A key internal control in the sales and collection cycle

10-27 (Objectives 10-1 , 10-4, 10-6) The following misstatements are included in the accounting records of the Joyce Manufacturing Company:

1. A material sale was recorded on the last day of the year even though the goods were not shipped until three days later.

2. Merchandise was shipped to a customer, but no bill of lading was prepared. Because billings are prepared from bills of lading, the customer was not billed.

3. The controller approved a payment to a consulting firm owned by his sister. The consulting firm did not actually perform any services for the company.

4. The shipping clerk included several additional valuable items in a shipment that were not included in the customer’s order and were not invoiced to the customer. The shipping clerk has an arrangement with the customer to share the proceeds from sales of the additional items shipped.

5. Cash paid on accounts receivable was stolen by the mail clerk when the mail was opened.

6. A sales invoice was miscalculated by $1,000 as a result of a key-entry mistake.

7. Cash paid on accounts receivable that had been prelisted by a secretary was stolen by the bookkeeper, who records cash receipts and accounts receivable. He failed to record the transactions.

1. 10-32 (Objectives 10-2 , 10-3, 10-4, 10-6) Each year near the balance sheet date, when the president of Bargon Construction, Inc., takes a 3-week vacation to Hawaii, she signs several checks to pay major bills during the period she is absent. Jack Morgan, head bookkeeper for the company, uses this practice to his advantage. Morgan makes out a check to himself for the amount of a large vendor’s invoice and, because there is no acquisitions journal, he records the amount in the cash disbursements journal as an acquisition from the supplier listed on the invoice. He holds the check until several weeks into the subsequent period to make sure that the auditors do not get an opportunity to examine an electronic copy of the cancelled check. Shortly after the first of the year when the president returns, Morgan resubmits the invoice for payment and again records the check in the cash disbursements journal. At that point, he marks the invoice “paid” and files it with all other paid invoices. Morgan has been following this practice successfully for several years and feels confident that he has developed a foolproof method.

Required

a. What is the auditor’s responsibility for discovering this type of embezzlement?

b. What weaknesses in Bargon’s processes exist?

c. What evidence can the auditor use to uncover the fraud?

2. 10-33 (Objectives 10-5 , 10-6) The following are various potential frauds in the sales and collection cycle:

2. The company engaged in channel stuffing by shipping goods to customers that had not been ordered.

2. The allowance for doubtful accounts was understated because the company altered the aging of accounts receivable to reduce the number of days outstanding for delinquent receivables.

2. The accounts receivable clerk stole checks received in the mail and deposited them in an account that he controlled. He issued credit memos to the customers in the amount of the diverted cash receipts.

2. The company contacted a major customer and asked them to accept a major shipment of goods before year-end. The customer was told that they could return the goods without penalty if they were unable to sell the goods.

2. A cashier stole cash receipts that had been recorded in the cash register.

2. The company recorded “bill-and-hold sales” at year-end. Although the invoices were recorded as sales before year-end, the goods were stored in the warehouse and shipped after year-end.

2. The company did not record credit memos for returns received in the last month of the year. The goods received were counted as part of the company’s year-end physical inventory procedures.

2. A cashier stole cash receipts by failing to record the sales in the cash register.

2. The CFO recorded fictitious credit sales at the end of the year without recording the associated cost of sales and reduction in inventory.

Required

b. Indicate whether the fraud involves misappropriation of assets or fraudulent financial reporting.

b. For those frauds that involve misappropriation of assets, state a control that would be effective in preventing or detecting the misappropriation.

b. For those frauds that involve fraudulent financial reporting, state an audit procedure that would be effective in detecting the fraud.

11-25 (Objective 11-3 ) The following are misstatements that have occurred in Fresh Foods Grocery Store, a retail and wholesale grocery company:

1. On the last day of the year, a truckload of beef was set aside for shipment but was not shipped. Because it was still on hand, the inventory was counted. The shipping document was dated the last day of the year, so it was also included as a current-year sale.

2. The incorrect price was used on sales invoices for billing shipments to customers because the wrong price was entered into the computer master file of prices.

3. A vendor invoice was paid even though no merchandise was ever received. The accounts payable software application does not require the input of a valid receiving report number before payment can be made.

4. Employees in the receiving department took sides of beef for their personal use. When a shipment of meat was received, the receiving department filled out a receiving report and forwarded it to the accounting department for the amount of goods actually received. At that time, two sides of beef were put in an employee’s pickup truck rather than in the storage freezer.

5. An accounts payable clerk processed payments to himself by adding a fictitious vendor address to the approved vendor master file.

6. During the physical count of inventory of the retail grocery, one counter wrote down the wrong description of several products and miscounted the quantity.

7. A salesperson sold an entire carload of lamb at a price below cost because she did not know the cost of lamb had increased in the past week.

8. A vendor’s invoice was paid twice for the same shipment. The second payment arose because the vendor sent a duplicate copy of the original 2 weeks after the payment was due.

Required
a. For each misstatement, identify one or more types of controls that were absent.

b. For each misstatement, identify the transaction-related management assertions that have not been met.

c. For each misstatement, suggest a control that may have prevented or detected the misstatement.

11-27 (Objectives 11-3 , 11-4) The following are misstatements that can occur in the sales and collection cycle:

1. A customer number on a sales invoice was transposed and, as a result, charged to the wrong customer. By the time the error was found, the original customer was no longer in business.

2. A former computer operator, who is now a programmer, entered information for a fictitious sales return and ran it through the computer system at night. When the money came in, he took it and deposited it in his own account.

3. A nonexistent part number was included in the description of goods on a shipping document. Therefore, no charge was made for those goods.

4. A customer order was filled and shipped to a former customer, which had already filed for bankruptcy.

5. The sales manager approved the price of goods ordered by a customer, but he wrote down the wrong price.

6. A computer operator picked up a computer-based data file for sales of the wrong week and processed them through the system a second time.

7. For a sale, a data entry operator erroneously failed to enter the information for the salesman’s department. As a result, the salesman received no commission for that sale.

8. Several remittance advices were batched together for inputting. The cash receipts clerk stopped for coffee, set them on a box, and failed to deliver them to the data input personnel.

Required
a. Identify the transaction-related management assertion(s) to which the misstatement pertains.

b. Identify one automated control that would have likely prevented each misstatement.

11-31 (Objectives 11-3 , 11-4) A growing number of organizations have been the target of hacking attacks, or cyberattacks, in recent years. High-profile examples in the U.S. include Target Corp., Home Depot Inc., the Internal Revenue Service, and other government agencies such as the Office of Personnel Management. Companies and governments need to consider the risks of a cyberattack, and consider backup plans in the event a cyberattack results in a loss of hardware, software, or data. The Committee of Sponsoring Organizations of the Treadway Commission (COSO) issued a thought paper, COSO in the Cyber Age, to help organizations assess and mitigate risks associated with cybersecurity through the existing COSO Framework. Visit the COSO Web site ( www.coso.org ), and refer to the “Guidance” tab. Read the thought paper to answer the following questions:

Required
a. The COSO guidance acknowledges that “cyber risk is not something that can be avoided; instead it must be managed.” Why is cyber risk unavoidable? Does this acknowledgement make it more or less difficult to address and mitigate cyber risk?

b. At the control environment level (the first of the five components of internal control), what should organizations do to address cyber risk?

c. The paper identifies five broad categories of cyberattack perpetrators and motivations. Briefly describe each group of perpetrators and their motivation.

d. What types of control activities are recommended to address cyber risks?

12-22 (Objective 12-2 ) The following are partial descriptions of internal controls for companies engaged in the manufacturing business:

1. When Mr. Clark orders materials, an electronic copy of the purchase order is sent to the receiving department. During the delivery of materials, Mr. Smith, the receiving clerk, records the receipt of shipment on this purchase order and then sends the purchase order to the accounting department, where it is used to record materials purchased and accounts payable. The materials are transported to the storage area by forklifts. The additional purchased quantities are recorded on storage records.

2. Every day, hundreds of employees clock in using their employee identification cards at Generous Motors Corporation. The data on these time records is used in the preparation of the labor cost distribution records, the payroll journal, and the electronic payments and payroll checks. The treasurer, Angela Lee, compares the payroll journal with the payroll records, signs the checks, and returns the payroll notifications and checks to Charles Strode, the supervisor of the computer department. The payroll checks and payment notices are distributed to the employees by Strode.

3. The smallest branch of Connor Cosmetics employs Mary Cooper, the branch manager, and her sales assistant, Janet Hendrix. The branch uses a bank account to pay expenses. The account is kept in the name of “Connor Cosmetics—Special Account.” To pay expenses, checks must be signed by Cooper or by the treasurer, John Winters. Cooper receives the cancelled checks and bank statements. She reconciles the branch account herself and files cancelled checks and bank statements in her records. She also periodically prepares reports of cash disbursements and sends them to the home office.

Required
a. Required List the deficiencies in internal control for each of these situations. To identify the deficiencies, use the methodology that was discussed in this chapter.

b. For each deficiency, state the type(s) of misstatement(s) that is (are) likely to result. Be as specific as possible.

c. How would you improve internal controls for each of the three companies? *

12-25 (Objective 12-5 ) The following are independent situations for which you will recommend an appropriate audit report on internal control over financial reporting as required by PCAOB auditing standards:

1. The auditor identified a material misstatement in the financial statements that was not detected by management of the company.

2. The auditor was unable to obtain any evidence about the operating effectiveness of internal control over financial reporting.

3. The auditor identified several significant deficiencies in internal control. Because of these significant deficiencies, the auditor believes that there is a reasonable possibility that internal control will not prevent or detect material misstatements on a timely basis.

4. The auditor determined that a deficiency in internal control exists that will not prevent or detect a material misstatement in the financial statements.

5. During interim testing, the auditor identified and communicated to management a significant control deficiency. Management immediately corrected the deficiency and the auditor was able to sufficiently test the newly instituted internal control before the end of the fiscal period.

6. As a result of performing tests of controls, the auditor identified a significant deficiency in internal control over financial reporting; however, the auditor does not believe that it represents a material weakness in internal control.

Required
For each situation, state the appropriate audit report from the following alternatives:

1. • Unqualified opinion on internal control over financial reporting

2. • Qualified or disclaimer of opinion on internal control over financial reporting

3. • Adverse opinion on internal control over financial reporting

1. 12-27 (Objectives 12-2 , 12-7) Most grocery stores use bar code scanning technologies that interface with cash registers used to process customer purchases. Cashiers use the scanners to read bar code labels attached to each product, which the system then uses to obtain unit prices, calculate transaction totals, including sales taxes, and update perpetual inventory databases. Similarly, cashiers scan bar codes on coupons or member discount cards presented by the customer to process discounts. Along with the scanning technologies, groceries use point-of-sale technologies that allow customers to swipe debit and credit cards for payment, while still maintaining the ability for customers to pay with cash.

Required
a. Which financial statement accounts are impacted by the use of these technologies in a typical grocery store?

b. Identify risks inherent to this business process in a grocery store that might affect the financial statement accounts identified in part a. For each risk, describe how these technologies help reduce the inherent risk.

c. How might an auditor use technology to test the operating effectiveness of a bar code scanner–based check-out system?

13-26 (Objectives 13-1, 13-4, 13-5) The following are independent internal controls commonly found in the acquisition and payment cycle. Each control is to be considered independently.

1. Before a check is prepared to pay for acquisitions by the accounts payable department, the related purchase order and receiving report are attached to the vendor’s invoice being paid. A clerk compares the quantity on the invoice with the receiving report and purchase order, compares the price with the purchase order, recomputes the extensions, re-adds the total, and examines the account number indicated on the invoice to determine whether it is correctly classified. He indicates his performance of these procedures by initialing the invoice.

2. At the end of each month, an accounting clerk accounts for all prenumbered receiving reports (documents evidencing the receipt of goods) issued during the month and traces each one to the related vendor’s invoice and acquisitions journal entry. The clerk’s tests do not include testing the quantity or description of the merchandise received.

3. The cash disbursements clerk is prohibited from handling cash. The bank account is reconciled by another person even though the clerk has sufficient expertise and time to do it.

4. Before a check is signed by the controller, she examines the supporting documentation accompanying the check. At that time, she initials each vendor’s invoice to indicate her approval.

5. After the controller signs the checks, her secretary writes the check number and the date the check was issued on each of the supporting documents to prevent their reuse.

Required
a. For each of the internal controls, state the transaction-related audit objective(s) the control is meant to fulfill.

b. For each control, list one test of control the auditor could perform to test the effectiveness of the control.

c. For each control, list one substantive test the auditor could perform to determine whether financial misstatements are actually taking place.

13-28 (Objectives 13-4, 13-7) Following are evidence decisions for the three audits described in Figure 13-3 :

· Audit A Ineffective client internal controls

· Audit B Very effective client internal controls

· Audit C Somewhat effective client internal controls

Evidence Decisions
1. The auditor decided it was possible to assess control risk below the maximum.

2. The auditor identified effective controls and also identified some deficiencies in controls.

3. The auditor performed extensive positive confirmations at the balance sheet date.

4. The auditor performed tests of controls.

5. The auditor performed extensive tests of controls and minimal substantive tests.

6. The auditor performed substantive tests.

7. This audit was likely the least expensive to conduct.

8. The auditor confirmed receivables at an interim date.

Required
a. Explain why Audit B represents the maximum amount of reliance that can be placed on internal control. Why can’t all the audit assurance be obtained by tests of controls?

b. Explain why the auditor may not place the maximum extent of reliance on controls in Audit B and Audit C.

c. For each of the eight evidence decisions, indicate whether the evidence decision relates to each of the audits described above. Every evidence decision relates to at least one of the audits, and some may relate to two or all three audits.

13-32 (Objectives 13-4, 13-6, 13-7) The following are parts of a typical audit for a company with a fiscal year-end of July 31.

1. Understand internal control and assess control risk.

2. Perform substantive analytical procedures for accounts payable.

3. Confirm accounts payable.

4. Perform tests of controls and substantive tests of transactions for the acquisition and payment and payroll and personnel cycles.

5. Perform other tests of details of balances for accounts payable.

6. Perform tests for review of subsequent events.

7. Accept the client.

8. Issue the audit report.

9. Set acceptable audit risk and decide preliminary judgment about materiality and performance materiality.

Required
a. Identify the phase of the audit in which each activity occurs.

b. Put parts 1 through 9 of the audit in the sequential order in which you would expect them to be performed in a typical audit.

c. Identify those parts that will frequently be done before July 31.