Auditing 304 part4


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Auditing 304 part4

  1. 1. ACCO.304-part 4 Jose Cintron, MBA-CPC
  2. 2. Revenue Cycle test of controls For testing sales orders, the auditor can enter test data to evaluate program results for: a missing or invalid customer number an invalid product code an order that exceeds the customer’s credit limit
  3. 3. Substantive Tests of Sales Transactions Recorded sales are valid Test for recorded sales for which there were no shipments, the auditor can trace from selected entries in the sales journal to make sure a related copy of the bill of lading exists. Sales are properly authorized
  4. 4. Substantive Tests of Sales Compare actual prices charged with the authorized price list: Cash Receipts Functions 1. receiving cash receipts Entails two risks: 1. theft 2. possibility of errors occurring in receipt processing
  5. 5. Control procedures “Sales” Control procedures are aimed at reducing risks. Many firms use a lockbox to minimize risks. Companies that process their own mail receipts should mark all checks “for deposit only.”
  6. 6. Example audit procedures for revenue recognition Perform a thorough review of original source documents including: invoices, shipping documents, customer purchase orders, cash receipts, and written correspondence between the client and customer
  7. 7. Example audit procedures for revenue recognition Analyze and review credit memos and other A/R adjustments for the period subsequent to the balance sheet date.
  8. 8. Example audit procedures for revenue recognition Analyze all large or unusual sales made in the last month prior to the end of the period. Vouch to original source documents. Confirm terms of the transaction directly with the customer.
  9. 9. Billing Customers Accounts Receivable When a delivery or shipment is complete, the system finishes the transaction by filing a shipment record and preparing a final invoice for the customer (which is recorded as sales revenue and accounts receivable). A sales invoice is the bill sent to the customer that indicates the amount due. Any person who has the power to enter or alter these transactions or to change the invoice before it is mailed to the customer should not have any authorization, custody, or recording responsibilities.
  10. 10. Account Receivables Be alert for the following, which may be present when the frauds described already are occurring or have occurred: Unexplained differences noted by customers on their A/R confirmations
  11. 11. Account Receivables Significant delays between the date the customer states a payment was made and the date payment was recorded as received by the firm.
  12. 12. Account Receivables A significant number of credit entries and other adjustments made to the A/R records. Discrepancies between customer names and amounts on deposit slips and subledger accounts and amounts credited
  13. 13. Example audit procedures Account Receivables Confirm account activity with customers directly. Confirm credit memo and sales return activity, as well as the dates on which payments were made. perform analytical reviews of credit memo and writeoff activity by comparing to prior periods. Look for unusual trends or patterns such as large numbers of credit memos.
  14. 14. Expenses Cycle Expenditure cycle–consists of activities related to the acquisition of and payment for plant assets and goods and services. Two major transaction classes: 1–purchases transactions 2-cash disbursements
  15. 15. Expenses Cycle Transactions in the expenditure cycle often affect more financial statement accounts than other cycles combined. The auditor often seeks a low level of risk of material misstatements in the financial statements due to expenditure cycle transactions.
  16. 16. Control Activities for expenses cycle The following functions should be assigned to different individuals or departments: 1 requisitioning goods and services 2 preparing purchase orders 3 receiving the goods 4 storing goods received for inventory 5 preparing the payment voucher 6 recording the liability
  17. 17. Investment and Finance auditing Cycle This pertains to activities relating to ownership of securities issued by other entities. The types of instruments included are: certificates of deposit, preferred and common stocks, and bonds. The investing cycle interfaces with cash receipts and disbursements transactions.
  18. 18. Investing Activities Investing activities–the purchase and sale of land, buildings, equipment, and other assets not generally held for resale. These activities also include the purchase and sale of financial instruments not intended for trading.
  19. 19. Financial Activities Financing activities–include transactions and events whereby cash is obtained from or repaid to creditors or owners. Financing activities would include acquiring debt, capital leases, issuing bonds or stock. These activities also include retiring debt, buying treasury stock and payment of dividends.
  20. 20. Materiality, Risk, and Audit Strategy It is crucial that an auditor obtain an intimate understanding of the client’s business and industry. There can be a sizable variation between industries in the importance of financing and investing activities. Industry knowledge is important for developing expectations with regard to financial statement line items.
  21. 21. Substantive test for plant assets Auditing information on the beginning balances for plant assets is one of the largest risks in an initial engagement. You may need to look at transactions that happened in years past. Initial Procedures As auditor, you must be sure that the starting G/L balance for plant assets agrees with the prior year’s working papers.
  22. 22. Test of details of balances There are various procedures or substantive tests that should be considered. These are: 1. Inspect plant assets 2. Examine title documents and contracts 3. Tests of accounting estimates for depreciation and asset impairment
  23. 23. The Financing cycle The two major transaction classes in the financing cycle are long-term debt transactions and stockholders’ equity transactions. The financing cycle interfaces with the expenditure cycle when cash is disbursed for bond interest, the redemption of bonds, cash dividends, and the purchase of treasury stock.
  24. 24. Substantive Tests of LongTerm Debt Balances The auditor’s main concern is understatement (completeness assertion). Initial Procedures The schedules associated with long-term debt may include separate schedules on L-T notes payable, obligation under capital leases, and listings of registered bond holders.
  25. 25. Confirm Debts-Financing The auditor should have direct communication with lenders and bond trustees to confirm the existence and terms of L-T debt. All confirmations should be compared with the records and any differences should be investigated. Recalculate Interest Expense Interest payments are traced to supporting vouchers, canceled checks, and confirmation responses.
  26. 26. AUDIT EVIDENCE USED TO TEST CASH Cash Disbursements Journal The cash disbursements journal is the company's checkbook. It contains all detailed entries for checks written during the period being audited (cash disbursements). Because all cash disbursements (other than those from a petty cash account) should be made via check or electronic transfer, the cash disbursements journal contains the cash credit entries that provide a population for testing cash disbursements.
  27. 27. AUDIT EVIDENCE USED TO TEST CASH Bank Reconciliations The company's bank reconciliation is the primary document used to test the cash balance in the financial statements. The amount of cash in the bank is almost always different from the amount in the general ledger (financial statements), and the reconciliation is designed to explain the difference between these two amounts. In addition, a bank account reconciliation that compares the book cash balance to the bank cash balance provides management with an opportunity to monitor the separation of duties for cash receipts and cash disbursements as well.
  28. 28. Bank Reconciliation When auditing the bank reconciliation, the auditor should begin by confirming the account balance listed as the “balance per bank” on the top of the bank reconciliation for each bank account from each bank that the client utilizes in the business. A confirmation letter is required to be sent by the auditor and received in the mail directly back from each bank at the offices of the public accounting firm.
  29. 29. Balance in the bank Once the “balance in the bank” has been confirmed and cross-referenced to the balance in the bank reconciliation, the following additional procedures are typically used in auditing the bank reconciliation: Verify the mathematical accuracy of the reconciliation, including the listing of outstanding checks and deposits in transit. Examine reconciling items to ensure they are appropriately classified (e.g., that they were legitimate outstanding checks that were written but not paid by the bank at the statement date). Agree the book balance to the trial balance, which has been traced to the general ledger.
  30. 30. AUDIT EVIDENCE USED TO TEST CASH Canceled Checks Describes the information found on a typical check. Whether the auditor examines the actual check or a scanned image obtained from the bank, knowledge of the codes for Federal Reserve districts, offices, states, and bank identification numbers could enable an auditor to spot a crude check forgery. A forger's mistakes with the optional identification printing or the magnetic check number might provide a tip-off. If the amount of a check is altered after it has cleared the bank, the alteration would be noted by comparing the magnetic imprint of the amount paid to the amount written on the check face.
  31. 31. The reverse side of a check carries the endorsement(s) of the payees and holders in due course; the date and the name and routing number of the bank where the check was deposited; and the date clearing.
  32. 32. Characteristic signs of check-kiting schemes Frequent deposits and checks in rounded and the same amounts. Frequent deposits with checks written on the same (other) banks. 1Short time lags between deposits and withdrawals. 2Frequent ATM account balance inquiries. 3Large periodic balances in individual accounts with no apparent business explanation. 4Low average balance compared to high level of deposits. 5Many checks made payable to other banks. 6“Cash” withdrawals with deposit checks drawn on another bank. 7Checks drawn on foreign banks with lax banking laws and regulations.
  33. 33. AUDIT EVIDENCE USED TO TEST CASH Individuals engaging in fraudulent schemes involving cash often try to conceal their crimes by removing canceled checks they made payable to themselves or endorsed on the back with their own names. Missing canceled checks are a red flag.
  34. 34. AUDIT EVIDENCE USED TO TEST CASH Bank Statements Most of the information shown on the bank statement is self-explanatory. However, auditors should not overlook the usefulness of some of the information: the number and dollar amount of deposits and checks can be compared to the detail data on the bank statement; the account holder's federal business identification number is on the statement, and this can be used in other databases; and the statement itself can be studied for alterations.
  35. 35. Professional Skepticism Professional skepticism and professional judgment are necessary responsibilities of auditors throughout the entire audit process. Professional skepticism is a state of mind that is characterized by appropriate questioning and a critical assessment of audit evidence. Auditors evaluate and consider: 1.Contradictory audit evidence obtained through different procedures. 2. The reliability of documentary evidence. 3. The reliability of information obtained from management.
  36. 36. Substantive Procedures Effective internal control reduces the control risk, and auditors thus have a reasonable basis for reducing the necessary effectiveness of further audit procedures. Ineffective internal control increases control risk, and auditors must increase the necessary effectiveness of further audit procedures.
  37. 37. Audit Evidence The final element of the performance principle requires that the audit team collect and evaluate sufficient appropriate evidence to afford a reasonable basis for their opinion. Evidence is the information used by auditors in arriving at the conclusions on which the audit opinion. To be considered appropriate, evidence must be relevant and reliable
  38. 38. Client Acceptance or Continuance An important element of a public accounting firm's quality control policies and procedures is a system for deciding whether to accept a new client and, on a continuing basis, deciding whether to continue providing services to existing clients. Public accounting firms are not obligated to accept undesirable clients, nor are they obligated to continue to serve clients when relationships deteriorate.
  39. 39. Engagement Letters Professional standards require auditors to reach a mutual understanding with clients concerning engagement requirements and expectations and to document this understanding, usually in the form of a written letter. When a new client is accepted or when an audit engagement continues from year to year, an engagement letter should be prepared. This letter sets forth the understanding with the client, including in particular: (1) the objectives of the engagement, (2) management's responsibilities, (3) the auditors' responsibilities, and (4) any limitations of the engagement.
  40. 40.