9.401 Auditing

1. 9.401 Auditing Chapters 12 to 14 Auditing Sales, Receivables and Receipts

2. S/R/R: Activities and Documents

3. S/R/R: Activities and Documents

4. S/R/R: Activities and Documents

5. How to rob your employer (just kidding)

6. How to rob your employer (just kidding)

7. How to rob your employer (just kidding)

8. Control objectives in S/R/R • Recorded sales occurred (ie. Shipment made) • No sales recorded twice • No shipments to non-existent customers • Existing sales are recorded • Recorded sales accurately recorded • Sales properly classified (eg. Receipt of a receivable is NOT a sale) • Sales recorded on correct dates • Sales transactions properly posted to customer accounts

9. Control objectives in S/R/R • All cash received is recorded • All receipts recorded actually occurred • Cash receipts are recorded and deposited in correct amounts • Cash receipts properly classified • Cash receipts recorded on correct dates • Cash receipts are properly posted to correct A/R accounts

10. General Controls in S/R/R • Segregation of duties in S/R/R • Segregation of duties in data processing • Program change controls • Physical access and security (cash & inventory) • Logical access and security • Documentation of programs and operations

11. Common Key Controls in S/R/R • Invoices are matched to shipping documents. • Shipping documents are pre-numbered and followed up to ensure none omitted or processed twice. • Customer credit authorized. • Standard prices authorized. • Sales only take place with authorized customers

12. Common Key Controls in S/R/R • Monthly statements sent to customers: complaints followed up by independent personnel. • A/R updated from invoices, G/L updated from sales journal, periodic reconciliation

13. Tests of Controls • Goal is to ensure that control operated effectively, as described, throughout period of reliance • May involve following documents. Ensure direction is correct • Reperform if possible and necessary • If control is computerized, check it’s working and check controls over changes • For segregation of duties: 1) observe segregation, 2) ensure physical and logical access is controlled, 3) enquire about vacation and sick day coverage, 4) be on lookout for exceptions

14. Tests of Controls: Dual purpose = tests that determine: 1) if controls are operating effectively AND 2) amount of monetary errors in account. Requires re-performance Eg. Ensure each invoice is accompanied by shipping document Ensure prices and extensions are correct

15. Evaluating results of TOC • If statistical sampling is used, can get a quantitative estimate of deviations that MAY exist in population given: • Results of your sample and • Possibility of sampling risk • Table 12-8 gives this upper bound of deviations. • If upper bound < tolerable exception rate, then… • If upper bound > tolerable exception rate, then…

16. Evaluating results of TOC • What happens to your upper bound (=CUER: computed upper exception rate) when: • ARACR increases? • Sample size increases? • Number of deviations increases? Does each additional deviation increase the CUER by a greater or lesser amount?

17. Analytical Procedures in S/R/R • MUST be used in planning and final stages • MAY be used to reduce tests of details • DR=APR*ARIA • The better your procedures, the lower your APR is • Using regression analysis • Using more variables • Finer level of detail

18. Analytical Procedure Steps • Define results to examine & relationship • State objectives of the review • Decide on examination methods • Define significant fluctuations • Specify intended reliance • Select the method of computation • Control non-sampling risk • Ensure audit control • Make the comparison • Identify significant fluctuations • Investigate significant fluctuations • State conclusions

19. Regression Analysis pros and cons • Pros: • Rigorous, provides higher assurance • Probabilities can be quantified • Can handle several variables • Cons: • Large number of observations needed • Specialized training, software required

20. Common S/R/R analytical procedures • Gross margin % • Sales by month and/or by product line • Sales returns and allowances/sales • Individual customer balances with prior yrs • Bad debt Expense/sales • Number of days sales in A/R • A/R turnover • Breakdown of aging categories with prior yr • Allowance/(A/R)

21. Substantive Procedures: A/R objectives • Recorded A/R exist • All A/R are recorded • A/R are recorded in proper period • Sales cutoff is proper • Receipts cutoff is proper • Returns/allowances cutoff is proper • A/R are accurate (proper pricing etc.) • A/R is valued correctly (allowance)

22. Substantive Procedures: A/R objectives • Rights to A/R are owned by client • Not factored or pledged • A/R is properly classified • LT vs. ST, related parties, directors etc.

23. Common A/R TOD Procedures • Ensure A/R trial balance ties in to G/L • Select items to confirm from trial balance • Scan trial balance for large, unusual or negative items. • Enquire of mgmt if there are related parties or long term receivables and how they identify them. • Ensure aged A/R trial balance is complete and accurate. Review procedures with manager. Review allowance for reasonableness.

24. Common A/R TOD Procedures • Check end of year sales, receipts, and returns were in this period, and subsequent period sales, receipts and returns were in subsequent period. • Examine receipts received after year end for evidence of ________ and _________. • Review minutes, correspondence and loan confirmations and enquire of mgmt if A/R are pledged or factored

25. Confirmations of A/R • Are they necessary? Should be used unless: • A/R are immaterial or • confirmations would be ineffective or unreliable or • CR and IR are low and other procedures can be used that provide sufficient appropriate audit evidence • Consider type • positive (more reliable) or negative

26. Confirmations of A/R • Consider timing of confirmations • Materiality, inherent risk, internal controls, audit risk, amount of business activity • Consider recipient and type of information to ask for: • individual invoices, account balance, or ask recipient to provide balance • Maintain control of confirmations (no client intervention) • Follow up of errors, exceptions and non responses

27. Evaluation of Results of TOD • Recall that we will have a list of KNOWN errors from a sample. • These will be extended to get PROBABLE or LIKELY errors: In DUS = (population/sample size) * (error/BV) • Calculate Upper Bound to account for sampling risk:

28. Calculating upper bounds of over and understatements • Sort errors by over- and under-statements. • For each error calculate the PROPORTION of the sample item that was in error (=error/BV of item) • For each group (over and understatements, sort from biggest proportionate error to smallest. • From table 12-9, calculate the increase in CUER for each deviation to the number of deviations you have.

29. Calculating upper bounds of over and understatements For each deviation, multiply: its proportion of error * the increase in CUER * the recorded value of the population. The total of all these represents your upper bound for the group (either overstatements or understatement) Note that the “proportion of error” for the first layer (=0 deviations) is usually 100%. Might reduce the resulting upper bound by the most likely errors in the opposite direction.

30. Evaluating TOD results • Compare known errors, most likely errors, and upper bounds to materiality (or your tolerable misstatement, whichever is lower) • If lower, no problem • If higher, consider: • Increase sample size • Ask that account balance be adjusted • Have client correct popn and re-test • As last resort, qualify opinion • Always consider as well qualitative considerations and affect on CR and IR decisions already made