A4 - Performing Further Procedures, Forming Conclusions, and Communications

What is the main focus of the Revenue Cycle?

Sales Revenue, Receivables, Cash Receipts

What are the records of the Revenue Cycle?

• Sales

• A/R

• Cash

• Sales Invoice

What are the source documents of the Revenue Cycle?

• Sales Order

• Shipping document

• Cash receipts

• A/R confirmation

• Remittance advice

For each transaction cycle, what two questions does the auditor want to answer?

1. Are controls operating effectively?

2. Have transactions, balances, and disclosures been recorded properly in accordance with GAAP?

What is the flow of departments for Sales in the Revenue Cycle?

1. Order and Credit

2. Warehouse and Shipping

3. Billing/Accounts Receivable

4. Accounting

What are the control procedures of the Order and Credit department under Sales in the Revenues Cycle?

1. Prepare prenumbered sales order

2. Perform credit check (authorization).

3. Approve credit for returns.

4. Follow up on old or past-due accounts.

5. Initiate write-offs, which should be approved by the treasurer.

What are the control procedures of the Warehouse and Shipping department under Sales in the Revenues Cycle?

1. Receive approved sales order from credit department

2. Pull inventory from warehouse and release to shipping

3. Performing independent check of goods received from warehouse and approved sales orders in shipping department

4. Prepare bill of lading

What are the control procedures of the Billing/Accounts Receivable department under Sales in the Revenues Cycle?

1. Match shipping docs and sales orders before preparing invoice

2. Periodically account for all prenumbered shipping docs

3. Perform independent checks of sales order pricing

4. Prepare prenumbered sales invoice

5. Batch and total invoices

6. Update A/R master file. Agree input to invoice batch totals

7. Print sales journal

8. Print sales summary. Agree to invoice batch totals (indp check)

9. Mail monthly customer statements

What are the control procedures of the Accounting department under Sales in the Revenues Cycle?

1. Receive sales summary

2. Perform independent check of invoice batch totals and sales summary

3. Review sales account classifications

4. Post to G/L

5. Follow-up customer exceptions (indp check)

What is the segregation of duties for Sales in the Revenue Cycle?

Authorization: Sales order and credit, treasurer

Record keeping: Billing/accounts receivalbe/accounting

Custody: Warehouse and shipping

What is the flow of departments for Cash Receipts in the Revenue Cycle?

1. Mail Room

2. Cashier

3. Accounts Receivable

4. Accounting

What are the control procedures of the Mailroom department under Cash Receipts in the Revenues Cycle?

1. Separate checks and remittance advices

2. Stamp restrictive endorsement on checks

3. Prepare prelisting of checks received

4. Forward checks to cashier. Forward remittance advices to A/R. Forward prelisting to accounting, cashier, and A/R.

What are the control procedures of the Cashier department under Cash Receipts in the Revenues Cycle?

1. Receive checks and prepare deposit

2. Prepare daily cash summary (copy to A/R and accounting)

3. Deliver checks to bank

4. File validated deposit slip

What are the control procedures of the Accounts Receivable department under Cash Receipts in the Revenues Cycle?

1. Match remittance advices and check deposit summary

2. Update A/R master file

3. Print C/R journal/updated A/R master file

4. Print CR summary (copy to accounting)

What are the control procedures of the Accounting department under Cash Receipts in the Revenues Cycle?

1. Independent check: compare the cash summary (cashier), the prelisting of checks (mail room), and the CR summary (A/R)

2. Post G/L

3. Prep bank reconciliation

What is the segregation of duties for Cash Receipts in the Revenue Cycle?

Record keeping: Accounts receivable/accounting

Custody: Mail room and cashier (treasurer)

What is the company’s responsibility with transaction cycles?

To properly segregate duties and implement effective controls

What is the auditor’s responsibility with transaction cycles?

To evaluate those controls, decide whether to rely on them, and determine the NET of substantive audit procedures

What presumption should there be in every audit?

That there is a risk of material misstatement due to revenue recognition fraud

Are using confirmations required?

Using confirmations is a generally accepted auditing procedure that is required, unless it’s immaterial, ineffective, and there’s low inherent/control risk.

What is not persuasive enough for existence of A/R in the Revenue Cycle?

Sales Order

Confirmations provide evidence of what assertions?

• Existence

• Rights and Obligations

What is the main focus of the Expenditure Cycle?

Purchases, Payables, and Cash Disbursements

What are the records in the Expenditure Cycle?

• Expense

• A/P

• Accrued liabilities

• Cash

What are the source documents in the Expenditure Cycle?

• Voucher

• Requisition

• Purchase order

• Receiving report

• Vendor invoice

• Cash disbursement

What are the records in the Investment Cycle?

• Investment

• Dividend or interest incomme

What are the source documents in the Investment Cycle?

• Confirmations

• Count securities

What are the records in the PP&E Cycle?

• Property, plan and equipment (aka Fixed Assets)

• Additions and disposals listing

• Property ledger

• Tax records

What are the source documents in the PP&E Cycle?

• See actual asset

• Vendor invoice

• Escrow documents

What are the records in the Payroll Cycle?

• Payroll expense

• Payroll accrual

• Payroll register

What are the source documents in the Payroll Cycle?

• Time cards

• Employee HR file

What are the records in the Financing Cycle?

• Debt or equity

• BOD meeting minutes

What are the source documents in the Financing Cycle?

• Confirmation

• Debt agreements

• Stock certificate book

What are the records in the Cash Cycle?

• Cash

• Bank reconciliation

• Items on bank reconciliation

• Outstanding checks

• deposit in transit

What are the source documents in the Cash Cycle?

• Deposit slips

• Remittance advice

• Bank (cutoff) statement

• Bank confirmation

What are the records in the Inventory Cycle?

• Inventory

• Inventory report

• Physical inventory listing

• Inventory listing schedule

What are the source documents in the Inventory Cycle?

• Test counts

• Prenumber inventory tags

• Receiving report

• Vendor invoice

What is the flow of departments for Purchases in the Expenditure Cycle?

1. Requisitioner

2. Purchasing

3. Receiving

4. Accounts Payable

5. Accounting

What are the control procedures of the Requisitioner department under Purchases in the Expenditure Cycle?

1. Prepare prenumbered requisition

2. Obtain approvals needed

3. Send OG copy to purchasing

4. Inspect goods when received from receiving dept. Sign receiving report upon receipt of goods (indp check)

What are the control procedures of the Purchasing department under Purchases in the Expenditure Cycle?

1. Receive approved requisition

2. Contact approved vendors

3. Issue prenumbered purchase order (PO) to vendor (OG), receiving (blind), and A/P (copy)

What are the control procedures of the Receiving department under Purchases in the Expenditure Cycle?

1. Receive goods from vendor

2. Inspect goods. All shipments received must have a PO.

3. Prepare receiving report

4. Match details of order received with blind copy of PO and indicate quantity received

5. Send goods to requisitioning dept. Obtain signature on receiving report that requisitioner received goods.

6. Distribute receiving report to A/P (OG) and purchasing (copy)

What are the control procedures of the Accounts Payable department under Purchases in the Expenditure Cycle?

1. Receive vendor’s invoice

2. Match documents: vendor’s invoice, RR, PO, requisition

3. Check math accuracy, approvals, G/L account coding

4. Prepare prenumbered voucher

5. Account for the numerical sequence of vouchers

6. Data entry: Prep purchase journal, update A/P master file, daily purchase summary

7. Reconcile daily purchase summary totals and daily entries to purchases journal

What are the control procedures of the Accounting department under Purchases in the Expenditure Cycle?

1. Receive purchase summary

2. Post to G/L

3. Reconcile G/L and A/P file

4. Reconcile vendor’s monthly statements and A/P master file

What is the segregation of duties for Purchases in the Expenditure Cycle?

Authorization: Purchasing/Requisitioning Dept

Record keeping: Accounts Payable/Accounting

Custody: Receiving

What is the flow of departments for Payables and Cash Disbursements in the Expenditure Cycle?

1. Accounts Payable

2. Treasurer

3. Accounting

What are the control procedures of the Accounts Payable department under Payables and Cash Disbursements in the Expenditure Cycle?

1. Pull voucher at due date and send to treasurer for payment

2. Receive cancelled voucher and supporting docs from treasurer

3. Receive check summary from treasurer for data entry

4. Data entry: Update A/R master file, Print cash disbursements journal

What are the control procedures of the Treasurer department under Payables and Cash Disbursements in the Expenditure Cycle?

1. Receive voucher for payment

2. Review document for completeness and approvals

3. Prepare prenumbered checks

4. Prepare check summary

5. Sign checks and cancel voucher and supporting docs

6. Mail check to vendor

7. Forward cancelled voucher/supporting docs to A/P

8. Send copy of check summary to: A/P and accounting

What are the control procedures of the Accounting department under Payables and Cash Disbursements in the Expenditure Cycle?

1. Receive check summary

2. Post to G/L

3. Perform independent check of totals per check summary and amounts journalized and posted by A/P

4. Perform periodic independent bank reconciliation

What is the segregation of duties for Payables and Cash Disbursements in the Expenditure Cycle?

Authorization: Purchasing/Requisitioning Dept

Record keeping: Accounts Payable/Accounting

Custody: Receiving (Purchased Item) and Treasurer (cash)

What piece of evidence is not persuasive alone to show that a liability should be recorded?

Purchase Order

What are the specific assertions typically addressed in the expenditure cycle?

Completeness and accuracy

How does an auditor typically search for unrecorded liabilities (completeness assertion)?

Review cash disbursements made subsequent to year end

Are accounts payable confirmations required? When are they used?

• Not required

• If used, it’s for small or zero balances to vendors

What is the Cash Cycle made up of?

Cash Receipts and Cash Disbursements

What are the two common cash fraud schemes?

• Lapping

• Kiting

What is Lapping and how do we prevent/detect such fraud schemes?

Occurs when the customer pays off a receivable but doesn’t credit the account. Employee withholds those funds, and continues to lap back new checks to previous customers.

Detected by comparing the dollar amounts and the date on the deposit slips with A/R credits.

What is Kiting and how do we prevent/detect such fraud schemes?

Occurs when client has 2 bank accounts, transfers money to one and records deposit, but forgets to record disbursement.

Detected by looking at bank transfer schedules and dates (receipt date before disbursement date)

What are the effective controls surrounding cash receipts?

• Lockbox

• Restrictive Endorsements

What are the relevant assertions for auditing the ending cash balances?

Completeness, valuation, allocation, and existence

How are the assertions for ending cash balances typically tested?

By sending out standard bank confirmations and performing tests on year-end bank reconciliations

What do bank confirmations tell you?

• Year-end bank balance

• Actual loans

• Contingent Liabilities

• Discounted Notes

• Pledged Collateral

• Guarantee or Security Agreements

What do year-end bank reconciliations tell you?

• Deposits in transit/Outstanding Checks (records)

• Banks fees/interest (source docs)

What is the Inventory Cycle made up of?

Purchases and Sales of Inventory

What duties should be segregated in the Inventory Cycle?

1. Purchasing: Serially numbered, properly approved purchase orders prepared and issued to accounting and receiving

2. Receiving: Receiving department is solely responsible for the receipt of goods. In addition to, verification of quantities received, detection of damaged goods, preparation of a receiving report, and delivery of goods received to the warehouse department.

3. Warehouse: The warehouse department acts as custodian for the verified quantity of goods received.

4. Shipping: The shipping department is responsible for shipment of goods after authorization (in the form of an approved sales order from the credit department).

What is a required substantive procedure when auditing the ending inventory balance?

Observing beginning beginning and ending physical inventory counts (if it’s impractical/impossible or immaterial, alt procedures must be applied)

What is excluded from inventory count?

Consigned inventory on hand because they don’t own it. UNLESS you’re the client whose inventory is being held by someone else until it’s sold.

What do you do with inventory held off-site?

Needs to be observed if significant, otherwise just send a confirmation

What is the Investment Cycle made up of?

Purchase and Sale of Stocks, bonds, and derivative instruments

What is the Segregation of Duties for the Investment Cycle?

1. Authorization of Purchase or Sale of Investments: Ideally, the board of directors should authorize the purchase or sale of investments.

2. Custody of Investments: An independent, third-party custodian is recommended but, at minimum, custody should take the form of joint control by two company officials with the investments kept in a safe-deposit box. If held by the company, the investments should be periodically counted and reconciled with the investment subsidiary ledger by a party not associated with the investments.

3. Record Keeping: A separate party from those mentioned above must keep detailed records of the investments.

What are the audit objectives of the Investment Cycle?

1. Determining whether GAAP has been consistently applied

2. Whether classification and valuation are properly determined and disclosed in a clear and understandable manner

3. Whether investments exist and are owned by the company

4. Whether gains and losses are accurately computed and disclosed

5. Whether investment income is properly reported.

What should the auditor do when auditing Marketable Securities during the Investment Cycle?

• Inquire of management

• Obtain written representation concerning management's intent and ability with respect to holding versus selling

What should marketable securities be carried at?

At Fair Value, but if held-to-maturity, then reported at amortized cost

What should the auditor do when auditing investments in securities when valuations are based on the investee’s financial result (excluding equity method)?

• Obtain and read the financial statements of the investee

• Obtain sufficient appropriate evidence regarding any fair values that are materially different between the investment and the investee's carrying amounts

• Consider any implications caused by a difference between financial statement periods of the entity and the investee

What is the Fair Value hierarchy?

1. Observable quoted prices in active markets for identical assets (e.g., stocks)

2. Observable inputs for similar assets/liabilities in active markets, or identical assets in markets that aren’t active (e.g., valuing real estate)

3. Unobservable inputs using estimate and valuation methods based on management’s judgment

Where does the auditor get investment pricing information from third parties?

• Pricing services

• Broker-dealers

• Impairment indicators

What is a unique test for completeness when auditing PP&E cycle?

Analysis of the repairs and maintenance account is often used to search for asset additions mistakenly recorded as repairs, when they should’ve been capitalized

What are the controls related to the PP&E Cycle?

• Acquisition

• Subsidiary Ledgers

• Physical Security

• Written Policies

• Disposition

When is there an overlap between cutoff and completeness assertion for PP&E?

If looking at items right before year-end to ensure they’re included

What is a unique test for existence for the PP&E cycle?

The auditor should be alert for unrecorded dispositions/retirements

What are the most significant risks related to the Payroll and Personnel Cycle?

The creation of fictitious employees and the falsification of hours worked

What is the segregation of duties under the Payroll and Personnel Cycle?

Authorization: Operating managers and personnel

Record keeping: Payroll

Custody: Treasurer

What are the two most important substantive tests and auditor might use to audit payroll?

• Analytical procedures, which are used because payroll is generally predictable

• Recalculation of all year-end payroll accruals

What is the Financing Cycle made up of?

All debt and equity transactions

What should the auditor determine in terms of the Financing Cycle?

• Whether GAAP has been properly applied

• That debt is properly classified (long term versus short term) and valued in the financial statements

• That disclosures are presented in a complete and understandable manner

• Determine whether any restrictions/appropriations exist on reported retained earnings

What should be traced to the board minutes for authorization under the Financing Cycle?

Treasury stock transactions, dividend declarations, and stock issuances

What should be done when the client uses a stock transfer agent in the Financing Cycle?

Third-party confirmations should be sent out to obtain evidence regarding the number of shares issued/outstanding and to obtain specific transaction details

What does a stock transfer agent do?

Ensures stock issuances comply with the articles of incorporation, prepares stock certificates, and maintains records of shares

What factors must an auditor review when developing an audit conclusion?

Misstatements found during an audit and conditions identified that are conducive to fraud risk

What are examples of material misstatements, since this is usually a matter of professional judgment?

• Affects trends in profit

• Masks a change in trend

• Change from a loss into income

• Affects compliance with loan covenants, contracts

• Increases management comp

• Misclassify account items

• Could become mmaterial

• Appears too costly to correct

What should the auditor consider when evaluating the materiality of a misstatement?

Both quantitative and qualitative factors

What should the auditor do when addressing misstatements discovered during an audit?

• Communicate on a timely basis with the appropriate level of management all misstatements accumulated during the audit, other than those that are clearly trivial.

• Request management to make appropriate corrections.

What should the auditor do if management refuses to make the appropriate corrections to misstatements?

Consider the implications for the audit report. For any uncorrected misstatements, the auditor should communicate that the misstatements could cause future-period material misstatements, even if the current period impact is immaterial.

What should audit documentation include?

• The amount below which misstatements are regarded as clearly trivial

• All misstatements accumulated during the audit and whether they have been corrected

• Auditor's conclusion regarding whether the uncorrected misstatements cause the financial statements to be materially misstated.

How can misstatements be corrected?

Using adjusting journal entries

If inventory SHOULD be recorded under a perpetual inventory system, then what 2 J/E does the seller record?

1. Sale → Dr: Cash or AR; Cr: Sales

2. Inventory Relief → Dr: COGS; Cr; Inventory

If inventory SHOULD be recorded under a periodic inventory system, then what J/E does the seller record?

1. Sale → Dr: Cash or A/R; Cr: Sales

2. COGS recorded during count

What is the equation for COGS?

Beginning Inventory + Purchases = Cost of Goods Available for Sale - Ending Inventory = Cost of Goods Sold

What is FOB Shipping Point?

As soon as the items are in the carriers truck, a journal entry should be recorded

What is FOB Destination?

The item has to be at the destination for the journal entry to occur

What is the Dr/Cr mnemonic?

DEA | LOR

Dividends, Expenses, Assets | Liabilities, OE, Revenues