Chapter 7 Notes: Auditing and Assurance Services

Chapter 7 Overall scrutinize Approach for the Revenue and Collection Cycle * Audit take chances- the seek that auditors will issue and unqualified opinion on financial statements that contain a material misstatement * Inherent pretend and find out risk * 3 step approach for audit risk model * Set audit risk at desired levels * Assess risk of material misstatement Determine detection risk based on the level of audit risk and risk of material misstatement * The components of the audit risk model ar assessed on an assertion-by-assertion basis * This judgement recognizes that certain assertions assume an increased level of importance and are of more interest to auditors than differents * Existence assertions is most-valuable in the audit or A/R and the occurrence is important for gross sales * If the audit police squad estimates that swear risk is below maximum they need to perform test of controls to confirm that the control activities are operating effectively and that th e auditors sign strategy is sound LO1 Inherent Risk in the Revenue and Collection Cycle Revenue Recognition Revenue Recognition- written text revenues in the entities To be recognized revenues essential be realized or realizable or earned * Revenue earning activities involve delivering or producing goods, rendering services, or performing other activities that constitute its ongoing major or central operations, and revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits awarded by the revenues * All criteria must be met for revenue to be realizes, realizable, or earned * Persuasive evidence of an arrangement exists * Delivery has occurred or services have been rendered * The sellers price to the buyer is fixed or determinable * Collectability is reasonably ensured Collectability of A/R In most companies, a portion of accounts receivable will not be paid. GAAP requires clients to provide and estimat ion of uncollectable amounts and provide and allowance for it.Estimation of allowance for doubtful accounts place be immanent and difficult for the client and the auditor. A reason for difficulty can be changing economic conditions. Customer Returns and Allowances Sometime guests have the right to return smart or unsold merchandise. An appropriate evaluation of revenue can be performed when these agreements are in the purchase contract and disclosed to the auditor. Clients may enter into unceremonial right of return agreements with customers unknown to the auditors. Liabilities for known return, warranties, and other potential obligations are very much very difficult to estimate. Companies with new products or technologies have an even high inherent risk in these areas.LO2 Revenue and Collection Cycle Typical Activities Basic activities in the revenue and collection round of golf are 1. Receiving and processing customer orders 2. Delivering goods and services to customers 3. Billing customers and accounting for A/R 4. Collecting and depositing cash received from customers Entity Level Control It is important that auditors consider the entity-level controls in all processes and procedures. In the revenue process, management should have a process for continually revaluationing revenue and comparing it to the budgets and forecasts. Management should constantly scrutinize total write-offs of A/R, merchandise returns, and the opportuneness of collections.Physical control over inventory and stores must include entity level control such as id badges and restricting access to facilities. Receiving and Processing Customer Orders, Including Credit Granting * Customers can initiate sales by mailing P/Os, call or fax , emails, websites or go to the phycial locations. * It is important that doctrine sales are authorized to ensure that the customer will be able to pay for the good or services * Access to master lodge for additions, deletions, and other changes mu st be limited to responsible people * If these controls fail, orders might be processed for fictitious customers, accredit might be approves for bad credit risks, and shipping documents might be created for goods that do not exists in the inventory. Customer orders, shipping documents, and invoices should be in prenumbered sequence so the placement can contain the sequence and tally whether any transaction have not be record or have been duplicated Delivering Goods and Services to Customers Physical custody of inventory - storeroom or warehouse - absentred to shipping department upon authorizations of the shipping order that permits the inventory clerk to release good to the shipping department. Proper authorization is important. Employees that perform each step to should transfer documents making them accountable. This prevents employees from misappropriating the goods or shipping product to friends without billing them. A bill of lading is a form that the carried signs to ve rify the goods shipped.A packing slip describes the good universe shipped is often included with the shipment Billing customers and Accounting for A/R When delivery or shipment is complete, the system finishes the transaction by filing a shipment record and preparing a final invoice for the customer. A sales invoice is the bill sent to the customer that indicates the amount due. People who have the bureau to enter or alter these transactions or change the invoice before it is mailed to the customer should not have any authorization, custody, or save responsibilities. There should also be physical protection of the files. Files that are lost or destroyed are unlikely accounts to be collected. With that said the records are assets.Audit cause in Management Reports and Data File Computerized processing of revenue and cash receipts transaction enables management to generate several reports that can provide important audit evidence. Pending Order Master File- sales transactions that were initiated but not yet completed or recorded as sales. May represent shipments that were made but not recorded in the sales daybook or could not be matched to a customer order. Credit Check Files- Computerized system may male automatic credit checks, but up to date maintenance of the credit information is very important. A sample of the credit check file can be tested for current status.Price List Master File- Computers system may produce customer invoices automatically but if the price tend master is incorrect the billings will be incorrect Sales Detail (journal) File- the detailed sales entries, including the shipping references and dates, should be in the sales detail (journal) file Sales Analysis Reports- Sales that are classified by product lines provide required information for the business segment disclosures A/R itemisation and Aging- The A/R listing of customers balances is the actual a/r property Receipts Listing- The cash receipts journal contains all the detail e ntries for cash deposits and assign to various accounts Customer Statements- Probably the best control over whether cash is received and recorded is the customer LO3 Control Risk Assessment Control risk assessment is important because it governs the nature, timing, and extent of substantive procedures that will be applied in the audit of account balances in the revenue and collection cycle.Balances include Cash in bank, A/R, Allowance for doubtful accounts, Bad Debts, Sales revenue Control Considerations Control for proper separation of responsibilities should be in place and operating. It involves divergent people and different departments performing the sales and credit authorization custody of good and cash and record keeping for sales, receivables, inventory, and cash receipts. The following control activities should be in place to prevent and detect errors 1. No sale order should be entered w/o a customer order 2. A credit check code or manual signature should be recorded for authorization 3. Pending order flies should be reviewed frequently to avoid misadventure to bill and record shipments Test of ControlsAn organization should have control activities in place and operating to prevent, detect, and correct accounting errors. Auditors can perform tests of controls to determine whether bon ton personnel are properly performing controls that are said to be in place. If personnel in the organization are not performing their control activities effectively, auditors need to design substantive procedures to try to detect whether control failures have produced materially misstated account balance. Dual testing involves selecting samples to obtain evidence about control over completeness in one direction and control over occurrence in the other direction.Completeness is whether all transactions that occurred were recorded and the occurrence direction determines whether recorded transactions represent valid economic events. Summary Control Risk Assessment Audi tors must evaluate the evidence obtained from an understanding of internal control and from tests of controls. The initial process of obtaining an understanding of the companys control and the later process of obtaining evidence from test of controls are two phases of control risk assessment. It control risk is assessed to be very low, the substantive procedures on the account balances can be reduced. It the test of controls reveal weakness, the substantive procedures need to be designed to lower the risk of failing to detect material misstatement in the account balances.LO4 Substantive Procedures in the Revenue and Collection Cycle When considering assertions and obtaining evidence about A/R and other assets, auditors must emphasize the existence assertion. It is important because companies and auditors have found themselves in malpractice lawsuits by issuing unqualified reports on F/S that have exaggerated assets and revenues. Company asserts existence by putting assets on B/S An alytical Procedures During an audit, a variety of analytical comparisons might be employed, depending on the destiny and the nature of the business. Comparisons of asset and revenue balances with recent history might help detect overstatements. Account interrelationships can be used in analytical procedures.A/R write-offs should be compared w/ estimates of doubtful accounts Confirmation of Accounts and Notes Receivable The use of validations for A/R is considered a required audit procedure by audit standards. If auditors hire not to use them they should document justification. A positive confirmation asks the customers to respond whether the balance is correct or incorrect. A variation of a positive confirmation is a blank form. A blank confirmation doesnt contain the balance customers fill it in themselves. Negative confirmation asks for a response except if something is wrong with the balance. Lack of response to negative confirmation is considered evidence that the account is fairly stated.Negative form is used mostly when the risk of material misstatement is considered low. Alternative Procedures a good deal clients customers are not willing or able to return the confirmation. They may not be able if, they are on a voucher system that lists payables by invoice instead of by vendor account. If this happens auditors have to perform alternative procedures to ensure existence. This includes examining 1. subsequent cash receipts (this is often performed even when customer has confirmed the account) 2. Sales orders, invoices, shipping documents 3. Correspondence files for past due accounts Review for Collectability Primary evidence cleared from the confirmations relates to existence.The audit team must review accounts for collectability and determine the adequacy of the allowance for doubtful accounts in support of the valuation assertion. To do this, auditors review subsequent cash receipts from the customer, discuss unpaid accounts with the credit manage r, and examine the credit files. Credit files should contain the customers financial statements, credit reports, and correspondence between the client and the customer. Based on this evidence, the audit team estimates the likely amount of the nonpayment for the customer, which is included in the estimate of all allowance for doubtful accounts. Cutoff and Sales Returns Auditors must make sure that sales are recorded in the proper period.The employ sales cutoff test which are test that ensure that sales are recorded in the proper period, generally when they are shipped, and that the cost of the sales is recorded and removed from inventory. Procedures include tracing shipping documents before and after social class-end to the sales journal to ensure the sale was recorded in the proper period. Credit memos for returns after year-end are vouched to receiving reports. Any goods returned after year end that were sold during the year being audited should be deducted from sales. Rights and Obligations Companies may sell or factor (the actions to sell A/R to another party, the factor, at a discount from face value) to gain cash immediately.It is difficult to determine whether receivables have been sold b/c customers do not usually know that someone else actually owns their account. The cash goes to the original seller who passes it on to the factor. Inquiring of management and examining support for large cash receipts is the best way to detect these transactions. Presentation and Disclosures The accounts in the revenue cycle require certain disclosures. These disclosures must ensure that the presentation and disclosure assertions of occurrence, rights and obligations, completeness, classification, accuracy and valuation, and understandability have been met. Receipt of confirmation information by email or fax is becoming more common. Auditor may receive an oral response to confirmation.