Chapter 7 Notes: Auditing and Assurance Services

Chapter 7 oer either Audit Approach for the Revenue and order Cycle * Audit lay on the line- the attempt that inspectors give issue and unqualified opinion on financial statements that charter a material misstatement * Inherent assay and control risk * 3 step approach for study risk model * Set analyze risk at desired levels * Assess risk of material misstatement delay learnion risk based on the level of audit risk and risk of material misstatement * The components of the audit risk model ar assessed on an assertion-by-assertion basis * This assessment recognizes that certain assertions assume an increased level of brilliance and argon of more interest to auditors than others * Existence assertions is important in the audit or A/R and the occurrence is important for gross sales * If the audit team estimates that control risk is below maximum they need to execute quiz of controls to confirm that the control activities are operating effectively and that the auditors i nitial strategy is sound LO1 Inherent Risk in the Revenue and Collection Cycle Revenue Recognition Revenue Recognition- inscribeing grosss in the entities To be recognized revenue enhancements must be realized or realizable or earned * Revenue earning activities involve delivering or producing goods, rendering work, or do other activities that constitute its ongoing major or central operations, and revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits repre directed by the revenues * All criteria must be met for revenue to be realizes, realizable, or earned * Persuasive depict of an arrangement exists * deliverance has occurred or services have been rendered * The grassers price to the emptor is fixed or determinable * Collectability is thinkably ensured Collectability of A/R In most companies, a portion of circulars receivable will non be paid. GAAP aims clients to appropriate and estim ation of uncollectable amounts and supply and permissiveness for it.Estimation of compensation for provisionary accounts can be subjective and difficult for the client and the auditor. A reason for difficulty can be changing economic conditions. Customer Returns and Allowances past nodes have the right to go un officed or unsold merchandise. An countenance evaluation of revenue can be performed when these agreements are in the procure contract and disclosed to the auditor. Clients may enter into informal right of return agreements with nodes unknown to the auditors. Liabilities for known return, warranties, and other potential obligations are often really(prenominal) difficult to estimate. Companies with new products or technologies have an even higher integral risk in these areas.LO2 Revenue and Collection Cycle Typical Activities staple fiber activities in the revenue and collection cycle are 1. Receiving and processing customer orders 2. Delivering goods and servic es to customers 3. bearing customers and accounting for A/R 4. Collecting and depositing silver received from customers Entity Level Control It is important that auditors consider the entity-level controls in all processes and procedures. In the revenue process, management should have a process for continually reviewing revenue and comparing it to the budgets and forecasts. Management should constantly scrutinize total write-offs of A/R, merchandise returns, and the timeliness of collections.Physical control over inventory and warehouses must entangle entity level control such as id badges and restricting access to facilities. Receiving and treat Customer Orders, Including Credit Granting * Customers can initiate sales by placard P/Os, call or fax , emails, websites or go to the phycial locations. * It is important that point of reference sales are authorized to ensure that the customer will be able to pay for the good or services * Access to master file for additions, deletio ns, and other changes must be peculiar(a) to responsible people * If these controls fail, orders dexterity be processed for fictitious customers, acknowledgement might be approves for bad source risks, and shipping documents might be created for goods that do not exists in the inventory. Customer orders, shipping documents, and invoices should be in prenumbered sequence so the remains can strike out the sequence and watch whether any transaction have not be enter or have been duplicated Delivering Goods and Services to Customers Physical custody of inventory - storeroom or warehouse - transferred to shipping department upon permissions of the shipping order that permits the inventory shop clerk to release good to the shipping department. Proper authorization is important. Employees that perform distributively step to should transfer documents making them accountable. This prevents employees from misappropriating the goods or shipping product to friends without guardianshi p them. A bill of lading is a form that the carried signs to verify the goods shipped.A wadding slip describes the good being shipped is often included with the shipment Billing customers and Accounting for A/R When delivery or shipment is complete, the system finishes the transaction by filing a shipment record and preparing a final invoice for the customer. A sales invoice is the bill sent to the customer that indicates the amount due. People who have the power to enter or alter these legal proceeding or change the invoice before it is mailed to the customer should not have any authorization, custody, or recording responsibilities. at that slip should also be physical protection of the files. Files that are lost or destroyed are un seeming accounts to be collected. With that express the records are assets.Audit rise in Management Reports and Data File Computerized processing of revenue and bullion receipts transaction enables management to generate several reports that can provide important audit evidence. Pending Order Master File- sales proceeding that were initiated but not yet completed or save as sales. May represent shipments that were made but not recorded in the sales journal or could not be matched to a customer order. Credit Check Files- Computerized system may male automatic credit checks, but up to date maintenance of the credit information is very important. A sample of the credit check file can be streamleted for current status.Price List Master File- Computers system may wee customer invoices automatically but if the price list master is nonsensical the billings will be in objurgate sales Detail (journal) File- the detailed sales entries, including the shipping references and dates, should be in the sales detail (journal) file gross sales Analysis Reports- Sales that are classified by product lines provide required information for the business segment disclosures A/R inclination and Aging- The A/R listing of customers paralleli sms is the actual a/r gold Receipts Listing- The bullion receipts journal contains all the detail entries for cash deposits and credits to various accounts Customer Statements- Probably the shell control over whether cash is received and recorded is the customer LO3 Control Risk sagaciousness Control risk assessment is important because it governs the nature, timing, and extent of substantive procedures that will be applied in the audit of account balances in the revenue and collection cycle.Balances include Cash in bank, A/R, Allowance for dubious accounts, Bad Debts, Sales revenue Control Considerations Control for proper(a) insulation of responsibilities should be in place and operating. It involves different people and different departments performing the sales and credit authorization custody of good and cash and record keeping for sales, receivables, inventory, and cash receipts. The following control activities should be in place to prevent and detect errors 1. No sale order should be entered w/o a customer order 2. A credit check code or manual signature should be recorded for authorization 3. Pending order flies should be reviewed frequently to avoid chastening to bill and record shipments Test of ControlsAn organization should have control activities in place and operating to prevent, detect, and correct accounting errors. Auditors can perform tests of controls to look out whether company personnel are properly performing controls that are said to be in place. If personnel in the organization are not performing their control activities effectively, auditors need to design substantive procedures to try to detect whether control failures have produced materially misstated account balance. Dual testing involves selecting samples to dominate evidence about control over completeness in one pleader and control over occurrence in the other direction.Completeness is whether all transactions that occurred were recorded and the occurrence direction steady downs whether recorded transactions represent effectual economic events. Summary Control Risk Assessment Auditors must prise the evidence obtained from an grounds of internal control and from tests of controls. The initial process of obtaining an understanding of the companys control and the later process of obtaining evidence from test of controls are two phases of control risk assessment. It control risk is assessed to be very low, the substantive procedures on the account balances can be reduced. It the test of controls reveal weakness, the substantive procedures need to be designed to lower the risk of failing to detect material misstatement in the account balances.LO4 Substantive Procedures in the Revenue and Collection Cycle When considering assertions and obtaining evidence about A/R and other assets, auditors must emphasize the existence assertion. It is important because companies and auditors have imbed themselves in malpractice lawsuits by issuing unqualified r eports on F/S that have overstated assets and revenues. Company asserts existence by putting assets on B/S Analytical Procedures During an audit, a variety of analytical comparisons might be employed, depending on the circumstances and the nature of the business. Comparisons of asset and revenue balances with novel history might help detect overstatements. Account interrelationships can be used in analytical procedures.A/R write-offs should be compared w/ estimates of dubitable accounts Confirmation of Accounts and Notes Receivable The use of confirmations for A/R is considered a required audit procedure by audit standards. If auditors choose not to use them they should document justification. A positive confirmation asks the customers to respond whether the balance is correct or incorrect. A variation of a positive confirmation is a blank form. A blank confirmation doesnt contain the balance customers fill it in themselves. Negative confirmation asks for a response exclusively i f something is wrong with the balance. Lack of response to negative confirmation is considered evidence that the account is fairly stated.Negative form is used mostly when the risk of material misstatement is considered low. pick Procedures Often clients customers are not willing or able to return the confirmation. They may not be able if, they are on a voucher system that lists payables by invoice kind of of by vendor account. If this happens auditors have to perform alternative procedures to ensure existence. This includes examining 1. concomitant cash receipts (this is often performed even when customer has confirmed the account) 2. Sales orders, invoices, shipping documents 3. Correspondence files for past due accounts Review for Collectability Primary evidence gained from the confirmations relates to existence.The audit team must review accounts for collectability and determine the adequacy of the allowance for doubtful accounts in support of the valuation assertion. To do t his, auditors review sequent cash receipts from the customer, discuss unpaid accounts with the credit manager, and examine the credit files. Credit files should contain the customers financial statements, credit reports, and rest between the client and the customer. Based on this evidence, the audit team estimates the likely amount of the nonpayment for the customer, which is included in the estimate of all allowance for doubtful accounts. Cutoff and Sales Returns Auditors must make sure that sales are recorded in the proper period.The employ sales crosscut test which are test that ensure that sales are recorded in the proper period, generally when they are shipped, and that the cost of the sales is recorded and removed from inventory. Procedures include tracing shipping documents before and after year-end to the sales journal to ensure the sale was recorded in the proper period. Credit memos for returns after year-end are vouched to receiving reports. Any goods returned after y ear end that were sold during the year being audited should be deducted from sales. Rights and Obligations Companies may sell or factor (the actions to sell A/R to another party, the factor, at a discount from face value) to gain cash immediately.It is difficult to determine whether receivables have been sold b/c customers do not usually know that someone else actually owns their account. The cash goes to the original seller who passes it on to the factor. Inquiring of management and examining support for large cash receipts is the best way to detect these transactions. Presentation and Disclosures The accounts in the revenue cycle require certain disclosures. These disclosures must ensure that the presentation and disclosure assertions of occurrence, rights and obligations, completeness, classification, accuracy and valuation, and comprehensibility have been met. Receipt of confirmation information by email or fax is becoming more common. Auditor may receive an spoken response to confirmation.