Problem 14-21, p. 490, 11th. Canadian Edition The following errors or fraud and other irregularities are included in the accounting records of Joyce Manufacturing Ltd.: The credit limit for a new customer was entered as $20,000 rather than $2,000 in the customer master file. A material sale was unintentionally recorded for the second time on the last day of the year. The sale had originally been recorded two days earlier. Cash paid on accounts receivable was stolen by the mail clerk when the mail was opened. Cash paid on accounts receivable that had been prelisted by a secretary was stolen by the bookkeeper who enter cash receipts and accounts receivable in the accounts receivable system. He failed to enter the transactions. A shipment to a customer was not billed because of the loss of the bill of lading. Merchandise was shipped to a customer, but no bill of lading was prepared. Since billings are prepared from bills of lading, the customer was not billed. A sale to a retail customer was unintentionally classified as a commercial sale. REQUIRED Identify whether each misstatement is an error, a fraud, or other irregularity. For each misstatement, state a control that should have prevented it from occurring on a continuing basis. For each misstatement, state an audit procedure that could uncover it.

Solution to 14.21 a. Type of Misstatement b. Control c. Procedure 1 Error Print a list of all master file changes for independent verification. Compare approved master file change form to listing of master file. 2. Sales invoices are prenumbered, properly accounted for in the sales journal, and a notation on the invoice is made of entry into the sales journal. Account for numerical sequence of invoices recorded in the sales journal, watching for duplicates. Confirm accounts receivable at year-end. 3. Fraud All payments from customers should be in the form of a cheque payable to the company. Monthly statements should be sent to all customers. Trace from recorded sales transactions to cash receipts for those sales; confirm accounts receivable balances at year end. 4. The listing of cash received should be compared to the postings in the accounts receivable master file and to the validated bank deposit slip. Trace cash received from prelisting to cash receipts journal. Confirm accounts receivable. 5. Use of prenumbered bills of lading that are periodically accounted for. Trace a sequence of prenumbered bills of lading to recorded sales transactions. Confirm accounts receivable at year end. 6. No merchandise may leave the plant without the preparation of a prenumbered bill of lading. Trace credit entries in the perpetual inventory records to bills of lading and the sales journal. Confirm accounts receivable at year end. 7. Internal review and verification by an independent person. Test accuracy of invoice classification.

Problem 12-22, page 403 YourTeam.com is an online retailer of college and professional sports team memorabilia, such as hats, shirts, pennants, and other sports logo products. Consumers select the university, college, or professional team from a pull-down menu on the company’s website. For each listed item, the website provides a product description, picture, and price for all products sold online. Customers click on the product number of the items they wish to purchase. YourTeam.com has established the following internal controls for its online sales: Only products shown on the website can be purchased online. Other company products not shown on the website are unavailable for online sale. The online sales system is linked to the perpetual inventory system that verifies quantities on hand before processing the sale. Before the sale is authorized, YourTeam.com obtains credit card authorization codes electronically from the credit card agency. Online sales are rejected if the customer’s shipping address does not match the credit card’s billing address. Before the sale is finalized, the online screen shows the product name, description, unit price, and total sales price for the online transaction. Customers must click on the Accept or Reject sales button to indicate approval or rejection of the online sale. Once customers approve the online sale, the online sales system generates a Pending Sales file, which is an online data file that is used by warehouse personnel to process shipments. Online sales are not recorded in the sales journal until warehouse personnel enter the bill of lading number and date of shipment into the Pending Sales data file.

REQUIRED: For each control, identify the transaction-related audit objective(s) being fulfilled if each control is in effect. For each control, describe potential financial misstatements that could occur if the control were not present. For each control, identify an important general control that would affect the quality of the control. For each control, list a test of control to test its effectiveness.

Solution to 12-22 a. b. Misstatement or Error Prevented c. General Control Needed d. Audit Test 1. Occurrence Accuracy Sales may be recorded for invalid or non-existent products. Sales may be processed on inaccurate price information. Access controls: only authorized individuals may access master files (e.g., use passwords). Review password access tables to ensure that only authorized individuals can access master files. 2. Occurrence Sales may be processed for existing products using quantities ordered, even when ordered quantities are not on hand. Program change controls: only authorized changes should be made to programs that perform calculations (e.g., reducing inventory for shipped orders). Use computer-assisted audit techniques to scan inventory files for inventory quantities that are less than zero. 3. Occurrence Sales may be processed for customers who are unable to pay. Access controls: only secure information should be sent/received to or from credit card companies. Computer-assisted audit techniques should be used to list any accounts receivable amounts for internet sales that have been outstanding for more than 30 days. 4. Occurrence Shipments may be made to persons making an unauthorized credit card purchase (e.g., with a stolen credit card). Segregation of duties: only authorized personnel should have access to physical media (e.g., hard drives) on which data is stored. Use computer-assisted audit techniques to list any customers where the credit card billing address is different from the shipping address. 5. Accuracy Sales may be processed inaccurately (e.g., wrong product, wrong price, wrong quantity). Program change controls: only authorized changes should be made to programs that perform calculations, e.g., calculating invoice totals. Complete a test order on the internet to ensure that the accept and reject buttons are functioning correctly. 6. Occurrence Timing Sales may be recorded even though shipment has not occurred. Sales may be recorded in the wrong time period. Access controls: only authorized individuals should be allowed to enter shipping information. Use computer-assisted audit techniques to list the pending file as of the year end date. Trace to subsequent sales documents.

Other audit procedures that could be performed are: test extensions on attached sales invoices for clerical accuracy (Valuation) test time delay between warehouse removal slip date and billing date for timeliness of billing (Timing) trace entries into perpetual inventory records to determine that inventory is properly relieved for shipments (Posting and summarization)  The test performed in part c. cannot be used to test the existence of sales because the auditor already knows that inventory was shipped for these sales. To test the validity of sales, the sales invoice entry in the sales journal is the sampling unit. Since the sales invoice numbers are not identical to the warehouse removal slips it would be improper to use the same sample.

Problem 12-27, page 405 The following are auditor judgments and audit sampling results for six populations. Assume large population sizes. 1 2 3 4 5 6 EPER (in percentage) 8 TER (in percentage) 20 15 ARACR (in percentage) 10 Actual sample size 100 60 Actual number of exceptions in the sample REQUIRED For each population, did the auditor select a smaller sample size than is indicated by using attribute sampling tables for determining sample size? Evaluate, selecting either a larger or smaller size than those determined in the tables. Calculate SER and CUER for each population. For which of the six populations should the sample results be considered unacceptable? What options are available to the auditor? Why is analysis of the exceptions necessary even when the populations are considered acceptable?

Problem 12-27, page 405 The following are auditor judgments and audit sampling results for six populations. Assume large population sizes. 1 2 3 4 5 6 EPER (in percentage) 8 TER (in percentage) 20 15 ARACR (in percentage) 10 Actual sample size 100 60 Actual number of exceptions in the sample REQUIRED For each population, did the auditor select a smaller sample size than is indicated by using attribute sampling tables for determining sample size? Evaluate, selecting either a larger or smaller size than those determined in the tables. Calculate SER and CUER for each population. For which of the six populations should the sample results be considered unacceptable? What options are available to the auditor? Why is analysis of the exceptions necessary even when the populations are considered acceptable?

TOLERABLE DEVIATION RATE (IN PERCENTAGE) 2 3 4 5 6 7 8 9 10 15 20 EXPECTED POPULATION DEVIATION RATE (IN PERCENTAGE) TOLERABLE DEVIATION RATE (IN PERCENTAGE) 2 3 4 5 6 7 8 9 10 15 20 5 PERCENT RISK OF OVER RELIANCE (ARACR) 0.00 149 99 74 59 49 42 36 32 29 19 14 0.25 236 157 117 93 78 66 58 51 46 30 22 0.50 . 0.75 208 1.00 156 1.25 124 1.50 192 103 1.75 227 153 88 77 2.00 181 127 68 2.25 61 2.50 150 109 2.75 173 95 3.00 195 129 84 3.25 148 112 3.50 167 76 40 3.75 185 100 4.00 146 89 5.00 158 116 6.00 179 50 7.00 37

10 PERCENT RISK OF OVER RELIANCE (ARACR) 2 3 4 5 6 7 8 9 10 15 20 10 PERCENT RISK OF OVER RELIANCE (ARACR) 0.00 114 76 57 45 38 32 28 25 22 11 0.25 194 129 96 77 64 55 48 42 18 0.50 0.75 265 1.00 . 176 1.25 221 132 1.50 105 1.75 166 88 2.00 198 75 2.25 65 2.50 158 110 58 2.75 209 94 52 3.00 3.25 153 113 82 3.50 73 3.75 131 98 4.00 149 4.50 218 130 87 34 5.00 160 115 78 5.50 142 103 6.00 182 116 7.00 199 7.50 8.00 60 8.50 68 EPDR

ACTUAL NUMBER OF DEVIATIONS FOUND 1 2 3 4 5 6 7 8 9 10 SAMPLE SIZE ACTUAL NUMBER OF DEVIATIONS FOUND 1 2 3 4 5 6 7 8 9 10 5 PERCENT RISK OF OVER RELIANCE 25 11.3 17.6 . 30 9.5 14.9 19.5 35 8.2 12.9 16.9 40 7.2 18.3 45 6.4 10.1 13.3 16.3 19.2 50 5.8 9.1 12.1 14.8 17.4 19.9 55 5.3 8.3 11.0 13.5 15.9 18.1 60 4.9 7.7 12.4 14.6 16.7 18.8 65 4.5 7.1 9.4 11.5 15.5 19.3 70 4.2 6.6 8.7 10.7 12.6 14.4 16.2 18.0 19.7 75 3.9 6.2 10.0 11.8 15.2 18.4 20.0 80 3.7 11.1 12.7 14.3 15.8 17.3 90 3.3 5.2 6.8 8.4 9.9 14.1 16.8 100 3.0 4.7 7.6 8.9 10.2 14.0 16.4 125 2.4 6.1 9.3 10.3 12.2 13.2 150 2.0 3.1 4.1 5.1 6.0 6.9 8.6 200 1.5 2.3 3.8 6.5

1 2 3 4 5 6 7 8 9 10 Sample size ACTUAL NUMBER OF DEVIATIONS FOUND . 1 2 3 4 5 6 7 8 9 10 10 PERCENT RISK OF OVER RELIANCE 20 10.9 18.1 . 25 8.8 14.7 19.9 30 7.4 12.4 16.8 35 6.4 10.7 14.5 40 5.6 9.4 12.8 15.9 19.0 45 5.0 8.4 11.4 14.2 17.0 19.6 50 4.5 7.6 10.3 12.9 15.4 17.8 55 4.1 6.9 11.7 14.0 16.2 18.4 60 3.8 6.3 8.6 10.8 14.9 16.9 18.8 70 3.2 5.4 9.3 11.1 14.6 17.9 19.5 80 2.8 4.8 6.5 8.3 9.7 11.3 14.3 15.7 17.2 18.6 90 2.5 4.3 5.8 7.3 8.7 10.1 12.7 15.3 16.6 100 2.3 5.2 6.6 7.8 9.1 11.5 13.8 15.0 120 1.9 4.4 5.5 9.6 10.6 11.6 12.5 160 1.4 2.4 3.3 4.9 5.7 7.2 8.0 9.5 200 1.1 2.6 4.0 4.6 7.0

12-27 The sample sizes and CUERs are shown in the following table: The auditor selected a sample size smaller than that determined from the tables in population 1 and 3. The effect of selecting a smaller sample size than the initial sample size required from the table is the increased likelihood of having the computed upper exception rate exceed the tolerable exception rate. If a larger sample size is selected, the result may be a sample size larger than needed to satisfy tolerable exception rate. That results in excess audit cost. Ultimately, however, the comparison of CUER to tolerable exception rate determines whether the sample size was too large or too small. Actual Sample Size Initial Sample Size from Table 13-7 Sample Exception Rate (SER) CUER from Table 13-8 1. 100 127 2.0% 6.2% 2. 99 0.0 3.0 3. 60 65 1.7 6.3 4. 93 4.0 8.9 5. 20 18 5.0 18.1 6. 13.3 >20.0 The sample exception rate and computed upper exception rate are shown in columns 4 and 5 in the above table.   The population results are unacceptable for populations 4 and 6. In each of those cases, the CUER exceeds tolerable exception rate. In population 1, the CUER is marginally more than the TER. The auditor’s options are to change tolerable exception rate or ARACR, increase the sample size, or perform other substantive tests to determine whether there are actually material errors in the population. Increasing sample size would not likely result in improved results for either population 4 or 6 because the CUER exceeds tolerable exception rate by a large amount. Analysis of exceptions is necessary even when the population is acceptable because the auditor wants to determine the nature and cause of all exceptions. If, for example, the auditor determines that an error was intentional, additional action would be required even if the CUER was less than tolerable exception rate.