The Audit Process Auditing

Running head: APPLYING THE AUDIT PROCESS

APPLYING THE AUDIT PROCESS 2

Part A: Identifying Internal Controls and Tests of Controls/Prepare an Audit Program

a) List the internal controls for the six transaction-related audit objectives

The six transaction-related audit objectives over sales are existence, completeness, accuracy, timing, classification, and posting and summarization. The corresponding internal controls in the client organization are:

i) Existence – pre-numbered sales invoices are made in duplicate and duplicate copies as well as the supporting customer orders and bills of lading are stored in an electronic file that is easily retrievable. Duties are segregated such that sales recording and authorization are done by different clerks in the order and credit departments

ii) Completeness – pre-numbered documents including sales order forms, invoices, and bills of lading are available in sequence

iii) Accuracy – there is an approved commodity price list for use by billing staff and invoice totals are calculated with the help of computer software to ensure accuracy in generated invoices

iv) Classification – transactions are accurately classified in the respective journals and ledgers

v) Timing – there is a clear sequence of shipping documents, dates match and are properly recorded

vi) Posting and summarization – the accounts receivable master file and general ledger are reconciled and subjected to regular internal audits

b) For each control, list a useful test of control to verify the effectiveness of the control

i) Existence – check whether pre-numbered sales invoice duplicates and supported by customer orders and bills of lading. Check whether duties are segregated such that sales recording and authorization are done by different employees

ii) Completeness – check whether pre-numbered shipping documents, including invoices and bills of lading, are available in sequence and are all used and accounted for

iii) Accuracy – check whether the approved commodity price list is accurate, with clear information on allowable discounts, and whether totals are calculated with the help of computer software to ensure accuracy

iv) Classification – check whether transactions are accurately classified in the respective ledgers and journals

v) Timing – checks whether there is a clear sequence of shipping document and whether dates match and are properly recorded

vi) Posting and summarization – check whether the accounts receivable master file and general ledger are properly reconciled

c) For each transaction-related audit objective for sales, list appropriate substantive tests of transactions audit procedures, considering internal controls

i) Sales transactions existence - in analyzing existence, the auditor i) traces sales journal entries to the corresponding shipping documents to check whether there are recorded sales that were not shipped; ii) examines cancelled shipping documents to check for sales records that could have been made more than once; and iii) checks for the degree of segregation of duties to verify that the people recording sales are not the ones authorizing the same such that there is a minimal risk of sales to fictitious persons.

ii) Completeness – the auditor checks for potential misstatements by tracing customer orders to the corresponding sales invoices and entries in the sales journal to the accounts receivable master file and general journal

iii) Accuracy - a fundamental test for accuracy is to examine sales journal entries and comparing the totals of selected transactions with the total postings to the accounts receivable master files and general journal

iv) Classification – a fundamental test for classification is to examine the duplicate sales invoices to check whether cash and credit sales are classified in their proper accounts. This would reveal misstatements such as sales of operating assets wrongly classified as sales rather than in the general journal.

v) Timing – a fundamental test is to compare the dates when a sale is recorded in the sales journal to the date on the bill of lading and sales invoice. Billing of sales is to be made when ownership is transferred to the customer

vi) Posting and summarization – a potential test for posting/summarization is to verify and cross-verify the sales journal to the totals posted in the general ledger using audit software to check for accuracy and consistency

d) Combine the audit procedures from parts b and c into an efficient audit program for sales

Transaction-Related Audit Objective

Internal Control

Substantive Test

Sample size for Test of Control

Control operates adequately in practice (Yes/No)

Existence

pre-numbered sales invoices duplicates are available as well as the supporting customer orders and bills of lading

Duties are segregated such that sales recording and authorization are done by different employees – different clerks in the order and credit departments

i) trace sales journal entries to the corresponding shipping documents to check whether there are recorded sales that were not shipped

ii) examine cancelled shipping documents to check for sales records that could have been made more than once

iii) verify segregation of duties

Completeness

pre-numbered documents including sales order forms, invoices, and bills of lading are available in sequence and are all used and accounted for

Trace customer orders to the corresponding invoices and entries in the sales journal to the accounts receivable master file and general journal

Accuracy

Approved commodity price list is accurate

Invoice totals are calculated with the help of computer software to ensure accuracy in generated invoices

Examine sales journal entries and compare the totals of selected transactions with the total postings to the accounts receivable master files and general journal

Classification

Transactions are accurately classified in the respective journals and ledgers

Examine the duplicate sales invoices to check whether cash and credit sales are classified in their proper accounts

Timing

There is a clear sequence of shipping documents, dates match and are properly recorded

compare the dates when sales are recorded in the sales journal to the date on the bill of lading and sales invoice

Posting and summarization

The accounts receivable master file and general ledger are reconciled and subjected to regular internal audits

Verify and cross-verify the sales journal to the totals posted in the general ledger using audit software to check for accuracy and consistency

Part B: Audit Risk and Procedures

a) Identify the major factors affecting client business risk and acceptable audit risk for this audit

Business risk is the risk resulting from significant conditions, circumstances, events, or actions and which may have an effect on the client’s business (IFAC, 2010). Several factors influence the Smalltown Regional Hospital’s business risk. First, the client has several large loans payable to local banks that are reluctant to extend more credit. There is a heightened risk of revenue overstatement in an attempt to present the hospital as a going concern to win more credit. Secondly, a modern hospital is under construction in the nearby city, raising questions on the hospital’s sustainability (going concern). Thirdly, the hospital faces a threat to its revenue streams – it relies on the county to make up deficits, but the county has, in the past year, reported deficits due to high unemployment. Finally, the client faces a reputational risk from its deficient record-keeping. The hospital faces a significant business risk, and given that previous audits have revealed misstatements, the auditor needs to offer a low acceptable audit risk.

b) What inherent risks are you concerned about?

Inherent risk could be perceived as the risk that there will be material misstatements, without considering the effectiveness of internal controls (Puncel, 2008). A fundamental inherent risk that should concern the auditor is that results of previous audits have shown misstatements in billing, cash receipts, and accounts receivable. A second inherent risk is the going concern issue and the question of whether the business is sustainable into the foreseeable future. Further, there is a risk of revenue overstatement in a bid to obtain credit approval from the bank, which is reluctant to extend more credit. The fourth inherent risk is that the organization has a shortage of accounting personnel, which limits proper internal verification. There is also a risk arising from the nature of business – there is a risk of no-for-profits understating revenues to obtain eligibility for donor and other forms of external funding.

c) Which risks would you consider to be significant risks?

A significant risk is an identified and assessed risk of material misstatement that the auditor believes would require special audit consideration (IFAC, 2010). There are two significant risks in the current audit. The first is the going concern and liquidity concern brought about by the threat of the modern hospital under construction, banks’ reluctance to offer credit, and the county’s growing deficits. The second significant risk is the fact that past audits have shown misstatements and the organization is known for poor record-keeping.

d) For each of the following, explain whether you plan to emphasize the tests in the audit of the sales and collection cycle and give reasons.