Problem 9-3, Page 473 Key Control, Control Test Evaluation The auditor learns that the auditee has a control procedure in place that addresses the validity of sales and existence of accounts receivable. When a truck driver picks up goods from the warehouse, the warehouse employee has the driver sign a “shipper’s receipt” showing the quantities and item numbers shipped, and the customer information. The shipper’s receipts are filed in date order in the warehouse office. A copy of the signed shipper’s receipt is sent to the accounting office where it is used to record the reduction in inventory and issue a sales invoice. The invoice number is noted on the shipper’s receipt and it is filed by invoice number in the accounting area. Since the auditee has a large number of customers, the auditor decides that this control will be tested. Required: Why would the auditor decide this is a key control? What will the auditor achieve by testing this control? Design a control test the auditor could perform for this control procedure. Describe the two parts of the test in detail. Assume the auditor performs a control test and finds the control procedure operated properly 95% of the time. How does this evidence affect the auditor’s control risk assessment? What if the control operated 60% of the time? 99% of the time?

The auditor would consider this a key control because it is an important procedure to make sure all invoices that were issued were for real sales. If it was not performed well non-existent sales could be entered and not detected.   The control test will indicate how well the company’s control procedures actually worked during the period under audit. If the test provides evidence that this control operated effectively during the audit period, the auditor can assess a low control risk for the controls relating to the existence assertion in receivables and sales. Since the auditee has a large number of customers, a large number of accounts would need to be audited at year end to get sufficient evidence that accounts receivable balance exists (is not overstated). This control test provides evidence that can allow the auditor to reduce the amount of substantive testing that needs to be done on the audit of year-end accounts receivable balance. This may be efficient. Also, this control test can be designed in a way to provide evidence on both control effectiveness and substantive evidence on existence of the sales transactions - if the test includes tracing the sale to the sales journal in the accounting records. This dual purpose test can be even more efficient than just testing the control itself. A control test has two parts. Part 1 is an identification of the data population from which a sample of items will be selected for audit. Here the sample will be selected from the population of sales invoices issued during the year. The sample should include invoices from throughout the year so the test will provide evidence for the whole audit period. Part 2 is a description of the action taken to produce relevant evidence. Here the action is to determine whether the selected invoices agree with information in another data population, the Shipper’s Receipts filed in the warehouse office for the whole year. At 95% or 100% the auditor would probably be able to conclude that this control is operating effectively. The larger the sample of invoices tested, the more confidence the auditor would have in this conclusion. For example, if 20 invoices were tested and one was wrong, compliance is 95%. If 100 invoices were tested and 5 were wrong the compliance rate is still 95% but the auditor has more confidence that this is the compliance rate for the whole population. Similarly, if 2 invoices were tested and neither was wrong, compliance is 100% but unless more invoices are examined the auditor would not have a lot of confidence assuming 100% compliance for the whole population. And as long as the auditor only looks at a sample and not the entire population of invoices, he or she can never have 100% confidence that the control is always operating. If the control test finds the control only operates 60% of the time, this is probably too low a compliance rate to indicate the control is reliable, regardless of how many invoices are tested. In this case there is probably no point in doing more control testing - the auditor should assume the control risk is high and do more substantive tests that can determine directly if there are misstatements (overstatements in this case) in sales and accounts receivable.

Problem 9-6, Page 475 Exhibit 9-6 contains an arrangement of example of transactions errors (lettered a – g) and a set of auditee control procedures and devices (numbered 1-15). a. Sales recorded, goods not shipped. b. Goods shipped, sales not recorded. c. Goods shipped to a bad credit risk customer d. Sales billed at the wrong price or wrong quantity. e. Product line A sales recorded as Product line B. f. Failure to post charges to customers for sales. g. January sales recorded in December. Control Procedures 1. Sales order approved for credit 2. Prenumbered shipping doc prepared, sequence checked 3. Shipping document quantity compared to sales invoice 4. Prenumbered sales invoices, sequence checked 5. Sales invoice checked to sales order 6. Invoiced prices compared to approved price list 7. General ledger code checked for sales product lines 8. Sales order batch totals compared to sales journal 9. Periodic sales total compared to same period accounts receivable postings 10. Accountants have instructions to date sales on the date of shipment 11. Sales entry date compared to shipping document date 12. Accounts receivable subsidiary totaled and reconciled to accounts receivable control account 13. Intercompany accounts reconciled with subsidiary company records 14. Credit files updated for customer payment history 15. Overdue customer accounts investigated for collection

Required: Opposite the examples of transaction letters a-f in Exhibit 9-6, write the name of the control objective organizations wish to achieve to prevent, detect, or correct the error. Opposite each numbered control procedure, place an X in the column that identifies the error(s) the procedure is likely to control by prevention, detection, or correction. For each error/control objective, identify the financial statement assertion most benefited by the control. For each company control procedure numbered 1-15 in Exhibit 9-6, write an auditor’s control test that could produce evidence on the question of whether the company’s control procedure has been installed and is operating effectively.

Problem 9-6, Page 369 a. Sales recorded, goods not shipped. VALIDITY b. Goods shipped, sales not recorded. COMPLETENESS c. Goods shipped to a bad credit risk customer. AUTHORIZATION d. Sales billed at the wrong price or wrong quantity. ACCURACY e. Product line A sales recorded as Product line B. CLASSIFICATION f. Failure to post charges to customers for sales. ACCOUNTING – POSTING AND SUMMARIZATION g. January sales recorded in December. PROPER PERIOD - CUTOFF Control Procedures 1. Sales order approved for credit X 2. Prenumbered shipping doc prepared, sequence checked 3. Shipping document quantity compared to sales invoice 4. Prenumbered sales invoices, sequence checked 5. Sales invoice checked to sales order 6. Invoiced prices compared to approved price list 7. General ledger code checked for sales product lines 8. Sales order batch totals compared to sales journal 9. Periodic sales total compared to same period accounts receivable postings 10. Accountants have instructions to date sales on the date of shipment 11. Sales entry date compared to shipping document date 12. Accounts receivable subsidiary totaled and reconciled to accounts receivable control account 13. Intercompany accounts reconciled with subsidiary company records 14. Credit files updated for customer payment history 15. Overdue customer accounts investigated for collection Note: Other categorizations bedsides those above may also be valid

For each error/control objective, identify the financial statement assertion most benefited by the control.   Assertions a. "Validity" Sales recorded, goods not shipped Existence/occurrence Ownership (Rights/obligations) b. "Completeness" Goods shipped, sales not recorded Completeness c. "Authorization" Goods shipped to a bad credit Valuation risk customer d. "Accuracy" Sales billed at the wrong price or wrong quantity e. "Classification" Product A sales recorded as Presentation/ Product line B disclosure f. "Accounting" Failure to post charges to customers for sales also Valuation g. "Proper period" January sales recorded in December

Auditee control procedures and auditor’s control tests For each auditee control procedure numbered 1-15, write an auditor's control test that could produce evidence whether the auditee's control procedure has been installed and is operating effectively. Sales Invoice Sample: Select a sample of random numbers representing recorded sales invoices, and: 1. Inspect the attached sales order for credit approval signature. 1. Trace customer to up-to-date credit file/information underlying the credit approval. 2. Inspect the attached shipping document for (i) existence, and (ii) prenumbering imprint. 3. Compare billed quantity on sales invoice to shipped quantity on shipping document. 4. Find the sales invoice associated with the random number (failure to find means an invoice wasn't recorded). Alternatively, use computer to add up the recorded sales invoice numbers and compare to a sum of digits check total. 5. Compare sales invoice to sales order for quantity, price, other terms. 6. Compare prices on sales invoice to approved price list. 7. Check product code for proper classification compared to product invoices. 11. Compare invoice date to shipping document date. 14. Note whether credit files are updated for customer payment history.