Boynton SM CH 14

CHAPTER 14
AUDITING THE REVENUE CYCLE
Learning Check
14-1. a. The revenue cycle includes the activities involved in the

exchange of goods and services with customers and the
realization of the revenue in cash.
b. The classes of transactions in this cycle for a

merchandising company are sales, sales adjustments,
and cash receipts. The primary accounts affected by
these transactions are sales, accounts receivable, cost of
sales, inventory, cash, sales discounts, sales returns and
allowances, bad debts expense, and allowance for
uncollectable accounts
14-2. a. Specific audit objectives for the revenue cycle are derived
from the five categories of management's financial
statement assertions.
b. Specific audit objectives for credit sales transactions

include the following:
Specific Audit Objectives
Transaction Objectives
Occurrence. Recorded sales transactions represent
Solutions Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 14-1
goods shipped or services provided during the period.
Recorded cash receipt transactions represent cash
received during the period.
Recorded sales adjustment transactions during the
period represent authorized discounts, returns and
allowances, and uncollectable accounts.
Completeness. All sales cash receipts and sales
adjustments made during the period were recorded.
Accuracy. All sales and cash receipts and sales
adjustments are accurately valued using GAAP and
correctly journalized, summarized and posted.
Cutoff. All sales, cash receipts and sales adjustments
have been recorded in the correct accounting period.
Classification. All sales, cash receipts, and sales
adjustments have been recorded in the proper
accounts.
Balance Objectives
Existence. Accounts receivable representing amounts
owed by customers exists at the balance sheet date.
Completeness. Accounts receivable include all claims
on customers at the balance sheet date.
Rights and Obligations. Accounts receivable at the
balance sheet date represent legal claims of the entity
on customers for payment.
Valuation and Allocation. Accounts receivable
represents gross claims on customers at the balance
sheet date and agrees with the sum of the accounts
receivable subsidiary ledger. The allowance for
uncollectable accounts represents a reasonable
estimate of the difference between gross receivables
and their net realizable value.
Disclosure Objectives
Occurrence and Rights and Obligations. Disclosed
revenue cycle events and transactions have occurred
and pertain to the entity.
Completeness. All revenue cycle disclosures that
should have been included in the financial statements
have been included.
Understandability. Revenue cycle information is
appropriately presented and information in disclosures
is understandable to users.
Accuracy and Valuation. Revenue cycle information is
disclosed accurately and at appropriate amounts.
14-3. Following are a few examples of differences between how

the auditor might use the knowledge of the entity and its
environment for a computer company v. a hotel.
a. Certain balance sheet accounts like accounts receivable

and inventories are going to be very significant for the
computer manufacturer, but relatively immaterial for the
hotel. The computer company is also likely to have a
higher ratio of sales to fixed assets, or sale to total assets,
than the hotel.
b. The computer company auditor will have significant

issues associated with the risk of misstatement with
respect to the existence of receivables and inventories
that are not present for the hotel. The computer company
auditor will also have to address valuation and allocation
issues associated with the collectability of receivables
and lower of cost or market of inventories that are
insignificant for the hotel. The hotel will have a potential
risk of material misstatement in terms of how it accounts
for revenues from properties that it manages for others,
as opposed to properties that it owns.
14-4. Factors that might motivate management to deliberately

misstate revenue cycle assertions include:
 Pressures to overstate revenues in order to report achieving
announced revenue or profitability targets or industry norms
that were not achieved in reality owing to such factors as
global, national, or regional economic conditions, the impact
of technological developments on the entity's
competitiveness, or poor management.
 Pressures to overstate cash and gross receivables or
understate the allowance for doubtful accounts in order to
report a higher level of working capital in the face of
liquidity problems or going concern doubts.
Factors that might contribute to unintentional misstatements

in revenue cycle assertions include:
 The volume of sales, cash receipts, and sales adjustments
transactions is often high, resulting in numerous
opportunities for errors to occur.
 The timing and amount of revenue to be recognized may be
contentious owing to factors such as ambiguous accounting
standards, the need to make estimates, the complexity of
the calculations involved, and purchasers' rights of return.
14-5. a. Following are example analytical procedures that the

auditor might use to estimate total revenue for a
household appliance manufacturer and for an airline.
Industry Possible Analytical Procedures

Household Appliance  Use past ratio of net sales to
Mfg. capacity with adjustments for
capacity changes.
 Use a combination of past
ratios of market share with
adjustments of current
changes in market share.
Requires knowledge of the
total market size in the
industry.
Airline  Estimate net revenues using
information on utilization of
capacity (airline seat miles)
and average revenue per seat.
b. Two analytical procedures that the auditor might use to

estimate gross margin for company might include.
Analytic Procedure Audit Significance

Compare historical Companies with commanding
trends in market market shares often are able to
share and gross obtain larger gross margins.
margin with current
unaudited data.
Evaluate the Companies with a high
percentage of proportion of revenues from new
revenues coming from products may earn premium
new products. gross margins due to the ability
to innovate.
c. Two analytical procedures that the auditor might use to

estimate net receivables and the allowance for doubtful
accounts for company might include.
Analytic Procedure Audit Significance

Accounts receivable Understanding a company’s
turn days history of accounts and sales
volume can assist the auditor in
evaluating net receivables and
the adequacy of the allowance
for doubtful accounts.
Evaluate the entities This procedure is primarily
history of related to the adequacy of the
uncollectable allowance for uncollectable
accounts expense to accounts. The above history of
net credit sales, with accounts receivable turn days
adjustment for would be most useful for
economic conditions evaluating estimating gross
receivables given sales.
14-6. Several control environment factors and their applicability

to revenue cycle assertions are:
 Integrity and ethical values - reduction of risk of
overstatement of revenues and receivables by eliminating
incentives to dishonest reporting.
 Commitment to competence - by chief financial officers and
accounting personnel.
 Management's philosophy and operating style -
conservatism in developing such accounting estimates as
the allowance for uncollectable accounts and allowance for
sales returns.
 Human resource policies and practices - bonding of
employees who handle cash
14.7.The following table summarizes the functions that apply to

credit sales transactions, the department that performs the
functions, and the principal documents or records produced in
performing the function.
Department that Principal documents and
Function performs function records produced in
Initiating Sales department Documents
credit Customer Order
sales Credit department Sales Order
Computer Files and Records

Customer Master File (with
credit information) and
Accounts Receivable Master
File.
Perpetual Inventory
Authorized Price List
Open Order File
Delivering Warehousing and Documents

good and shipping Shipping documents
services department for Reports of unfilled orders
goods. and back orders
Line operating Computer Files and Records

departments for Open Order File
services. Perpetual Inventory
Shipping File
Department that Principal documents and
Function performs function records produced in
Recording Accounting Documents
sales (Billing) Sales Invoice
Sales Reports and Sales
Journal
Various Exception Reports
Monthly Customer
Statements
Computer Files and Records

Sales Transaction File
Accounts Receivable Master
File
14-8. In order to assess control risk as low based on programmed

control procedures the auditor should test the following.
Control Importance to Control Risk

Assessment
Programmed control If a programmed control procedure in
procedures critical to a low control risk
assessment then the auditor should
directly test the control procedure.
Computer general In order to obtain assurance that the
control procedures programmed control procedure
functions effectively throughout the
period the auditor also needs to these
the effectiveness of computer general
control procedures.
Manual follow-up Programmed controls usually report
procedures. exceptions noted when performing
the control. As a result auditors also
need to test the effectiveness of
manual controls that follow-up on
reported exceptions.
14-9. The following tables describes programmed controls for a

typical manufacturing company.
Potential Programmed CAATs (Assuming Test
Misstatement Control Data)
a. Sales The computer Submit test data for a
invoices may compares entries in transaction that has
not be the sales journal shipping information,
recorded. with underlying both with and without
shipping a supporting sales
information. All invoice.
shipping
documents must be
matched with a
sales invoice.
b. Sales invoice The computer Submit test data with
may be compares dates on dates on sales
recorded in the sales invoice invoices that both do
the wrong with dates on and do not match
accounting shipping with dates on related
period. documents. shipping files.
c. A fictitious The computer will Submit test data with
sales invoice, not prepare a sale sales invoice
or a sales invoice without information that both
transaction underlying is and is not
for which information on supported by
revenue shipping files. underlying shipping
should not be information.
recognized, is
recorded.
d. Sales are The computer Submit test data for
made without searches a field for sales orders that both
credit appropriate credit are and are not
approval. authorization supported by
before an order is appropriate credit
placed on an open authorization.
order file.
e. A sales The computer Submit test data for
invoice has matches quantities sales invoices that
incorrect on a sales invoices both do and do not
quantities or with underlying match underlying
prices. shipping shipping information
information and and authorized price
matches prices with lists.
an authorized price
list.
f. Sales The computer Submit test data for
invoices may checks run-to-run batches that with
not be posted totals of beginning complete and
or may not accounts receivable incomplete data sets
be balances, plus sales in terms of completed
journalized transactions, with transactions.
the ending
receivable
balances.
g. Sales The computer Submit test data with
invoices may matches customer underlying
be posted to information on the information that both
the wrong sales invoice with does and does not
customer’s the master match with
accounts. customer file, the information on
sales order, and the previously created
shipping sales order and
documents. shipping files.
14-10. A common management control involves having

managers with responsibility for sales to review daily or weekly
sales reports to assess the reasonableness of recorded sales.
Further management responsible for warehousing and shipping
should review daily or weekly sales and inventory movement
reports to assess the reasonableness of recorded sales and
inventory removed from the perpetual inventory.
14-11. The sub-functions involved in cash receipts include (1)

receiving cash receipts, (2) depositing cash in bank, and (3)
recording the cash receipts.
14-12. a. Two important controls pertaining to cash sales and the

transaction class audit objectives to which they relate
are:
 The customer's expectation of a printed receipt and
supervisory surveillance of over the counter sales
transactions helps to ensure that all cash sales are
processed through the cash registers or terminals -
completeness.
 Independent check by supervisor on the accuracy of
cash count sheets, and verification of agreement of
cash on hand with totals printed by a cash register or
terminal - existence or occurrence and valuation or
allocation.
b. Two important controls pertaining to the initial handling of

mail receipts are (1) immediate restrictive endorsement
of checks received and (2) preparation of a multi-copy
listing (prelist) of mail receipts.
14-13. a. A lockbox is a post office box that is controlled by the
company's bank. The bank picks up the mail daily, credits
the company for the cash, and sends the remittance
advices to the company for use in updating accounts
receivable. This system eliminates the risk of diversion of
the receipts by company employees and failure to record
the receipts.
b. Depositing receipts intact daily means that all receipts

are deposited; that is, cash disbursements should not be
made out of undeposited receipts. This control reduces
the risk that receipts will not be recorded (completeness),
and the resulting bank deposit record establishes the
existence or occurrence of the transactions.
14-14. Four controls that can aid in preventing or detecting errors

or irregularities in recording cash
receipts are summarized below along with potential tests of
controls:
Control Test of Control

Independent check of Inspect a sample of daily cash
agreement of validated summaries and examine
deposit slip with daily cash evidence of agreement with
summary. validated deposit slip by
responsible employee.
Computer check of Use CAATs to test computer
information included in the matching of information from
cash receipts journal with cash receipts journal with
information from prelist. electronic prelist. Also follow-up
on how exceptions are reported
and examine evidence or
correction of errors reported on
exception reports.
Preparation of periodic Examine a sample of periodic
independent bank bank reconciliations. Make
reconciliations. inquiries about bank
reconciliation procedures and
test accuracy on a sample basis.
Mailing of monthly Observe the mailing of monthly
statements to customers. statements to customers. Make
inquiries about procedures to
follow-up on issues raised by
customers, and examine reports
or other evidence of follow-up.
14-15. a. The functions pertaining to sales adjustments

transactions are: granting cash discounts; granting sales
returns and allowances; and determining uncollectable
accounts.
b. The following three types of controls pertaining to sales

adjustments transactions have as their common focus
establishing the validity, or existence of occurrence, of
such transactions:
 Proper authorization of all sales adjustments
transactions.
 The use of appropriate documents and records,
particularly the use of an approved credit memo for
granting credit for returned or damaged goods, and an
approved write-off authorization memo for writing off
uncollectable customer accounts.
 Segregation of duties for authorizing sales adjustment
transactions and handling and recording cash receipts.
14-16. a. The accounts receivable balance is a function of the

transactions that are posted to the account, namely credit
sales, cash receipts, and sales adjustments. A sound
system of internal controls over these three transaction
cycles that ensure the completeness and accuracy of
these transactions, should also ensure the completeness
and accuracy of account receivable.
b. The primary control over the balance involves sending

monthly statements to customers and having an
independent function to receive and follow-up on any
issues raised by customers.
c. The rights and obligations assertion for accounts
receivable involves selling, or factoring, cash receipts. If
an entity sells its receivables, it should keep a
documentary record of the receivables that have been
sold or pledged, and have a process for following up on
collection of those receivables and the reduction of the
related liability to the factoring agent. These records
should be compared with monthly statements received
from a bank or factoring agent.
d. Public companies normally control establish controls over

the presentation and disclosure assertion and related
audit objectives through an effective and independent
disclosure committee. The disclosure committee should
have individuals who are knowledgeable about GAAP and
the transactions being processed.
14-17. The following table provides example controls and tests of

controls for each assertion (and transaction level audit
objective) related to credit sales and cash receipts. Examples
emphasize programmed control procedures where appropriate.
Student should note that tests of controls should also
emphasize testing computer general controls, observing
exception reports, and testing manual follow-up of items that
appear on exception reports.
Credit Sales
Assertion (Audit Control Test of Controls
Objective)
Existence and Computer matches Submit test data where
Occurrence sales invoice invoice data does not
(Occurrence) information with match with underlying
underlying shipping information.
shipping
information.
Completeness Computer prints a Submit test data with
(Completeness) report of all goods shipments that have not
shipped but not been billed to test
billed. accuracy of report of all
good shipped but not
billed.
Existence and Comparison of Submit test data with
Occurrence / invoice date with shipments in one period
Completeness the accounting and billing in the
(Cutoff) period when goods subsequent period.
were shipped.
Valuation and Computer matches Submit test data with
Allocation sales prices with invoice prices that do
(Accuracy) authorized price not match the
list and sales order. authorized price list or
sales order.
Presentation and Computer matches Submit test data the
Disclosure customer number customer information on
(Classification) on sales invoice the sales invoice does
with customer not match the
number on sales underlying sales order.
order.
Rights and If an entity sells its Observe and reperform
Obligations receivables, it procedures for
should keep a documenting
documentary receivables that have
record of the been factored or sold.
receivables that
have been sold and
it should compare
that record with
monthly
statements
received from a
factoring company.
Cash Receipts
Assertion (Audit Control Test of Controls
Objective)
Existence and Independent check Observe and reperform
Occurrence of agreement of manual controls to
(Occurrence) cash and checks check independent
with cash count check of the prelist with
sheets and prelist. the cash receipts
journal.
Completeness Independent check Observe and reperform
(Completeness) of agreement of manual controls to
cash and checks check independent
journal.
Existence and Preparation of Observe and test the
Occurrence / periodic accuracy of independent
Completeness independent bank bank reconciliations.
(Cutoff) reconciliations.
Valuation and Independent check Observe and reperform
Allocation of agreement of manual controls to
(Accuracy) cash and checks check independent
journal.
Presentation and Mailing of Make inquiries about
Disclosure statements to mailing of monthly
(Classification) customers. statements to
customers. Observe
notes and procedures
used to follow-up upon
questions raised by
customers.
Rights and If an entity sells its Observe and reperform
Obligations receivables, it procedures for
should keep a documenting
documentary receivables that have
record of the been factored or sold.
receivables that
have been sold and
it should compare
that record with
monthly
statements
received from a
factoring company.
14-18. a. The transaction classes that should be considered in

assessing control risk for accounts receivable assertions
are: credit sales, cash receipts, and sales adjustments.
b. In assessing control risk for the existence or occurrence

account balance assertion for accounts receivable, the
following transaction class control risk assessments
should be considered:
 Existence or occurrence for sales transactions that
increase accounts receivable.
 Completeness for cash receipts and sales adjustments
transactions that decrease accounts receivable.
c. A revised acceptable level of detection risk for tests of
details and a revised level of substantive tests must be
determined for an assertion when the relevant final or
actual inherent risk assessments, control risk
assessments, and analytical procedure risk assessments,
differ from the planned assessed levels.
14-19. The following table explains some example preliminary
audit strategies for each financial statement assertion in the
context of the audit risk model.
Assertion Inherent Control Analytic Test of Details

Risk Risk Procedures Risk
Risk
Existence Maximum Low if Moderate Moderate
and due to internal to high which will allow
Occurrence revenue controls depending for smaller
recognitio over the on sample sizes
n occurrence reliability of and changing
problems. of sales are expectation the timing of
strong. model. confirmations
of receivables.
It will also
reduce the
extent of cutoff
tests.
Completenes Moderate. Low if Moderate Moderate to
s Not a internal to high high which will
significant controls depending allow for
inherent over the on smaller sample
risk. occurrence reliability of sizes and
of sales are expectation changing the
strong. model. timing of
confirmations
of receivables.
It will also
reduce the
extent of cutoff
tests.
Rights and Moderate Moderate Moderate Low: Consider
Obligations to high to high to high confirming with
depending depending depending factoring agent
on the on internal on and search for
entity’s controls. reliability of large unusual
ability to However, expectation cash receipts.
generate control are model.
operating more
cash flow. nonroutine
than
routine.
Valuation and High or Moderate Moderate The auditor
Allocation maximum to high to high can test the
due to depending depending accuracy of
subjective on internal on receivables at
nature of controls reliability of gross value
allowance. over expectation with
collection model. confirmation.
of The auditor
receivables should
. consider
extensive tests
of the
allowance after
year-end.
Presentation Inherent Moderate Maximum: Maximum to
and risk is to high Analytical High. It is
Disclosure usually depending procedures often cost
high or on internal are not effective to
maximum. controls directed at substantively
over testing test disclosures
disclosures. disclosures. which are not
complex for
receivables.
14-20. In vouching recorded accounts receivable transactions to

supporting documentation, a sample of debits to customers'
accounts is compared to data on supporting sales invoices and
matching shipping documents, sales orders, and customer
orders. The evidence obtained pertains primarily to specific
audit objectives derived from the existence or occurrence,
rights and obligations, and valuation or allocation assertions
for accounts receivable.
14-21. Both the sales cutoff test and the cash receipts cutoff test
pertain to accounts receivable. The sales cutoff test involves:
 Examining shipping documents for several days before and
after the cutoff date to determine the date and terms of
shipment.
 Tracing shipping documents to sales and inventory records
to establish that the entries were made in the correct
accounting period.
 Inspecting invoices for a period of time before and after the
cutoff date to ascertain the validity and propriety of the
shipments and corresponding entries.
 Inquiring of management about any direct shipments by
outside suppliers to customers and determining the
appropriateness of related entries.
In performing a cash receipts cutoff test, the auditor may be
present at the balance sheet date to personally observe the
promptness of the cutoff. In particular, the auditor determines
that all collections received prior to the close of business are
included in cash on hand or in deposits in transit and are
credited to accounts receivable. Alternatively, the auditor may
review the daily cash summary and validated deposit slip for
the last day of the year.
Both cutoff tests relate to the occurrence and completeness

audit objectives for accounts receivable.
14-22. a. It may not be necessary to confirm accounts receivable

when:
 The balance is immaterial to the financial statements.
 The use of confirmations would be ineffective as an
audit procedure.
 The auditor's combined assessment of inherent risk
and control risk is low, and that assessment, made in
conjunction with the evidence expected to be provided
by analytical procedures or other substantive tests of
details, is sufficient to reduce audit risk to an
acceptably low level for the applicable financial
b. Factors to be considered in choosing the form of

confirmation request are (1) the acceptable level of
detection risk and (2) the composition of the customer
balances. The positive form is used when detection risk is
low or individual customer balances are relatively large.
The negative form should be used only when all three of
the following conditions apply:
 The acceptable level of detection risk for the related
assertions is moderate or high.
 A large number of small balances is involved.
 The auditor has no reason to believe that the recipients
of the requests are unlikely to give them consideration.
c. When no response is received after the second or third

positive confirmation request to a customer, the auditor
should apply such alternative procedures as (1)
examining subsequent collections and (2) vouching open
invoices comprising the customer's balance. Alternate
procedures may be omitted when both of the following
conditions apply:
 There are no unusual qualitative factors or systematic
characteristics related to the nonresponses, such as
that all nonresponses pertain to year-end transactions.
 The nonresponses, projected as 100% misstatements
to the population and added to the sum of all other
unadjusted differences, would not affect the auditor's
decision about whether the financial statements are
materially misstated
14-23. a. The aged trial balance is used primarily in assessing the

adequacy of the allowance for uncollectable accounts.
b. Procedures applied to the aged trial balance include (1)

footing and crossfooting the aged trial balance and
comparing the total to the general ledger balance for
accounts receivable and (2) testing the aging of the
amounts shown in the aging categories by examining
supporting documentation such as dated sales invoices.
c. After testing the accuracy of the aged trial balance the

auditor should perform the following procedures to draw a
conclusion about the fair presentation of the allowance
for doubtful accounts.
 Examine past due accounts for evidence of
collectability such as correspondence with customers
and outside collection agencies, credit reports, and
customers’ financial statements.
 Discuss collectability of accounts with appropriate
management personnel.
 Evaluated management’s process for estimated the
allowance for doubtful accounts using hindsight.
 Evaluate the adequacy of the allowance given
information about industry trends, aging trends, and
collection history for specific customers.
d. Hindsight allows auditors to evaluate the reasonableness

of management’s process for estimating the allowance for
doubtful accounts. The reliability of management’s
process for developing this accounting estimate can be
gauged by evaluating estimates in prior periods and the
degree to which those estimates accurately estimated
subsequent uncollectable accounts.
14-24. GAAP disclosure for accounts receivable include:

 Disclosure of receivables from employees, officers, affiliated
companies and other related parties.
 Appropriate classification of material credit balances.
 Appropriate classification of current and noncurrent
receivables.
 Disclosure of pledging, assigning, or factoring receivables.
Comprehensive Questions
14-25. (Estimated Time: 15 Minutes)
The auditor should consider separately audit the revenues

associated with the 27 owned properties and the 40 managed
properties.
Revenues for the 27 owned properties represent direct

revenues of the motel chain. The auditor might consider
evaluating the summer season separate from the balance of
the year as the auditor will expect occupancy to be high during
that time of year and the auditor will also expect that revenues
should reflect higher rates. The auditor would also expect that
for the balance of the year occupancy should be lower and
revenues per night will be reduced due to significant price
competition. Knowledge of the industry will be particularly
helpful in gauging the reasonableness of occupancy rates and
revenues per unit.
Revenues for the 40 managed hotels will likely be related to

management fees based on revenues earned for absentee
owners. The auditor needs to consider the same issues as
above, but also need to determine the appropriateness of the
management fee based on the contract with absentee owners.
14-26. (Estimated time - 25 minutes)
1. The following table provides the solutions to the

quantitative requirements in parts a through g.
2. Receivables are growing faster than sales. In addition,

Sales price per unit has gone up and the ratio of sales to
total assets has increased. This might be evidence of
problems with revenue recognition. In addition, during
this period of accounts receivable growth, accounts
receivable turn days increased during the last year, and
the uncollectable account expense to account receivable
write-off has gone down. The auditor should also
consider whether the allowance for doubtful accounts is
adequate.
Internal Control Questionnaire

Question Yes No
1. Are cash registers or point-of-sale devices used for over-the-
counter sales?
2. Is there periodic surveillance of cash sales procedures?
3. Are customers who pay by check required to provide
identification?
4. Are checks restrictively endorsed on receipt?
5. Is a receipt produced by the cash register given to each
customer?
6. Is an independent check made of agreement of cash and
checks on hand with
cash count sheets and cash register readings?
7. Is cash deposited intact daily?
8. Is an independent check made of agreement of daily cash
register summaries
with validated deposit slips?
9. Is an independent check made of agreement of amounts
journalized with daily
cash register summaries and validated deposit slips?
10. Are periodic independent bank reconciliations made?
11. Are employees who handle cash bonded?
14-28. (Estimate Time: 30 Minutes)
Weakness Recommended Improvement

Financial secretary exercises To extent possible, financial
too much control over secretary's responsibilities
collections. should be confined to record
keeping.
Finance committee is not Finance committee should

exercising its assigned assume a more active
responsibility for collections. supervisory role.
The auditing function has An audit committee should be

been assigned to the finance appointed to perform periodic
committee, which also has auditing procedures or engage
responsibility for the outside auditors to perform
administration of the cash the procedures.
function. Moreover, the
finance committee has not
performed the auditing
function.
The head usher has sole The number of counters
access to cash during the should be increased to at least
period of the count. One two, and cash should remain
person should not be left under joint surveillance until
alone with the cash until the counted and recorded so that
amount has been recorded or any discrepancy will be
control established in some brought to attention.
other way.
The collection is vulnerable to The collection should be
robbery while it is being deposited in the bank's night
counted and from the church depository immediately after
safe prior to its deposit in the the count. Physical
bank. safeguards, such as locking
and bolting the door during
the period of the count, should
be instituted. Vulnerability to
robbery will also be reduced
by increasing the number of
counters.
The head usher's count lacks The financial secretary should
usefulness from a control receive a copy of the
standpoint because he collection report for posting to
surrenders custody of both the financial records. The head
the cash and the record of usher should maintain a copy
the count. of the report for use by the
audit committee.
Contributions are not Contributions should be
deposited intact. There is no deposited intact. If it is
assurance that amounts considered necessary for the
withheld by the financial financial secretary to make
secretary for expenditures cash expenditures, she should
will be properly accounted be provided with a cash
for. working fund. The fund should
be replenished by check based
upon a properly approved
reimbursement request and
satisfactory support.
Members are asked to draw Members should be asked to
checks to "cash", thus make checks payable to the
making the checks church. At the time of the
completely negotiable and count, ushers should stamp
vulnerable to the church's restrictive
misappropriation. endorsement (For Deposit
Only) on the back of the
check.
No mention is made of Key employees and members
bonding. involved in receiving and
disbursing cash should be
bonded.
Written instructions for Because much of the work in
handling cash cash collections is performed
collections apparently have by unpaid, untrained church
not been prepared. members, often on a short-
term basis, detailed written
instructions should be
prepared.
14-29. (Estimated Time: 30 minutes)
a. Consolidated Electricity Company: Cash Receipts

Flowchart
Documentary Key Reports Computer

Programs and Files
Audit Trail
Customer
Payment
Remittance
Advice
Accounts
Receivable
File
Data
Entry
CASH RECEIPTS
at
PROGRAM:
CRT rece
Updates AR Master
File and Daily
Transaction Tape.
Deposit Also Produces
Slip Deposit Slip for
Cash Received
Cash
Receipts
Transaction
File
b. Yes, the new cash receipts procedures have created some
systems and internal control problems. These problems
include the following:
 There are some potential control problems in the data
entry procedures. The CRT operator should be
restricted to cash receipts processing activities. There
should be safeguards to detect or prevent
unauthorized entries to the system.
 The old master file records are destroyed in the update
process. The company should keep a backup of the
accounts receivable file in case the file is destroyed.
This can be accomplished by periodically dumping the
accounts receivable file on magnetic tape or another
disk
 There is no assurance that all cash receipts have been
entered correctly into the system. There should be
some independent computation of batch and/or hash
totals involving the remittance advices and the number
of transactions so that a comparison at the conclusion
of processing would reveal omissions or errors
 The remittance advices The remittance advices are
destroyed the next day, which probably is too soon.
Any errors or operator alterations not discovered by the
end of the next business day would be difficult to trace
and correct.
14-30. (Estimated Time – 25 Minutes)
a. Substantive Test b. Financial c. Type of

Statement Evidence
Assertion
Vouch aged trial Valuation or Documentary
balance to supporting allocation
documentation
Apply analytical Existence or Analytical
procedures occurrence,
completeness,
valuation or
allocation
Vouch recorded Existence or Documentary
receivables to occurrence,
supporting rights and
documentation obligations,
valuation or
allocation
Perform sales cutoff Existence or Documentary
Statement Evidence
Assertion
test occurrence,
completeness
Confirm accounts All except Confirmation
receivable presentation and
disclosure.
Vouch aged trial Valuation or Documentary
balance to supporting allocation
documentation
Vouch recorded Existence or Documentary
receivables to occurrence,
supporting rights and
documentation obligations,
valuation or
allocation
Verify accuracy of Valuation or Mathematical
accounts receivable allocation
trial balance and
agreement with
general ledger
control
Examine subsequent Existence or Documentary
collections or occurrence,
allocation completeness,
valuation
Confirm accounts All except Confirmation
receivable presentation and
Statement Evidence
Assertion
disclosure
Compare statement Presentation and Documentary
presentation with disclosure
GAAP
Perform cash receipts Existence or Documentary
cutoff test occurrence,
completeness
14-31. (Estimated Time – 20 minutes)
Schedule of Adjustments
Cost of
Sales Goods Sold
Transaction Unde Over Unde Over
r r
D 4,00 2,40
0 0
E 10,0 5,60
00 0
F 6,00
0
H 8,00
0
Total 14,0 14,0 5,60
00 00 0
Adjusting Entry DR CR
Inventory 5,60
0
5,60
0

a. King might justify omitting the confirmation of Cycle's
accounts receivable when:
 The balance is immaterial to the financial statements.
 The use of confirmations would be ineffective as an
audit procedure.
 The auditor's combined assessment of inherent risk
and control risk is low, and that assessment, made in
conjunction with the evidence expected to be provided
by analytical procedures or other substantive tests of
details, is sufficient to reduce audit risk to an
acceptably low level for the applicable financial
b. In designing confirmation requests, the auditor considers

the acceptable level of detection risk needed to be
achieved, the composition of the client's customer balances,
and the likelihood that the customers will conscientiously
respond. The positive form is used when detection risk is
low or individual customer balances are relatively large.
The negative form should be used only when all three of
the following conditions apply:
 The acceptable level of detection risk for the related
assertions is moderate or high.
 A large number of small balances is involved.
 The auditor has no reason to believe that the recipients
of the requests are unlikely to give them consideration.
c. When no response is received after the second or third

positive confirmation request to a customer, the auditor
should apply such alternative procedures as (1) examining
subsequent collections and (2) vouching open invoices
comprising the customer's balance. Alternate procedures
may be omitted when both of the following conditions
apply:
 There are no unusual qualitative factors or systematic
characteristics related to the nonresponses, such as
that all nonresponses pertain to year-end transactions.
 The nonresponses, projected as 100% misstatements
to the population and added to the sum of all other
unadjusted differences, would not affect the auditor's
decision about whether the financial statements are
materially misstated.
Case
s
14-33. (Estimated Time – 30 Minutes)
Year 5 Yar 4 Year 3 Year 2 Year 1

Unaudited Unaudited Unaudited Unaudited Unaudited
Accounts Receivable Gros s 535,000 295,000 265,000 207,500 175,000
Allowance for Uncollectable Accounts ($14,500) ($6,400) ($5,275) ($5,900) ($5,400)
Net Receivables 520,500 288,600 259,725 201,600 169,600
Total Assets 2,200,000 1,800,000 1,500,000 1,200,000 1,000,000
Total Revenues 2,700,000 2,050,000 1,750,000 1,400,000 1,200,000
Uncollectable Accounts Expense 33,750 25,625 21,875 17,500 15,000
Writeoff of Accounts Receivable 22,600 24,500 22,500 17,000 14,000
a. Selected Ratios
Sales to average total as sets 1.35 1.24 1.30 1.27
Industry Median 1.25 1.23 1.29 1.26
Difference 0.10 0.01 0.01 0.01
AR Growth to Sales Growth 2.53 0.65 1.15 1.13
AR collection period 55 49 48 48
Industry Median 47 48 47 47
Difference 8 1 1 1
Uncollectable account expense to net credit sales 1.25% 1.25% 1.25% 1.25%
Industry Median 1.50% 1.30% 1.25% 1.25%
Difference -0.25% -0.05% 0.00% 0.00%
Uncollectable account expense to bad debt writeoffs 1.493 1.046 0.972 1.029
b. The unaudited figures for Aurora Manufacturing, Inc. show the

following:
 There was a significant increase in sales compared to total
assets, particularly when compared to industry averages.
This is an indication of possible existence and occurrence
problems as past history of the ratio of total assets to sales
would predict lower sales levels. The auditor should expand
the scope of accounts receivable confirmations.
 The collection period is increasing relative to industry
averages and past history. Further, accounts receivable are
growing faster than sales. The Aurora continues to use a
historical rate of 1.25% of credit sales to provide for
uncollectable accounts while industry trends show an
increase in the rate of bad debts to credit sales. The is an
indication of possible problems of associated with the net
realizable value of receivables. The auditor needs to expand
the scope of tests of collection of current receivables, the
allowance for uncollectable accounts, and the provision for
bad debt expense.
Comprehensive Cases
14-34. See separate file with answers to the comprehensive case

related to the audit of Mt. Hood Furniture that is included with
this chapter.

this chapter.

this chapter.
Professional Simulation
Analytical
Procedure
s
Internal Risk Audit
Situatio Controls Assessme Procedure
n nt s
To: Audit File

Re: Analytical procedures
From: CPA Candidate
Ratio Unaudited Ratio Auditor’s Expectation

Range
Accounts Receivable 54 days 42 days – 48 days
Turn Days
Sales and Accounts Sales Growth: Sales Growth: 6% - 9%
Receivable Growth 7% Accounts Receivable
Rates Accounts Growth: 6% - 9%
Receivable
Growth: 14%
Sales to Net Fixed 10.0 6.0 – 8.0
Assets
The above analytical procedures show that receivables are growing
faster than sales, the ratios of accounts receivable turn day and
sales to net fixed assets are both significantly larger than the
auditor’s expectation. The most likely misstatement due to the
potential overstatement of both sales and receivables relates to the
occurrence of sales and the existence of receivables due to revenue
recognition problems. The increase in accounts receivable turn
days also points to possible problems with the valuation of
receivables at net realizable value due to the understatement of the
allowance for doubtful accounts.
Internal
Controls
Analytical Risk Audit
Situatio Procedure Assessme Procedure
n s nt s
Assertion
A. Existence and Occurrence
B. Completeness
C. Rights and Obligations
D. Valuation and Allocation
E. Presentation and Disclosure
Identify the appropriate assertion for each of the following internal
controls. Check all that apply.
Internal Control (A) (B) (C) (D) (E)
1. The computer prints a report of
all shipments that have not     
resulted in a sales invoice.
2. The computer matches the date
on the bill of lading with the
    
accounting period when the sales
invoice is recorded.
3. The computer matches prices on
the sale invoice with prices on the     
master price list.
4. The computer matches the     
customer number on the sales
invoice with the customer number
on the master customer file.
5. The computer compares control
totals on shipping documents     
with corresponding control totals
Risk
Assessme
nt
Analytical Internal Audit
Situatio Procedure Controls Procedure
n s s
To: Audit File

Re: Control Risk Assessment
From: CPA Candidate
Based on the following assessments the auditor should assess

control risk as moderate for the purpose of considering the controls
over the accounts receivable balance. Accounts receivable is
affected by the existence and occurrence assertion for credit sales
(low in this case) and the completeness control related to cash
receipts (moderate in this case) and sales return (low in this case).
A conservative risk assessment would be to use a moderate risk
assessment for control risk when planning the confirmation of
accounts receivable.
Control Risk
Control Assessment
The computer matches sales invoice information with Low
underlying shipping information.
The computer matches sales prices with the Low
authorized price list.
A prelist is prepared for cash receipts and compared Moderate
with deposit slips.
The computer prepares a daily report of authorized Low
sales returns that have not resulted in a receiving
report or a credit memo.
Audit
Procedure
s
Analytical Internal Risk
Situatio Procedure Controls Assessme
n s nt
Audit procedure
A. Select a sample of recorded sales transactions from several
days before and after year-end and examining supporting sale
invoices and shipping documents to determine that sales were
recorded in the proper period.
B. Trace beginning balance for accounts receivable to the prior
year’s working papers.
C. Send positive confirmations for accounts receivable and follow-
up on disputed confirmations.
D. Trace a sample of revenue transactions from shipments to
recorded sales invoices in the sale journal.
E. Determine whether there are credit balances that are
significance in the aggregate that should be reclassified as
liabilities.
F. Send confirmations to entities that have purchased accounts
receivable.
G. Compare uncollectable accounts expense to net credit sales.
H. Review activity in the general ledger account for accounts
receivable and investigate entries that appear unusual in
amount or source.
I. Use generalized audit software to recompute the aging of
accounts receivable and investigate the credit history of
accounts that are over 60 days past due.
J. Observe that all cash received through the close of business on
the last day of the fiscal year is include in cash on hand or
deposits in transit and that now receipts of the subsequent
period are included.
Determine the audit procedure that best addresses the following

risks.
Risk (A) (B) (C) (D)
(E) (F) (G) (H) (I)
(J)
1. Recorded sales may not represent     
goods shipped during the year.     
2. The allowance for doubtful accounts
may not reasonably estimate the
    
difference between gross
    
receivables and their net realizable
value.
3. All sales during the period may not     
be recorded.     
4. All legal claims on accounts     
receivable are adequately disclosed.     
5. Accounts receivable information
may not be appropriately classified     
and presented in the financial     
statements.

Boynton SM CH 14

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CHAPTER 14

AUDITING THE REVENUE CYCLE

14-1. a. The revenue cycle includes the activities involved in the

b. The classes of transactions in this cycle for a

b. Specific audit objectives for credit sales transactions

14-3. Following are a few examples of differences between how

a. Certain balance sheet accounts like accounts receivable

b. The computer company auditor will have significant

14-4. Factors that might motivate management to deliberately

Factors that might contribute to unintentional misstatements

14-5. a. Following are example analytical procedures that the

Industry Possible Analytical Procedures

b. Two analytical procedures that the auditor might use to

Analytic Procedure Audit Significance

c. Two analytical procedures that the auditor might use to

Analytic Procedure Audit Significance

14-6. Several control environment factors and their applicability

14.7.The following table summarizes the functions that apply to

Computer Files and Records

Delivering Warehousing and Documents

Line operating Computer Files and Records

Computer Files and Records

14-8. In order to assess control risk as low based on programmed

Control Importance to Control Risk

14-9. The following tables describes programmed controls for a

14-10. A common management control involves having

14-11. The sub-functions involved in cash receipts include (1)

14-12. a. Two important controls pertaining to cash sales and the

b. Two important controls pertaining to the initial handling of

b. Depositing receipts intact daily means that all receipts

14-14. Four controls that can aid in preventing or detecting errors

Control Test of Control

14-15. a. The functions pertaining to sales adjustments

b. The following three types of controls pertaining to sales

14-16. a. The accounts receivable balance is a function of the

b. The primary control over the balance involves sending

d. Public companies normally control establish controls over

14-17. The following table provides example controls and tests of

14-18. a. The transaction classes that should be considered in

b. In assessing control risk for the existence or occurrence

Assertion Inherent Control Analytic Test of Details

14-20. In vouching recorded accounts receivable transactions to

Both cutoff tests relate to the occurrence and completeness

14-22. a. It may not be necessary to confirm accounts receivable

b. Factors to be considered in choosing the form of

c. When no response is received after the second or third

14-23. a. The aged trial balance is used primarily in assessing the

b. Procedures applied to the aged trial balance include (1)

c. After testing the accuracy of the aged trial balance the

d. Hindsight allows auditors to evaluate the reasonableness

14-24. GAAP disclosure for accounts receivable include:

14-25. (Estimated Time: 15 Minutes)

The auditor should consider separately audit the revenues

Revenues for the 27 owned properties represent direct

Revenues for the 40 managed hotels will likely be related to

14-26. (Estimated time - 25 minutes)

1. The following table provides the solutions to the

2. Receivables are growing faster than sales. In addition,

14-27. (Estimated time - 20 minutes)

Internal Control Questionnaire

14-28. (Estimate Time: 30 Minutes)

Weakness Recommended Improvement

Finance committee is not Finance committee should