Internal control case study with answer

Case study The Kwan Pharmaceutical Company, a drug manufacturer, occasionally receives requests from customers for credit memos. The Company has the following internal controls for recording sales returns and evaluating the adequacy of the Accounts Receivable Allowance (A/R Allowance). 1. All customer requests for credits are documented in a log and are forwarded to the Controller. 2. The Controller reviews each credit request for reasonableness and discusses it with the appropriate personnel related to the initial sale. 3. The Controller documents the credit memo on a form explaining the reason for the credit and the amount of the credit. 4. The Controller and the CFO both physically sign the credit memo paperwork. 5. The credit is issued by a separate department prior to the reduction of the A/R Allowance for the customer, or is refunded by check. 6. The Controller updates the accounting software for the credit memo. 7. On a quarterly basis, the Controller evaluates the adequacy of the A/R Allowance. Sample of the Balance Sheet (in 000s): A/R A/R allowance Net A/R 12/31/14 1,500 (100) 1,400 12/31/13 1,000 (100) 900 As the Senior Auditor, it is your responsibility to design the audit plan to test Sales Returns and Allowances. Required: A. In the form of a chart for Kwan Pharmaceutical Co, design an audit program for Sales Returns (credit memo): 1. List the audit objectives to be achieved 2. List the key controls from the preceding summary 3. Suggest test of controls for each objective 4. Suggest substantive test of transactions for each objective B. Suggest testing to evaluate the adequacy of the A/R Allowance. C. What does the trend of the A/R Allowance figures suggest to you? How would you modify your testing scope to address what you see? Chapter 13 Developing the Overall Audit Plan and Audit Program Copyright © 2014 Pearson Education Use the five types of audit tests to determine whether financial statements are fairly stated. Select the appropriate types of audit tests. Understand how information technology affects audit testing. Understand the concept of evidence mix and how it should be varied in different circumstances. 13-2 Copyright © 2014 Pearson Education Design an audit program. Compare and contrast transaction-related audit objectives with balance-related and presentation and disclosure-related audit objectives. Integrate the four phases of the audit process. 13-3 Copyright © 2014 Pearson Education 1 Use the five types of audit tests to determine whether financial statements are fairly stated. 13-4 Copyright © 2014 Pearson Education ➢ Risk assessment procedures ➢ Tests of Controls ➢ Substantive Tests of Transactions ➢ Tests of Details of Balances 13-5 Copyright © 2014 Pearson Education Audit risk model Tests of controls AAR IR × CR = PDR Substantive Tests of Sufficient Analytical + tests of + procedures + details of = appropriate transactions balances evidence Further audit procedures 13-6 Copyright © 2014 Pearson Education A major part of these procedures are done to obtain an understanding of internal control. 13-7 Copyright © 2014 Pearson Education 13-8 Copyright © 2014 Pearson Education 2 Select the appropriate types of audit tests. 13-9 Copyright © 2014 Pearson Education 13-10 Copyright © 2014 Pearson Education 13-11 Copyright © 2014 Pearson Education 3 Understand how information technology affects audit testing. 13-12 Copyright © 2014 Pearson Education Auditing standards provide guidance for auditors of entities that transmit, process, maintain, or access significant information electronically. 13-13 Copyright © 2014 Pearson Education Computer-assisted audit techniques may be used to test automated controls or data. Reports produced by IT may be used to test the effectiveness of IT general controls.