MGTD60 - Chapter 11

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University of Toronto Scarborough
Financial Accounting
Kevin Ha

MGTD60H3 – Chapter 11 – Substantive Testing and Income Statement Accounts 11.1 – Relationship between Risk Assessment and Substantive Procedures Differences between Auditing IS and BS Accounts - In chapter 10, BS accounts include the use of confirmations, vouching of balances back to third-party supporting evidence, and tests of completeness and cut-off of the balances on either side of the year end - BS accounts are made up of a portion of IS transactions - IS accounts are audited when the related BS accounts are audited - If auditing IS accounts is different from BS accounts, auditors use substantive analytical procedures coupled with some tests of details (vouching) and verification of expense classifications Extent of Substantive Procedures and Timing of Substantive Procedures - Same as Chapter 10 11.2 – Substantive Testing of Revenue - Sales revenue is usually a significant account for an entity (except start-ups) because of its size (materiality), the volume of transactions that flow through the account (high), and the overall high inherent risk associated with the account - 3 key assertions: o Occurrence  Testing needs to ensure that sales recorded in the general ledger are in fact bona fide sales and have occurred  Testing AR is also helpful in testing occurrence of revenue o Accuracy  Ensuring sales are recorded in the right amount  Prevent overstating revenue o Cut-off  Possibility to record sales which will occur after year end  Vouching the sale to delivery documentation for the sale of goods and understanding the client’s shipping terms o Completeness for long-term contracts - Procedures are designed to test material transactions on either side of year end, or all sales in the last week before year end, to ensure all sales are recorded in the right period - 2 significant revenue accounts: o Sales revenue/progress billings o Dividend and interest income  Recalculation of expected interest income based on average cash balances for the year and interest rates in place for the past 12 months  The compare to actual income earned MGTD60H3 – Chapter 11 – Substantive Testing and Income Statement Accounts  Dividend income is tested by vouching the dividends back to dividend statements and bank account Principal Objectives in Auditing Revenue 1. All sales on IS represent the exchange of goods/services during the period (O) 2. All sales and other revenues that accrued to the entity during the period are on the IS (C) 3. Sales and OR are stated at appropriate amounts (A and CO) 4. Sales and OR are properly classified, described, and disclosed (CL and CU) Processes Impacting on Sales Revenue - Sales Process - Sales Returns and Allowances (Credit Memos) Processes Illustrative Procedures for A
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