Auditing and Assurance Services

Chapter 10 - Auditing the Revenue Process

Chapter 10 Auditing the Revenue Process True / False Questions

1. Revenue is realized when a product or service is exchanged for cash or a promise to pay cash or other assets that can be converted into cash. True False

2. Revenue must be realized (or realizable) and earned to be recognized. True False

3. Channel stuffing is an improper practice used to boost sales by inducing distributors to buy more inventory than they can promptly resell. True False

4. The return of vendor purchases is a part of the revenue process. True False

5. The revenue process affects numerous accounts in the financial statements. True False

6. A remittance advice is used to track purchases. True False

7. Order entry is the initial function in the revenue cycle. True False

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Chapter 10 - Auditing the Revenue Process

8. Credit authorization is used to determine if a customer is able to pay for goods. True False

9. A negative confirmation requests that customers respond whether they agree or not with the amount due to the client stated in the confirmation. True False

10. A positive confirmation requests that customers respond whether they agree or not with the amount due to the client stated in the confirmation. True False

Multiple Choice Questions

11. In general, revenue is recognized when A. Goods are shipped B. It is earned and realized C. It is recorded in the sales journal D. It is received in cash

12. According to the SEC's SAB No. 101, which of the following is not necessary for revenue recognition? A. The seller's price to the buyer is fixed B. Collectibility is reasonably assured C. The seller has determined that the buyer will take the discount D. Persuasive evidence of an arrangement exists

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Chapter 10 - Auditing the Revenue Process

13. What is channel stuffing? A. A company records revenue before delivery terms can be arranged B. A company records revenue on goods that will be shipped overseas C. A company induces distributors to buy substantially more inventory than they can promptly resell D. A company alters the terms and conditions of recorded sales to entice customers to accept delivery of goods

14. Tracing bills of lading to sales invoices provides evidence that A. Shipments to customers were properly authorized B. Recorded sales were shipped C. Billed sales were shipped D. Shipments to customers were billed

15. At which point in an ordinary sales transaction of a wholesaling business would a lack of specific authorization be of least concern to the auditor? A. Granting of credit B. Shipment of goods C. Determination of discounts D. Selling of goods for cash

16. Tracing copies of sales invoices to shipping documents will provide evidence that all A. Shipments to customers were recorded as receivables B. Billed sales were shipped C. Accounts receivable ledger is complete D. Shipments to customers were billed

17. An auditor tests an entity's policy of obtaining credit approval before shipping goods to customers in support of management's financial statement assertion of A. Valuation or allocation B. Completeness C. Existence or occurrence D. Rights and obligations

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Chapter 10 - Auditing the Revenue Process

18. Which of the following tests of controls most likely would help assure an auditor that goods shipped are properly billed? A. Scan the sales journal for sequential and unusual entries B. Examine shipping documents for matching sales invoices C. Compare the accounts receivable ledger to daily sales summaries D. Inspect unused sales invoices for consecutive prenumbering

19. Tracing shipping documents to prenumbered sales invoices provides evidence that A. No duplicate shipments or billings occurred B. Shipments to customers were properly billed C. All goods ordered by customers were shipped D. All prenumbered sales invoices were accounted for

20. Tests designed to detect credit sales made after the end of the year that have been recorded in the current year provide assurance about management's assertion of A. Classification B. Cutoff C. Occurrence D. Authorization and accuracy

21. When evaluating internal control of an entity that processes revenue transactions on the Internet, an auditor would be most concerned about the A. Potential for computer disruptions in recording sales B. Lack of sales invoice documents as an audit trail C. Frequency of archiving and data retention D. Inability to establish test data

22. Which of the following is not an inherent risk factor for the revenue process? A. Complexity of revenue recognition issues B. Difficulty of auditing transactions C. Special industry practices D. The client does not follow its stated policies for sales order approvals

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Chapter 10 - Auditing the Revenue Process

23. Data Corporation has just computerized its billing and accounts receivable record keeping. You want to make maximum use of the new computer in your audit of Data Corporation. Which of the following audit techniques could not be performed through a computer program? A. Tracing audited cash receipts to accounts receivable credits B. Selecting accounts to be confirmed on a random basis C. Examining sales invoices for completeness, consistency between different items, valid conditions, and reasonable amounts D. Resolving differences reported by customers on confirmation requests

24. In auditing accounts receivable the negative form of confirmation request most likely would be used when A. Recipients are likely to return positive confirmation requests without verifying the accuracy of the information B. The combined assessed level of inherent and control risk relative to accounts receivable is low C. A small number of accounts receivable are involved but a relatively large number of errors are expected D. The auditor performs a dual purpose test that assesses control risk and obtains substantive evidence

25. Auditors may use positive and/or negative forms of confirmation requests for accounts receivable. Which of the following statements is true regarding the auditor's use of confirmations? A. The positive confirmation form must always be used to confirm all balances regardless of size B. A combination of the two confirmation types can be used, with the positive form used for large balances and the negative form used for small balances C. A combination of the two confirmation types can be used, with the positive form used for trade receivables and the negative form for other receivables D. The positive confirmation form should be used when controls related to receivables are satisfactory and the negative confirmation form should be used when controls related to receivables are unsatisfactory

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Chapter 10 - Auditing the Revenue Process

26. In determining the adequacy of the allowance for uncollectible accounts, the least reliance should be placed upon which of the following? A. The credit manager's opinion B. An aging schedule of past due accounts C. Subsequent year collections of amounts in accounts receivable at the balance sheet date D. Ratios calculated showing the past relationship of the valuation allowance to net credit sales

27. An aged trial balance of accounts receivable is usually used by the auditor to A. Verify the existence of recorded receivables B. Ensure that all accounts are promptly credited C. Evaluate the results of tests of controls D. Evaluate the provision for bad debts

28. Audit documents often include a client-prepared aged trial balance of accounts receivable as of the balance sheet date. This aging is used by the auditor to A. Evaluate internal control over credit sales B. Test the accuracy of recorded credit sales C. Evaluate the allowance for doubtful accounts D. Verify the existence of the recorded receivables

29. In connection with the examination of financial statements by an independent auditor, the client suggests that members of the internal audit staff be utilized to minimize audit costs. Which of the following tasks could most appropriately be delegated to the internal audit staff? A. Selection of accounts receivable for confirmation, based upon the internal auditor's judgment as to how many accounts and which accounts will provide sufficient coverage B. Preparation of schedules for negative accounts receivable responses C. Evaluation of the internal control for accounts receivable and sales D. Determination of the adequacy of the allowance for doubtful accounts

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Chapter 10 - Auditing the Revenue Process

30. Which of the following is the best argument against the use of negative accounts receivable confirmations? A. The cost-per-response is excessively high B. There is no way of knowing if the intended recipients received them C. Recipients are likely to feel that, in reality, the confirmation is a subtle request for payment D. The inference drawn from receiving no reply may not be correct

31. An auditor's purpose in reviewing credit ratings of customers with delinquent accounts receivable most likely is to obtain evidence concerning management's assertions about A. Valuation and allocation B. Completeness C. Existence D. Rights and obligations

32. Which of the following controls most likely would be effective in offsetting the tendency of sales personnel to maximize sales volume at the expense of high bad debt write-offs? A. Employees responsible for authorizing sales and bad debt write-offs are denied access to cash B. Shipping documents and sales invoices are matched by an employee who does not have authority to write off bad debts C. Employees involved in the credit-granting function are separated from the sales function D. Subsidiary accounts receivable records are reconciled to the control account by an employee independent of the authorization of credit

33. Alpha Company uses its sales invoices for posting perpetual inventory records. Inadequate control activities over the invoicing function allow goods to be shipped that are not invoiced. The inadequate control activities could cause an A. Understatement of revenues, receivables, and inventory B. Overstatement of revenues and receivables and an understatement of inventory C. Understatement of revenues and receivables and an overstatement of inventory D. Overstatement of revenues, receivables, and inventory

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Chapter 10 - Auditing the Revenue Process

34. Alpha Company uses its sales invoices for posting perpetual inventory records. Inadequate control activities over the invoicing function allow goods to be invoiced that are not shipped. The inadequate control activities could cause an A. Understatement of revenues, receivables, and inventory B. Overstatement of revenues and receivables and an understatement of inventory C. Understatement of revenues and receivables and an overstatement of inventory D. Overstatement of revenues, receivables, and inventory

35. Immediately upon receipt of cash, a responsible employee should A. Record the amount in the cash receipts journal B. Prepare a listing of remittances C. Update the subsidiary accounts receivable records D. Prepare a deposit slip in triplicate

36. For the most effective internal control, monthly bank statements should be received directly from the banks and reviewed by the A. Controller B. Cash receipts accountant C. Cash disbursement accountant D. Internal auditor

37. Which one of the following would the auditor consider to be an incompatible operation if the cashier receives remittances from the mailroom? A. The cashier prepares the daily deposit B. The cashier makes the daily deposit at a local bank C. The cashier posts the receipts to the accounts receivable subsidiary ledger cards D. The cashier endorses the checks

38. Which is not a key segregation of duties for the revenue process? Different parties should A. Prepare shipping orders and prepare bills of lading B. Perform the credit and billing functions C. Perform the shipping and billing function D. Receive cash and adjust accounts receivable

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Chapter 10 - Auditing the Revenue Process

39. All of the following are important controls over credit memos except A. Proper segregation of duties to ensure that sales discounts taken were earned B. Credit memos should be approved by someone other than whoever initiated it C. Credit memos should be supported by a receiving document for returned goods D. Proper segregation of duties between access to customer records and authorizing credit memos

40. An auditor would consider a cashier's job description to contain compatible duties if the cashier receives remittances from the mailroom and also A. Records the journal entry to recognize the cash receipt B. Prepares the monthly bank reconciliation C. Prepares the daily deposit slip D. Approves customer discounts

41. Auditors are more concerned with the occurrence assertion for revenues than the completeness assertion because: A. Clients are more likely to overstate than understate revenues B. Clients are more likely to understate than overstate revenues C. It is difficult to determine when services have been performed D. The allowance for doubtful accounts often is understated

42. An auditor selects a sample from the file of shipping documents to determine whether invoices were prepared. This test is performed to assess the assertion of A. Authorization and accuracy B. Completeness C. Cutoff D. Occurrence

43. Which of the following control activities 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

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Chapter 10 - Auditing the Revenue Process

44. Which of the following internal control activities most likely would ensure that all billed sales are correctly posted to the accounts receivable ledger? A. Daily sales summaries are compared to daily postings to the accounts receivable ledger B. Each sales invoice is supported by a prenumbered shipping document C. The accounts receivable ledger is reconciled daily to the control account in the general ledger D. Each shipment on credit is supported by a prenumbered sales invoice

45. A CPA auditing an electric utility wishes to determine whether all customers are being billed. The CPA's best direction of test is from the A. Meter department records to the billing (sales) register B. Billing (sales) register to the meter department records C. Accounts receivable ledger to the billing (sales) register D. Billing (sales) register to the accounts receivable ledger

46. To determine whether the system of internal control operated effectively to minimize errors of failure to invoice a shipment, the auditor would select a sample of transactions from the population represented by the A. Customer order file B. Bill of lading file C. Open invoice file D. Sales invoice file

47. Which of the following procedures would ordinarily be expected to best reveal improper cutoff of sales at the balance sheet date? A. Compare shipping documents with sales records B. Apply gross profit rates to inventory disposed of during the period C. Trace payments received subsequent to the balance sheet date D. Send accounts receivable confirmation requests

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Chapter 10 - Auditing the Revenue Process

48. If the objective of a test of details is to detect overstatements of sales, the auditor should trace transactions from the A. Cash receipts journal to the sales journal B. Sales journal to the cash receipts journal C. Shipping documents to the accounting records D. Accounting records to the shipping documents

49. Which of the following misstatements is not related to the completeness assertion for revenue? A. Goods are shipped, but revenue is not recorded B. This year's revenue is recorded next year C. Next year's revenue is recorded this year D. Revenue is not recognized for services that have been performed

50. Which of the following is a test of controls for the transaction assertion of completeness for revenue? A. Test a sample of sales invoices for authorized customer orders B. Review sales orders for proper credit approval C. Trace shipping documents to sales invoices and the sales journal D. Examine reconciliation of subsidiary ledger to general ledger control account

51. To achieve good internal control, which department should perform the activities of matching shipping documents with sales orders and preparing daily sales summaries? A. Billing B. Shipping C. Credit D. Sales Order

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Chapter 10 - Auditing the Revenue Process

52. An auditor confirms a representative number of open accounts receivable as of December 31 and investigates respondents' exceptions and comments. By this procedure, the auditor would be most likely to learn of which of the following? A. One of the cashiers has been covering a personal embezzlement by lapping B. One of the sales clerks has not been preparing charge slips for credit sales to family and friends C. One of the EDP control clerks has been removing all sales invoices applicable to his account from the data file D. The credit manager has misappropriated remittances from customers whose accounts have been written off

53. An auditor most likely would limit substantive tests of sales transactions when control risk is assessed as low for the existence or occurrence assertion concerning sales transactions and the auditor has already gathered evidence supporting A. Opening and closing inventory balances B. Cash receipts and accounts receivable C. Shipping and receiving activities D. Cutoffs of sales and purchases

54. Cooper, CPA is auditing the financial statements of a small rural municipality. The receivable balances represent residents' delinquent real estate taxes. Internal control at the municipality is weak. To determine the existence of the accounts receivable balances at the balance sheet date, Cooper would most likely A. Send positive confirmation requests B. Send negative confirmation requests 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

55. Auditors sometimes use ratios as audit evidence. For example, an unexplained increase in the ratio of gross profit to sales may suggest which of the following possibilities? A. Fictitious purchases B. Fictitious sales C. Selling and general expenses erroneously being recorded as merchandise purchases D. Unrecorded sales

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Chapter 10 - Auditing the Revenue Process

56. Which of the following might be detected by an auditor's review of the client's sales cutoff? A. Excessive goods returned for credit B. Unrecorded sales discounts C. Lapping of year-end accounts receivable D. Inflated sales for the year

57. An auditor reconciles the total of the accounts receivable subsidiary ledger to the general ledger control account as of October 31. By this procedure, the auditor would be most likely to learn of which of the following? A. An October invoice was improperly computed B. An October check from a customer was posted in error to the account of another customer with a similar name C. An opening balance in a subsidiary ledger account was improperly carried forward from the previous accounting period D. An account balance is past due and should be written off

58. Once a CPA has determined that accounts receivable have increased because of slow collection in a "tight money" environment, the CPA would be likely to A. Increase the balance in the allowance for bad debts account B. Review the going concern ramifications C. Require the client to tighten their credit policy D. Expand tests regarding the collectability of receivables

59. Which of the following is not an issue related to the valuation of accounts receivable? A. The valuation of revenue that makes up the detail of accounts receivable B. A proper allowance for doubtful accounts C. The net realizable value of accounts receivable D. Proper cut-off

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Chapter 10 - Auditing the Revenue Process

60. In the confirmation of accounts receivable the auditor would most likely A. Randomly select a representative sample of accounts for confirmation B. Seek to obtain positive confirmations for at least 50% of the total dollar amount of the receivables C. Require confirmation of all receivables from agencies of the federal government D. Require that confirmation requests be sent within one month of the fiscal year-end

61. Confirmation is most likely to be a relevant form of evidence with regard to assertions about accounts receivable when the auditor has concerns about the receivables' A. Valuation B. Classification C. Existence D. Completeness

62. In which of the following circumstances would the use of the negative form of accounts receivable confirmation most likely be justified? A. A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers B. A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances C. A small number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers D. A small number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances

63. To reduce the risks associated with accepting e-mail responses to requests for confirmation of accounts receivable, an auditor most likely would A. Request the senders to mail the original forms to the auditor or the auditor may follow up with a telephone call to verify the response B. Examine subsequent cash receipts for the accounts in question C. Consider the e-mail responses to the confirmations to be exceptions D. Mail second requests to the e-mail respondents

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Chapter 10 - Auditing the Revenue Process

64. The confirmation of customers' accounts receivable rarely provides reliable evidence about the completeness assertion because A. Many customers merely sign and return the confirmation without verifying its details B. Recipients usually respond only if they disagree with the information on the request C. Customers may not be inclined to report understatement errors in their accounts D. Auditors typically select many accounts with low recorded balances to be confirmed

65. Which of the following statements would an auditor most likely add to the negative form of confirmations of accounts receivable to encourage timely consideration by the recipient? A. "This is not a request for payment; remittances should not be sent to our auditors in the enclosed envelope." B. "Report any differences on the enclosed statement directly to our auditors; no reply is necessary if this amount agrees with your records." C. "If you do not report any differences within 15 days, it will be assumed that this statement is correct." D. "The following invoices have been selected for confirmation and represent amounts that are overdue."

66. Some firms that dispose of only a small part of their total output by consignment shipments fail to make any distinction between consignment shipments and regular sales. Which of the following would suggest that goods have been shipped on consignment? A. Numerous shipments of small quantities B. Numerous shipments of large quantities and few returns C. Large debits to accounts receivable followed by small periodic credits D. Large debits to accounts receivable followed by large periodic credits

67. Which of the following most likely would be the result of ineffective internal control policies and procedures in the revenue process? A. Final authorization of credit memos by personnel in the Sales Department could permit an employee defalcation scheme B. Fictitious transactions could be recorded, causing an understatement of revenues and an overstatement of receivables C. Irregularities in recording transactions in the subsidiary accounts could result in a delay in goods shipped D. Omission of shipping documents could go undetected, causing an understatement of inventory

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Chapter 10 - Auditing the Revenue Process

68. Upon receipt of customers' checks in the mailroom, a responsible employee should prepare a listing of remittances that is forwarded to the cashier. A copy of the listing should be sent to the A. Internal auditor to investigate the listing for unusual transactions B. Treasurer to compare the listing with the monthly bank statement C. Accounts receivable bookkeeper to update the subsidiary accounts receivable records D. Entity's bank to compare the listing with the cashier's deposit slip

69. Mill Company uses a batch processing method to process its sales transactions. Data on Mill's sales transaction tapes are electronically sorted by customer number and are subjected to programmed edit checks in preparing its invoices, sales journals, and updated customer account balances. One of the direct outputs of the creation of these tapes most likely would be a: A. Report showing exceptions and control totals B. Printout of the updated inventory records C. Report showing overdue accounts receivable D. Printout of the sales price master file

70. Which of the following sets of duties would ordinarily be considered basically incompatible in terms of good internal control? A. Preparation of monthly statements to customers and maintenance of the accounts receivable subsidiary ledger B. Posting to the general ledger and approval of additions and terminations relating to the payroll C. Custody of unmailed signed checks and maintenance of expense subsidiary ledgers D. Collection of receipts on account and maintaining accounts receivable records

71. During a review of a small business entity's internal control system, the auditor discovered that the accounts receivable clerk approves credit memos and has access to cash. Which of the following controls would be most effective in offsetting this weakness? A. The owner reviews errors in billings to customers and postings to the subsidiary ledger B. A controller receives the monthly bank statement directly and reconciles the checking accounts C. The owner reviews credit memos after they are recorded D. The controller reconciles the total of the detailed accounts receivable accounts to the amount shown in the ledger

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Chapter 10 - Auditing the Revenue Process

72. Which of the following procedures most likely would not be an internal control activity designed to reduce the risk of errors in the billing process? A. Comparing control totals for shipping documents with corresponding totals for sales invoices B. Using computer programmed controls on the pricing and mathematical accuracy of sales invoices C. Matching shipping documents with approved sales orders before invoice preparation D. Reconciling the control totals for sales invoices with the accounts receivable subsidiary ledger

73. Smith is engaged in the audit of a cable TV firm that services a rural community. All receivable balances are small, customers are billed monthly, and internal control is effective. To determine the existence of the accounts receivable balances at the balance sheet date, Smith would most likely A. Send positive confirmation requests B. Send negative confirmation requests C. Examine evidence of subsequent cash receipts instead of sending confirmation requests D. Use statistical sampling instead of sending confirmation requests

74. Which of the following most likely would give the most assurance concerning the valuation assertion for accounts receivable? A. Tracing amounts in the subsidiary ledger to details on shipping documents B. Comparing receivable turnover ratios to industry statistics for reasonableness C. Inquiring about receivables pledged under loan agreements D. Assessing the allowance for uncollectible accounts for reasonableness

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Chapter 10 - Auditing the Revenue Process

75. An auditor is reviewing sales cutoff as of March 31, 2009. All sales are shipped FOB destination and the company records sales three days after shipment. The auditor notes the following items:

If the client records the required adjustments, the net effect on income in thousands of dollars for the period ended March 31, 2010 is A. An increase of 12 B. An increase of 8 C. A decrease of 12 D. A decrease of 8

76. Customers having substantial year-end past due balances fail to reply after second request forms have been mailed directly to them. Which of the following is the most appropriate audit procedure? A. Examine shipping documents B. Review collections during the year being examined C. Intensify the study of the client's system of internal control with respect to receivables D. Increase the balance in the allowance for uncollectible accounts

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Chapter 10 - Auditing the Revenue Process

77. Which of the following strategies most likely could improve the response rate of the confirmation of accounts receivable? A. Including a monthly statement of the customer's account B. Restricting the selection of accounts to be confirmed to those customers with relatively large balances C. Requesting customers to respond to the confirmation requests directly to the auditor by fax or e-mail D. Notifying the recipients that second requests will be mailed if they fail to respond in a timely manner

78. In confirming accounts receivable, an auditor decided to confirm customers' account balances rather than individual invoices. Which of the following most likely would be included with the client's confirmation letter? A. An auditor-prepared letter explaining that a nonresponse may cause an inference that the account balance is correct B. A client-prepared letter reminding the customer that a nonresponse will cause a second request to be sent C. An auditor-prepared letter requesting the customer to supply missing and incorrect information directly to the auditor D. A client-prepared statement of account showing the details of the customer's account balance

79. When comparing prices and terms on a sample of sales invoices with the authorized price list and terms of trade, the auditor is testing the ____________ assertion. A. Cutoff B. Authorization C. Occurrence D. Completeness

80. When a sample of sales transactions recorded in the sales journal is traced back to the customer orders and shipping documents, the auditor is testing the ____________ assertion. A. Cutoff B. Authorization C. Completeness D. Occurrence

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Chapter 10 - Auditing the Revenue Process

81. When tracing a sample of shipping documents from throughout the year to the details of the sales invoices and to the sales journal and customers' accounts receivable subsidiary ledger, the auditor is testing the _____________ assertion. A. Classification B. Cutoff C. Existence D. Completeness

82. When reviewing bank confirmations for any liens on receivables, the auditor is testing the ______________ assertion. A. Valuation and allocation B. Rights and obligations C. Existence D. Completeness

Short Answer Questions

83. Explain how revenue recognition is important to the audit of the revenue process.

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84. Listed below are six assertions regarding the financial presentations made in the revenue process. For each, give an example of how an auditor could use one of the types of documents contained in the revenue process to test the assertion. Occurrence Completeness Authorization Accuracy Cutoff Classification -

85. The XYZ Company billing department has decided to assign one employee to each of its customers. This employee will be responsible for granting credit to the client and then handling the billing. XYZ believes this will result in better customer service, because the client will only have to deal with one person and that one person will be very familiar with the credit terms. As an auditor, would you agree with XYZ's decision?

86. What inherent risk factors should an auditor consider when auditing the revenue process of a computer manufacturer?

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Chapter 10 - Auditing the Revenue Process

87. Match the test of controls described below to the appropriate assertion it is used to test: Assertions: a) Occurrence b) Completeness c) Authorization d) Accuracy e) Cutoff f) Classification Test of Controls: 1) Recompute financial information on a sample of sales invoices 2) Review of cash receipts journal for unusual items 3) Observe the endorsement of checks 4) Test a sample of sales invoices for the presence of authorized customer order and shipping document 5) Compare the dates on the sales invoices with the dates of the relevant shipping documents 6) Test a sample of cash receipts transactions for proper cash discounts.

88. Assume an account receivable confirmation is returned with a note to the auditor describing a difference between your client's records and the customer's records. Clearly describe below two potential non-misstatement timing differences that could cause a discrepancy between a client's receivable records and his/her customer's records. The timing differences you describe should be such that after investigation you would determine that your client's receivable balance is not misstated due to these differences.

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89. You are auditing the allowance for doubtful accounts (ADA) and perform the analytical procedures shown below. Assume that no significant changes have occurred during the year in either the client's credit policies or customer base. What concerns, if any, about adjusting the ADA should the auditor have based on the information shown below?

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90. Identify whether the following tests are tests of controls, substantive analytical procedures, tests of details of transactions, or tests of details of account balances: 1) Select a sample of customer receivables and send positive confirmations to each one 2) Examine monthly bank reconciliations for the internal auditors' initials indicating internal verification and review of the reconciliation. 3) Select a sample of entries in sales journal and trace each to the shipping documents 4) Compute receivable turnover and compare with previous years 5) For a sample of new customers, determine whether credit approval was properly administered and documented 6) Compare the dates on a sample of sales invoices with the dates of shipment and the dates they were recorded in the sales journal

91. Describe the two types of confirmations and indicate which one is more reliable and why.

92. Assume you are working on a 12/31 year-end audit. It is now March 31st and the 12/31 accounts receivable aging shows a large receivable that was outstanding on 12/31 for 120 days. Further, the client's receivables are typically collected in less than 45. You anticipate that the client's allowance for doubtful account should be increased and inform the client about your disposition. The client disagrees. Is there an alternative substantive procedure that you could perform that would provide convincing evidence that this balance is collectible? If so, explain.

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93. According to the Certified Fraud Examiners, there are eight common methods for committing financial statement fraud. List 4 of the 8.

94. Identify four of the seven primary functions in the revenue cycle and describe each function.

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Chapter 10 Auditing the Revenue Process Answer Key

True / False Questions

1. Revenue is realized when a product or service is exchanged for cash or a promise to pay cash or other assets that can be converted into cash. TRUE

AACSB: Analytic AICPA BB: Legal AICPA FN: Measurement Bloom's: Knowledge Difficulty: Easy Learning Objective: 1

2. Revenue must be realized (or realizable) and earned to be recognized. TRUE

AACSB: Analytic AICPA BB: Legal AICPA FN: Measurement Bloom's: Knowledge Difficulty: Easy Learning Objective: 1

3. Channel stuffing is an improper practice used to boost sales by inducing distributors to buy more inventory than they can promptly resell. TRUE

AACSB: Analytic AICPA BB: Legal AICPA FN: Measurement Bloom's: Knowledge Difficulty: Easy Learning Objective: 1

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Chapter 10 - Auditing the Revenue Process

4. The return of vendor purchases is a part of the revenue process. FALSE

AACSB: Analytic AICPA BB: Legal AICPA FN: Measurement Bloom's: Knowledge Difficulty: Easy Learning Objective: 3

5. The revenue process affects numerous accounts in the financial statements. TRUE

AACSB: Analytic AICPA BB: Legal AICPA FN: Measurement Bloom's: Knowledge Difficulty: Easy Learning Objective: 3

6. A remittance advice is used to track purchases. FALSE

AACSB: Analytic AICPA BB: Legal AICPA FN: Measurement Bloom's: Knowledge Difficulty: Easy Learning Objective: 4

7. Order entry is the initial function in the revenue cycle. TRUE

AACSB: Analytic AICPA BB: Legal AICPA FN: Measurement Bloom's: Knowledge Difficulty: Easy Learning Objective: 5

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Chapter 10 - Auditing the Revenue Process

8. Credit authorization is used to determine if a customer is able to pay for goods. TRUE

AACSB: Analytic AICPA BB: Legal AICPA FN: Measurement Bloom's: Knowledge Difficulty: Easy Learning Objective: 5

9. A negative confirmation requests that customers respond whether they agree or not with the amount due to the client stated in the confirmation. FALSE

AACSB: Analytic AICPA BB: Legal AICPA FN: Measurement Bloom's: Knowledge Difficulty: Easy Learning Objective: 14

10. A positive confirmation requests that customers respond whether they agree or not with the amount due to the client stated in the confirmation. TRUE

AACSB: Analytic AICPA BB: Legal AICPA FN: Measurement Bloom's: Knowledge Difficulty: Easy Learning Objective: 14

Multiple Choice Questions

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Chapter 10 - Auditing the Revenue Process

11. In general, revenue is recognized when A. Goods are shipped B. It is earned and realized C. It is recorded in the sales journal D. It is received in cash

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Knowledge Difficulty: Easy Learning Objective: 1 Learning Objective: 2

12. According to the SEC's SAB No. 101, which of the following is not necessary for revenue recognition? A. The seller's price to the buyer is fixed B. Collectibility is reasonably assured C. The seller has determined that the buyer will take the discount D. Persuasive evidence of an arrangement exists

AACSB: Analytic AICPA BB: Legal AICPA FN: Measurement Bloom's: Knowledge Difficulty: Easy Learning Objective: 1 Learning Objective: 2

13. What is channel stuffing? A. A company records revenue before delivery terms can be arranged B. A company records revenue on goods that will be shipped overseas C. A company induces distributors to buy substantially more inventory than they can promptly resell D. A company alters the terms and conditions of recorded sales to entice customers to accept delivery of goods

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Knowledge Difficulty: Easy Learning Objective: 1 Learning Objective: 2

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Chapter 10 - Auditing the Revenue Process

14. Tracing bills of lading to sales invoices provides evidence that A. Shipments to customers were properly authorized B. Recorded sales were shipped C. Billed sales were shipped D. Shipments to customers were billed

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: Analysis Difficulty: Easy Learning Objective: 2 Learning Objective: 4 Learning Objective: 9

15. At which point in an ordinary sales transaction of a wholesaling business would a lack of specific authorization be of least concern to the auditor? A. Granting of credit B. Shipment of goods C. Determination of discounts D. Selling of goods for cash

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Easy Learning Objective: 2 Learning Objective: 5 Learning Objective: 9

16. Tracing copies of sales invoices to shipping documents will provide evidence that all A. Shipments to customers were recorded as receivables B. Billed sales were shipped C. Accounts receivable ledger is complete D. Shipments to customers were billed

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: Analysis Difficulty: Easy Learning Objective: 2 Learning Objective: 4 Learning Objective: 9

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Chapter 10 - Auditing the Revenue Process

17. An auditor tests an entity's policy of obtaining credit approval before shipping goods to customers in support of management's financial statement assertion of A. Valuation or allocation B. Completeness C. Existence or occurrence D. Rights and obligations

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: Analysis Difficulty: Easy Learning Objective: 2 Learning Objective: 9

18. Which of the following tests of controls most likely would help assure an auditor that goods shipped are properly billed? A. Scan the sales journal for sequential and unusual entries B. Examine shipping documents for matching sales invoices C. Compare the accounts receivable ledger to daily sales summaries D. Inspect unused sales invoices for consecutive prenumbering

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: Analysis Difficulty: Easy Learning Objective: 2 Learning Objective: 9

19. Tracing shipping documents to prenumbered sales invoices provides evidence that A. No duplicate shipments or billings occurred B. Shipments to customers were properly billed C. All goods ordered by customers were shipped D. All prenumbered sales invoices were accounted for

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: Analysis Difficulty: Easy Learning Objective: 2 Learning Objective: 9

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Chapter 10 - Auditing the Revenue Process

20. Tests designed to detect credit sales made after the end of the year that have been recorded in the current year provide assurance about management's assertion of A. Classification B. Cutoff C. Occurrence D. Authorization and accuracy

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Application Difficulty: Easy Learning Objective: 12 Learning Objective: 13 Learning Objective: 16 Learning Objective: 2

21. When evaluating internal control of an entity that processes revenue transactions on the Internet, an auditor would be most concerned about the A. Potential for computer disruptions in recording sales B. Lack of sales invoice documents as an audit trail C. Frequency of archiving and data retention D. Inability to establish test data

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Easy Learning Objective: 2 Learning Objective: 7

22. Which of the following is not an inherent risk factor for the revenue process? A. Complexity of revenue recognition issues B. Difficulty of auditing transactions C. Special industry practices D. The client does not follow its stated policies for sales order approvals

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Easy Learning Objective: 7

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Chapter 10 - Auditing the Revenue Process

23. Data Corporation has just computerized its billing and accounts receivable record keeping. You want to make maximum use of the new computer in your audit of Data Corporation. Which of the following audit techniques could not be performed through a computer program? A. Tracing audited cash receipts to accounts receivable credits B. Selecting accounts to be confirmed on a random basis C. Examining sales invoices for completeness, consistency between different items, valid conditions, and reasonable amounts D. Resolving differences reported by customers on confirmation requests

AACSB: Technology AICPA BB: Leveraging Technology AICPA FN: Leveraging Technology Bloom's: Application Difficulty: Easy Learning Objective: 13 Learning Objective: 14 Learning Objective: 9

24. In auditing accounts receivable the negative form of confirmation request most likely would be used when A. Recipients are likely to return positive confirmation requests without verifying the accuracy of the information B. The combined assessed level of inherent and control risk relative to accounts receivable is low C. A small number of accounts receivable are involved but a relatively large number of errors are expected D. The auditor performs a dual purpose test that assesses control risk and obtains substantive evidence

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Easy Learning Objective: 10 Learning Objective: 11 Learning Objective: 13 Learning Objective: 14

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Chapter 10 - Auditing the Revenue Process

25. Auditors may use positive and/or negative forms of confirmation requests for accounts receivable. Which of the following statements is true regarding the auditor's use of confirmations? A. The positive confirmation form must always be used to confirm all balances regardless of size B. A combination of the two confirmation types can be used, with the positive form used for large balances and the negative form used for small balances C. A combination of the two confirmation types can be used, with the positive form used for trade receivables and the negative form for other receivables D. The positive confirmation form should be used when controls related to receivables are satisfactory and the negative confirmation form should be used when controls related to receivables are unsatisfactory

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Easy Learning Objective: 10 Learning Objective: 13 Learning Objective: 14

26. In determining the adequacy of the allowance for uncollectible accounts, the least reliance should be placed upon which of the following? A. The credit manager's opinion B. An aging schedule of past due accounts C. Subsequent year collections of amounts in accounts receivable at the balance sheet date D. Ratios calculated showing the past relationship of the valuation allowance to net credit sales

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Analysis Difficulty: Easy Learning Objective: 13

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Chapter 10 - Auditing the Revenue Process

27. An aged trial balance of accounts receivable is usually used by the auditor to A. Verify the existence of recorded receivables B. Ensure that all accounts are promptly credited C. Evaluate the results of tests of controls D. Evaluate the provision for bad debts

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Easy Learning Objective: 13

28. Audit documents often include a client-prepared aged trial balance of accounts receivable as of the balance sheet date. This aging is used by the auditor to A. Evaluate internal control over credit sales B. Test the accuracy of recorded credit sales C. Evaluate the allowance for doubtful accounts D. Verify the existence of the recorded receivables

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Easy Learning Objective: 13

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Chapter 10 - Auditing the Revenue Process

29. In connection with the examination of financial statements by an independent auditor, the client suggests that members of the internal audit staff be utilized to minimize audit costs. Which of the following tasks could most appropriately be delegated to the internal audit staff? A. Selection of accounts receivable for confirmation, based upon the internal auditor's judgment as to how many accounts and which accounts will provide sufficient coverage B. Preparation of schedules for negative accounts receivable responses C. Evaluation of the internal control for accounts receivable and sales D. Determination of the adequacy of the allowance for doubtful accounts

AACSB: Analytic AICPA BB: Resource Management AICPA FN: Decision Making Bloom's: Analysis Difficulty: Easy Learning Objective: 13 Learning Objective: 14

30. Which of the following is the best argument against the use of negative accounts receivable confirmations? A. The cost-per-response is excessively high B. There is no way of knowing if the intended recipients received them C. Recipients are likely to feel that, in reality, the confirmation is a subtle request for payment D. The inference drawn from receiving no reply may not be correct

AACSB: Communications AICPA BB: Critical Thinking AICPA FN: Decision Making Bloom's: Analysis Difficulty: Easy Learning Objective: 13 Learning Objective: 14

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Chapter 10 - Auditing the Revenue Process

31. An auditor's purpose in reviewing credit ratings of customers with delinquent accounts receivable most likely is to obtain evidence concerning management's assertions about A. Valuation and allocation B. Completeness C. Existence D. Rights and obligations

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Application Difficulty: Easy Learning Objective: 13 Learning Objective: 16

32. Which of the following controls most likely would be effective in offsetting the tendency of sales personnel to maximize sales volume at the expense of high bad debt write-offs? A. Employees responsible for authorizing sales and bad debt write-offs are denied access to cash B. Shipping documents and sales invoices are matched by an employee who does not have authority to write off bad debts C. Employees involved in the credit-granting function are separated from the sales function D. Subsidiary accounts receivable records are reconciled to the control account by an employee independent of the authorization of credit

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Analysis Difficulty: Moderate Learning Objective: 2 Learning Objective: 3 Learning Objective: 5 Learning Objective: 6

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Chapter 10 - Auditing the Revenue Process

33. Alpha Company uses its sales invoices for posting perpetual inventory records. Inadequate control activities over the invoicing function allow goods to be shipped that are not invoiced. The inadequate control activities could cause an A. Understatement of revenues, receivables, and inventory B. Overstatement of revenues and receivables and an understatement of inventory C. Understatement of revenues and receivables and an overstatement of inventory D. Overstatement of revenues, receivables, and inventory

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Analysis Difficulty: Moderate Learning Objective: 2 Learning Objective: 3 Learning Objective: 4

34. Alpha Company uses its sales invoices for posting perpetual inventory records. Inadequate control activities over the invoicing function allow goods to be invoiced that are not shipped. The inadequate control activities could cause an A. Understatement of revenues, receivables, and inventory B. Overstatement of revenues and receivables and an understatement of inventory C. Understatement of revenues and receivables and an overstatement of inventory D. Overstatement of revenues, receivables, and inventory

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Analysis Difficulty: Moderate Learning Objective: 2 Learning Objective: 3 Learning Objective: 4

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Chapter 10 - Auditing the Revenue Process

35. Immediately upon receipt of cash, a responsible employee should A. Record the amount in the cash receipts journal B. Prepare a listing of remittances C. Update the subsidiary accounts receivable records D. Prepare a deposit slip in triplicate

AACSB: Communications AICPA BB: Critical Thinking AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 2 Learning Objective: 4 Learning Objective: 5

36. For the most effective internal control, monthly bank statements should be received directly from the banks and reviewed by the A. Controller B. Cash receipts accountant C. Cash disbursement accountant D. Internal auditor

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 2 Learning Objective: 6

37. Which one of the following would the auditor consider to be an incompatible operation if the cashier receives remittances from the mailroom? A. The cashier prepares the daily deposit B. The cashier makes the daily deposit at a local bank C. The cashier posts the receipts to the accounts receivable subsidiary ledger cards D. The cashier endorses the checks

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 2 Learning Objective: 6

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Chapter 10 - Auditing the Revenue Process

38. Which is not a key segregation of duties for the revenue process? Different parties should A. Prepare shipping orders and prepare bills of lading B. Perform the credit and billing functions C. Perform the shipping and billing function D. Receive cash and adjust accounts receivable

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 2 Learning Objective: 6

39. All of the following are important controls over credit memos except A. Proper segregation of duties to ensure that sales discounts taken were earned B. Credit memos should be approved by someone other than whoever initiated it C. Credit memos should be supported by a receiving document for returned goods D. Proper segregation of duties between access to customer records and authorizing credit memos

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 2 Learning Objective: 6

40. An auditor would consider a cashier's job description to contain compatible duties if the cashier receives remittances from the mailroom and also A. Records the journal entry to recognize the cash receipt B. Prepares the monthly bank reconciliation C. Prepares the daily deposit slip D. Approves customer discounts

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Analysis Difficulty: Moderate Learning Objective: 2 Learning Objective: 6

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Chapter 10 - Auditing the Revenue Process

41. Auditors are more concerned with the occurrence assertion for revenues than the completeness assertion because: A. Clients are more likely to overstate than understate revenues B. Clients are more likely to understate than overstate revenues C. It is difficult to determine when services have been performed D. The allowance for doubtful accounts often is understated

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Comprehension Difficulty: Moderate Learning Objective: 2 Learning Objective: 9

42. An auditor selects a sample from the file of shipping documents to determine whether invoices were prepared. This test is performed to assess the assertion of A. Authorization and accuracy B. Completeness C. Cutoff D. Occurrence

AACSB: Communications AICPA BB: Industry AICPA FN: Measurement Bloom's: Comprehension Difficulty: Moderate Learning Objective: 2 Learning Objective: 9

43. Which of the following control activities 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

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 2 Learning Objective: 9

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Chapter 10 - Auditing the Revenue Process

44. Which of the following internal control activities most likely would ensure that all billed sales are correctly posted to the accounts receivable ledger? A. Daily sales summaries are compared to daily postings to the accounts receivable ledger B. Each sales invoice is supported by a prenumbered shipping document C. The accounts receivable ledger is reconciled daily to the control account in the general ledger D. Each shipment on credit is supported by a prenumbered sales invoice

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 2 Learning Objective: 9

45. A CPA auditing an electric utility wishes to determine whether all customers are being billed. The CPA's best direction of test is from the A. Meter department records to the billing (sales) register B. Billing (sales) register to the meter department records C. Accounts receivable ledger to the billing (sales) register D. Billing (sales) register to the accounts receivable ledger

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 2 Learning Objective: 9

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Chapter 10 - Auditing the Revenue Process

46. To determine whether the system of internal control operated effectively to minimize errors of failure to invoice a shipment, the auditor would select a sample of transactions from the population represented by the A. Customer order file B. Bill of lading file C. Open invoice file D. Sales invoice file

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Moderate Learning Objective: 2 Learning Objective: 9

47. Which of the following procedures would ordinarily be expected to best reveal improper cutoff of sales at the balance sheet date? A. Compare shipping documents with sales records B. Apply gross profit rates to inventory disposed of during the period C. Trace payments received subsequent to the balance sheet date D. Send accounts receivable confirmation requests

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Moderate Learning Objective: 2 Learning Objective: 9

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Chapter 10 - Auditing the Revenue Process

48. If the objective of a test of details is to detect overstatements of sales, the auditor should trace transactions from the A. Cash receipts journal to the sales journal B. Sales journal to the cash receipts journal C. Shipping documents to the accounting records D. Accounting records to the shipping documents

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Analysis Difficulty: Moderate Learning Objective: 12 Learning Objective: 13 Learning Objective: 2

49. Which of the following misstatements is not related to the completeness assertion for revenue? A. Goods are shipped, but revenue is not recorded B. This year's revenue is recorded next year C. Next year's revenue is recorded this year D. Revenue is not recognized for services that have been performed

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Analysis Difficulty: Moderate Learning Objective: 2 Learning Objective: 9

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Chapter 10 - Auditing the Revenue Process

50. Which of the following is a test of controls for the transaction assertion of completeness for revenue? A. Test a sample of sales invoices for authorized customer orders B. Review sales orders for proper credit approval C. Trace shipping documents to sales invoices and the sales journal D. Examine reconciliation of subsidiary ledger to general ledger control account

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 2 Learning Objective: 9

51. To achieve good internal control, which department should perform the activities of matching shipping documents with sales orders and preparing daily sales summaries? A. Billing B. Shipping C. Credit D. Sales Order

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 5 Learning Objective: 6

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Chapter 10 - Auditing the Revenue Process

52. An auditor confirms a representative number of open accounts receivable as of December 31 and investigates respondents' exceptions and comments. By this procedure, the auditor would be most likely to learn of which of the following? A. One of the cashiers has been covering a personal embezzlement by lapping B. One of the sales clerks has not been preparing charge slips for credit sales to family and friends C. One of the EDP control clerks has been removing all sales invoices applicable to his account from the data file D. The credit manager has misappropriated remittances from customers whose accounts have been written off

AACSB: Communications AICPA BB: Industry AICPA FN: Measurement Bloom's: Analysis Difficulty: Moderate Learning Objective: 13 Learning Objective: 14 Learning Objective: 9

53. An auditor most likely would limit substantive tests of sales transactions when control risk is assessed as low for the existence or occurrence assertion concerning sales transactions and the auditor has already gathered evidence supporting A. Opening and closing inventory balances B. Cash receipts and accounts receivable C. Shipping and receiving activities D. Cutoffs of sales and purchases

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 12 Learning Objective: 9

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Chapter 10 - Auditing the Revenue Process

54. Cooper, CPA is auditing the financial statements of a small rural municipality. The receivable balances represent residents' delinquent real estate taxes. Internal control at the municipality is weak. To determine the existence of the accounts receivable balances at the balance sheet date, Cooper would most likely A. Send positive confirmation requests B. Send negative confirmation requests 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

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 10 Learning Objective: 14

55. Auditors sometimes use ratios as audit evidence. For example, an unexplained increase in the ratio of gross profit to sales may suggest which of the following possibilities? A. Fictitious purchases B. Fictitious sales C. Selling and general expenses erroneously being recorded as merchandise purchases D. Unrecorded sales

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Analysis Difficulty: Moderate Learning Objective: 11

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Chapter 10 - Auditing the Revenue Process

56. Which of the following might be detected by an auditor's review of the client's sales cutoff? A. Excessive goods returned for credit B. Unrecorded sales discounts C. Lapping of year-end accounts receivable D. Inflated sales for the year

AACSB: Communications AICPA BB: Industry AICPA FN: Measurement Bloom's: Analysis Difficulty: Moderate Learning Objective: 12 Learning Objective: 13

57. An auditor reconciles the total of the accounts receivable subsidiary ledger to the general ledger control account as of October 31. By this procedure, the auditor would be most likely to learn of which of the following? A. An October invoice was improperly computed B. An October check from a customer was posted in error to the account of another customer with a similar name C. An opening balance in a subsidiary ledger account was improperly carried forward from the previous accounting period D. An account balance is past due and should be written off

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Analysis Difficulty: Moderate Learning Objective: 13

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Chapter 10 - Auditing the Revenue Process

58. Once a CPA has determined that accounts receivable have increased because of slow collection in a "tight money" environment, the CPA would be likely to A. Increase the balance in the allowance for bad debts account B. Review the going concern ramifications C. Require the client to tighten their credit policy D. Expand tests regarding the collectability of receivables

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Moderate Learning Objective: 13

59. Which of the following is not an issue related to the valuation of accounts receivable? A. The valuation of revenue that makes up the detail of accounts receivable B. A proper allowance for doubtful accounts C. The net realizable value of accounts receivable D. Proper cut-off

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Knowledge Difficulty: Moderate Learning Objective: 13

60. In the confirmation of accounts receivable the auditor would most likely A. Randomly select a representative sample of accounts for confirmation B. Seek to obtain positive confirmations for at least 50% of the total dollar amount of the receivables C. Require confirmation of all receivables from agencies of the federal government D. Require that confirmation requests be sent within one month of the fiscal year-end

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Moderate Learning Objective: 13 Learning Objective: 14

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Chapter 10 - Auditing the Revenue Process

61. Confirmation is most likely to be a relevant form of evidence with regard to assertions about accounts receivable when the auditor has concerns about the receivables' A. Valuation B. Classification C. Existence D. Completeness

AACSB: Communications AICPA BB: Industry AICPA FN: Measurement Bloom's: Comprehension Difficulty: Moderate Learning Objective: 13 Learning Objective: 14

62. In which of the following circumstances would the use of the negative form of accounts receivable confirmation most likely be justified? A. A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers B. A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances C. A small number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers D. A small number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Moderate Learning Objective: 13 Learning Objective: 14

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Chapter 10 - Auditing the Revenue Process

63. To reduce the risks associated with accepting e-mail responses to requests for confirmation of accounts receivable, an auditor most likely would A. Request the senders to mail the original forms to the auditor or the auditor may follow up with a telephone call to verify the response B. Examine subsequent cash receipts for the accounts in question C. Consider the e-mail responses to the confirmations to be exceptions D. Mail second requests to the e-mail respondents

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Moderate Learning Objective: 13 Learning Objective: 14

64. The confirmation of customers' accounts receivable rarely provides reliable evidence about the completeness assertion because A. Many customers merely sign and return the confirmation without verifying its details B. Recipients usually respond only if they disagree with the information on the request C. Customers may not be inclined to report understatement errors in their accounts D. Auditors typically select many accounts with low recorded balances to be confirmed

AACSB: Communications AICPA BB: Critical Thinking AICPA FN: Risk Analysis Bloom's: Analysis Difficulty: Moderate Learning Objective: 13 Learning Objective: 14

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Chapter 10 - Auditing the Revenue Process

65. Which of the following statements would an auditor most likely add to the negative form of confirmations of accounts receivable to encourage timely consideration by the recipient? A. "This is not a request for payment; remittances should not be sent to our auditors in the enclosed envelope." B. "Report any differences on the enclosed statement directly to our auditors; no reply is necessary if this amount agrees with your records." C. "If you do not report any differences within 15 days, it will be assumed that this statement is correct." D. "The following invoices have been selected for confirmation and represent amounts that are overdue."

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Moderate Learning Objective: 13 Learning Objective: 14

66. Some firms that dispose of only a small part of their total output by consignment shipments fail to make any distinction between consignment shipments and regular sales. Which of the following would suggest that goods have been shipped on consignment? A. Numerous shipments of small quantities B. Numerous shipments of large quantities and few returns C. Large debits to accounts receivable followed by small periodic credits D. Large debits to accounts receivable followed by large periodic credits

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: Analysis Difficulty: Hard Learning Objective: 1 Learning Objective: 2

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Chapter 10 - Auditing the Revenue Process

67. Which of the following most likely would be the result of ineffective internal control policies and procedures in the revenue process? A. Final authorization of credit memos by personnel in the Sales Department could permit an employee defalcation scheme B. Fictitious transactions could be recorded, causing an understatement of revenues and an overstatement of receivables C. Irregularities in recording transactions in the subsidiary accounts could result in a delay in goods shipped D. Omission of shipping documents could go undetected, causing an understatement of inventory

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Hard Learning Objective: 2 Learning Objective: 3 Learning Objective: 9

68. Upon receipt of customers' checks in the mailroom, a responsible employee should prepare a listing of remittances that is forwarded to the cashier. A copy of the listing should be sent to the A. Internal auditor to investigate the listing for unusual transactions B. Treasurer to compare the listing with the monthly bank statement C. Accounts receivable bookkeeper to update the subsidiary accounts receivable records D. Entity's bank to compare the listing with the cashier's deposit slip

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Hard Learning Objective: 2 Learning Objective: 4 Learning Objective: 5

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Chapter 10 - Auditing the Revenue Process

69. Mill Company uses a batch processing method to process its sales transactions. Data on Mill's sales transaction tapes are electronically sorted by customer number and are subjected to programmed edit checks in preparing its invoices, sales journals, and updated customer account balances. One of the direct outputs of the creation of these tapes most likely would be a: A. Report showing exceptions and control totals B. Printout of the updated inventory records C. Report showing overdue accounts receivable D. Printout of the sales price master file

AACSB: Technology AICPA BB: Leveraging Technology AICPA FN: Leveraging Technology Bloom's: Application Difficulty: Hard Learning Objective: 2 Learning Objective: 4

70. Which of the following sets of duties would ordinarily be considered basically incompatible in terms of good internal control? A. Preparation of monthly statements to customers and maintenance of the accounts receivable subsidiary ledger B. Posting to the general ledger and approval of additions and terminations relating to the payroll C. Custody of unmailed signed checks and maintenance of expense subsidiary ledgers D. Collection of receipts on account and maintaining accounts receivable records

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Comprehension Difficulty: Hard Learning Objective: 2 Learning Objective: 6

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Chapter 10 - Auditing the Revenue Process

71. During a review of a small business entity's internal control system, the auditor discovered that the accounts receivable clerk approves credit memos and has access to cash. Which of the following controls would be most effective in offsetting this weakness? A. The owner reviews errors in billings to customers and postings to the subsidiary ledger B. A controller receives the monthly bank statement directly and reconciles the checking accounts C. The owner reviews credit memos after they are recorded D. The controller reconciles the total of the detailed accounts receivable accounts to the amount shown in the ledger

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Analysis Difficulty: Hard Learning Objective: 2 Learning Objective: 6 Learning Objective: 9

72. Which of the following procedures most likely would not be an internal control activity designed to reduce the risk of errors in the billing process? A. Comparing control totals for shipping documents with corresponding totals for sales invoices B. Using computer programmed controls on the pricing and mathematical accuracy of sales invoices C. Matching shipping documents with approved sales orders before invoice preparation D. Reconciling the control totals for sales invoices with the accounts receivable subsidiary ledger

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Application Difficulty: Hard Learning Objective: 2 Learning Objective: 9

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Chapter 10 - Auditing the Revenue Process

73. Smith is engaged in the audit of a cable TV firm that services a rural community. All receivable balances are small, customers are billed monthly, and internal control is effective. To determine the existence of the accounts receivable balances at the balance sheet date, Smith would most likely A. Send positive confirmation requests B. Send negative confirmation requests C. Examine evidence of subsequent cash receipts instead of sending confirmation requests D. Use statistical sampling instead of sending confirmation requests

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Hard Learning Objective: 10 Learning Objective: 13 Learning Objective: 14

74. Which of the following most likely would give the most assurance concerning the valuation assertion for accounts receivable? A. Tracing amounts in the subsidiary ledger to details on shipping documents B. Comparing receivable turnover ratios to industry statistics for reasonableness C. Inquiring about receivables pledged under loan agreements D. Assessing the allowance for uncollectible accounts for reasonableness

AACSB: Communications AICPA BB: Industry AICPA FN: Measurement Bloom's: Application Difficulty: Hard Learning Objective: 11 Learning Objective: 12 Learning Objective: 13

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Chapter 10 - Auditing the Revenue Process

75. An auditor is reviewing sales cutoff as of March 31, 2009. All sales are shipped FOB destination and the company records sales three days after shipment. The auditor notes the following items:

If the client records the required adjustments, the net effect on income in thousands of dollars for the period ended March 31, 2010 is A. An increase of 12 B. An increase of 8 C. A decrease of 12 D. A decrease of 8

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Bloom's: Analysis Difficulty: Hard Learning Objective: 12 Learning Objective: 13 Learning Objective: 16

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Chapter 10 - Auditing the Revenue Process

76. Customers having substantial year-end past due balances fail to reply after second request forms have been mailed directly to them. Which of the following is the most appropriate audit procedure? A. Examine shipping documents B. Review collections during the year being examined C. Intensify the study of the client's system of internal control with respect to receivables D. Increase the balance in the allowance for uncollectible accounts

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Hard Learning Objective: 13 Learning Objective: 14

77. Which of the following strategies most likely could improve the response rate of the confirmation of accounts receivable? A. Including a monthly statement of the customer's account B. Restricting the selection of accounts to be confirmed to those customers with relatively large balances C. Requesting customers to respond to the confirmation requests directly to the auditor by fax or e-mail D. Notifying the recipients that second requests will be mailed if they fail to respond in a timely manner

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Analysis Difficulty: Hard Learning Objective: 13 Learning Objective: 14

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Chapter 10 - Auditing the Revenue Process

78. In confirming accounts receivable, an auditor decided to confirm customers' account balances rather than individual invoices. Which of the following most likely would be included with the client's confirmation letter? A. An auditor-prepared letter explaining that a nonresponse may cause an inference that the account balance is correct B. A client-prepared letter reminding the customer that a nonresponse will cause a second request to be sent C. An auditor-prepared letter requesting the customer to supply missing and incorrect information directly to the auditor D. A client-prepared statement of account showing the details of the customer's account balance

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Hard Learning Objective: 13 Learning Objective: 14

79. When comparing prices and terms on a sample of sales invoices with the authorized price list and terms of trade, the auditor is testing the ____________ assertion. A. Cutoff B. Authorization C. Occurrence D. Completeness

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Application Difficulty: Easy Learning Objective: 12

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Chapter 10 - Auditing the Revenue Process

80. When a sample of sales transactions recorded in the sales journal is traced back to the customer orders and shipping documents, the auditor is testing the ____________ assertion. A. Cutoff B. Authorization C. Completeness D. Occurrence

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Application Difficulty: Easy Learning Objective: 12

81. When tracing a sample of shipping documents from throughout the year to the details of the sales invoices and to the sales journal and customers' accounts receivable subsidiary ledger, the auditor is testing the _____________ assertion. A. Classification B. Cutoff C. Existence D. Completeness

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Application Difficulty: Easy Learning Objective: 12

82. When reviewing bank confirmations for any liens on receivables, the auditor is testing the ______________ assertion. A. Valuation and allocation B. Rights and obligations C. Existence D. Completeness

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Bloom's: Application Difficulty: Easy Learning Objective: 12

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Chapter 10 - Auditing the Revenue Process Short Answer Questions

83. Explain how revenue recognition is important to the audit of the revenue process. To determine whether the financial statements are presented fairly and in conformity with GAAP, the auditor must know what is in accordance with GAAP and what is not. There are specific guidelines regarding revenue recognition under GAAP and these guidelines should be reflected in the financial statements. The understanding of when it is appropriate to recognize revenue is very important in testing the occurrence and completeness assertions. Further, the revenue area is subject to high fraud risk and numerous significant fraudulent financial reporting incidents involved improper revenue recognition schemes. Accordingly, the auditor must possess knowledge about the client's revenue recognition process and plan the audit accordingly.

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Application Difficulty: Moderate Learning Objective: 1

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Chapter 10 - Auditing the Revenue Process

84. Listed below are six assertions regarding the financial presentations made in the revenue process. For each, give an example of how an auditor could use one of the types of documents contained in the revenue process to test the assertion. Occurrence Completeness Authorization Accuracy Cutoff Classification Student Answers will vary, but here are some examples: Occurrence - The shipping document provides important evidence regarding the occurrence assertion. Because sales are not recorded until the product has been shipped, all recorded sales should have a valid shipping document that documents the sale. The auditor can use these documents to test whether the sales did occur. Completeness - The auditor can use the client's sales invoices and sales journal to test for completeness. In this case, the auditor will trace the sales invoice to the sales journal. This will provide assurance that all shipped items have been recorded as revenue. Authorization - One example of a document used to test authorization is the write-off authorization form. This form authorized the write-off of an uncollectible account. The auditor can determine that all written off uncollectible accounts have been properly authorized by reviewing these documents. Accuracy - To ensure that Accounts Receivable is recorded at its proper net amount, the auditor will need to consider the Allowance for Uncollectible Accounts. The credit approval form can aid in this consideration, by giving the auditor an idea of the level at which credit is granted to determine the anticipated overall creditworthiness of the client's customers. Cutoff - The Open-Order Report can be helpful in testing for cutoff. The auditor could obtain this report for year-end and test that the orders listed as open have not been recorded as revenue. Classification - The Sales Journal is used to test for proper classification through an auditor's review of the journal. The journal provides details about each of the transactions made and to which accounts the transactions were posted.

AACSB: Communications AICPA BB: Critical Thinking AICPA FN: Measurement Bloom's: Knowledge Difficulty: Moderate Learning Objective: 4 Learning Objective: 9

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Chapter 10 - Auditing the Revenue Process

85. The XYZ Company billing department has decided to assign one employee to each of its customers. This employee will be responsible for granting credit to the client and then handling the billing. XYZ believes this will result in better customer service, because the client will only have to deal with one person and that one person will be very familiar with the credit terms. As an auditor, would you agree with XYZ's decision? From an audit perspective, the policy is risky. By not segregating the duties of granting credit and billing, sales can easily be made to customers who are not credit worthy, especially if the XYZ employee is in any way compensated for the number of sales made. Even if there is no compensation, the XYZ employee may give credit to a friend or family member who wouldn't otherwise qualify. All this could lead to a misstatement in Accounts Receivable.

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Analysis Difficulty: Easy Learning Objective: 6

86. What inherent risk factors should an auditor consider when auditing the revenue process of a computer manufacturer? The auditor will want to consider industry-related factors such as the high competition of the industry, as well as the high rate of technological change. If the company is unable to keep up with the competition, they may try to cover the poor performance with inflated sales. The auditor will also want to consider any long-term contracts the manufacturer may be in the process of completing. The timing of the revenue recognition for a large project could have a significant impact on the financial statements. Accounts that may be difficult to audit, such as Allowance for Uncollectible Accounts and any prior misstatements in the financials may also increase the inherent risk assessment of the auditor.

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Comprehension Difficulty: Moderate Learning Objective: 7

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Chapter 10 - Auditing the Revenue Process

87. Match the test of controls described below to the appropriate assertion it is used to test: Assertions: a) Occurrence b) Completeness c) Authorization d) Accuracy e) Cutoff f) Classification Test of Controls: 1) Recompute financial information on a sample of sales invoices 2) Review of cash receipts journal for unusual items 3) Observe the endorsement of checks 4) Test a sample of sales invoices for the presence of authorized customer order and shipping document 5) Compare the dates on the sales invoices with the dates of the relevant shipping documents 6) Test a sample of cash receipts transactions for proper cash discounts. 1) d; 2) f; 3) b; 4) a; 5) e; 6) c

AACSB: Communications AICPA BB: Industry AICPA FN: Measurement Bloom's: Comprehension Difficulty: Easy Learning Objective: 9

88. Assume an account receivable confirmation is returned with a note to the auditor describing a difference between your client's records and the customer's records. Clearly describe below two potential non-misstatement timing differences that could cause a discrepancy between a client's receivable records and his/her customer's records. The timing differences you describe should be such that after investigation you would determine that your client's receivable balance is not misstated due to these differences. 1. Client shipped to customer before year end but customer received after year end. 2. Customer sent payment to client before year end but client received after year end.

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Comprehension Difficulty: Moderate Learning Objective: 14

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Chapter 10 - Auditing the Revenue Process

89. You are auditing the allowance for doubtful accounts (ADA) and perform the analytical procedures shown below. Assume that no significant changes have occurred during the year in either the client's credit policies or customer base. What concerns, if any, about adjusting the ADA should the auditor have based on the information shown below?

It appears that the industry has remained relatively stable in both its ADA/AR and Days AR outstanding while the client has significantly increased in the Days AR Outstanding in 2011. Assuming no significant changes in customer base or credit policies, the client should increase the allowance in 2011 since Days AR Outstanding has increased.

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making Bloom's: Analysis Difficulty: Moderate Learning Objective: 11

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Chapter 10 - Auditing the Revenue Process

90. Identify whether the following tests are tests of controls, substantive analytical procedures, tests of details of transactions, or tests of details of account balances: 1) Select a sample of customer receivables and send positive confirmations to each one 2) Examine monthly bank reconciliations for the internal auditors' initials indicating internal verification and review of the reconciliation. 3) Select a sample of entries in sales journal and trace each to the shipping documents 4) Compute receivable turnover and compare with previous years 5) For a sample of new customers, determine whether credit approval was properly administered and documented 6) Compare the dates on a sample of sales invoices with the dates of shipment and the dates they were recorded in the sales journal 1) Tests of details of account balances 2) Tests of controls 3) Tests of details of transactions 4) Substantive analytical procedures 5) Tests of controls 6) Tests of details of transactions

AACSB: Communications AICPA BB: Critical Thinking AICPA FN: Decision Making Bloom's: Comprehension Difficulty: Hard Learning Objective: 11 Learning Objective: 12 Learning Objective: 13 Learning Objective: 9

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Chapter 10 - Auditing the Revenue Process

91. Describe the two types of confirmations and indicate which one is more reliable and why. The two types of confirmations are positive and negative. A positive confirmation requests that customers indicate whether they agree with the amount stated in the confirmation. A response is required either way. A negative confirmation only requires a response if there is a disagreement. The positive confirmation is more reliable, because there is always a response. If a negative confirmation is not returned to the auditor, he/she must assume that there is no problem with the amount, which may or may not, be true. There is less assurance provided about the correctness of the amounts from a negative confirmation.

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Difficulty: Easy Learning Objective: 14

92. Assume you are working on a 12/31 year-end audit. It is now March 31st and the 12/31 accounts receivable aging shows a large receivable that was outstanding on 12/31 for 120 days. Further, the client's receivables are typically collected in less than 45. You anticipate that the client's allowance for doubtful account should be increased and inform the client about your disposition. The client disagrees. Is there an alternative substantive procedure that you could perform that would provide convincing evidence that this balance is collectible? If so, explain. Determining that the balance was paid after year end would provide convincing evidence that balance was in fact collectible as of 12/31.

AACSB: Communications AICPA BB: Industry AICPA FN: Measurement Bloom's: Application Difficulty: Moderate Learning Objective: 13

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Chapter 10 - Auditing the Revenue Process

93. According to the Certified Fraud Examiners, there are eight common methods for committing financial statement fraud. List 4 of the 8. 1. Early revenue recognition 2. Holding the books open past the accounting period 3. Fictitious sales 4. Failure to record returns 5. Fraud in the percentage of completion method 6. Related party transactions 7. Overstating receivables and inventory 8. Liability and expense omissions

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Knowledge Difficulty: Easy Learning Objective: 1

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Chapter 10 - Auditing the Revenue Process

94. Identify four of the seven primary functions in the revenue cycle and describe each function. Answer should include four of the following:

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Difficulty: Easy Learning Objective: 5

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