1. Electronic Presentations in Microsoft ® PowerPoint ® Prepared by Brad MacDonald SIAST © 2009 McGraw-Hill Ryerson Limited

2. Learning Objectives Chapter Overview Chapter 11 Revenues, Receivables, and Receipts Process Tous droits réservés McGraw Hill Ryerson.

3. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 3 Learning Objectives 1.Describe the revenues, receivables, and receipts process, including typical transactions, source documents, controls and account balances. 2.Outline control tests for auditing control over customer credit approval, delivery, accounts receivable, cash receipts and bank statement. 3.Explain the importance of the existence assertion for the audit of cash and accounts receivable. 4.Identify considerations for using confirmations when auditing cash and accounts receivable. 5.Perform substantive audit procedures for the audit of bank statement reconciliations, explaining how auditors can search for lapping and kiting. Tous droits réservés McGraw Hill Ryerson.

4. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 4 Chapter Overview Understanding the Revenues, Receivables, and Receipts Process Control Risk Assessment Special Note: The Existence Assertion Special Note: Using Confirmations Special Note: Audit of Bank Reconciliations with attention to Kiting and Lapping Tous droits réservés McGraw Hill Ryerson.

5. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 5 Understanding the Revenue, Receivables and Receipts Process The auditor must understand the business’s method of generating revenues and use of them in operations in order to assess the business risk and risk of misstatement. Tous droits réservés McGraw Hill Ryerson.

6. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 6 Risk Assessment for Revenues, Receivables and Receipts An organization’s ability to generate revenues are critical aspects that an auditor must understand. –The auditor mainly considers revenue and receipt transactions and accounts receivable balances. –Management’s assertions regarding existence, ownership, completeness, valuation and disclosure all present risks the auditor needs to consider. Tous droits réservés McGraw Hill Ryerson.

7. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 7 Revenues, Receivables and Receipts Process: Typical Activities Refer to Exhibit 11-1 –Revenue, receivables and receipt process activities include: Receiving and processing customer orders. Delivering goods and services to customers. Billing customers and accounting for receivables. Collecting and depositing cash. Reconciling bank accounts. Tous droits réservés McGraw Hill Ryerson.

8. Revenue and Collection Process Start Here Customer Orders Bill Customers Collections Warehousing Shipping and Delivery Credit Granting Tous droits réservés McGraw Hill Ryerson.

9. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 9 Authorization When a customer order is received, a number of authorizations are required. –Customer status, credit status and availability of inventory need to be verified before a sales order can be created. –The proper price for the sale also needs to be determined. –Once approved, an open sales order and a packing slip are created, and inventory may be updated for the commitment of goods. Tous droits réservés McGraw Hill Ryerson.

10. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 10 Custody Physical custody of inventory starts with the stockroom or warehouse where inventory is kept. –Custody is transferred to the shipping department on the authorization of the packing slips. –If stock keepers or shippers have the ability to change quantities shown on packing slips, a weakness in separation of duties is created. Tous droits réservés McGraw Hill Ryerson.

11. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 11 Custody Custody of accounts receivable implies the power to alter those records. –Receivable balances can be altered directly, or by entering transactions such as returns, allowances or write-offs. –Personnel with this power may have a combination of incompatible responsibilities. Tous droits réservés McGraw Hill Ryerson.

12. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 12 Recording When the shipment is complete, several documents are created: –a bill of lading as evidence of the actual delivery of goods, –a sales invoice that bills the customer for the goods, and –the open sales order is closed. –Personnel with the ability to enter, alter, or physically intercept the sales invoice may have a combination of incompatible responsibilities. Tous droits réservés McGraw Hill Ryerson.

13. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 13 Periodic Reconciliation A comparison of the total unpaid balances to the accounts receivable control account is a common reconciliation. –This should be performed by personnel who have no responsibility over authorization, custody or recording of transactions. –An aged trial balance is usually used for this reconciliation. Tous droits réservés McGraw Hill Ryerson.

14. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 14 Cash Receipts and Cash Balances Most companies require little authorization to accept payments from customers. –Cash can be received in many ways, over the counter, mail, lockbox, or electronic funds transfer. –Authorization is required for approving discounts, returns and allowances. Receiving cash and approving discounts or allowances are incompatible functions. Tous droits réservés McGraw Hill Ryerson.

15. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 15 Custody At some point, someone has the cash and cheques in hand, and has physical custody at that point. –A number of controls should be considered, including rotation of staff, technological controls and insurance. Tous droits réservés McGraw Hill Ryerson.

16. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 16 Recording The accountants who record cash, should not also handle cash. –Cash should be recorded using the remittance lists. –The cash account, accounts receivable control account, and the accounts receivable subsidiary accounts are all updated. Tous droits réservés McGraw Hill Ryerson.

17. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 17 Periodic Reconciliation Bank reconciliations need to be prepared carefully. –Deposit slips should be traced to the cash remittance lists, paid cheques should be compared to the disbursements journal. –The reconciliation should be performed by personnel who do not have responsibility for recording cash receipts or disbursements. Tous droits réservés McGraw Hill Ryerson.

18. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 18 Audit Evidence in Management Reports and Data Files Audit evidence will be found in a number of reports created by management: –Pending order master file (completeness). –Credit check files (up-to-date maintenance). –Price list master file (must be correct for billing). –Sales detail (sales journal) file (compare to shipments and dates). –Sales analysis reports (by product line, by employee and investigate unusual items). –Accounts receivable aged trial balance (assessing bad debts and accounting for balances). –Cash receipts journal (deposits, receipts, adjusting entries re: bank). Tous droits réservés McGraw Hill Ryerson.

19. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 19 Control Risk Assessment Control risk assessment governs the nature, extent, and timing of substantive audit procedures applied in the audit of account balances. Tous droits réservés McGraw Hill Ryerson.

20. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 20 Control Risk Assessment Account balances affected by the revenue, receivable and receipts process include: cash in bank cash receipts accounts receivable allowance for doubtful accounts bad debt expense sales revenue sales returns allowances and discounts perpetual inventory records and shipping records Tous droits réservés McGraw Hill Ryerson.

21. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 21 Control Risk Assessment General Control Considerations: –Ensure proper segregation of responsibilities. –Consider bonding of key employees. –Control structure should provide for detailed checking of business rules and/or policies. –Control information is collected through an internal control questionnaire or by conducting a walk-through. Tous droits réservés McGraw Hill Ryerson.

22. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 22 Detailed Test of Controls Tests of controls should address all of the control objectives. –Cut-off is important to revenue cycle. –Tests include identification of population and expression of the action to be taken. Note dual direction of testing for completeness and validity requires selection of sample from appropriate population. –See Exhibit 11-4 for procedures. Tous droits réservés McGraw Hill Ryerson.

23. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 23 Control Risk Assessment The purpose of testing controls is to determine nature, extent, and timing of substantive procedures. –Good controls – low control risk: Smaller sample sizes, earlier timing for substantive tests. –Poor controls – high control risk: Larger samples, more work at year end. Tous droits réservés McGraw Hill Ryerson.

24. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 24 Substantive Procedures Audit procedures to gather direct evidence on account balances are called substantive procedures. –Recalculation, observation, confirmation, enquiry, vouching, tracing, scanning, and analytical review. Detailed list in Appendix 11C –Dual purpose procedures – gain substantive purpose evidence and control purpose evidence with the same test. Tous droits réservés McGraw Hill Ryerson.

25. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 25 Special Note: The Existence Assertion For accounts receivables and other assets, auditors place emphasis on existence and rights assertions. –Computation Focus on assets that depend largely on calculations. –Inspection of Physical Assets Inventories and assets can be examined, title documents can be vouched, security documents can be inspected. Tous droits réservés McGraw Hill Ryerson.

26. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 26 Special Note: The Existence Assertion –Confirmation Bank accounts, receivables can be confirmed. Assets at other locations or in the hands of custodians can also be confirmed. –Enquiry Enquire as to agreements regarding minimum balances, pledging of receivables, pledging of other assets. Tous droits réservés McGraw Hill Ryerson.

27. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 27 Special Note: The Existence Assertion –Inspection of documents (vouching) Examine title documents, collateral, pledges. –Inspection of documents (scanning) Look for misclassified assets, uncharacteristic balances, errors or overpayments, or related party transactions and balances. Tous droits réservés McGraw Hill Ryerson.

28. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 28 Special Note: The Existence Assertion –Analysis Comparison of assets to related revenues or expenses, expenses with revenues, contra revenues with revenues, and write-offs. Tous droits réservés McGraw Hill Ryerson.

29. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 29 Special Note: Using Confirmations Confirmation is considered to be a required generally accepted audit procedure. –For cash and loan balances, a standard bank confirmation form is used for confirmation of deposit and loan balances. There are sections on the form for: –deposits and overdrafts, –loans and other direct or contingent liabilities, and –exceptions and comments. Tous droits réservés McGraw Hill Ryerson.

30. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 30 Confirmation of Accounts and Notes Receivable Confirmations can provide evidence about existence and valuation of accounts and notes receivable. –Statistical methods can be used to determine the size and selection of accounts to be confirmed. –Confirmations may make use of positive confirmations or negative confirmations. Confirmation will not provide sufficient evidence regarding ownership. Tous droits réservés McGraw Hill Ryerson.

31. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 31 Positive Confirmations A positive confirmation requires a response in all cases, whether the balance is correct or incorrect. –Used where individual balances are large, or where accounts are in dispute. –The confirmation may ask for information on balances or specific invoices depending on knowledge of the customer’s accounting records. –Generally produces high quality evidence. Tous droits réservés McGraw Hill Ryerson.

32. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 32 Negative Confirmations The negative confirmation form only requires a response if the customer disagrees with the balance. –Useful where inherent and control risk are low, where a great number of customers are involved, and where the auditor believes that the customers will handle the confirmations correctly. –Evidence collected is considered less reliable than from use of positive confirmations. Tous droits réservés McGraw Hill Ryerson.

33. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 33 Confirmations The auditor needs to control the confirmations, including the address to which they are sent. –This will ensure that confirmations reach the intended customers, and that the customers actually exist. –Auditors also need to be concerned with response rate, and need to consider alternative procedures where response rate is poor. Tous droits réservés McGraw Hill Ryerson.

34. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 34 Confirmations Confirmation of receivables can be performed at a date other than year-end in some cases. –The auditor needs to consider the strength of controls affecting receivables. –Some additional procedures will be required at year-end. Tous droits réservés McGraw Hill Ryerson.

35. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 35 Summary: Confirmations –Confirmations of cash, loans and accounts and notes receivable are required unless auditors can justify substituting procedures. –Auditors need to exercise care in ensuring that responses are received from real debtors. –Note that other procedures are required to assess collectability of receivables and ownership of receivables. Tous droits réservés McGraw Hill Ryerson.

36. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 36 Audit of Bank Reconciliation Bank reconciliations are audited 100%: –Bank balance is confirmed with bank. –The reconciliation is recalculated and re- footed. –Reconciling items are vouched 100% to supporting documentation. –The auditor obtains cutoff bank statement directly from the client’s bank. Tous droits réservés McGraw Hill Ryerson.

37. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 37 Accounts Receivable Lapping Manipulation of accounts receivable to cover a theft or fraud. –Receipts from one customer are applied to another customer’s account to cover misappropriation payments received. –Audit will include comparison of cheques on a daily deposit slip to the detail of customer accounts credited on that day. Looking for a customer credited for whom no payment received. Tous droits réservés McGraw Hill Ryerson.

38. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 38 Cheque Kiting Deliberate floating of funds using “hot cheques” to create apparent cash balances. –The depository bank does not know the cheque is on insufficient funds, and the deficiency will be covered by a second hot cheque. –Uses the time required for cheques to clear to obtain an unauthorized short-term loan. –Auditor will review all interbank transfers. Tous droits réservés McGraw Hill Ryerson.

39. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 39 Casettes – Substantive Procedures Specific examples of test of controls and substantive procedures are in the form of casettes (mini-case studies). –Each case has the following parts: Method Paper Trail Amount Audit ObjectiveControl Test of Controls Audit of Balance Audit Approach Tous droits réservés McGraw Hill Ryerson.

40. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 40 Audit Casettes: Substantive Audit Procedures 11.1 The Embezzling Cashier –Problem: Cash embezzlement caused overstated accounts receivable, overstated customer discounts expense and understated cash sales. Company failed to earn interest income on funds “borrowed.” Tous droits réservés McGraw Hill Ryerson.

41. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 41 Audit Casettes: Substantive Audit Procedures 11.2 Bill Often, Bill Early –Problem: Overstated sales and receivables understated discounts expense and overstated net income resulted from recording sales too early and failure to account for customer discounts taken. 11.3 Thank Goodness It’s Friday –Problem: Overstated sales caused overstated net income, retained earnings, current assets, working capital and total assets. Overstated cash collections did not change the total current assets or total assets, but they increased the amount of cash and decreased the amount of accounts receivable. Tous droits réservés McGraw Hill Ryerson.