CASE 5: Test of controls

Discussion Questions

1. Evidential Matter is deemed to be sufficient and competent based on the judgment of the
auditor and the significance of the answers provided in the said oral conversation. The quality of
the oral evidence is tested through correlating factors such as perception of the management’s
integrity, the knowledge and authority of the individual giving the information, and the purpose
as to why it is necessary to get the information.

As to level of assurance, oral evidence gives less assurance than physical evidence such as
observing the actual existence and confirmation directly to appropriate departments.

Through this kind of oral evidence, Carole Mitchell aimed to observe the design and operation
efficiency and effectiveness of lakeside’s control procedures and policies. She was able to gather
necessary documents but still have to gather other concrete evidence to further assure the
reliability of oral evidence; these tests include a review of completed internal documents,
organizational charts, flow chart, system manuals etc.

As to fair presentation of account balances through substantive testing, the client’s employee
shall furnish the details and any other relevant information as to the function of control
procedures within the accounting systems, and the auditor shall only rely most on other types of
testing rather than oral evidence.

2. The accounts receivable produce cash flow into the company, giving an opportunity to the
employees to commit theft. Organizations make plans for diverting this financial inflow.
Some of the ways the employees can commit theft include the following:

a. When the customer pays their credit balance on the company, the employees can stole
the money with the credit being written off because it proves to be uncollected by the
end of accounting period. This situation of changing the funds can happen when an aged
account is collected that been written off, it can be removed from the book without any
suspicion.
b. Since the revenue department and the collection of account receivables is in one
department, lapping can happen. If there are collections of accounts by the company
but the money can steal by an employee since there is only one department. Since the
collection of the receivables is not recorded, the company will be sent another invoice
to the customers. To stop the second bill, if there are collections from other customers,
the collections will apply to the balances of the first customers. The cash collection can
be stolen on a daily or weekly basis to take over each previous theft.
c. Since the company record the sales in the total amount of the invoice even if it has
discounts. The employee can remove cash less to 2% if the customer pays within 10
 days. The difference can be recorded that the sale discount has been taken if it doesn’t
have a specific policy for rebilling for incorrect amounts.

4. The reason why Accounts Receivable be confirmed as of an interim date earlier than the end of the
year. Because of the poor internal control the company has for the revenues and cash receipts cycle
therefore the financial information for December cannot be relied upon. And to confirmed if there
severe internal control problems were encountered.

6. Auditor wants to have additional evidence about a particular balance in order to

The confirmation of selected specific account is used by the auditor to gather additional evidence or
assurance about a particular balance. Indication that suggests a necessity for confirmation of account
includes the following:

a) The balance appears to be with a related party;

b) The account is quite large in relation to other accounts receivable;
c) The account is far overdue, implying a bad debt to be written off or improper recording of payment;
d) Unusual activity within the account such as when earlier charges were ignored and later invoices
were paid.

8. The auditor after the oral conversation was able to evaluate potential problems or red flags which will
be the main focus to ensure that no material misstatement will exist. Following are the thing that should
concern the auditor:

 Open access of Accounts Receivable subsidiary ledger to all employees within the company
which may yield to manipulation of information or fraud activities.
 Miller is the only authorized or responsible in handling the subsidiary ledger which indicate the
lack of control and therefore errors and irregularities may not be discovered.
 No formal system exists for setting credit limits and granting credit
 Aging of the receivables is performed only once a year. The receivable shall be verified
periodically to assure that account is up to date to changes.
 The credit files are not updated. Credit files include the credit capability of a customer, inability
to pay will result to larger amount to be written off.
 The basis for writing off account is solely dependent on Roger’s judgement.
Exhibit 5-2
Step Anticipated Results
1-A Total sales invoice together with sales
invoice slip should have the same amount.
It should be indicate that they made
comparisons.
1-B Sales invoice and bill of landing should have
the same amount. The employees must
leave there initials as it serve to be the proof
of the test and there should be prior
comparison.
1-C There must be consistency in invoices of the
cash remittance list and the cash that
receive. In addition, for the purpose of
control procedures, company should
encourage its customer to contain in the
invoice slip the amount of payment.
1-G The bank deposited slip and the amount
received should have the same amount and
the date of payment and deposit should be
the same.
1-E The approved price list should be follow in
pricing the customers and it should be the
base of the entire price in the invoice.
2.
Step Anticipated Results
2-A There should be a proper sales invoice in
accordance with each debit entry.
2-B Cash remittance list and each credit should
be the same as to amount depending on the
method of posting and probability time of
payment .
2-C Bank deposit slips and each specific account
that is credited should be the same.
Potential Problem(s)
There are misstated in recording the sales,
this happen when the invoices do not
agree. Employees do not comply with the
systems requirements.
When the sales and bill of landing are
having different balances it notifies the
auditor that there are inventory have been
shipped or there are records that have
incorrect amounts or incorrect inventory.
Anyone in the company may have been
engaged in lapping or commit theft
Test that has been done notifies the
auditor of the chance that there is lapping
because of the difference on cash receipts
it can point out the theft.
Sales income is overstated because of the
improper pricing and the customers may
pay wrong amounts. Because the invoice
price don’t less the discounts. Employees
may receive kickbacks because the invoice
price is too high.
Potential Problem(s)
The company prepare all sales invoice with
other documents internally, the
employees can made up the sales. This
test can notify the auditor to any
misinterpretation of the sales.
Employees may commit lapping; tracing
can refer to errors in postings within the
system.
This test can possibly uncover the
employees attempts to cover shortage of
cash or lapping
3.

Step Anticipated Results Potential Problem(s)

3 Company’s file should contain entire and Auditory can find additional evidences
updated credit reports on the individual concerning the collectability and validity
customers. company’s receivable if the reports they
have are incomplete. Credit reports are
very important in putting a proper credit-
granting system because it shows that the
company’s control is efficiently operating.

4.

Step Anticipated Results Potential Problem(s)

4 The total amount and the date must be the Two cash remittance are the cash thefts
same in the balance that is recorded in the and cash shortages this two are often have
cash receipts journal and it should be mistake in footing the listing of cash
correct. transactions.