Tutorial 13 The Audit of Sales and Receipts Cycle 2
Tutorial 13: The Audit of Sales and Receipts Cycle 2
Review the lecture notes and reading materials, ask in the tutorial if you do not understand.
Part I Multiple Choice and Short Question
1.An aged list of accounts receivable is usually used by the auditor to:
a.verify the validity of recorded receivables
b.ensure that all accounts are promptly credited
c.evaluate the results of tests of control
d.evaluate the provision for doubtful debts
2.Smith Ltd. is engaged in the audit of a cable TV firm. All receivable balances are small and its internal control is effective. To test the existence assertion of the accounts receivable balances at the balance sheet date, Smith Ltd. would be most likely to:
a.send positive confirmation requests
b.send negative confirmation requests
c.examine evidence of subsequent cash receipts instead of sending confirmation
requests
https://www.360docs.net/doc/888725781.html,e statistical sampling instead of sending confirmation requests
3.An auditor should perform alternative procedures to substantiate existence of accounts receivable when:
a.no reply to a positive confirmation request is received
b.no reply to a negative confirmation request is received
c.Collectability of the receivables is in doubt
d.pledging of the receivables is likely
4.Which of the following is not a primary objective of the auditor in the examination of accounts receivable?
a.determine the approximate realizable value
b.determine the adequate of internal control
c.establish the existence of the receivable
d.determine the approximate time of collectability of the receivable
5.In determining the adequacy of the provision for doubtful debts, the least reliance should be placed upon which of the following?
a.the credit manager’s opinion
b.an ageing schedule of past due accounts
c.calculation of debtors turnover
d.calculation of current ratio
https://www.360docs.net/doc/888725781.html, the most important procedures for verifying accounts receivable balance.
7.List the audit purposes for positive circularization of debtor balances.
Part II Long Questions
1.You are the audit senior in charge of the audit of ABC Ltd. You are told at the start of the interim audit to verify the debtor balances by direct communication with the customers.
Required
a.What is the difference between a ‘positive’ and ‘negative’ circularization?
b.Explain how the auditor should organize a debtors circularization from a sales
ledger containing 3,000 customers from which he intends to send 70 confirmation letters.
c.What is the reason for including in the circularization customers whose account
shows a ‘Nil’ balance?
d.What action should the auditor take with regard to 15 non-replies?
2.The balance sheets of Smith Ltd. are extracted as follows:
Debtors Total Assets
31 December XX $40,000,000 $80,000,000
31 December YY $15,000,0000 $70,000,000
At 31 December, XX, there were 300 debtors. The auditor of Smith Ltd. is verifying the debtor’s circularization after the year end. However, the response rate is very low. As a result, the auditor has to apply alternative audit procedures to verify the debtors balance.
Required:
a.What are the advantages of debtor’s circularization?
b.Describe the audit procedures of reviewing subsequent settlements which may be performed by an auditor if the debtors do not reply.
c.Can the auditor send confirmation letters to debtors before the year end?
If yes, explain what additional procedures should be taken to ensure that the debtors balance at the year end is fairly stated.
d.What points should an auditor consider when he relies on the third party confirmation?
3.You are the auditor of Lucky Ltd. whose balance sheet at 30 June XX includes an item ‘debtors $20,000,000’, which is material in relation to the other accounts.
The debtors figure is net of a provision for bad and doubtful debts. Part of the provision is against a large debt due from a customer with whom your client has traded for many years. The debt includes a number of overdue items but director is unsure of the need for the provision.
How should you assess the need for the provision?
4.QQ Ltd is garment-manufacturing company engaged in the export of garments to the US market. Over 2001 and 2002, the garment manufacturing industry suffered from weak demand from the US, but QQ Ltd still reported a much better return than its competitors in the industry. Its gross profit on sales was constant at 40% for 2001 and 2002. Due to cost restraints, the auditors have cut down the number of audit tests, especially cut-off tests. Furthermore, any discrepancy on debtors’ confirmation not exceeding 5% of the balance will not be investigated.
Before the auditors signed the 2002 audit report, the finance director fired the company’s accountant. The accountant was angry and told the auditors about improper accounting practices adopted by the finance director. Firstly, sales were invoiced on the date of receipt of customer orders. Secondly, customers were encouraged to settle their invoices early by giving 5% cash discount on invoice amount if the invoice was settled within 14 days from the delivery date. However, the booking of discounts allowed was delayed to the last day of the credit period, i.e.
75 days from the delivery date. The cash receipts records were correct and showed cash receipts amounting to 95% of the invoice amount.
The auditors increased the sample size of a few audit procedures and carried out additional audit procedures aimed to detect fraud. They also studied the accounting records fro 2001 and 2002 and quantified the actual sales and actual discounts allowed for 2001 and 2002 as below:
Reported data Actual data
2002 2001 2002 2001
$ million $ million $ million $ million sales 660 700 640 690 Discount allowed 6.5 7.1 7.5 7.9
Required:
(a)Identify FOUR possible misstatements to those items on the balance sheet and
profit and loss account of QQ Ltd for 2002. Sate clearly whether there may have been an overstatement or an understatement.
(b)Identify TWO irregularities and make recommendation thereon.
(c)Suggest audit procedures for detecting the inappropriate accounting treatment.
State clearly the source of the sample (source data) and the records or documents to be traced to.
(d)Quantify the impact on the net profit for 2002. Your answer should also take into
account the impact brought forward from 2001.. (Ignore taxation)
(June 2002, HKAAT)
Part II Revision Questions
Question 6, Dec 1995, HKAAT Paper 6 - Auditing
Tutorial Exercise – Answer
Tutorial 13: The Audit of Sales and Receipts Cycle 2
Part I Multiple Choice and short Questions
1.d
2.b
3.a
4.d
5.d
6.sending confirmation letter
7.customers are asked to reply whether they agree with the balance or not or asked to supply the balances themselves. The method is used where there is:
a.weak internal control
b.suspicion of irregularities
c.numerous sales and cash receipts transactions
Part II Long questions
1.
a.Under a positive circularization, the customers are asked to reply whether they agree with the balance noted in the confirmation letter.
Under a negative circularization, customers are asked to reply only when they disagree with the balance noted in the letter
b.The auditor should obtain the client’s permission to carry out a circularization and get a letter to the debtors signed by a senior official.
He should decide which 70 balances to circularize and should cover:
i.major balances
ii.high-volume customers
iii.credit balances
iv.old or disputed balances
The accounts chosen should be listed and the confirmation letters should be sent out directly by the auditor with a prepaid envelope for replies direct to the auditor. As replies are received, they should be reconciled. After a suitable period, second requests should be sent out to non-replies followed by a telephone request for a reply. When it is felt no further replies will be received, a summary of results should
be prepared and any additional audit work carried out as necessary. For instance, subsequent cash receipts can be checked.
c.The auditor should include nil balance debtors in a circularization in case there are items missing from the ledger and the balance should not be nil.
d.The auditor should adopt alternative techniques to check the balances of debtors who do not reply to a circularization
i.Tracing original invoices and then tracing despatch notes
ii.Investigating cash received after the balance date
iii.Checking the customer’s name and address in a directory or trade journal
iv.C hecking correspondence files to see if the amount is in dispute for any reason or if the customer has gone into liquidation
.
2. a. The advantages of debtor’s circularization are;
i.direct external evidence is available for the existence and ownership of an
asset
ii.It provides confirmation of the effectiveness of the system of internal control iii.It assists in the auditor’s evaluation of cut-off procedures
iv.It provides evidence of items of dispute
b. the audit procedures for subsequent settlement of trade debtors are as follows;
i.obtain a list of trade debtors and where possible an aging analysis of the
debtors from the company
ii.agree the balances of the debtors list to the sales debtors ledger accounts and the sales ledger control account in the general ledger
iii.select debtors, especially those long outstanding balances, from the sales ledger accounts and check their subsequent settlement postings to the bank
or cash accounts
iv.test check the actual cash receipts from bank accounts to bank pay-in-slips and bank statements or to cash receipt notes if any
v.identify those long outstanding and unsettled balances and discuss with the sales director of the reasons and consider the adequacy of bad debts
provision made by the company
c. the auditor will need to carry out the following procedures where his
circularization is carried out before the year end:
i.review and reconcile entries on the sales ledger control account for the
period
-select sales entries from the control account and verify by checking to sales day book entries, copies sales invoices and despatch notes
-select goods returned notes and other evidence of return or allowances and check that appropriate credit entries have been posted to the sales ledger control account
-select sample from the cash received records and ensure that receipts have been credited to the control account
ii.select a small circularization for year end balances
iii.review the list of balances at the circularization date and year end and investigate any unusual movements or transactions
d. On relying on third party confirmation, the auditor should consider:
i.the third party’s qualification to give confirmation
ii. the third party’s relationship with the audit client & in particular his degree of independence
iii.the reasonableness of the reply in the light of the auditor’s expectation. The confirmation letter should be directly sent to the auditor at his own office rather than the client office
3. To check the need for a provision on this customer the auditor would enquire of management on what basis the provision has been made and check any documentation such as communication with the customer and possibly a liquidator. The payment record of the customer should be checked to ensure all amounts are really overdue. He should also check that no payments were received after date.
4.
Balance Sheet Item Possible Misstatement
Debtors Overstatement
Profit and loss account items
Sales Overstatement
Discounts allowed Understatement
Net profit Overstatement
(b) Irregularities Recommendation
(i) Sales were recognized for goods not actually delivered. As a result, both sales and debtors were overstated. Proper sales cut-off procedures should be documented and followed by the employees. Only delivered goods can be
recognized as sales.
(ii) The company delayed the recording of discounts allowed by nearly two months after customers had settled their invoice. As a result, discounts allowed were understated. The management should properly document the procedures on discounts allowed. Credit notes should be authorised an issued to customers for discounts allowed on early payment.
Accounting staff should record the discounts allowed immediately together with the payment from customers.
OR The management should send monthly
debtors’ statements to customers and ensure all discrepancies reported from the customers are properly followed up.
(c)
Audit objectives Audit procedures
(i) to ensure that sales are recorded in the proper period. (i)- Select a sample of shipping documents immediately before and after
the year end
. -V ouch the shipping documents to
customer orders.
-Trace the shipping documents to sales
invoices.
-Check posting to the sales journal and
debtor’s account with proper amounts on the proper date.
OR - Select debtor balances covering large
and small balances from the list of debtors.
-Send confirmation to debtors. -Reconcile discrepancies between the
client’s balances against the balance confirmed by the customer.
- Follow up all discrepancies
(Note: In practice. Tests on both sales cut-off and debtors circularization have to be performed in order to accomplish the audit objectives) (ii) (ii)
To ensure that discounts allowed are recognised at the proper amount and in the proper period. -Select a sample of cash receipts from the bank account/cashbook. -Trace the cash receipt to sales invoices -Identify any credits given, such as
discounts allowed, recalculate the customer discounts (trace the discounts allowed to credit notes for proper authorization)
- Trace the discounts allowed for proper
recording (both amount and date) to discount allowed account/journal and debtors account/subledger (trace the cash receipts for proper recording (both amount and date) to debtors account/subledger)
(d) 2002
2001 Impact $ million $ million $ million
$ million
$ million
Sales
Reported 660 700 Actual 640 690
Sales overstated 20 10 Gross profit (40%) 8.0 4.0 4.0 Discounts allowed Reported 6.5 7.1 Actual 7.5 7.9 1.0 0.8 0.2 Overstatement of net profit 9.0
4.8
4.2