Chapter 12 Example Question #1 - Audit objectives over the sales cycle

For each of the following statements, identify the audit assertion that it relates to:

a. Sales are made to customers that do not have approved credit.

b. Goods not ordered by the customer are shipped.
c. Unit prices on customer invoices are incorrect.
d. Invoices are not posted to customer accounts.
e. Goods are shipped but not invoiced.
f. Sales may be made to unauthorized customers.
g. Fictitious sales may be recorded.

Chapter 12 Example Question #1 - Audit objectives over the sales cycle ANSWER

a. Appropriate valuation of accounts receivable

b. Transactions occurred and sales are not overstated.
c. Accuracy of the financial information.
d. Completeness of the financial information
e. Completeness of sales transactions.
f. Accuracy, valuation, and allocation of accounts receivable is correct.
g. Sales transactions have occurred (occurrence).

Chapter 12 Example Question #2 - Cash sales system controls

As the internal auditor of the Sellanything Group of companies, you have been asked to
investigate the cash sales system of Stationery Ltd., one of the subsidiaries. Stationery sells
office supplies in the Halifax area. Its prices are highly competitive and it offers a same-day
delivery service for orders telephoned before noon. Costs are kept down by requiring cash
on delivery. Sales are made in the following way:

• The customer phones through an order to the sales department, which raises a pre-
numbered multi-copy sales order, two of which (the invoice copies) are priced and
totalled.
• The shipping department makes up the order and gives the goods to the driver with
the invoice copies of the order.
• The driver delivers the goods, collects the cash, and receipts the customer’s copy of
the invoice.
• The driver returns and hands over the cash and the second copy of the invoice to
the cashier.
• The cashier records and deposits the cash.

Required

a. Identify any weaknesses in the cash sales system.

 b. Describe any audit tests you would perform to ensure that there was no material
error or fraud within the system.

Chapter 12 Example Question #2 - Cash sales system controls ANSWER

a) Weaknesses in the cash sales system:

Sales ordering
1. Phone orders should be authenticated by requiring an order number. There should also be
a check of the customer’s details to an approved customer list as well as a check as to the
availability of inventory.

Dispatch of goods
2. There do not appear to be any shipping documents produced. The sales order can be
used as a shipping document. There should be a check that the goods shipped match
the amount on the sales order.

Cash receipts
3. There does not appear to be a cash register or point-of-sale terminal; these devices are
indispensable. They provide:
• Immediate visual display of the amount of the cash sale and the amount tendered
• A printed receipt for the customer and an internal record of the transaction
• A printed record of the day’s receipts

4. At the end of the day there should be an independent check of the total printed by the
register with the amount of cash on hand.

5. The cash should then be forwarded to the cashier’s department for deposit in the bank,
together with the register or terminal printed totals.

6. The total printed by the cash register and the validated deposit slip should be sent to
general accounting to be entered in the cash receipts journal.

7. An employee not otherwise involved in executing or recording cash transactions should

perform periodic bank reconciliations.

b) It would be difficult to ensure that there was no material error or fraud within this
system. This is because of the problem associated with the lack of segregation of
duties over the cash receipts function, due to the role undertaken by the driver.
You could select a sample of the sales orders kept in the sales
department. Each of these orders should be vouched to:
• Details of the goods dispatched in the dispatch department
• The handwritten sales invoice
• Bank deposit details
 The problem is that there is too much control by the cashier, and it would be
difficult to determine whether all cash received was banked.
To provide any conclusive evidence, an auditor would probably have to be
engaged separately (not as part of the audit because of the excessive cost). The
objective of the separate audit assignment should be kept confidential. The
auditor should select sales details for a whole month and vouch every transaction
to dispatch records, invoices, and banking details. Any discrepancies should be
carefully followed up. If there were too many discrepancies, the auditor should
check another month to ensure that they were not systematic differences.

Chapter 12 Example Question #3 - Control strengths and weaknesses

Soak City Waterpark is a family-owned business just outside of Winnipeg. The waterpark is
only open for business from May to September. During the winter, the waterpark undergoes
repairs and maintenance upgrades.

The capital assets for Soak City are significant and the waterpark recently completed an
expansion project, where additional fencing, a restaurant, and a POS system were installed
and three additional slides were constructed.

The following are Soak City’s accounting procedures for revenue, receivables, and receipts.
This is strictly a cash business. Revenues consist primarily of admission fees, but other
revenues include restaurant sales and locker rentals. There are six cash registers open at
peak times, and each starts with a daily float of $200. When the park is closed, the cash tills
are kept in a vault.

At the end of each day, each cashier counts out the float and places the remaining cash in
an envelope and gives it to the admissions manager. The admissions manager counts the
cash and prepares the bank deposit. The admissions manager also completes a sales
summary report, which summarizes the cash sales. This report is forwarded to the
accounting department and the sales are recorded in the general ledger based on this
report. When completing this report, she calculates and compares the admission revenues
recorded in the tills with the cash collected. This information is forwarded to the general
manager, who compares the sales with the bank statements.

Required

a. Identify the control strengths at Soak City Waterpark.

b. Identify the control weaknesses at Soak City Waterpark. For each weakness, state
the implication (the WCGW) of the weakness and make a recommendation to
correct it.

Chapter 12 Example Question #3 - Control strengths and weaknesses ANSWER

a) Strengths:
• The cash tills are kept in a vault
• Comparison of cash sales to the amount deposited per the bank statement
• Comparison of the admission revenues to the cash collected
• The tills are counted by the cashiers and again by the admissions manager

b) Weakness: Cashier puts cash in an envelope and gives it to admissions

manager – admissions manager counts the cash, and prepares the deposit and
the sales report
Implication: Lack of segregation of duties – Manager is given uncounted cash
(custody) and also is responsible for the recording of the sales. Therefore, the
manager can take cash and hide it by reporting the wrong sales figure to cover it
up.
Recommendation: The cashier should count the cash and complete the sales
summary. The admissions manager should count the cash and prepare the
deposit.

Weakness: Sales are recorded based on the sales report sent by the
admissions manager
Implication: Sales may be recorded incorrectly if there is an error on the report.
Recommendation: Sales should be recorded based on the sales report per the
cash till. The accounting staff should compare the amount deposited for the day
to the cash sales for the day.

Chapter 12 Example Question #4 - Integrative Case—Tiny Dreams Toy Co.

Tiny Dreams Toy Co. (Tiny Dreams) is a manufacturer of children’s building block toys. It has
been in business for more than 35 years and it sells to a wide variety of customers including
large and small toy retailers across the country. The company’s year end is May 31.

The company has a large manufacturing plant, four large warehouses, and a head office.
Upon manufacture, the toys are stored in one of the warehouses until they are shipped to
customers. The company does not have an internal audit department.

Sales ordering, goods shipped, and invoicing

Each customer has a unique customer account number and this is used to enter sales
orders when they are received in writing from customers. The orders are entered by an
order clerk and the system automatically checks that the goods are available and that the
order will not take the customer over their credit limit. For new customers, a sales manager
completes a credit application; this is checked through a credit agency and a credit limit is
entered into the system by the credit controller. The company has a price list, which is
updated twice a year. Larger customers are entitled to a discount; this is agreed to by the
sales director and set up within the customer master file.

Once the order is entered, an acceptance is automatically sent to the customer by email
confirming the goods ordered and a likely shipping date. The order is then sorted by
customer address. The warehouse closest to the customer receives the order electronically
and a shipping list and sequentially numbered goods shipped report (GSR) are
automatically generated. The warehouse team packs the goods from the shipping list and,
before they are sent out, a second member of the team double-checks the shipping list to
the GSR, which accompanies the goods.

Once shipped, a copy of the GSR is sent to the accounting team at head office and a
sequentially numbered sales invoice is raised and compared with the GSR. Periodically, a
computer sequence check is performed for any missing sales invoice numbers.

Fraud

During the year, a material fraud was uncovered. It involved cash/cheque receipts from
customers being diverted into employees’ personal accounts. In order to cover up the fraud,
receipts from subsequent unrelated customers were then recorded against the earlier
outstanding receivable balances and this cycle of fraud would continue.

The fraud occurred because two members of staff who were related colluded. One
processed cash receipts and prepared the weekly bank reconciliation; the other employee
recorded customer receipts in the sales ledger. An unrelated sales ledger clerk was
supposed to send out monthly customer statements but this was not performed. The bank
reconciliations each had a small unreconciled amount but no one reviewed the
reconciliations after they were prepared. The fraud was only uncovered when the two
employees went on holiday at the same time and it was discovered that cash receipts from
different customers were being applied to older receivable balances to hide the earlier
sums stolen.

Required

a. Recommend six tests of controls the auditor would normally carry out on the sales
system of Tiny Dreams, and explain the objective for each test.
b. Describe substantive procedures the auditor should perform to confirm Tiny
Dreams’ year-end receivables balance.
c. Identify and explain controls Tiny Dreams should implement to reduce the risk of
fraud occurring again and, for each control, describe how it would mitigate the risk.
d. Describe substantive procedures the auditor should perform to confirm Daydreams’
revenue.

a) Tests of control and objective of each test for the sales cycle of Tiny Dreams
Test of control Objective of test
The auditor should: To ensure that:

Test whether the system will refuse a fake The system will only accept and
customer by trying to enter a fictitious process valid customer orders.
customer account number.

Test whether the system will reject an order Customers who are poor credit risks do
over a customer’s credit limit by trying to not receive goods on credit.
enter an amount over that limit (with the
client’s permission).

Test and agree a sample of credit The system will only process sales to
applications and agree the approved credit customers with approved credit and
limit with the approved credit limit entered in within the approved limit.
the sales system.

Test a sample of invoices against the current Customers were charged the correct
price list to ensure the current prices were amounts for goods.
charged.

Test a sample of invoices against authorized Customers are given only authorized
discounts on the customer master file. sales discounts.

Assess the application controls by trying to Customers are given only authorized
process an order with a sales discount for a sales discounts.
customer not authorized to receive one.

Select a sample of accepted orders and Customer orders are complete and
confirm the system generated an accurate.
acceptance e-mail and it was sent to the
customer.

Confirm that the system automatically All orders are filled accurately and
generates a sequentially numbered shipping completely.
note and observe the warehouse staff using
this document to process orders.

Observe the warehouse staff double-check Shipments are accurate.

all goods against the goods shipped report
(GSR) and the shipping list before goods are
shipped from the warehouse.
 Agree a sample of GSRs with a valid sales Shipped goods are all invoiced
invoice. correctly.

Perform a sequence check at year end to All sales are invoiced and complete at
ensure there are no invoice numbers year end.
missing.

b) Substantive procedures to confirm the receivables balance for Tiny Dreams include:
• Select a representative sample of credit customers with balances due at year end and
send out positive accounts receivable confirmations. Follow up with the client’s
permission, by sending a reminder letter to any non-replies.
• Vouch subsequent cash receipts.
• Calculate average days in receivables. Compare the number of days with the same
period last year and investigate any significant differences.
• Agree the accounts receivable sub-ledger to the accounts receivable general ledger
balance.
• Ensure that shipped goods are recorded in the correct accounting period by selecting
a sample of goods shipped reports (GSRs) before and just after the year end and
follow the shipments through to the sales invoice.
• Identify any overdue balances by inspecting the aged receivables report. Discuss
these with the credit manager to determine whether an allowance or write down is
necessary.
• For any overdue balances, determine whether there are any disputed invoices by
reading customer correspondence.
• Read the minutes of Tiny Dreams’ board meetings to determine whether there are any
material disputed receivables.
• Verify that any credit notes issued after the year end that relate to receivables before
the year end have been recorded in the correct period.
• Scan the accounts receivable sub-ledger and identify credit balances that may need
to be reclassified as payables.
• Select a sample of invoices and vouch the invoice to the related shipping document
(GSR) and the approved customer sales order.

c) Controls to reduce the risk of fraud occurring again include:

Control Mitigate risk

The entity should: This control should reduce the risk of:

Ensure appropriate segregation of duties Staff colluding to easily commit a fraud.

by having someone with no access to
the cash receipts prepare the bank
reconciliation.
 Ensure that two unrelated staff One person stealing cash receipts and
members process cash receipts. being undetected or colluding with other
members of the accounting team.

Promptly send monthly statements to all Not detecting that there had been a
customers. delay in payments being credited to
customers’ accounts.

Require that a responsible official (not Not detecting the fact that there could
the person who prepared the be significant problems with cash and
reconciliation) regularly review the bank bank if a small unreconciled amount
reconciliations and promptly investigate represents two large balances that
and resolve any unreconciled amounts. almost cancel each other out. Bank
reconciliations can often quickly spot
fraud.

Regularly rotate accounting department Staff committing fraud, because they

staff duties. know the chances of getting caught
increase significantly when their roles
rotate.

Ensure that the accounts receivable Frauds occurring because errors in the
sub-ledger is reconciled to the general receivable balances can be spotted.
ledger monthly, and a responsible
official reviews the reconciliation
monthly.

Consider creating an internal audit Employees committing fraud, because

department to assess the effectiveness the presence of an internal audit
of controls, identify weaknesses, and department would be a deterrent.
conduct fraud investigations. Internal controls would be tested, which
increases the likelihood of fraudulent
activities being identified more quickly.

d) Substantive procedures to confirm Tiny Dreams’ revenue include:

• Compare the revenue amount with those of prior years and the budget and
investigate any significant differences.
• Compare the yearly sales for each major category of toys manufactured against
the amounts in the prior year. Discuss any significant differences with
management.
• Calculate Tiny Dreams’ gross margin and compare with the prior year’s
amounts. If there are any significant differences, investigate.
• Select a sample of invoices and ensure that discounts given to large customers
are accurate by recalculating the discounts provided.
• Select a sample of invoices and recalculate the sales tax to ensure it has been
correctly applied.
• Ensure completeness of revenue by selecting a sample of customer orders and
agreeing these to the shipping notes and sales invoices through to the sales
ledger.
• Ensure there is an accurate cut-off by selecting a sample of shipping notes
before and after the year end. Follow these through to sales invoices and the
sales journal in the correct accounting period.
• Ensure that sales returns were recorded in the proper accounting period by
selecting a sample of credit notes issued after the year end and following them
through to the sales invoice.