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Problem 12-32, p. 421 Items 1 through 8 are selected questions of the type generally found in internal control questionnaires used by auditors to obtain.

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Presentation on theme: "Problem 12-32, p. 421 Items 1 through 8 are selected questions of the type generally found in internal control questionnaires used by auditors to obtain."— Presentation transcript:

1 Problem 12-32, p. 421 Items 1 through 8 are selected questions of the type generally found in internal control questionnaires used by auditors to obtain an understanding of internal control in the revenue cycle. In using the questionnaire for a particular client, a “yes” response to a question indicates a possible internal control, whereas a “no” indicates a potential weakness. Are sales invoices independently compared with customers’ orders for prices, quantities, extensions, and footings? Are sales orders, invoices, and credit memoranda issued and filed in numerical sequence, and are the sequences accounted for periodically? Are the selling function and cash register functions independent of cash receipts, shipping, delivery, and billing? Are all COD, scrap, equipment, and cash sales accounted for in the same manner as charge sales, and is the recordkeeping independent of the collection procedure? Is the collection function independent of, and does it constitute a check on, billing and recording sales? Are customer master files balanced regularly to general ledger control accounts by an employee independent of billing functions? Are cash receipts entered in the accounts receivable system by persons independent of the mail-opening and receipts-listing functions? Are receipts deposited intact on a timely basis? REQUIRED For each of the items 1 through 8, state the transaction-related audit objectives being fulfilled if the control is in effect. For each control, list a test of control to test its effectiveness.. For each of the items above, identify the nature of the potential financial misstatement. For each of the potential misstatements in part (c), list an audit procedure to determine whether a material error exists.

2 Solution to Problem 12-32 a. Transaction-related Audit Objective
b. Test of Control c. Misstatements d. Audit Procedure 1 Recorded sales are for the amount of goods ordered and are correctly billed and recorded. (Accuracy) Examine indication of internal verification on sales documents. Incorrect prices may be charged, the customer may be billed for the wrong quantity, or the total amount may be computed incorrectly. Recompute information on the sales invoices. Trace details on sales invoices to shipping records, price lists, and customers’ orders. 2 Recorded sales and credit transactions are for shipments actually made and existing sales transactions are recorded. (Occurrence and Completeness) Account for the numerical sequences of sales orders, invoices, and credit memoranda. Shipments or returns are not recorded. Orders from customers are misplaced and not filled. Examine correspondence concerning credit memoranda to ensure that they were properly issued. Trace shipping documents to resultant sales invoice and entry into sales journal and accounts receivable master file. Send accounts receivable confirmations. 3 Existing transactions are recorded; recorded transactions are valid. (Completeness and Occurrence) The auditor should observe the employees and discuss the procedures with personnel. Sales could be made and not recorded, with the employee keeping the proceeds of the sale. Trace selected shipping documents to related duplicate sales invoices, the sales journal, and accounts receivable master file. 4 Existing transactions are recorded. (Completeness) The auditor should observe the activities of those employees and discuss the procedures with personnel. These unusual sales could be made but not recorded and the proceeds kept from the company. Examine sales documents for these sales and trace the entries into the cash receipts books. 5 Existing transactions are recorded and recorded sales are for the amount of goods ordered and are correctly billed. (Completeness and Accuracy) The auditor should observe the activities of employees and discuss the procedures with personnel. A receivable might intentionally not be recorded, allowing the cash to be kept from the company. Trace from the shipping records to the sales invoice, to the accounts receivable master file, and to cash receipts. 6 Sales and collection transactions are properly included in the subsidiary records and are correctly summarized. ( Occurrence and Accuracy) Observation of procedures and examination of indication of internal verification. Unintentional misstatements could be posted in the control accounts and left undetected for long periods of time. Perform tests of clerical accuracy—foot journals and trace postings from journal to general ledger and accounts receivable master file. 7 Existing cash receipts transactions are recorded. (Completeness) Observation and discussion of procedures with employees. Cash could be received, not recorded, and kept from the company by an employee or lost prior to deposit. Trace receipts recorded on a list—such as from a prelist of cash—to the books of original entry; send accounts receivable confirmations. 8 Transactions are recorded at the proper time. (Cutoff) Compare date per books to the date the deposit appears on the bank statement. Cash receipts might be recorded in the wrong accounting period, lost, or stolen. Trace cash recorded on a list, such as a prelist of cash, to the cash receipts journal and to the bank statement.

3 Problem 12-33, page 421 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.

4 Solution to 12-33 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.

5 Problem 12-38, Page 423 You were asked in February 2015 by the board of directors of your church to review its accounting procedures. As part of this review, you have prepared the following comments relating to the collections made at weekly services and recordkeeping for members’ pledges and contributions. The finance committee is responsible for preparing an annual budget based on anticipated needs of the various church committees and for the annual fall “pledge campaign” during which most members make a commitment to contribute a certain amount to the church over the following year. The financial records are maintained by the treasurer who has authority to sign cheques drawn on the church’s bank account. The ushers take up the collection during the services each Sunday and place it uncounted in a deposit bag in the church safe. The treasurer, who is retired, comes in Monday morning, counts the collection, and deposits it into the church’s bank account. Some members use predated numbered envelopes, but most do not. The treasurer enters members’ contributions into a spreadsheet for the numbered envelopes only. The treasurer issues receipts to each member every January based on the spreadsheet amounts. The contributions up to 2013 had always exceeded the amounts pledged so that the value of the receipts given out was less than total contributions; the excess was recorded as “loose” or “open” collection. In 2014, the total of the receipts given out by the treasurer exceeded the total funds received by the church. The church is registered as a charity un the Income Tax Act and is required to file a return each year to comply with its rules. Th chairperson of the finance committee is upset because the church has received a letter from the Canada Revenue Agency in connect with the return for 2014 because the return showed receipts given exceeded the funds actually received. The letter indicated that such differences could result in the removal of the church’s ability to issued income tax receipts. REQUIRED Identify the risks of error or fraud, identify control weaknesses, and recommend improvements in procedures for the following: Collections made a weekly services. Recordkeeping for members’ pledges and contributions. (Adapted from AICPA)

6 Solution to Problem 12-38 Risk Weakness Recommended Improvement
a. Collections 1. Treasurer could steal cash and hide the theft Treasurer exercises too much control over collections. To the extent possible, the treasurer’s responsibilities should be confined to record keeping. 2. Increased opportunity for theft by all individuals with access to cash Finance committee is not exercising its assigned responsibility for collection. Finance committee should assume a more active supervisory role. 3. These individuals could steal cash and hide the theft. The auditing function has been assigned to the finance committee, which also has responsibility for the administration of the cash function. Moreover, the finance committee has not performed the auditing functions. Individuals should be appointed to perform periodic auditing procedures or engage verification procedures. 4. Treasurer could steal cash and hide the theft The treasurer has sole access to cash during the period of the count. One person should not be left alone with the cash until the amount has been recorded or control established in some other way. The number of counters should be increased to at least two, and cash should remain under joint surveillance until counted and recorded so that any discrepancies will be brought to attention. 5. Cash could be stolen while in the safe Cash is kept in the church safe prior to its deposit in the bank. The collection should be deposited in the bank’s night depository immediately after the count. Physical safeguards, such as locking and bolting the door during the period of the count, should be instituted. Vulnerability to robbery will also be reduced by increasing the number of counters

7 6. Money could be stolen by ushers
6. Money could be stolen by ushers. If the church were to be robbed (see 5. above), there would be no record of the amount stolen. 6. The ushers do not count the collection but simply place it in the church safe. The ushers should count the collection using specially developed count sheets. One copy of the count and the receipts should be placed in a night depository at the bank; the second copy should be left at the church. 7. If theft does take place by employees or members, there would be no reimbursement. Employees or members acting in a financial role do not appear to be bonded. Key employees and members involved in receiving and disbursing cash should be bonded. 8. Procedures for handling cash could vary from week to week, resulting in poor quality documentation. Written instructions for handling cash collections apparently have not been prepared. Especially because much of the work involved in cash collections is performed by unpaid, untrained church members, often on a short-term basis, detailed written instructions should be prepared. b.Record keeping 1. It is possible that the amount recorded in the spreadsheet for member contributions is in error. The envelope system has not been encouraged. Control features that it could provide have been ignored. The envelope system should be encouraged. Counters should indicate on the outside of each envelope the amount contributed. Envelope contributions should be reported separately and supported by the empty collection envelopes. Prenumbered envelopes will permit ready identification of the donor by authorized persons without general loss of confidentiality. 2. It may be that some members are receiving tax receipts that are far in excess of their actual givings. This weakness is especially a problem because the tax department may revoke the church’s status as a charitable organization. The church has no record of individual givings and thus receipts are not based on the amounts actually given. Members should have to document their givings by using envelopes or cheques payable to the church. The counters should list the givings by envelope number every Sunday and reconcile total to the funds (cash and cheques) received and deposited. The treasurer should use the same list to update the individual member’s giving record which is used to prepare the annual tax receipt for the member.

8 Problem 2 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?

9 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 Tolerable Exception Rate Sample Exception Rate (SER) CUER from Table 13-8 1. 100 127 6.0% 2.0% 6.2% 2. 99 3.0 0.0 3. 60 65 8.0 1.7 6.3 4. 93 5.0 4.0 8.9 5. 20 18 20.0 18.1 6. 15.0 13.3 >20.0 The sample exception rate and computed upper exception rate are shown in columns 5 and 6 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.

10 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 0.50 313 0.75 386 208 1.00 . 257 156 1.25 303 124 1.50 392 192 103 1.75 227 153 88 77 2.00 294 181 127 68 2.25 390 61 2.50 234 150 109 2.75 286 173 95 3.00 361 195 129 84 3.25 458 238 148 112 3.50 280 167 76 40 3.75 341 185 100 4.00 421 221 146 89 5.00 478 240 158 116 6.00 266 179 50 7.00 298 37

11 EXPECTED POPULATION DEVIATION RATE (IN PERCENTAGE)
TOLERABLE DEVIATION RATE (IN PERCENTAGE) 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 1.00 398 176 1.25 . 221 132 1.50 105 1.75 390 166 88 2.00 198 75 2.25 262 65 2.50 353 158 110 58 2.75 471 209 94 52 3.00 258 3.25 306 153 113 82 3.50 400 73 3.75 235 131 98 4.00 274 149 4.50 318 130 87 34 5.00 160 115 78 6.00 349 182 116 7.00 385 199 8.00 424 60

12 ACTUAL NUMBER OF DEVIATIONS FOUND
Sample size ACTUAL NUMBER OF DEVIATIONS FOUND 1 2 3 4 5 6 7 8 9 10 5 PERCENT RISK OF OVER RELIANCE (RIA or Beta Risk) 20 14.0 21.7 28.3 34.4 40.2 45.6 50.8 55.9 60.7 65.4 69.9 25 11.3 17.7 23.2 28.2 33.0 37.6 42.0 46.3 50.4 54.4 58.4 30 9.6 14.9 19.6 23.9 28.0 31.9 35.8 39.4 43.0 46.6 50.0 35 8.3 12.9 17.0 20.7 24.3 27.8 31.1 37.5 40.6 43.7 40 7.3 11.4 15.0 18.3 21.5 24.6 27.5 30.4 33.3 36.0 38.8 45 6.5 10.2 13.4 16.4 19.2 22.0 24.7 27.3 29.8 32.4 34.8 50 5.9 9.2 12.1 14.8 17.4 19.9 22.4 27.1 29.4 31.6 55 5.4 8.4 11.1 13.5 15.9 18.2 20.5 22.6 24.8 26.9 28.9 60 4.9 7.7 12.5 14.7 16.8 18.8 20.8 22.8 26.7 65 4.6 7.1 9.4 11.5 13.6 15.5 17.5 19.3 21.2 23.0 70 4.2 6.6 8.8 10.8 12.7 14.5 16.3 18.0 19.7 21.4 23.1 75 4.0 6.2 8.2 10.1 11.8 15.2 16.9 18.5 20.1 21.6 80 3.7 5.8 9.5 14.3 18.9 20.3 90 3.3 5.2 6.9 9.9 12.8 14.2 100 3.0 4.7 7.6 9.0 10.3 125 2.4 3.8 5.0 6.1 7.2 9.3 12.3 13.2 150 2.0 3.2 5.1 6.0 7.8 8.6 200 1.5 3.9 300 1.0 1.6 2.1 2.6 3.1 3.5 4.4 4.8 5.6 400 0.8 1.2 2.3 2.7 3.6 4.3 500 0.6 1.3 1.9 2.9 3.4

13 ACTUAL NUMBER OF DEVIATIONS FOUND
Sample size ACTUAL NUMBER OF DEVIATIONS FOUND 1 2 3 4 5 6 7 8 9 10 10 % Risk of Incorrect Acceptance (RIA or Beta Risk) 20 10.9 18.1 24.5 30.5 36.1 41.5 46.8 51.9 56.8 61.6 66.2 25 8.8 14.7 20.0 24.9 29.5 34.0 38.4 42.6 50.8 54.8 30 7.4 12.4 16.8 21.0 28.8 32.5 36.2 39.7 43.2 46.7 35 6.4 10.7 14.5 18.2 21.6 28.2 31.4 34.5 37.6 40.6 40 5.6 9.4 12.8 16.0 19.0 22.0 27.7 33.2 35.9 45 5.0 8.4 11.4 14.3 17.0 19.7 22.3 24.8 27.3 29.8 32.2 50 4.6 7.6 10.3 12.9 15.4 17.8 20.2 22.5 24.7 27.0 29.2 55 4.2 6.9 11.8 14.1 16.3 18.4 20.5 22.6 24.6 26.7 60 3.8 8.7 10.8 15.0 16.9 18.9 20.8 22.7 65 3.5 5.9 8.0 10.0 12.0 13.9 15.7 17.5 19.3 22.8 70 3.3 5.5 7.5 9.3 11.1 14.6 18.0 19.6 21.2 75 3.1 5.1 7.0 10.4 12.1 13.7 15.2 18.3 19.8 80 2.9 4.8 6.6 8.2 9.8 11.3 15.8 17.2 18.7 90 2.6 4.3 7.3 10.1 11.5 16.7 100 2.3 3.9 5.3 7.9 9.1 12.7 125 1.9 6.3 8.3 10.2 11.2 150 1.6 3.6 4.4 6.1 7.8 8.6 200 1.2 2.0 2.7 3.4 4.0 6.5 7.1 300 0.8 1.3 1.8 4.7 400 0.6 1.0 1.4 1.7 2.4 3.0 500 0.5 1.1 2.1


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