20) A communication addressed to the debtor requesting him or her to confirm whether the
balance as stated on the communication is correct or incorrect is a
A) legal confirmation.
B) negative confirmation.
C) positive confirmation.
D) bank confirmation.
21) A positive confirmation is more reliable evidence than a negative confirmation because
A) the auditor has a document which can be used in court.
B) follow-up procedures can be performed if a response is not received from the debtor.
C) the debtor’s lack of response indicates agreement with the stated balance.
D) fewer confirmations can be sent out.
22) Negative confirmations of accounts receivable is less effective than positive confirmations of
accounts receivable because
A) a majority of recipients usually lack the willingness to respond objectively.
B) some recipients may report incorrect balances that require extensive follow-up.
C) the auditor cannot infer that all nonrespondents have verified their account information.
D) negative confirmations do not produce evidential matter that is statistically quantifiable.
23) The auditor obtains corroborating audit evidence for accounts receivable by using positive or
negative confirmation requests. Under which of the following circumstances might the negative
form of the accounts receivable confirmation be useful?
A) A substantial number of accounts are in dispute.
B) Internal control over accounts receivable is ineffective.
C) Client records include a large number of relatively small balances.
D) The auditor believes that recipients of the requests are unlikely to give them consideration.
24) Which one of the following circumstances would indicate that positive confirmations should
be used on this engagement?
A) A significant portion of the total accounts receivable balance is represented by a small
number of accounts with large balances.
B) The internal control over accounts receivable is good.
C) The recipients are mostly businesses rather than individuals.
D) The auditor is unaware of disputed or inaccurate accounts.
25) The use of the negative (as opposed to the positive) form of receivables confirmation is
indicated when
A) internal control surrounding accounts receivable is considered to be ineffective.
B) there is reason to believe that a substantial number of accounts may be in dispute.
C) a large number of small balances are involved.
D) accounts receivable consists of current balances only.
26) Beltrand, PA, is auditing the financial statements of a small rural municipality. The
receivable balances represent residents’ delinquent property taxes or receivables over the due
date. The internal controls at the municipality are weak. To determine the existence of the
accounts receivable balances at the balance sheet date, Beltrand would most likely
A) send positive confirmation requests.
B) send negative confirmation request.
C) examine evidence of subsequent cash receipts.
D) inspect the internal records such as copies of the tax invoices that were mailed to the
residents.
27) The most reliable evidence from confirmations is obtained when they are sent
A) several months before the year-end, so the auditor will have adequate time to perform
alternate procedures if they are required.
B) at various times throughout the year to different sections of the sample, so that the entire
sample is representative of account balances scattered throughout the year.
C) as close to the balance sheet date as possible.
D) at various times throughout the year to the same group in the sample, so that the sample will
not have a time bias.
28) Frag Jones Company has a December year end, with a tight reporting deadline, so the
auditors confirmed the accounts receivable as of November 30 using positive confirmations. In
addition to following up confirmation discrepancies, the auditor should
A) test December transactions.
B) send negative confirmations as of the end of December.
C) text November transactions.
D) do cut-off testing for the month of October.
29) After the items for confirmation have been selected, the auditor must maintain control of the
confirmations until
A) the names are provided to client’s personnel to type the envelopes.
B) the sealed envelopes are provided to client’s personnel to be mailed.
C) the responses are received by the client with the return mail.
D) they are returned by the debtor to the auditor.
30) An auditor should perform alternative procedures to substantiate the existence of accounts
receivable when
A) no reply to a positive confirmation request is received.
B) no reply to a negative confirmation request is received.
C) collectability of the accounts receivable is in doubt.
D) pledging of the accounts receivable is probable.
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31) Positive accounts receivable confirmations were circularized, and there were many
differences where the client stated that the goods had not been received as of the date of the
confirmation. In addition to the possibility that the goods were not received by the client, this
type of reported difference could be an indication of
A) a cutoff misstatement.
B) timing differences with respect to recording sales returns.
C) improper recording of sales allowances.
D) theft of cash or lapping.
32) State the five specific balance-related audit objectives as applied to accounts receivable.
33) You are the auditor of Foundry Inc., a company that manufactures chocolate bars and
assorted candies. The description of the sales and collection cycle for Foundry is as follow:
Clients & Credit Limits
Foundry has 50 clients as they mostly sell to grocery stores’ central purchasing departments or
distributors. For each customer, Foundry performs a credit check prior to setting the credit limit
for the client. The credit limit is reviewed each year.
In the past year, the credit limits were increased by 10%. This is due to the growth in product
lines of Foundry and increased demand from customers. This also came at the same time the
CEO of Foundry set the objective of growing the company’s revenue by 25% over the next two
years. Increasing the credit limit has helped Foundry move towards that objective.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is calculated by the controller by taking a percentage of the
total sales for the month. The controller has been taking 3% of total sales. The estimate has not
been revised in the current year, but it has always been sufficient to cover for any write-off
incurred.
Required: For each of the two areas discussed above, identify the risk areas and the most likely
misstatements for Foundry.
34) Discuss the alternative procedures an auditor can perform to test the existence objective for
accounts receivable when customers do not respond to confirmation requests.
35) A) An auditor is concerned that accounts receivable may be understated due to sales to
customers that have been omitted from the sales journal and from the accounts receivable master
file. Describe the procedure(s) the auditor should perform in these circumstances.
B) Describe how the auditor tests the classification objective for accounts receivable.
36) A) Assuming the client’s internal controls are adequate, describe how the auditor can verify
proper cutoff of sales transactions.
B) Describe how the auditor tests the rights objective for accounts receivable.
37) A) Describe the differences between positive and negative confirmations. Which type is
more reliable?
B) Discuss the advantages and disadvantages of using negative accounts receivable
confirmations rather than positive confirmations.
C) Discuss the circumstances in which it is acceptable to use negative confirmation requests.
D) The auditor’s decision regarding the type of accounts receivable confirmation to use involves
a continuum, starting with using no confirmations in some circumstances, to using only
negatives, to using both positives and negatives, to using only positives. Discuss the primary
factors affecting this decision.
38) You are conducting an audit and have obtained the following figures with respect to sales
and accounts receivable:
2012 2011
Accounts receivable $ 3,343,000 $ 2,694,000
Allowance for doubtful accounts 212,150 207,660
Sales 25,640,000 24,630,000
Required:
A) What are the audit implications of these figures?
B) Identify key audit steps that you would perform for any of the above accounts.
39) Following are three different situations with respect to the audit of accounts receivable and
sales. For each, specify the evidence mix that you would use (tests of control, substantive tests,
type of confirmation/timing), and explain why.
A) The client is in a volatile industry, selling products that can quickly become technically
obsolete. Total accounts receivable is $65 million, with a bad debt allowance of $7 million. The
company has recently laid off three accounting staff to save money.
B) A small company has 45 different customers, with balances ranging from $500 to $25,000 per
customer. There is one accountant on staff, and a professional accountant comes in once per
week for three hours to review the work and prepare journal entries. Bad debts are rare, as the
owner is actively involved in accounts receivable collection.
C) Big Department Store Finance Corporation has fifty staff in the accounting department, a
sophisticated software package, and about $250 million in accounts receivable. The corporation
manages the department store credit cards. About 100,000 credit card customers have balances
less than $300 on their accounts, while the balances for the remaining customers range up to a
maximum of $5,000.
40) Your audit client is a large retail chain with its own credit card, with annual sales of about
$100 million. On December 31, there were approximately 40,000 open accounts with total
receivables of approximately $18.5 million. Very few customer balances exceed $1,000. The
company’s general office maintains the accounts receivable records. The large volume of
transactions processed by the company has necessitated extensive segregation of duties and
frequent balancing of data during processing. Accordingly, the company’s general and system
controls are considered to be very good. A complete record of each customer’s account is stored
on a relational database and includes the following information:
Description of field contents
Type of account (personal, corporate) Customer account number
Customer name and address Credit limit (code for 8 credit levels)
Status code (Active, inactive, bad debt) Number of transactions this month
Current month’s charges Current month’s payments
Total Outstanding Balance Aged balance over 30 days
Aged balance over 60 days Aged balance over 90 days
Aged balance over 120 days Year account opened
Year last active Total purchases this year to date
Total returns this year to date Number of months active
Total purchases last year Number of months active last year
Source transactions are store purchase invoices, payments, and adjustments. Daily, all the orders
are received and entered into the computer and processed against the customer master file. Each
account is updated and automatically analyzed to determine whether the transactions just
processed have created a condition that should be brought to the attention of the authorization or
collection sections. Exception reports are automatically printed and forwarded to these groups.
The company sends monthly statements to customers on a cyclical basis. About 2,000 statements
are mailed each billing day. As the accounts are updated, the day’s transactions are accumulated
and added to the starting control figure for each cycle. The new control figures are balanced with
the sum of all the individual accounts in the cycle (accumulated as each account is processed). In
addition, a detailed transaction and cycle control report is prepared, providing an audit trail in
customer account number sequence.
Required:
Describe the audit procedures you would perform in your year end audit work of accounts
receivable for this company. For each audit test, state the relevant audit assertion(s). Be sure to
include different types of tests as necessary (e.g. manual, or using computer assisted audit
techniques), and clearly identify those tests that can be completed using CAATs.
13.4 Illustrate the risk assessment and substantive tests of accounts receivable using Hillsburg
Hardware Limited
1) In monetary-unit sampling, the values of the estimated likely maximum misstatements are
referred to as the
A) point estimates.
B) precision intervals.
C) confidence intervals.
D) misstatement bounds.
2) When errors are found, a common and standard assumption in practice is to assume
A) a 100% assumption for all errors.
B) that the actual sample errors are representative of the population errors.
C) that the population errors are larger than the sample errors.
D) that the population errors are smaller than the sample errors.
3) Whenever a statistical method is used, a decision rule determines whether the population is
acceptable. The decision rule for dollar-unit sampling is “Accept the conclusion that the book
value is not misstated by a material amount if
A) the upper error bound falls between the understatement and overstatement tolerable
misstatement amounts.”
B) both the lower and upper error bound falls between the understatement and overstatement
tolerable misstatement amounts.”
C) both the understatement and overstatement tolerable misstatement amounts fall between the
upper and lower error bound.”
D) the overstatement tolerable misstatement amount falls between the lower and upper error
bound.”