Chapter 11.pdf

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Accounting & Financial Management
AFM 451
James Wainberg

Chapter 11 – The Revenues, Receivables and Receipts Process Understanding the Revenue, Receivables and Receipts Process  The auditor must understand the business’s method of generating revenues and use of them in operations in order to ASSESS the BUSINESS RISK AND RISK OF MISSTATEMENT. o Management’s assertions regarding existence, ownership, completeness, valuation and disclosure ALL present risks the auditor needs to consider. Revenues, Receivables and Receipts Process: Typical Activities  Revenue, receivables and receipt process activities include: o Receiving and processing customer orders. o Delivering goods and services to customers. o Billing customers and accounting for receivables. o Collecting and depositing cash. o Reconciling bank accounts.  Note: There will be different controls along the way to ensure all of these processes and activities are correct, complete and accurate Authorization  When a customer purchase order (PO) is received, a number of AUTHORIZATIONS need to be verified BEFORE a sales order can be created. o The customer status (new or current)  We have to understand whether the client is new or a continuing client. o Their credit status o Availability of inventory (backorder)  Is it available...if not can we backorder it o Approved pricing of products  We have to ensure that the customer understood the pricing agreement  Note: o Most important aspect is authorization. o POs can be faxed in/emailed by customers. These represent a contract with our customers. Sales Approval  Looking to see whether a sales order has the proper authorization for any differences in pricing Keval Shah Chapter 11 – AFM 451 1  Once the authorizations are passed the system creates: 1. An open sales order (in the PENDING ORDER MASTER FILE) 2. A packing slip (will go to the stock keeper – very important document – allows shipping department to ship those documents)  Authorizes the stock keeper to release inventory to shipping department  Authorized the shipping department to ship the goods  The system should also update the: 3. Inventory master file for the commitment of goods.  Note: The pending open sales order and packing slip SHOULD BE NUMBERED IN SEQUENCE so that the system can determine if any transactions have not been completed (completeness) ***Important Control Activities***: Control activities relate to: 1. CUSTODY of assets and records (Inventory) (***UFE Case Question – shipping dep. adjusting this)  Physical custody of inventory starts with the STOCKROOM or WAREHOUSE where inventory is kept. i. Custody is transferred to the shipping department only on the authorization of the packing slips.  If stockkeepers or shippers have the ability to change quantities shown on packing slips, a weakness in separation of duties is created. This can allow for inventory to be stolen. 2. Properly RECORDING transactions and events  When the shipment is complete, the open sales order is closed and the following documents are created: i. a BILL OF LADING shipping document – outlines what # of products were shipped ii. a SALES INVOICE billing the customer for goods shipped – sent to the customer  Personnel with the ability to enter, alter, and/or physically intercept the sales invoice have a combination of incompatible responsibilities (authorization, custody & recording). 3. Performing RECONCILIATION procedures to check completeness and integrity of records  A comparison of the total unpaid balances to the accounts receivable control account is a common reconciliation. An aged trial balance is usually used for this reconciliation.  This should be performed by personnel who have no responsibility over authorization, custody or recording of transactions. i. i.e. Match Bill of Lading to SHIPPING INVOICE ii. When we look at A/R match it to aged TB Cash Receipts and Cash Balances  Most companies require little authorization to ACCEPT payments from customers.  Cash can be received in many ways, over the counter, mail, lockbox, or electronic funds transfer. o Cheques provide an extra layer of security – cash no records kept  Authorization is required for approving discounts, returns and allowances. o Receiving cash and approving discounts or allowances are incompatible functions. (because they can pocket it) Keval Shah Chapter 11 – AFM 451 2 Custody of Cash  At some point, someone has the cash and cheques in hand, and has physical custody. o A number of controls should be considered, including forced vacations, rotation of staff, technological controls and insurance (e.g., fidelity bond). o Lock boxes are a great way to account for cash or cheques being stolen  It’s a good idea to record the cash/cheques ASAP in the process (i.e., REMITTANCE LISTS) o Remittance Lists  Having 2 people involved – why not have 2 people opening the mail. 2 people requires collusion …maybe one person will have a conscience and will want to steal Recording of Cash Receipts  The accountants responsible for recording of cash into the accounting system should NOT also handle cash.  Cash should be initially recorded using CASH REMITTANCE LISTS, the accountant should record from these lists.  A copy of the list is sent to A/R and GL accountants  The cash account + A/R control account + A/R subsidiary accounts are all updated. o A/R Control Account = Involved all A/R transactions from ALL debtors = A/R Balance o A/R Subsidiary Account = every debtor has an account. All of the sub A/R balances total up to the control A/R receivable Periodic Reconciliation  Bank reconciliations need to be prepared monthly o Bank deposit slips should be traced to the cash remittance lists o Paid cheques should be compared to the disbursements journal.  The reconciliations should be performed by personnel who do not have responsibility for recording cash receipts (i.e., preparing remittance lists) or disbursements. Audit EVIDENCE in Management Reports and Data Files  Audit evidence will be found in a number of reports created by management o Pending order master file (completeness) o Credit check files (up-to-date maintenance)  Case  Always try to be EXTRA conservative…if its done on a regular basis don’t suggest it should be done more o Price list master file (must be correct for billing)  who has access to it  should be different from the sales rep o Sales detail (sales journal) file (compare to shipments and dates) o Sales analysis reports (by product line, by employee and investigate unusual items)  One district had larger sales for one period and smaller sales for the next period. Red Flag. Would not find this without checking for period vs. period. o A/R aged trial balance (assessing bad debts and accounting for balances) o Cash receipts journal (deposits, receipts, adjusting entries re: bank) Keval Shah Chapter 11 – AFM 451 3  Whenever there are dates involved, check to see if the period is good enough (regular) – for CASE Internal Control Objectives for Sales 1. VALIDITY – Sales are valid and documented 2. COMPLETENESS – No sales transactions are omitted 3. AUTHORIZATION – Sales are authorized 4. ACCURACY – Sales invoices are accurately prepared 5. CLASSIFICATION – Sales transactions are properly classified 6. ACCOUNTING – Sales transactions recorded conform to GAAP 7. PROPER PERIOD – Sales transactions are in the proper period ***Dual-direction testing tests for COMPLETENESS and VALIDITY at the same time. Control Tests for Sales ***Know these tests and match to IC Objectives – what does it provide evidence for?*** 1. Select a sample of shipping docs: a. Scan for missing numbers (Provides evidence for – COMPLETENESS) b. Trace to related sales invoices (COMPLETENESS) 2. Scan sales invoices for missing numbers in the sequence (COMPLETENESS) 3. Select a sample of sales invoices (Sales Journal) a. Perform recalculations to verify arithmetic accuracy (ACCURACY) b. Vouch to supporting shipping documents (VALIDITY, ACCURACY, PROPER PERIOD, AUTHO.) c. Vouch prices to approved price list (AUTHORIZATION) d. Vouch credit approval (AUTHORIZATION) e. Trace posting to general ledger and customer account (ACCOUNTING) 4. Observe customer order handling (OVERALL CONTROL ENVIRONMENT) Control Tests for Cash Receipts 1. Select a sample of recorded cash receipts (cash rec jrnl): a. Vouch to deposit slip and remittance advices (VALIDITY) b. Trace to bank statement (VALIDITY) c. Trace posting to general ledger accounts (ACCOUNTING) d. Trace posting to subsidiary accounts (ACCOUNTING) 2. Select a sample of remittance lists a. Trace to cash receipts journal (COMPLETENESS) b. Trace journal posting to general ledger (ACCOUNTING) c. Trace to bank statement (ACCURACY) 3. Observe the work habits of cashiers and their interactions with persons keeping cash records (OVERALL CONTROL ENVIRONMENT) Control Tests for A/R 1. Trace sales invoices to accounts receivable (ACCOUNTING) 2. Trace cash receipts to accounts receivable posting (ACCOUNTING) Keval Shah Chapter 11 – AFM 451 4 3. Select a sample of credit memos a. Review for proper approval (AUTHORIZATION) b. Trace to posting in customer accounts (ACCOUNTING) 4. Select a sample of customer accounts a. Vouch debits to supporting sales invoices (VALIDITY) b. Vouch credits to supporting cash receipts documents and approved credit memos (VALIDITY) 5. Observe mailing of monthly customer statements (VALIDITY) Summary: Control Risk Assessment Control Risk Assessment  Process that the auditor uses to understand the client’s IC that will be sufficient to identify and assess the RMM of the F/S whether due to fraud or error, and to design and perform further audit procedures; required to comply with the second examination standard of GAAS  The purpose of testing controls is to determine nature, extent, and timing of substantive procedures.  Good controls = low control risk:  Smaller sample sizes, earlier timing for some substantive tests.  Poor controls = high control risk:  Larger samples, more work at year end. Special Note: Evidence for THE EXISTENCE ASSERTION  For accounts receivables and other assets, auditors place their main emphasis on existence and rights assertions.  Recalculation o Focus on assets that DEPEND LARGELY ON CALCULATIONS (prepaid expenses, depreciation, interest payments).  Inspection of Physical Assets o Inventories and assets can be examined, o Title to cars, land, buildings can be vouched, o Securities held for investment can be inspected.  Confirmation o Bank accounts, receivables can be confirmed. o Assets at other locations or in the hands of custodians can also be confirmed.  Enquiry o Enquire should be made as to agreements regarding minimum balances, pledging of receivables, pledging of other assets.  **Not the most convincing of evidence  Inspection of Documents (VOUCHING) o Examine title documents, collateral, pledges  Inspection of Documents (SCANNING) o Look for misclassified assets, uncharacteristic balances, errors or overpayments, or related party transactions and balances Keval Shah Chapter 11 – AFM 451 5  Analysis (ANALYTICAL PROCEDURES) o Comparison of assets to related revenues or expenses, expenses with revenues, contra revenues with revenues, and write-offs. Special Note: Confirmation of A/R and Notes Receivable Confirmations can provide evidence about EXISTENCE and VALUATION of accounts and notes receivable.  Statistical methods can be used to determine the size and selection of accounts to be confirmed.  Confirmations may make use of positive confirmations or negative confirmations.  Confirmations will NOT provide sufficient evidence regarding ownership.  e.g., A/R may be sold (factored) or collateralized Positive Confirmations  A positive confirmation requires a response in all cases, whether the balance is correct or incorrect.  Used where individual balances are large, or where accounts are in dispute.  The confirmation may ask for information on balances or specific invoices depending on knowledge of the customer’s accounting records.  Nonresponses are tolerated if the auditor can verify the info through other means.  Generally produces high quality evidence. o Auditors need to consider alternative procedures when no response is provided.  Customer POs, Sales Invoices, Bills of Lading, Subsequent Collections  Response Rate = # of confirmations returned/# of confirmations sent  Detection Rate = # of misstatements reported/number of actual account misstatements Negative Confirmations  The negative confirmation form only requires a response if the customer disagrees with the balance.  Useful when o inherent and control risk are low, o a large number of customers are involved, and o where the auditor believes that the customers will handle the confirmations correctly.
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