Auditing, 12e (Arens)
Chapter 12 Audit of the Sales and Collection Cycle; Tests of Controls
12.1 Identify and describe typical records and transactions in the sales cycle
1) The overall objective in the audit of the sales and collection cycle is to evaluate whether
A) the sales account and the accounts receivable account are free of errors.
B) the sales account and the accounts receivable account are free of material errors.
C) the sales account and the accounts receivable account are presented fairly in accordance with
an applicable financial reporting framework.
D) the account balances affected by the cycle are fairly presented in accordance with an
applicable financial reporting framework.
2) Which of the following actions is more likely to be a result of error rather than fraud?
A) consignment sales are knowingly recorded as revenue
B) orders are shipped to a customer with a bad credit rating
C) fictitious revenue transactions are recorded and reported
D) subsequent period revenue is deliberately recorded in the current period
3) There are three main types of revenue manipulations. Which of the following revenue
manipulations affects the occurrence objective?
A) recording subsequent period sales as current period sales
B) the use of “bill and holds” (goods are invoiced but not shipped)
C) understatement of bad debts
D) creation of fictitious sales that are misclassified as revenue
4) There are three main types of revenue manipulations. Which of the following revenue
manipulations affects the cutoff objective?
A) avoiding recording of returns and allowances for the year
B) recording subsequent period sales as current period sales
C) understatement of bad debts
D) creation of fictitious sales that are misclassified as revenue
5) There are three main types of revenue manipulations. Which of the following revenue
manipulations affects the valuation objective?
A) recording subsequent period sales as current period sales
B) the use of “bill and holds” (goods are invoiced but not shipped)
C) understatement of bad debts
D) creation of fictitious sales that are misclassified as revenue
6) Which of the following controls pertains to audit trails in the batch processing of sales
transactions?
A) groups of documents are totalled
B) audit trail is available in electronic form
C) the focus is on preventing incorrect transactions
D) remittance advice information is matched to sales invoice numbers
7) What is the primary focus with respect to error detection and correction for the online
processing of sales transactions?
A) reject groups of transactions when one transaction is in error
B) trace daily sales totals from the journals to the general ledger
C) account for numeric sequencing of input documents
D) prevent the entering of incorrect transactions using data entry edits
8) What information would be considered semi-permanent as well as transaction information?
A) Customer number or code
B) Customer credit limit
C) Transaction amount
D) Current balance outstanding
9) Which of the following data elements would be included in the customer master file as semi-
permanent information?
A) transaction date
B) credit limit
C) transaction amount
D) amount paid
10) Which of the following is an example of a data entry input edit that could be used to improve
the accuracy of online data entry of sales orders?
A) matching of customer number to master file
B) automatic posting of sales to the general ledger account
C) reconciliation of the customer master file to accounts receivable
D) daily point-of-sales control totals matched to cash receipts
11) Before goods are shipped on account to a new customer, a properly authorized person must
A) prepare the sales invoice.
B) approve the journal entry.
C) approve credit.
D) verify that the unit price is accurate.
12) Which of the following documents and records is used to record the packages, weights and
sizes shipped using an external trucking company?
A) remittance advice
B) shipping advice containing shipment tracking number
C) returns receiving report
D) bill of lading
13) A document sent to each customer showing his or her beginning accounts receivable balance
and the amount and date of each sale, cash payment received, credit memo issued, and the
ending balance is the
A) accounts receivable subsidiary ledger.
B) monthly statement.
C) remittance advice.
D) sales invoice.
14) A document that describes which accounts receivable accounts are to be written off and why
is called a(n)
A) uncollectible account authorization form.
B) journal entry authorization form.
C) master file change form.
D) sales returns and allowances journal.
15) A document that is used to describe and authorize additions, changes or deletion of sales
prices or customer data is called a(n)
A) uncollectible account authorization form.
B) journal entry authorization form.
C) master file change form.
D) transaction file change form.
16) Poor controls over credit limit approval or in changing the credit limit in the master file may
result in
A) confused and frustrated customers.
B) incomplete sales records.
C) financial statement errors for sales and AR accounts.
D) excessive bad debts and uncollectible account receivables.
17) Which of the following control weaknesses could result in problems with collectability of
accounts receivable?
A) Unauthorized individuals can establish or change credit limits.
B) Matching shipping documents to sales records is done weekly.
C) When there is one error in a batch of transactions, the whole batch is rejected.
D) Cash receipts are matched to the customer accounts rather than against specific invoices.
18) A document prepared for shipment of the goods sold using a trucking company is called the
A) sales order.
B) bill of lading.
C) sales invoice.
D) customer order.
19) Most companies recognize sales when
A) a customer order is received.
B) the merchandise is shipped.
C) the merchandise is received by the customer.
D) cash is received on account.
20) Some companies use a lockbox system, whereby customers mail payments to a post office
box address. The lockbox contents could be handled by a bank, another external organization, or
the owner of the company. One of the advantages of using a lockbox is that
A) improves segregation of duties.
B) results in more accurate bank deposits.
C) results in more accurate accounts receivables.
D) provides more detailed bank deposit information.
21) The document that is used to prepare and reconcile the deposit of cash and improve the
control over the custody of assets (cash) is the
A) sales invoice.
B) credit memo.
C) remittance advice.
D) cash receipts journal.
22) Zhang Corporation returned $6,000 of defective goods to Meli Inc. Meli has a strict policy of
no cash refund. Meli should
A) write off the account receivable.
B) issue a credit memo to Zhang.
C) wait until Zhang places its next order to record the return.
D) not adjust their accounting records since $6,000 is not material for Meli.
23) Proper accounting requires that an account receivable must be written off by the client when
A) the client company concludes that an amount is no longer collectible.
B) the customer files for bankruptcy.
C) a collection agency cannot inspire the customer to pay the debt.
D) the account is at least six months old.
24) A) Describe the four business functions that result in sales transactions in a typical sales and
collection cycle and, for each function, state the key documents and records involved.
B) State the five classes of transactions that comprise the sales and collection cycle.
C) The sales and collections cycle is comprised of nine business functions. The first four
functions result in sales transactions. Discuss each of the remaining five business functions that
occur after sales transactions, and identify the key documents and records involved in each of
those five functions.
25) During your lunch, your audit team went to a local mall, in the food court, since they needed
to be quick today. You dropped off a photofinishing film at a film developer, saying that you
would pick it up after work that day. After telling you that she preferred using her digital camera
to using regular film, your supervisor said,
“Next week, you are going to be working at a client that just happens to be a group of
photography stores. Tell me, what controls do you think should be programmed into the cash
register to help ensure that sales transactions are accurate and complete?”
Required:
Answer your supervisor’s question.
26) Gonzo is an on-line dating agency. Gonzo has been in business for 5 years and has been able
to reach revenues of $1 million last year. Given its recent expansion, Gonzo’s shareholders have
required that the company’s financial statements be audited for the first time this year. You have
been assigned to the audit team for this mandate.
The senior manager asked you to review the process description for the sales of Gonzo. The
manager asked you to identify the controls in place that could be tested and used for the audit
and also, any controls that might be missing. Briefly explain the impact on the audit.
Gonzo’s CEO provided you with the following description of their processes and activities for
the past year:
Sales
Gonzo’s web-site is operational 24 hours per day. All of the sales for Gonzo are done on-line
when the customer opens a profile. A customer will pay $50 to open a profile and will then pay
$10 per month to keep his profile active. Most customers pay on-line with their credit cards and
the sale is automatically recorded in the sales ledger of Gonzo at the time of payment.
Gonzo also had a promotion for the last 3 months of the year. If the customer wanted to
subscribe for one year, they could pay $100 upfront to keep their profile active for the full year
instead of paying $10 each month for 12 months. This proved to be a popular sales tactic as
customers enjoyed the $20 savings.
Web-Site Security
In the past year, one hacker managed to intrude the web-site and steal the credit card information
of 25 Gonzo customers. To ensure quality of customer service, Gonzo reimbursed a total of
$10,000 to the customers to compensate them for the amounts that were stolen as a result of the
intrusion on their web-site. Since then, Gonzo hired a third party, Mindster Box, to update the
security features of their web-site. Mindster Box performs monthly updates to the security
features and monitors any intrusion attempt. Gonzo did not have a problem since.
Collection and Reconciliation
As most of the sales are done by credit card, Gonzo receives the money from large credit card
companies on a by-weekly basis.
When the money is received from the credit card company, Jo-Ann, the accounting manager of
Gonzo, reconciles the detail of the payments received by the credit card company to the sales
ledger of Gonzo. Jo-Ann has often complained that this is nearly impossible to do since the
accounting system of Gonzo keeps track of the payment by the on-line user name which is often
very different from the actual name of the person as stated on the detailed report provided by the
credit card company.
Jo-Ann therefore mostly relies on the statement of the credit card company to record and adjust
revenues reported by Gonzo.
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27) You have just been assigned to manage the audit for a new large client of your firm, Cheap
Music Downloads Inc. (CMD). CMD is a subsidiary of a client of your firm that manufactures
audio and video equipment for international distribution. CMD has been in operation for two
years, when its custom information systems were established.
CMD runs a web site that allows customers to order songs using their credit card only. There are
tens of thousands of small transactions daily. Once the credit card has been authorized by the
credit card processing intermediary, CMD’s web sales system generates a 16 digit sequential
code that the customer uses to access the song via the web site. CMD will then record both the
sale and the royalty for the song.
Quarterly, CMD remits royalties to artists based upon the number of copies of the song that has
sold, if the accumulated royalty exceeds $25.00 for that artist. Artist royalties that do not exceed
$25.00 will be paid every two years if there has not been a payment during that time.
All contracted royalty rates, artist names and song titles are recorded in CMD’s database tables.
Required:
Describe three internal controls that should exist over sales or royalty transactions or over the
database tables. For each control:
(i) State the control
(ii) Describe (not just state) the audit assertion associated with the control
(or state the purpose of the control)
(iii) Provide an audit test that you could use to test the control
12.2 State the relationship between overall audit planning risks and risks for sales and
collections cycle assertions
1) As the quality of the enterprise risk management process declines, and the quality of internal
controls over all declines
A) risk of fraud decreases.
B) risk of fraud increases.
C) the extent of control testing increases.
D) the extent of substantive testing decreases.
2) The information systems audit specialist on your audit team has indicated that the general
controls over program changes are excellent for all application cycles. What impact does this
have upon your audit of sales invoice processing?
A) Generalized audit software should be used to select a sample of sales transactions for control
testing.
B) Tests of controls should be omitted; only substantive tests may be conducted.
C) There could be problems with the accuracy of calculations for sales taxes and goods and
excise taxes.
D) The auditor can place reliance upon the programs performing sales calculations.
3) The information systems audit specialist on your audit team has indicated that the general
controls over program changes are inadequate for all application cycles. What impact does this
have upon your audit of sales invoice processing?
A) The auditor could potentially rely upon only manual controls.
B) Only interdependent controls should be considered for control testing.
C) It is likely that calculations, such as extensions, are performed consistently and accurately
throughout the year.
D) Unauthorized access to information recorded in the master files is likely.
4) One of the reasons that the auditor considers the type of information systems and its functions
is to
A) assess whether hardware functioning affects applications.
B) evaluate design effectiveness of internal controls.
C) complete risk assessment by audit assertion for cycles.
D) assess whether programmed controls can be relied upon.
5) When a company uses purchased software packages for its accounting software, such
packages normally do not permit the company to change the software package’s functionality.
This means that the auditor will consider
A) access controls as being poor.
B) program change controls as poor.
C) program change controls as excellent.
D) access controls as being excellent.
6) When there are problems with program change procedures or with access controls the auditor
may choose to
A) rely less upon manual controls since control risk has been increased.
B) not rely on programmed or interdependent application controls.
C) reduce control risk, which reduces the level of substantive testing.
D) use an information technology audit specialist to assess programmed application controls.
7) One of the key internal controls to prevent transactions in the sales and collection cycle to
fictitious customers is to
A) have the bank reconciliation done by someone who is independent of the treasury function.
B) account for the integrity of the numerical sequence of sales orders.
C) compare customer numbers entered to the customer master file.
D) include the sales price list of all products in the computer files.
8) To test for recorded sales for which there were no actual shipments, the auditor traces from the
A) bill of lading to the sales journal.
B) sales journal to the shipping documents.
C) sales journal to the accounts receivable subsidiary ledger.
D) bill of lading to the supporting customer order and sales order.
9) Tamra is performing a test of control consisting of looking at the numerical sequence of credit
memos issued by the company. Tamra is performing a block test by looking for any missing
number in the sequence. This test will provide evidence of
A) completeness.
B) occurrence, completeness.
C) occurrence and accuracy.
D) accuracy and completeness.
10) Which of the following control procedures may prevent the failure to bill customers for some
shipments?
A) Each shipment should be supported by a prenumbered sales invoice that is accounted for.
B) Each sales order should be approved by authorized personnel.
C) Sales journal entries should be reconciled to daily sales summaries.
D) Each sales invoice should be supported by a shipping document.