ACCTG 16A FINAL EXAMINATION ANSWER

IB-IB, Merly J.

5th year- BSA

TEST 3

Question and Problems

3-1 How do different levels of control risk in the revenue and collection cycle affect the nature, timing and
extent of accounts receivable confirmation procedures?

-These different levels of control risk affect the assertions embodied in the revenue and collection cycle.
These different control risk, if they are designed effectively and operated efficiently, the auditor can select a
minimum number of samples of the accounts receivable for testing. With regards to the nature of the nature of
the procedures, higher level of control risk make the auditors use positive confirmations instead of negative
confirmations , and to consider assuring subsequent payments by the customers.

3-2 What feature(s) of cash receipts internal control system would be expected to prevent (a) an employee’s
absconding with company funds and replacing the funds during audit engagements with cash from the
employee pension fund, and (b) the cash receipts journal and recorded cash sales from reflecting more than
amount shown on the daily deposit slip?

a) Existence or Occurrence: Recorded receipts represent actual cash collections from customers. Duties
of handling cash receipts are segregated from posting to accounts receivable. A person performing
both functions could misappropriate cash and conceal the shortage by making an entry directly to the
customer’s accounts.
b) Completeness: All receipts are processed and recorded. A daily cash summary is prepared and
reconciled to total of prelisting and over-the-counter receipts. The summary total is compared to the
total in the cash receipts journal and the total on the validated deposit ticket. This control ensures that
all cash receipts are deposited and recorded.

3-3 What is the meaning of a strength in the transaction processing controls of the revenue and collection
cycle? A weakness? Why are the weaknesses not subject to test of controls auditing?

- A strength is defined as a control procedure that can detect, prevent or correct errors in a timely matter from
entering into the accounting records that form a basis of financial statements. A weakness is the lack of
acontrol procedure where the auditor thinks one should exist.

-Weaknesses are not subject to test of controls auditing because no reliance is placed on a weakness.
Strength must be audited because the review phase only describes apparent strengths that may not actually
exist.

3-4 Why is it necessary to evaluate the controls after the test of controls audit of the revenue and collection
cycle when an evaluation was already made after the understanding phase?

3-5 Describe the processing of transactions in the sales and collections cycle in the following functions:

a. Order entry – generally receives customers request to purchase merchandise either by telephone or in the
form of a written purchase order from the customer.
 b. Credit approval -  is the process a business or an individual undergoes to become eligible for a loan or pay
for goods and services over an extended period.

c. Warehousing - the practice or process of storing goods in a warehouse.

d. Shipping - the transport of goods by sea or some other means.

e. Customer billing - The standard accounting definition of billing describes it as the process of

f. Collecting accounts receivable – Where you collect receivables or credits from your customers

g. Granting credit for returns and allowances – Where you allow returns and allowances for the defective
products.

h. Recording uncollectible accounts expense – recording the uncollectibles

i. Writing off uncollectible accounts - Existence of recorded write-offs in the most important transaction-related
audit objective that the auditor should keep in mind in the verification of the write-off of individuals uncollectible
accounts

3-6 Identify features of the following documents that facilitate control and explain how they do so:

a. Shipping document - A pre numbered document prepared to initiated shipment of goods, indicating the
description of the merchandise, the quantity shipped, and relevant data.

b. Remittance advice - a document that a customer attaches to a check in payment of an invoice.

c. Uncollectible account form - A pre numbered document used internally, Indicating authority to write an
account Receivable off as uncollectible.

3-7 Why do people perpetrate fraud involving sales transactions?

- Because sales involves cash that is susceptible to theft.

3-8 Why is it difficult to detect the withholding of cash receipts?

-It would be difficult to detect the concealment of cash receipts when the duties of handling cash
receipts are not separated with the posting to accounts receivable. This will give way to the person to
misappropriate cash and conceal the shortage by making an entry directly to the customer’s accounts.

3-9 Identify three ways an employee might misappropriate cash receipts.

-Cash Discounts,

- Sales Returns, Allowances, Corrections

-Uncollectible Accounts

3-10 Explain why auditors perform test of controls

- Tests of controls precede substantive testing and performed to reduce the assessed level of control risk below the
maximum level.

3-11 What concerns does an auditor have in auditing adjustment to sales?

3-12 When an entity’s controls for collection are ineffective, what potential misstatements could arise in the
financial statements?

- It can be overstatement of net income, for example is the sales, returns and allowances. The primary
emphasis is normally on testing the existence of recorded transactions as a means of uncovering any
diversion of cash from the collection of accounts receivable that has been covered up by a fictitious
sales, returns and allowances.

3-13 What test of controls related to uncollectible accounts do auditors perform?

- Inspect credit files in support of accounts written off as uncollectible. The major control for preventing
this type of misstatement is proper authorization of the write-off of uncollectible accounts by a
designated level of management only after a thorough investigation of the reason the customer has not
paid.

3-14 The following questions relate to tests of controls. Choose the best response.

A 1.) To determine whether an entity’s internal control operated effectively to minimize errors of failure to post
invoices to the customer’s accounts ledger, the auditor would select a sample of transactions from the
population represented by the

a. customer order life

b. bill lading of file

c. subsidiary customers’ accounts ledger

d. sales invoice file.

B 2) To gather audit evidence that uncollected items in customers’ accounts represented valid trade
receivables, the auditor would select a sample of items from the population represented by the

a. customer order file

b. bill of lading file

c. subsidiary customers’ accounts ledger

d. sales invoice file.

A 3) Tracing bills of lading to sales invoices will provide evidence that

a. recorded sales were shipped

b. invoiced sales were shipped

c. subsidiary customers’ accounts ledger

d. sales invoice file.

D 4) Tracing copies of sales invoices to shipping documents will provide evidence that all
a. shipments to customers were recorded as receivables

b. billed sales were shipped

c. debit to the subsidiary accounts receivable ledger are for sales shipped

d. shipments to customers were billed

3-15 The following questions relate to internal controls. Choose the best response.

B 1) to achieve good internal control, which department should perform the activities of matching shipping
documents with sales orders and preparing daily sales summaries?

a. Billing b. Shipping c. Credit d. Sales order

A 2) Which of the following would the auditor to be an incompatible operation for a cashier if the cashier
receives remittances from the mailroom?

a. Posting the receipts to the accounts receivable subsidiary ledger cards.

b. Making the daily deposit at the local bank

c. Preparing the daily deposit

d. Endorsing the checks

A 3) The most likely result of ineffective internal controls in the sales cycle is that

a. fictitious transaction could be recorded, causing an understatement of revenues and an overstatement of

b. irregularities in recording transactions in the subsidiary accounts could delay the shipment of goods.

c. omission of shipping documents could go undetected, causing an understatement of inventory

d. final authorization of credit memos by personnel in the sales department could permit an employee
deflection scheme

D 4) For the most effective internal control, monthly bank statements should be received directly from the
banks and reviewed by the

a. controller b. cash receipts c. cash disbursements accountant d. internal auditor