Assertions are defined to be representations by management, explicit or otherwise, that are embodied in the financial statements, as used by the auditor to consider the different types of potential misstatements that may occur. 1.2 HKSA 500 Audit Evidence states that the auditor should use assertions “in sufficient detail to form a basis for the assessment of risks of material misstatement and the design and performance of further audit procedures”. Assertions used by the auditor are categorized as follows:
(a) assertions about classes of transactions and events for the period under audit;
(b) assertions about account balances at the period end; and
(c) assertions about presentation and disclosures. Categories Assertions Descriptions a. Class of transactions and events 1. Occurrence Transactions and events that have been recorded have occurred and pertain to the entity. 2. Completeness All transactions and events occurred and pertain to the entity should have been recorded. 3. Accuracy Amounts and other data relating to recorded transactions and events have been recorded appropriately. 4. Cut-off Transactions and events have been recorded in the correct period. 5. Classification Transactions and events have been recorded in the proper accounts. b. Account balances 1. Existence Assets, liabilities and equity interests are in existence. 2. Rights and obligations The entity possesses and controls the rights to assets, and liabilities are the obligations of the entity. 3. Completeness All assets, liabilities and equity interests that are in existence and owned by the entity have been recorded. 4. Valuation and allocation Assets, liabilities and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded. c. Presentation and disclosure 1. Occurrence and rights and obligations Disclosed events, transactions, and other matters have occurred and pertain to the entity. 2. Completeness All disclosures that have occurred and pertain to the entity have been included. 3. Classification and understandability Financial information is appropriately presented and described, and disclosures are clearly expressed. 4. Accuracy and valuation Financial and other information is disclosed fairly and at appropriate amounts. 2. Audit Objectives 2.1 Each audit procedure that an auditor carries out must gather evidence to serve his desired purposes. The purposes are the audit objectives that should be met in order to state the appropriate opinion on the specific account or balance, then to a specific group of accounts or balances, hence to the entire financial statement.
2.2 The audit objectives can be classified into transaction-related audit objectives and balance-related audit objectives. The former intends to help auditors to accumulate sufficient and appropriate audit evidence in supporting the classes of transactions being audited while the latter helps auditors in supporting the account balances.
2.3 The general transaction-related audit objectives and balance-related audit objectives together with the comparison to assertions mentioned in HKSA 500 are stated in the following tables. a. Audit objectives table: General transaction-related audit objectives General balance-related audit objectives Existence Existence Completeness Completeness Accuracy Accuracy Classification Classification Timing Cutoff Posting and summarization Detail tie-in Realisble value Rights and obligations Presentation and disclosure b. Comparison of transactions-related audit objectives to assertions General transaction-related audit objectives Assertions about classes of transactions and events for the period under audit Existence Occurrence Completeness Completeness Accuracy Accuracy Classification Classification Timing Cutoff Posting and summarization c. Comparison of balance-related audit objectives to assertions General balance-related audit objectives Assertions about classes of transactions and events for the period under audit Existence Existence / Occurrence Completeness Completeness Accuracy Accuracy and valuation Classification Classification Cutoff Cutoff Detail tie-in Valuation and allocation Realizable value Valuation and allocation Rights and obligations Rights and obligations Presentation and disclosure Accuracy and valuation
3. Documents and Records 3.1 Customer order (客戶訂單) – a request for goods from an existing or a new customer received by sales representative or other personnel in the sales department. 3.2 Sales order (銷售訂單) – a document recording the description, quantity and/or related information of the goods and services ordered to confirm the order received. It is also used internally for credit approval and authorization for delivery of goods or services.
3.3 Shipping document/goods delivery note (送貨單) –
(a) a document prepared at the time when the goods are shipped or delivered, detailing the description, the quantity shipped and other relevant data.
(b) bill of lading (提單) is an example of the shipping document that is prepared by the carrier to acknowledge the receipts of goods and also serves as a notice to customer for shipment by the seller.
3.4 Sales invoice – a document indicating the details of goods sold, such as descriptions, quantity, terms of sales and the total price billed.
3.5 Sales journal (sales day book) – a journal for recording sales and it serves as a posting summary to the general ledger.
3.6 Credit note (貸記單)
(a) It is raised as a result of approval for customers’ returns or granting allowances to customers.
(b) Its function is like an invoice but acts in the opposite way that it indicates the amount to be deducted from a customer’s account.
3.7 Sales returns and allowances journal – similar to the sales journal mentioned above but it records the sales returns and allowances on the other hand (i.e., the credit notes)
3.8 Remittance advice (付款通知書) – a document prepared by the customer indicating his name, the numbers and the amounts of the individual invoices paid by him. That is, this document is received from the customer with his payment.
3.9 Cash receipt journal – a journal for recording cash receipts from cash sales, collections and all other cash received.
3.10 Accounts receivable ledger – a subsidiary ledger of customers accounts for recording individual sales, cash receipts, sales returns and allowances.
3.11 Monthly statement (月結單) – a document sent to each customer detailing the beginning balance of the month, the movement of transactions during the month like the amount and date of each sale, return and cash receipt, and the ending balance due. 4. Planned Risks Assessment Procedures 4.1 Understanding of the client business and transactions 4.1.1 An audit usually starts with an understanding of client’s nature of business and related transactions and documents. This can facilitate the inherent risk assessment.
4.1.2 The business functions and its related documents, classes of transactions and account balances of the sales and collection cycle are summarized in the following table. Business functions Related documents Classes of transactions Account balances 1. Process customer orders and grant credit.
2. Ship and deliver goods.
3. Bill customers and record sales. Customer order, sales order, shipping documents, delivery notes, sales invoices, sales day book, accounts receivable ledger Sales of goods and rendering of services for cash or credit. Dr. Accounts receivable
Cr. Sales revenue 4. Process and record cash receipts. Remittance advice, pay-in slip, bank book, accounts receivable ledger The receipt of cash from the customer for the goods and services received. Dr. Cash
Cr. Accounts receivable 5. Process and record goods returns and allowances. Credit note, returns inward day book The return of goods by the customer for cash or credit Dr. Sales return
Cr. Accounts receivable 6. Write off uncollectible accounts receivable Uncollectible account authorization, general journal, accounts receivable ledger Write off of uncollectible accounts to bad debt expenses Dr. Bad debt
Cr. Accounts receivable 7. Allowance for doubtful debts General journal, accounts receivable ledger Allowance for doubtful debt Dr. Bad debt expenses
Cr. Allowance for doubtful debts 4.1.3 The purpose of preliminary analytical procedures at planning phase(a) To understand the client’s business and transactions;
(b) To identify financial statement accounts that are likely to have errors; and
(c) To allocate more resources to investigate those accounts of high risks; that is those accounts with material misstatements. 4.2 Assessment of inherent risks 4.2.1 In examining the sales and collection cycle, the auditor should consider the inherent risk factors that may affect both the sales revenue and cash receipts transactions and the financial statements accounts affected by those transactions.
4.2.2 Examples of the inherent risk factors that may affect the sales and collection cycle are as follows:
(a) Business related or industry related factors such as competitiveness, changes in technology and government regulations. For example, due to the decline in competitiveness, the company may face a declining sales volume which can lead to operating losses and poor cash flows.
(b) The presence of misstatements in previous audits indicates that it is likely that a misstatement to be present during the current year audit.
(c) Illegal acts and related party transactions. 4.2.3 High inherent risk of the completeness of sales revenue (especially in cash sales) (Dec 12, Jun 13, Dec 13) (a) There are numerous transactions for a restaurant, for example, and the chances of human error are high.
(b) Cash is subject to a high risk of misappropriation. Staff will not report the sales if cash is misappropriated. How to mitigate?
(a) However, the control risk is considered as medium to low if the company has installed the computerized billing system to prevent the omission of sales transactions.
(b) There is adequate segregation of duties and the computerized system can help to reduce human error. 4.3 Preliminary assessment of control risks 4.3.1 A preliminary assessment of control risks is carried out by the auditor for the purposes of:
(a) evaluating the effectiveness of internal control for preventing material misstatements in the financial statements.
(b) planning the nature, timing and extent of testing.
(c) evaluating the effect of information technology on client’s accounting systems, availability of data and the need to use computer-assisted techniques. 5. Control Risks Assessment of Sales and Collection Cycle 5.1 Assertions used by the auditor in sales and collection cycle 5.1.1 Classes of sales transactions
(Dec 13, Jun 14, Dec 14)
AssertionsDescriptions 1. Occurrence Recorded sales are for title of goods actually transferred to customers. 2. Completeness All existing sales transactions are recorded. 3. Accuracy Recorded sales are according to the accurate amount presented in the sales invoice in terms of (1) units shipped to customer, (2) unit price and (3) total amount of the sales. 4. Timing/cut-off Sales are recorded at the correct dates/periods. 5. Classification Sales transactions are properly classified and record in the correct account. 5.1.2 Classes of cash receipt transactions
(Jun 10)
AssertionsDescriptions 1. Occurrence Recorded receipts are for cash actually received by the company. 2. Completeness Existing cash receipts are recorded. 3. Accuracy Cash receipts are recorded at the amount received. 4. Timing Cash receipts are recorded at the correct dates/periods. 5. Classification Cash receipts transactions are properly classified and record in the correct account. 5.1.3 Accounts receivable balances
(Dec 11)
AssertionsDescriptions 1. Existence Recorded accounts receivable are in existence. 2. Rights and obligations Ownership to accounts receivable are valid. 3. Completeness All accounts receivable are recorded. 4. Cut-off Accounts receivable transactions around the year end date is included in the appropriate accounting period. 5. Valuation and allocation Accounts receivable are included in the financial statements at appropriate amounts. => bad debts & allowance for doubtful debts 6. Presentation and disclosures All events, transactions, and other matters relating to accounts receivable of the entity are properly presented and disclosed. 5.2 Steps for assessing the control risks of sales and collection cycle 5.2.1 Steps for assessing the control risks (Jun 09, Jun 14)Control risk is the risk that material misstatements will not be prevented or detected by internal control. To assess the control risk for sales and collection cycle, the auditor should take the following steps:
(a) Understand and document internal controls over the sales process based on a reliance approach;
(b) Plan perform tests of controls on sales transactions; and
(c) Set and document the control risk for the sales process. 5.3 Understanding and documenting of internal controls 5.3.1 Control activities over sales and receipts – six major functions in a typical sales and receipts cycle
(a) Processing customer orders
(b) Shipping/dispatching goods
(c) Billing customers and recording sales
(d) Processing and recording cash receipts
(e) Processing sales returns and allowances
(f) Writing off bad debts and providing for doubtful debts (a) Processing customer orders Control Activities Test of Controls - All customer orders should be checked for credit limit and proper authorization. Special approval needed if credit limit exceeded
- Orders should be matched with invoices to follow up delivery and billing. Outstanding orders should be prepared periodically for management review and actions.
- Examine the orders for proper approval on granting credit to both existing and new customers. (existence)
- Scrutinize the sales order forms to identify if they are properly accounted for, e.g. sequentially prenumbered. (completeness)
- Ensure that outstanding orders are properly followed up by senior staff and sequence checks are done by senior staff. (completeness)
(b) Shipping/dispatching goods Control Activities Test of Controls - Goods cannot be shipped without prior approval.
- Despatch notes should be pre-numbered and a register kept of them to relate to sales invoices and orders.
- Select a sample of shipping documents to ensure that shipments of goods are done after proper authorization. (existence)
- Ensure that deliveries of goods are recorded and properly accounted for by using pre-numbered dispatch notes. (completeness)
- Examine the duplicate of goods delivery note for customer’s signature as evidence of receipt of goods. (existence)
(c) Billing customers and recording sales Control Activities Test of Controls - Customers should be correctly and timely billed.
- Ensure that sales journal and the accounts receivable subsidiary ledger are updated frequently to provide latest information.
- Examine copies of sales invoices for supporting shipping documents, e.g. bills of lading and customers’ orders. (existence)
- Select a sample of sales invoices and examine for the numerical sequence. (completeness)
- Examine documents for unbilled shipments and unrecorded sales at any time. (completeness)
- Observe the mailing of monthly statements to customers by a properly designated person. (existence and accuracy)
(d) Processing and recording cash receipts Control Activities Test of Controls - All cash/cheques receipts should be recorded in cash receipts journal and deposited in the bank on a timely basis.
- Accounts receivable subsidiary ledger should be updated promptly.
- Policy on granting cash discounts must exist.
- Observe the procedures of handling cash receipts to ensure that the persons are completely independent of the handling accounts receivable functions. (existence)
- Ensure that cash/cheques received are banked promptly and intact. (existence)
- Control account reconciliation is prepared promptly and having supervisor’s review. (accuracy)
- Discuss with management for policy established for granting of cash discounts.
(e) Processing sales returns and allowances Control Activities Test of Controls - Sales returns and allowances should be promptly investigated and then recorded with confirmation.
- Pre-numbered credit notes should be issued and recorded promptly.
- Examine credit notes to ensure that they are pre-numbered and sequentially accounted for. (completeness)
- Examine relevant documents, e.g. correspondence with customers, credit notes issued with approval, etc. (existence)
(f) Writing off bad debts and providing for doubtful debts Control Activities Test of Controls - Credit manager’s approval should be obtained.
- Adequate allowance should be provided for outstanding debts.
- Examine the policy for bad debts written-off and provision for bad debts. (existence)
- Examine documents, e.g. bad debts written off form, to obtain evidence of whether policy has been followed up and authorization has been granted. (existence)
- Examine manager’s approval for calculation of provision for doubtful debts. (accuracy)
5.4 Test of controls classified by assertions (a) Classes of sales transactions Assertions Test of Controls 1. Occurrence - Examine proper approvals for customers’ orders, delivery notes, and sales invoices.
- Observe the independent handling of complaints about monthly statement.
2. Completeness - Check the numerical sequence and completeness of delivery notes and sales invoices.
- Trace samples of delivery notes to the related sales invoices and entries in the sales day book.
3. Accuracy - Examine proper approval for customers’ order and delivery notes and examine indications of internal review for recording sales transactions.
4. Timing - Review documents for unbilled shipments and unrecorded sales and compare the dates on delivery notes, sales invoices and entries on sales journal.
5. Classification - Review chart of accounts and independent review for proper classification.
(b) Classes of cash receipt transactions
(Jun 10)
AssertionsTest of Controls 1. Occurrence - Observe segregation of duties and independent reconciliation of bank balances.
2. Completeness - Observe immediate preparation of incoming cheque listing and endorsement of income cheques.
3. Accuracy - Review periodic bank reconciliation prepared by independent person.
4. Timing - Examine evidence for daily deposit of cash receipts and review of bank reconciliation.
5. Classification - Trace cash receipts to cash receipt journal for proper classifications and review cash book for unusual items.
- Inspect the signatures for proper approval.
(c) Accounts receivable balances Assertions Test of Controls 1. Existence - Select samples from debtors list and send debtors’ confirmation.
2. Rights and obligations - Review bank confirmation for accounts receivable pledged to bank.
4. Completeness - Trace samples of delivery notes to the related sales invoices and entries in the sales day book and in debtors’ ledger.
4. Cut-off - Review the accounts receivable transactions around the year-end in the debtors’ ledger and trace to the supporting sales invoices and delivery notes to ensure that they are recorded in the correct period.
5. Valuation and allocation - Examine evidence of approval of allowance for bad debts.
6. Presentation and disclosures - Review evidence of internal review for proper disclosure of those accounts with pledging of accounts receivable and are of related party transactions, etc.
Question 1
You have worked on the audit for Company A, a company selling medicine to more than three hundred pharmacy stores, for a few years and this year you are manager-in-charge of the audit. A newly-recruited accounting graduate who has no practical experience is assigned as your assistant. He does not agree to perform any further audit procedures on the cash receipts during the year since confirmations will be sent to the banks for the year end balances and confirmation will be sent to selected receivables. Required: (a) Identify and briefly explain the five assertions of cash receipts. (10 marks)
(b) List the general audit procedures that should be performed on the bank reconciliation statements? (5 marks)
(c) Provide one test of control procedure associated with each of the assertions of cash receipts. (5 marks)
(HKIAAT PBE Paper III Auditing and Information Systems June 2010 Q5) 6. Substantive Procedures for Sales and Cash Receipts Transactions 6.1 Analytical procedures for sales transactions 6.1.1 Analytical procedures are useful for examining the fairness of accounts of sales revenue, cash receipts, sales returns and discounts, and bad debt expenses. 6.1.2 Examples of the analytical procedures for sales revenue and cash receipts (Jun 13)(a) Compare gross profit percentage (by product line/ by geographical location) with previous years and industry data.
(b) Compare reported revenue with budgeted revenue.
(c) Compare sales return or discounts as a percentage of revenue to previous years and/or industry data.
(d) Analysis of ratio of sales in the last month to total sales for the quarter or year.
(e) Estimate the sales commission by multiplying net revenue by commission rate and compare with recorded sales commission expense. 6.2 Substantive procedures for sales transactions 6.2.1 Examples of substantive tests for sales transactions are as follows: Assertions Substantive procedures 1. Occurrence - Select samples from sales journal and trace to sales orders, sales invoices and delivery notes.
2. Completeness - Trace delivery notes/ sales invoices to entries in sales day book and debtors’ ledger.
3. Accuracy - Vouch details of sales invoices to related customers’ orders, price lists and delivery notes; and
- Trace sales invoice to recorded sales.
4. Timing - Compare dates of recorded sales transactions with dates on delivery notes.
5. Classification - Examine supporting documents for sales transactions and evaluate whether the transactions are properly classified.
6.3 Substantive procedures for cash receipts transactions 6.3.1 Examples of substantive tests for cash receipts transactions are as follows: Assertions Substantive procedures 1. Occurrence - Trace from cash receipt journal to bank statement and proof of cash receipts.
2. Completeness - Trace delivery notes/sales invoices to entries in sales day book and debtors’ ledger.
- Trace the incoming cheque listing with the bank statements and cash receipt journal.
3. Accuracy - Trace from cash receipt journal to sales invoices, bank statement and proof of cash receipts.
4. Timing - Compare dates of cash receipts listing, pay-in slip and entries in cash book.
5. Classification - Examine documents supporting cash receipts for proper classification.
6.4 Substantive procedures for unearned revenue 6.4.1 Examples of the substantive procedures for unearned revenue (Dec 12, Dec 14, Jun 15)(a) Obtain the list of unearned revenue from the client.
(b) Check casting and agree the total to the trial balance.
(c) Review the list for large and unusual items and verify to ensure the existence and accuracy of the liability
(d) Select samples from the unearned revenue list and check to the control list.
(e) Select samples from control list and check to the unearned revenue list.
(f) Reconcile the number of unearned revenue coupons to the earned revenue coupons.
(g) Check the coupon price to a coupon.
(h) Recalculate the unearned revenue.
(i) Review the basis for computing unearned revenue, ensure that it is consistently applied as in the prior year and in accordance with GAAP.
7. Tests of Details of Accounts Receivable 7.1 Under HKSA 330, the substantive procedures for testing accounts receivable involve:
(a) Substantive analytical procedures – useful in checking accounts receivable and related accounts either at the planning stage or as an overall review.
(b) Tests of details of:
(i) classes of accounts receivable transactions – procedures are similar to substantive testing for sales transactions.
(ii) accounts receivable balances – sending debtor’s confirmation is an essential procedure for obtaining existence, rights and valuation of the accounts receivable.
(iii) disclosures. 7.2 Analytical procedures 7.2.1 Examples of the analytical procedures for accounts receivable (Jun 11, Dec 12)(a) Compare accounts receivable turnover and days outstanding in accounts receivable with previous years’ and industry data.
(b) Compare bad debt expense as a percentage of sales revenue to previous years and industry data.
(c) Compare percentage of allowance for doubtful debts to accounts receivable to previous years and industry data.
(d) Aging analysis of outstanding balances. Compare with previous year and note any drastic changes.
(e) Compare the total balance of trade receivables with that of last year. 7.3 Tests of details of accounts receivable
(Dec 11, Dec 12, Dec 14)
Audit ObjectivesSubstantive procedures 1. Existence - Select samples from debtors’ list and vouch to the sales invoices/shipping documents, and send debtors’ confirmation.
2. Rights and obligations
(Dec 14) - Review any liens on accounts receivable by inquiry of management and examining bank confirmation, loan agreement, and board minutes.
- Send confirmation to bank and examine correspondence files that may disclose the evidence of client’s right to trade receivable.
3. Completeness - Select samples from shipping documents/ delivery notes and trace them to the related sales invoices and to sales day book.
- Obtain a list of the individual balances from the debtors’ ledger.
- Check casting and agree the total to the trade receivables figure in the draft financial statement.
- Obtain a list of credit balances in the debtors’ ledger and obtain explanations from management.
4. Valuation and allocation
(Dec 11, Dec 14) - Examine results of debtors’ confirmation and review aging analysis and correspondences with debtors for any disputes arose before and after year end.
- Discuss the assumptions underlying the general provision with management to ensure reasonable.
- Recalculate the provision based on management’s assumptions and agree to the figure in the financial statements.
- Compare the prior year provision to the amounts actually written off as bad in the year to test how accurate management usually are in estimating possible bad debts.
- Obtain a list of aged receivables and investigate the recoverability of any old balances.
- Check whether receivables have been settled after the year-end to ensure recoverability.
- Where overdue receivables have not been settled, trace the balances to the allowance for doubtful debts. Where the balances are not included in the allowance, discuss with management the basis on which they believe the debtor to be recoverable.
- Ensure doubtful receivables and recoveries identified from other audit work are properly reflected in the income statement.
5. Cut-off - Select sample of good received notes immediately prior to the year-end and immediately after the year end and ensure that they have been recorded in the correct period.
6. Presentation and disclosures - Evaluate the adequacy of disclosure for debtors’ balances that have been pledged as security by reviewing bank confirmation and other supporting documents.
Question 2
The firm PC & Co., your employer, is the external auditor of Great Mind Limited (“GML”) which is a company that carries out a trading business. As the manager in charge of the audit of the financial statements of GML, you have worked on this audit assignment for a few years. The company employed a new accountant in June 2011, James Chow, an accounting graduate from a University, as the previous accountant resigned. A newly recruited junior is assigned as your assistant. You decided to let the assistant carry out some audit procedures regarding the sales cycle and trade receivables. GML has a year end of 31 December 2011. Required: (a) How does the change in the accountant at GML affect the extent of test of controls and test of details? (2 marks)
(b) What are the analytical procedures for trade receivables? (6 marks)
(c) Besides presentation and disclosure, what are the other four assertions for trade receivables? For each of these four assertions, provide two tests of details procedures.
(10 marks)
(d) What are the possible substantive procedures for sales cut off? (2 marks)
(HKIAAT PBE Paper III Auditing and Information Systems December 2012 Q2)
8. Debtors’ Confirmation (Debtors’ Circularisation) 8.1 Procedures of sending debtors’ confirmation 8.1.1 Procedures (Jun 11, Jun 13)(a) Select sample of receivables to be circularized.
(b) Inform client of intended list of those to be circularized.
(c) Consider implications if client objects to any of the accounts selected being circularized.
(d) Record names and amounts circularized.
(e) Record replies received and consider implications of any accounts not agreed.
(f) For non-replies perform alternative procedures so as to obtain sufficient appropriate audit evidence for accounts receivable balances. 8.2 Controls over confirmation requests and responses 8.2.1 Controls (Jun 11, Dec 12, Jun 13)HKSA 505 requires the auditor, when using external confirmation procedures, to maintain control over external confirmation requests, including:
(a) determining the information to be confirmed or requested;
(b) selecting the appropriate confirming party;
(c) designing the confirmation requests, including determining that requests are properly addressed and contain return information for responses to be sent directly to the auditor; and
(d) Sending the requests, including follow-up requests when applicable, to the confirming party. Question 3
The firm of WM & Co., your employer, is the external auditor of Bubble Boom Limited (“BBL) which is a company in the wholesale business. You have worked on this audit assignment for a few years and this year you are the senior in charge of the audit. You have already conducted tests of controls for the transaction cycles, and control risks are assessed as medium for these cycles. You decide to let an audit assistant help you perform some analytical procedures for accounts receivables and send out debtors’ confirmation. Required: (a) Provide four examples of analytical procedures for accounts receivable. (4 marks)
(b) What are the procedures for sending out debtors’ confirmation? (5 marks)
(c) What control should the auditors maintain over the external confirmation procedures?
(3 marks)
(d) Subsequent to the date of the financial report, as part of your audit procedures after the balance sheet date; but before the issue of the audit report, you learned of the bankruptcy of BBL’s unsecured debtor with a material balance. The newspaper described the event in detail. BBL did not write off this bad debt. There is no other material misstatement except this issue. What kinds of opinion may be expressed by the auditor? (5 marks)
(e) Define materiality and state how it affects the audit opinion. (3 marks)
(HKIAAT PBE Paper III Auditing and Information Systems June 2011 Q4) 8.3 Audit objectives and assertions addressed by the confirmation 8.3.1 Audit objectives addressed by the confirmation (Dec 11)External confirmation of an account receivable provides reliable and relevant audit evidence regarding:
(a) The existence of the account as at a certain date.
(b) Confirmation may provide further evidence on the cut-off of sales revenue recognition and cash receipts.
(c) The rights and obligations assertions.
(d However, confirmation does not ordinarily provide all the necessary audit evidence relating to the valuation assertion. It is because the confirmation does not guarantee the ability of the customer to pay the amount due. Question 4
The firm of FM & Co. is the external auditor of a digital product trading company, DP Limited. Peter Pan has worked on this audit assignment for several years and this year he is the senior in charge of the audit. After conducting the test of controls for the sales and purchases transaction cycles, he assessed the control risks as medium for the transaction cycles. He instructed his assistant to carry out some substantive procedures for trade payables and trade receivables. Peter told the assistant that the partner will perform the overall review after one month. Required: (a) What are the possible analytical procedures for trade payables? (3 marks)
(b) What are the assertions for trade receivables? (4 marks)
(c) What are the possible substantive procedures for the valuation assertion for trade receivables? (6 marks)
(d) If all confirmations of trade receivables are returned and confirmed, there is adequate audit evidence for the valuation assertion. Do you agree? Please explain. (3 marks)
(e) What are the objectives of performing the final overall review? (4 marks)
(HKIAAT PBE Paper III Auditing and Information Systems December 2011 Q2) 8.4 Management requests not to seek external confirmation 8.4.1 In relation to management’s request not to seek external confirmation, the auditor is required to:
(a) obtain audit evidence to support the validity of management’s requests and consider whether there are valid grounds for this.
(b) have an attitude of professional skepticism and considers whether the request has any implications regarding management’s integrity, when considering the reasons provided by management.
(c) consider whether this indicates the possible existence of fraud.
8.4.2 If the auditor agrees to management’s request not to seek external confirmation, the auditor should apply alternative audit procedures to obtain sufficient appropriate audit evidence for this purpose.
8.4.3 If the auditor does not accept the validity of management’s request and management is not willing to send external confirmation, there will be a limitation on the scope of the auditor’s work and the auditor should consider the possible impact on the audit opinion and auditor’s report. 8.5 Positive confirmation and negative confirmation (a) Positive confirmation 8.5.1 Positive confirmation requests the respondent to reply to the auditor either by indicating the respondent’s agreement with the given information, or by asking the respondent to fill in information (i.e. blank confirmation form).
8.5.2 A response to a positive confirmation request is ordinarily expected to provide reliable audit evidence.
8.5.3 If no response is received to a positive confirmation, alternative audit procedures may include the examination of the following documents:
(a) subsequent cash receipts, examination of shipping documentation or other client documentation to provide audit evidence for the existence assertion.
(b) sales near the period-end to provide audit evidence for the cut-off assertion.
(c) other records, such as goods received notes, to provide audit evidence of the completeness assertion. (b) Negative confirmation 8.5.4 Negative confirmation requests the respondent to reply only when disagreement with the information provided in the request.
8.5.5 When no response has been received to a negative confirmation request, there will be no explicit audit evidence that intended third parties have received the confirmation requests and verified that the information there is correct.
8.5.6 HKSA 505 specifies that negative confirmation may be used to verify the accounts receivable balance when all of the following conditions are met:
(a) The assessed risk of material misstatement is lower;
(b) A large number of small balances is involved;
(c) A substantial number of errors is not expected; and
(d) The auditor has no reason to believe that respondents will disregard these requests. 8.5.7 Examples of positive debtors’ confirmation REQUEST FOR CONFIRMATION OF ACCOUNTS RECEIVABLE—
POSITIVE REQUEST (Prepared on client’s letterhead) (Date)
(Customer’s name and address) Dear__________: In connection with an audit of the financial statements of (insert name of client) as of (insert date) and for the (insert period [e.g., year, quarter]) then ended, please confirm directly to our auditors (insert name and address of auditors) the amount of your indebtedness to us as of (insert date), which according to our records amounted to $______.2 Please check the appropriate response below after determining whether this is in agreement with your records. If there are differences, please provide any information in sufficient detail to assist our auditors in reconciling the difference. After checking the appropriate response below, please sign and date your reply and mail it directly to our auditors in the enclosed return envelope. DO NOT SEND ANY PAYMENTS TO OUR AUDITORS. Thank you for your anticipated timely cooperation with this request. Respectfully, (Name of client) (Client’s authorized signature and title) *********************************************** TO: (Insert auditor’s name) ( ) The balance due (insert client’s name) shown above as of (insert date) is correct. ( ) Our records show a balance of $_______ as of (insert date) and the difference may be due to the following: 8.5.8 Examples of negative debtors’ confirmation REQUEST FOR CONFIRMATION OF ACCOUNTS RECEIVABLE—
NEGATIVE REQUEST (Prepared on client’s letterhead) (Date)
(Customer’s name and address) Dear__________: Our auditors (insert name and address of auditors) are conducting an audit of our financial statements as of (insert date) and for the (insert period [e.g., year, quarter]) then ended. Our records show the amount of your indebtedness to us as of (insert date) to be $_______. If this amount is not correct, please report details of any differences directly to our auditors in the space provided below and use the enclosed return envelope. IF YOU DO NOT WRITE TO OUR AUDITORS, THEY WILL CONSIDER THE BALANCE SHOWN ABOVE TO BE CORRECT. NO REPLY IS NECESSARY IF THE AMOUNT SHOWN ABOVE AGREES WITH YOUR RECORDS. DO NOT SEND ANY PAYMENTS TO OUR AUDITORS. Thank you for your anticipated timely cooperation with this request. Respectfully, (Name of client) (Client’s authorized signature and title) TO: (Insert auditor’s name) The balance due (insert client’s name) shown above as of (insert date) is not correct. Our records show a balance of $_______ and the difference may be due to the following: Additional Examination Style Questions Question 5
In the audit of Belmont Manufacturing Co Ltd’s accounts for the year ended 31 December 2001, the following data are extracted from the accounting records.
Sales Invoice No.Date of Sales Invoice
(Note I and II) Goods Dispatched Note (GDN) No. Date of GDN Invoice Amount S0920 27 December 2001 D2193 27 December 2001 $30,000 S0921 29 December 2001 D2198 3 January 2002 $20,000 S0922 30 December 2001 D2195 29 December 2001 $40,000 S0923 30 December 2001 D2196 31 December 2001 $15,000 S0924 31 December 2001 D2200 8 January 2002 $14,000 S0925 2 January 2002 D2201 8 January 2002 $32,000 S0926 2 January 2002 D2192 27 December 2001 $50,000 S0927 3 January 2002 D2194 28 December 2001 $24,000 S0928 4 January 2002 D2199 6 January 2002 $18,000 S0929 5 January 2002 D2197 31 December 2001 $60,000 Note I: All the sales invoices are on FOB origin terms, i.e. the title passes to the buyer when the goods are shipped.
Note II: The sales journal is updated according to the date of sales invoice. Belmont Manufacturing Co Ltd recorded all the sales with invoice issued on or before 31 December 2001 as sales for the year ended 31 December 2001. It is Belmont’s pricing policy to fix its selling price at cost plus 25%. Required:
(a) Briefly explain the term “cut-off test”. (2 marks)
(b) When and why do the auditors have to obtain
(i) the number of last GDN on or before the year-end, and
(ii) the number of the first GDN after the year-end?
How would the auditors make use of these data? (4 marks)
(c) Classify each of the sales invoices from S0920 to S0929 into the correct accounting year. You are required to state the basis of your classification in general. (11 marks)
(d) Based on the cut-off error identified in (c), quantify the impact to the profit of Belmont for the year ended 31 December 2001. (3 marks)
(Total 20 marks)
(Adapted HKAAT December 2001)
Appendix I – Sales and Collection Cycle Flowchart Source: https://hkiaatevening.yolasite.com/resources/PBEAuditNotes/Ch9-SalesCycle.doc Web site to visit: https://hkiaatevening.yolasite.com Author of the text: indicated on the source document of the above text If you are the author of the text above and you not agree to share your knowledge for teaching, research, scholarship (for fair use as indicated in the United States copyrigh low) please send us an e-mail and we will remove your text quickly. Fair use is a limitation and exception to the exclusive right granted by copyright law to the author of a creative work. In United States copyright law, fair use is a doctrine that permits limited use of copyrighted material without acquiring permission from the rights holders. Examples of fair use include commentary, search engines, criticism, news reporting, research, teaching, library archiving and scholarship. It provides for the legal, unlicensed citation or incorporation of copyrighted material in another author's work under a four-factor balancing test. (source: http://en.wikipedia.org/wiki/Fair_use) The information of medicine and health contained in the site are of a general nature and purpose which is purely informative and for this reason may not replace in any case, the council of a doctor or a qualified entity legally to the profession. The texts are the property of their respective authors and we thank them for giving us the opportunity to share for free to students, teachers and users of the Web their texts will used only for illustrative educational and scientific purposes only.
What accounts are affected by sales?
Since a sales journal entry consists of selling inventory on credit, four main accounts are affected by the business transaction: the accounts receivable and revenue accounts as well as the inventory and cost of goods sold accounts.
What are the accounts and classes of transactions in the sales and collection cycle?
CLASSES OF TRANSACTIONS IN THE SALES AND COLLECTION CYCLE are – Sales (cash and sales on account), Cash receipts, Sales returns and allowances, Charge-off of uncollectible accounts and Estimate of bad debt expense.
What is the effect of sales on accounting?
Sales affects the balance sheet because sales generate revenue and revenue increases the company's assets. If your customer pays when you close the sale, the money goes into the cash account on the assets side of the balance sheet -- the current assets subsection, specifically.
What is sales and collection cycle audit?
The sales and collections cycle in a business refers to the set of processes that begin when a customer purchases goods or services and ends when your business receives payment in full.
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