Chapter 7 Notes: Auditing and Assurance Services

Chapter 7 Overall Audit Approach for the tax income and appeal Cycle * Audit stake- the jeopardy that size upors will issue and unqualified scene on financial statements that contain a material misstatement * Inherent run a risk and harbor risk * 3 step approach for analyse risk model * Set audit risk at desired levels * esteem risk of material misstatement Determine spyion risk based on the level of audit risk and risk of material misstatement * The components of the audit risk model atomic number 18 assessed on an assertion-by-assertion basis * This assessment recognizes that certain assertions capture an increased level of importance and atomic number 18 of more interest to auditors than a nonher(prenominal)s * man assertions is as yettful in the audit or A/R and the circumstance is crucial for gross gross revenue * If the audit team estimates that obligate risk is under maximum they need to set test of controls to confirm that the control activities ar gon operating effectively and that the auditors initial strategy is sound LO1 Inherent risk of exposure in the Revenue and aggregation Cycle Revenue Recognition Revenue Recognition- recording revenues in the entities To be recognized revenues essential be recognise or realizable or earned * Revenue earning activities involve delivering or producing goods, rendering services, or performing other activities that constitute its ongoing major(ip) or central operations, and revenues are considered to beat been earned when the entity has substantially set up what it must do to be entitled to the benefits represented by the revenues * every criteria must be met for revenue to be realizes, realizable, or earned * cogent distinguish of an arrangement exists * Delivery has occurred or services start out a bun in the oven been rendered * The vendors harm to the buyer is fixed or determinable * Collectability is jolly interpretd Collectability of A/R In most companies, a portion o f deemancys collect will non be paid. GAAP requires clients to tin and estimation of uncollectable amounts and provide and allowance for it.Estimation of allowance for doubtful accounts jackpot be subjective and unvoiced for the client and the auditor. A reason for difficulty can be changing economic conditions. guest Returns and Allowances Sometime clients have the right to return loose or unsold merchandise. An appropriate e valuation of revenue can be performed when these agreements are in the purchase contract and disclosed to the auditor. Clients whitethorn enclose into informal right of return agreements with customers unknown to the auditors. Liabilities for known return, warranties, and other voltage obligations are lots very difficult to estimate. Companies with new products or technologies have an even higher inherent risk in these areas.LO2 Revenue and Collection Cycle Typical Activities Basic activities in the revenue and collection daily round are 1. Rece iving and processing customer sanctifys 2. Delivering goods and services to customers 3. Billing customers and account for A/R 4. Collecting and depositing specie received from customers Entity Level picture 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 follow-uping revenue and comparing it to the budgets and forecasts. Management should continuously scrutinize total write-offs of A/R, merchandise returns, and the timeliness of collections.Physical control everyplace inventory and warehouses must include entity level control such as id badges and restricting access to facilities. Receiving and Processing Customer set ups, Including Credit Granting * Customers can open up cut-rate sales agreements by mailing P/Os, call or fax , emails, websites or go to the phycial locations. * It is important that faith sales are authorized to ensure that the custome r will be able to conduct for the good or services * Access to master file for additions, deletions, and other transforms must be limited to responsible people * If these controls fail, orders might be processed for fictitious customers, credit might be approves for bad credit risks, and merchant vessels documents might be created for goods that do not exists in the inventory. Customer orders, transferral documents, and invoices should be in prenumbered sequence so the form can point the sequence and determine whether whatever transaction have not be preserve or have been duplicated Delivering Goods and Services to Customers Physical keep of inventory -> storeroom or warehouse -> transferred to shipping department upon authorizations of the shipping order that permits the inventory clerk to release good to the shipping department. ripe authorization is important. Employees that perform each step to should transfer documents making them accountable. This prevents employ ees from misappropriating the goods or shipping product to friends without billing them. A bill of lading is a form that the carried signs to verify the goods shipped.A packing slip describes the good cosmos shipped is often included with the shipment Billing customers and Accounting for A/R When oral communication 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 transactions or change the invoice before it is mailed to the customer should not have any authorization, hands, or recording responsibilities. There should also be physical trade protection of the files. file cabinets that are lost or destroyed are unlikely accounts to be collected. With that said the records are assets.Audit Evidence in Management Reports and Data File Computerized processing of revenue and cash receipts transaction enables management to stupefy several reports that can provide important audit evidence. Pending Order eclipse File- sales transactions that were initiated exactly not yet spotless or recorded as sales. May represent shipments that were made but not recorded in the sales ledger or could not be matched to a customer order. Credit Check Files- Computerized system may male automatic credit checks, but up to date keep of the credit learning is very important. A sample of the credit check file can be tested for current status.Price List Master File- Computers system may produce customer invoices automatically but if the price list master is incorrect the billings will be incorrect gross revenue Detail (journal) File- the detailed sales entries, including the shipping references and dates, should be in the sales detail (journal) file Sales Analysis Reports- Sales that are sort by product lines provide required information for the business instalment disclosures A/R Listing and Aging- The A/R listing of customers balances is the unquestionable a/r Cash Receipts Listing- The cash receipts journal contains all the detail entries for cash deposits and credits to various accounts Customer Statements- likely the best control all over whether cash is received and recorded is the customer LO3 Control risk of infection Assessment Control risk assessment is important because it governs the personality, 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 doubtful accounts, Bad Debts, Sales revenue Control Considerations Control for straight-laced separation of responsibilities should be in place and operating. It involves contrasting people and different departments performing the sales and credit authorization custody of good and cash and record keeping for sales, receivables, inventory, and cash re ceipts. 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 tactual sensation should be recorded for authorization 3. Pending order flies should be reviewed frequently to avoid failure to bill and record shipments Test of ControlsAn plaque should have control activities in place and operating to prevent, detect, and correct accounting errors. hearers can perform tests of controls to determine whether company personnel are aright performing controls that are said to be in place. If personnel in the organization are not performing their control activities effectively, auditors need to invention substantive procedures to try to detect whether control failures have produced materially misstated account balance. Dual testing involves selecting samples to obtain evidence about control over completeness in one direction and control over occurrence in the other directio n.Completeness is whether all transactions that occurred were recorded and the occurrence direction determines whether recorded transactions represent valid economic events. Summary Control Risk Assessment Auditors must evaluate the evidence obtained from an understanding of internal control and from tests of controls. The initial process of obtaining an understanding of the companys control and the subsequent 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 cosmea assertion. It is importan t because companies and auditors have found themselves in malpractice lawsuits by issuing unqualified reports on F/S that have overstated assets and revenues. Company asserts populace 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 recent history might help detect overstatements. Account interrelationships can be used in analytical procedures.A/R write-offs should be compared w/ estimates of doubtful accounts Confirmation of Accounts and Notes Receivable The use of tabs 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 check mark asks the customers to respond whether the balance is correct or incorrect. A variation of a positive stay is a blank form. A blank confirmation doesnt contain the balance cust omers fill it in themselves. Negative confirmation asks for a response only if something is wrong with the balance. Lack of response to interdict confirmation is considered evidence that the account is fairly stated.Negative form is used generally when the risk of material misstatement is considered low. Alternative 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 instead of by vendor account. If this happens auditors have to perform alternative procedures to ensure existence. This includes examining 1. subsequent 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 earned from the confirmations relates to existence.The audit team must review accounts for collectability and determine the adequac y of the allowance for doubtful accounts in support of the valuation assertion. To do this, auditors review subsequent cash receipts from the customer, discuss gratis(predicate) accounts with the credit manager, and examine the credit files. Credit files should contain the customers financial statements, credit reports, and correspondence 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 cutoff 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 pe riod. Credit memos for returns after year-end are vouched to receiving reports. Any goods returned after year 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 freehanded 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 foundation and disclosure assertions of occurrence, rights and obligations, completeness, classification, accuracy and valuation, and understandability have been met. Receipt o f confirmation information by email or fax is becoming more common. Auditor may receive an oral response to confirmation.