Accounting Question

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client’s policy does not seem ethical, and one might question what other similar policies exist.
(2)
What response is appropriate if the accountant’s assistant, Jane McClain, believes that
someone should be informed or, at a minimum, the financial statements should include a note
regarding the policy. Arguments for such a note would be that it is a significant accounting
policy or that a possible liability exists. Both of these seem doubtful.
(3)
In recent years, auditors have increasingly attempted to provide value-added services to
clients in
addition to the audit itself. The problem described in this case is a flaw in the client’s
business process and should be brought to the attention of management.
.
Chapter 11 Appendices
Audit Case Exercises
11A-1 KCN Revenue Cycle Controls (Estimated time: 20 minutes)
(a)
Sales controls:
Control
1.
2.
3.
(b)
Error or Fraud Controlled
Application controls are applied when
customer orders are entered by the
sales order clerk.
The computer assigns numbers to sales
invoices when they are prepared.
Monthly statements are mailed to
customers.
Controls errors in the delivery and billing of
sales transactions.
Controls the recording of sales to ensure
completeness.
Controls the recording of fictitious sales and
inaccurate sales to customer accounts.
Cash receipts controls
Internal Control Procedure
1.
2.
3.
Cash receipts are prelisted by the
receptionist.
The accounting manager reconciles
control totals generated by the
accounts
receivable
computer
program.
The computer summaries of cash
collections and cash sales are
reconciled to prelistings of cash
receipts and cash deposits by the
accounting manager.
Error or Fraud Controlled
Controls errors in the recording of cash and
controls the abstraction of cash.
Controls the embezzlement of cash receipts
and errors in and incomplete postings to
accounts receivables records.
Controls the abstraction of cash and the
incorrect recording of cash receipts and
cash sales.
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11A-2 KCN Internal Control Weaknesses (Estimated time: 15 minutes)
The first weakness is that sales invoices are prepared and mailed prior to delivery of goods. Errors
may occur in that different quantities of goods may ultimately be delivered than have been ordered, or
goods may not be delivered at all. A related problem, at year-end, is that sales may be recorded for
goods not delivered until subsequent to year-end, thus overstating sales and accounts receivable for
the year.
The second weakness is that accounts receivable are not written-off on a regular basis. This may
result in an inadequate Allowance for Doubtful Accounts, with an associated understatement of Bad
Debt Expense. Also, if management is not monitoring receivables collections, the company may
currently be selling goods on credit to uncreditworthy customers.
11A-3 KCN Attributes Sampling (Estimated time: 35 minutes)
(a)
Audit sampling for tests of controls can be used when performance of the internal control
procedure leaves some evidence of performance, such as a completed document or the initials
of the person performing the procedure. This evidence of performance allows the auditors to
determine whether the control procedure was applied to each item included in the sample. In
addition, sampling will only be used in circumstances in which (1) the auditors wish to assess
control risk for an assertion below the maximum, and (2) the likely rate of deviation from the
control is less than the tolerable deviation rate.
(b)
The appropriate table for determining the required sample size is illustrated in Figure 9-4.
Using the row for a 1 percent expected deviation rate, and the column for a tolerable
deviation rate of 15 percent, we find a required sample size of 30 items, with 1 allowable
deviation.
(c)
Keystone Computers & Networks, Inc.
Attributes Sampling Summary—Revenue Cycle
December 31, 20X5
Objectives of test: To test the operating effectiveness of the procedures for matching sales
invoices with deliver receipts.
Test
(1)
Population
Sales invoices
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Sampling unit: Individual reports
Random selection procedure: Random number table
Risk of assessing control risk too low: 5%
Planning Parameters:
TolerableD
eviation
Rate
1. Matching of
sales invoices
with
delivery
receipts
15%
Sample Results:
Expected
Deviation
Rate
Sample
Size
1%
30
Number
of
Deviations
Achieved
Maximum
Rate
Conclusion:
11B-1 SOLUTION: KCN Substantive Procedures Audit Program (Estimated time: 20 minutes)
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(a)
―KCN has engaged in a strategy to sell to customers with higher credit risk.‖ The
implication of this risk is that the company may experience significant additional amounts of
bad debt expense. The audit team addressed this risk primarily with the following steps:
10. Review the adequacy of the allowance for uncollectible accounts by performing the
following procedures:
(a) Review the aged trial balance of accounts receivable with the president.
(b) Review confirmation exceptions for indications of disputed amounts.
(c) Analyze and review trends in the following relationships:
(1) Accounts receivable to net sales.
(2) Allowance for bad debts to accounts receivable.
(3) Bad debt expense to net sales.
13. Review credit memoranda for sales returns and allowances through the last day of
fieldwork to determine if an adjustment is needed to record the items as of year-end.
14. (c) Compute the accounts receivable turnover.
(b)
―The officers of the company receive significant bonuses based on quarterly results.‖ The
implication of this risk is that management may be inclined to misstate quarterly results to
maximize bonuses. The audit team addressed this risk primarily with the following steps:
•
•
•
•
11B-2 (a)
The confirmation procedures for accounts receivable, which include steps 2., 4., 5., 6.,
and 7.
Review credit files and investigate any indications of fictitious accounts, step 8.
The cut-off procedures for sales, steps 11., 12., and 13.
The analytical procedures in step 14., especially the sales by month by salesperson.
Examining the sales by month schedule provides an indication that management may be
overstating revenue to meet quarterly and annual sales budgets. From the schedule, we see a
pattern of increases in sales in the months of March, June, September, and December, with
respect to computer sales. Also, note that the amount of sales tends to fall off in the month
following the end of the quarter. This pattern is even more pronounced with respect to
consulting revenue. The pattern is illustrated more dramatically with the following two
tables. Schedule I presents monthly sales amounts as a percentage of total sales for the year,
and
Schedule II presents changes in monthly sales from the same quarter in the previous year.
Schedule I
Keystone Computers & Networks
Monthly Sales (Percentages)
For the Year Ended 12/31/20X5
January
Sales of
Computers
20X5
7.72%
Consulting
Revenue
20X5
6.96%
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Revenue
20X5
7.11%
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