregation of duties in S/R/R Segregation of duties in data processingSegregation of duties in data processing Program change controlsProgram change controls Physical access and security (cash & Physical access and security (cash &

inventory)inventory) Logical access and securityLogical access and security Documentation of programs and operationsDocumentation of programs and operations

Common Key Controls in S/R/R

1)1) Invoices are matched to shipping Invoices are matched to shipping documents.documents.

2)2) Shipping documents are pre-numbered and Shipping documents are pre-numbered and followed up to ensure none omitted or followed up to ensure none omitted or processed twice.processed twice.

3)3) Customer credit authorized.Customer credit authorized.

4)4) Standard prices authorized.Standard prices authorized.

5)5) Sales only take place with authorized Sales only take place with authorized customerscustomers

Common Key Controls in S/R/R

6)6) Monthly statements sent to customers: Monthly statements sent to customers: complaints followed up by independent complaints followed up by independent personnel.personnel.

7)7) A/R updated from invoices, G/L updated A/R updated from invoices, G/L updated from sales journal, periodic reconciliationfrom sales journal, periodic reconciliation

Tests of Controls Goal is to ensure that control operated Goal is to ensure that control operated

effectively, as described, throughout period of effectively, as described, throughout period of reliancereliance

May involve following documents. Ensure May involve following documents. Ensure direction is correctdirection is correct

Reperform if possible and necessaryReperform if possible and necessary If control is computerized, check it’s working If control is computerized, check it’s working

and check controls over changesand check controls over changes For segregation of duties: 1) observe segregation, For segregation of duties: 1) observe segregation,

2) ensure physical and logical access is 2) ensure physical and logical access is controlled, 3) enquire about vacation and sick controlled, 3) enquire about vacation and sick day coverage, 4) be on lookout for exceptions day coverage, 4) be on lookout for exceptions

Tests of Controls: Dual purpose

= tests that determine:= tests that determine:

1) if controls are operating effectively AND1) if controls are operating effectively AND

2) amount of monetary errors in account.2) amount of monetary errors in account.

Requires re-performanceRequires re-performance

Eg. Ensure each invoice is accompanied by shipping Eg. Ensure each invoice is accompanied by shipping documentdocument

Ensure prices and extensions are correctEnsure prices and extensions are correct

Evaluating results of TOC

If statistical sampling is used, can get a quantitative If statistical sampling is used, can get a quantitative estimate of deviations that MAY exist in population estimate of deviations that MAY exist in population given:given: Results of your sample andResults of your sample and Possibility of sampling riskPossibility of sampling risk

Table 12-8 gives this upper bound of deviations. Table 12-8 gives this upper bound of deviations. If upper bound < tolerable exception rate, then…If upper bound < tolerable exception rate, then… If upper bound > tolerable exception rate, then…If upper bound > tolerable exception rate, then…

Evaluating results of TOC

What happens to your upper bound What happens to your upper bound (=CUER: computed upper exception rate) (=CUER: computed upper exception rate) when:when: ARACR increases?ARACR increases? Sample size increases?Sample size increases? Number of deviations increases? Does Number of deviations increases? Does

each additional deviation increase the each additional deviation increase the CUER by a greater or lesser amount?CUER by a greater or lesser amount?

Analytical Procedures in S/R/R

MUST be used in planning and final stagesMUST be used in planning and final stages MAY be used to reduce tests of detailsMAY be used to reduce tests of details

DR=APR*ARIADR=APR*ARIA The better your procedures, the lower your APR isThe better your procedures, the lower your APR is

Using regression analysisUsing regression analysis Using more variablesUsing more variables Finer level of detailFiner level of detail

Analytical Procedure Steps1)1) Define results to examine & relationshipDefine results to examine & relationship2)2) State objectives of the reviewState objectives of the review3)3) Decide on examination methodsDecide on examination methods4)4) Define significant fluctuationsDefine significant fluctuations5)5) Specify intended relianceSpecify intended reliance6)6) Select the method of computationSelect the method of computation7)7) Control non-sampling riskControl non-sampling risk8)8) Ensure audit controlEnsure audit control9)9) Make the comparisonMake the comparison10)10) Identify significant fluctuationsIdentify significant fluctuations11)11) Investigate significant fluctuationsInvestigate significant fluctuations12)12) State conclusionsState conclusions

Regression Analysis pros and cons Pros:Pros:

Rigorous, provides higher assuranceRigorous, provides higher assurance Probabilities can be quantifiedProbabilities can be quantified Can handle several variablesCan handle several variables

Cons:Cons: Large number of observations neededLarge number of observations needed Specialized training, software requiredSpecialized training, software required

Common S/R/R analytical procedures

Gross margin %Gross margin % Sales by month and/or by product lineSales by month and/or by product line Sales returns and allowances/salesSales returns and allowances/sales Individual customer balances with prior yrsIndividual customer balances with prior yrs Bad debt Expense/salesBad debt Expense/sales Number of days sales in A/RNumber of days sales in A/R A/R turnoverA/R turnover Breakdown of aging categories with prior Breakdown of aging categories with prior

yryr Allowance/(A/R)Allowance/(A/R)

Substantive Procedures: A/R objectives1)1) Recorded A/R existRecorded A/R exist

2)2) All A/R are recordedAll A/R are recorded

3)3) A/R are recorded in proper periodA/R are recorded in proper period• Sales cutoff is properSales cutoff is proper• Receipts cutoff is properReceipts cutoff is proper• Returns/allowances cutoff is properReturns/allowances cutoff is proper

4)4) A/R are accurate (proper pricing etc.)A/R are accurate (proper pricing etc.)

5)5) A/R is valued correctly (allowance)A/R is valued correctly (allowance)

Substantive Procedures: A/R objectives6)6) Rights to A/R are owned by clientRights to A/R are owned by client

• Not factored or pledgedNot factored or pledged

7)7) A/R is properly classifiedA/R is properly classified• LT vs. ST, related parties, directors etc.LT vs. ST, related parties, directors etc.

Common A/R TOD Procedures1)1) Ensure A/R trial balance ties in to G/LEnsure A/R trial balance ties in to G/L2)2) Select items to confirm from trial balanceSelect items to confirm from trial balance3)3) Scan trial balance for large, unusual or Scan trial balance for large, unusual or

negative items.negative items.4)4) Enquire of mgmt if there are related parties Enquire of mgmt if there are related parties

or long term receivables and how they or long term receivables and how they identify them.identify them.

5)5) Ensure aged A/R trial balance is complete Ensure aged A/R trial balance is complete and accurate. Review procedures with and accurate. Review procedures with manager. Review allowance for manager. Review allowance for reasonableness.reasonableness.

Common A/R TOD Procedures

6)6) Check end of year sales, receipts, and Check end of year sales, receipts, and returns were in this period, and subsequent returns were in this period, and subsequent period sales, receipts and returns were in period sales, receipts and returns were in subsequent period.subsequent period.

7)7) Examine receipts received after year end Examine receipts received after year end for evidence of ________ and _________.for evidence of ________ and _________.

8)8) Review minutes, correspondence and loan Review minutes, correspondence and loan confirmations and enquire of mgmt if A/R confirmations and enquire of mgmt if A/R are pledged or factoredare pledged or factored

Confirmations of A/R Are they necessary? Should be used unless:Are they necessary? Should be used unless:

A/R are immaterial orA/R are immaterial or confirmations would be ineffective or unreliable confirmations would be ineffective or unreliable

oror CR and IR are low and other procedures can be CR and IR are low and other procedures can be

used that provide sufficient appropriate audit used that provide sufficient appropriate audit evidenceevidence

Consider typeConsider type positive (more reliable) or negativepositive (more reliable) or negative

Confirmations of A/R Consider timing of confirmationsConsider timing of confirmations

Materiality, inherent risk, internal controls, audit Materiality, inherent risk, internal controls, audit risk, amount of business activityrisk, amount of business activity

Consider recipient and type of information to ask Consider recipient and type of information to ask for:for: individual invoices, account balance, or ask individual invoices, account balance, or ask

recipient to provide balancerecipient to provide balance Maintain control of confirmations (no client Maintain control of confirmations (no client

intervention)intervention) Follow up of errors, exceptions and non responsesFollow up of errors, exceptions and non responses

Evaluation of Results of TOD

Recall that we will have a list of KNOWN Recall that we will have a list of KNOWN errors from a sample.errors from a sample.

These will be extended to get PROBABLE These will be extended to get PROBABLE or LIKELY errors: In DUS = or LIKELY errors: In DUS =

(population/sample size) * (error/BV)(population/sample size) * (error/BV) Calculate Upper Bound to account for Calculate Upper Bound to account for

sampling risk:sampling risk:

Calculating upper bounds of over and understatements

1)1) Sort errors by over- and under-statements.Sort errors by over- and under-statements.

2)2) For each error calculate the PROPORTION For each error calculate the PROPORTION of the sample item that was in error of the sample item that was in error (=error/BV of item)(=error/BV of item)

3)3) For each group (over and understatements, For each group (over and understatements, sort from biggest proportionate error to sort from biggest proportionate error to smallest.smallest.

4)4) From table 12-9, calculate the From table 12-9, calculate the increase increase in in CUER for each deviation to the number of CUER for each deviation to the number of deviations you have.deviations you have.

Calculating upper bounds of over and understatements

For each deviation, multiply:For each deviation, multiply:

its proportion of error *its proportion of error *

the increase in CUER *the increase in CUER *

the recorded value of the population. the recorded value of the population.

The total of all these represents your upper bound The total of all these represents your upper bound for the group (either overstatements or for the group (either overstatements or understatement)understatement)

Note that the “proportion of error” for the first Note that the “proportion of error” for the first layer (=0 deviations) is usually 100%. layer (=0 deviations) is usually 100%.

Might reduce the resulting upper bound by the Might reduce the resulting upper bound by the most likely errors in the opposite direction.most likely errors in the opposite direction.

Evaluating TOD results Compare known errors, most likely errors, and Compare known errors, most likely errors, and

upper bounds to materiality (or your tolerable upper bounds to materiality (or your tolerable misstatement, whichever is lower)misstatement, whichever is lower)

If lower, no problemIf lower, no problem If higher, consider:If higher, consider:

Increase sample sizeIncrease sample size Ask that account balance be adjustedAsk that account balance be adjusted Have client correct popn and re-testHave client correct popn and re-test As last resort, qualify opinionAs last resort, qualify opinion

Always consider as well qualitative Always consider as well qualitative considerations and affect on CR and IR decisions considerations and affect on CR and IR decisions already madealready made

9.401 auditing

Documents

recordedrecorded sales

sales journal

auditing sales

srrrecorded sales

upper bound of deviations

check controls

correct amountscash

exceptions tests of