NaimExplain

Describe the three basic steps an auditor should follow when designing tests of controls and substantive tests of transactions. Answer: The three basic steps in designing tests of controls and substantive tests of transactions are: • Determine key internal controls for each audit objective. • Design tests of controls for each control used to support a reduced control risk. • Design substantive tests of transactions to test for monetary misstatements for each objective.

The transaction-related audit objectives and the client’s methods of controlling misstatements are essentially the same for credit memos as for sales with the exception of two differences. What are the two differences from the auditor’s perspective? Answer: The first difference is materiality. In many instances, sales returns and allowances are so immaterial that auditors ignore them. The second difference is the emphasis on the occurrence objective. For sales returns and allowances, auditors usually emphasize testing recorded transactions to uncovering any theft of cash from the collection of accounts receivable that was covered up by fictitious sales returns and allowances.

If sales invoices are automatically calculated and posted by a company’s computer system, can the auditor reduce substantive tests of transactions for the accuracy objective? Answer: If the auditor determines that the computer is programmed accurately and the price list master file is authorized and correct, detailed invoice computations can be reduced or eliminated. The auditor would then focus on determining that effective computer controls exist to ensure that the computer system is properly programmed and has not been altered since it was last tested by the auditor.

For each of the following potential misstatements, provide one potential audit test that could be used to detect the misstatement. • Recorded sale for which there was no shipment • Sale recorded more than once • Shipment made to nonexistent customers Answer: The potential audit tests include the following: • Recorded sale for which there was no shipment. Vouch selected entries in the sales journal to related copies of shipping and other supporting documents. • Sale recorded more than once. Review a numerically sorted list of recorded sales transactions for duplicate numbers. The auditor may also test for proper cancellation of shipping documents. • Shipment made to nonexistent customers. Trace customer information on sales invoices to the customer master file.

When designing substantive tests of transaction for Sales, the auditor is concerned with several types of misstatements. What are these types of misstatements and are they intentional or unintentional? Answer: The auditor is concerned with sales being included in the journals for which no shipment was made, sales recorded more than once, and shipments being made to non-existent customers and recorded as sales. The first two types of misstatements can be intentional or unintentional, but the third type is always intentional.

Discuss the four business functions that result in sales transactions in a typical sales and collection cycle and, for each function, state the key documents and records involved. Answer: The four business functions that result in sales transactions, and related documents and records, are: • Processing customer orders. Key documents include customer order and sales order. • Granting credit. Customer order or sales order. • Shipping goods. Shipping document (bill of lading). • Billing customers and recording sales. Sales invoice, sales journal, summary sales report, accounts receivable master file, accounts receivable trial balance, and monthly statements.

Explain what lapping means, and discuss the internal control deficiency that allows it to occur. Also discuss the procedures the auditor can perform to detect lapping. Answer: Lapping, which is a common type of defalcation, is the postponement of entries for the collection of receivables to conceal an existing cash shortage. It involves deferring recording the cash receipts from one customer and covering the shortages with subsequent receipts from another customer. Improper segregation of duties in which a person who handles cash receipts is allowed to enter those receipts into the accounting records allows lapping to occur. The auditor can detect lapping by comparing the name, amount, and dates shown on remittance advices with cash receipts journal entries and related deposit slips.