3-1. Directly.

Higher levels of control risk induce auditors to audit larger samples of receivables, with confirmation date closer to
the fiscal year end date. As for nature of the procedures: higher levels of control risk induce auditors to use positive
confirmations instead of negative confirmations, and to consider vouchingsubsequentpaymentsbythecustomers.
3-2. The featuresofacashreceiptsinternal controlsystemwhichwouldbeexpectedto prevent an employee from absconding with
company funds and covering with funds from the employee pension fund is the prohibition against one employee
havingcustodyof companyfunds and noncompanyfunds. The auditor can detect
suchtransfersbycontrollingandcountingbothfundssimultaneously. To prevent the cash receipts journal and recorded cash sales
from reflecting more than the amount shown on the daily deposit slip, the internal control system should provide that receipts
be recorded daily and intact. A careful bank reconciliationbyanindependentpersoncoulddetectsucherrors.
3-3. A strength is defined as a control procedure that can detect, prevent or correct errors in a timely matter from entering into
the accounting records that form the basisoffinancialstatements. Aweaknessisthelackof acontrol procedure where
theauditorthinksoneshouldexist. Weaknesses are not subject to test of controls auditing because no reliance is placed on a
weakness. Strengths must be audited because the review phase only describes apparentstrengthsthatmaynotactuallyexist.
3-4. The evaluation after the review phase was to determine which controls appeared adequate as a basis for justifying a low
control risk assessment. The final assessment after test of controls auditing is to determine if the controls are
actuallyoperatingaswellastheyappearedtobe.
3-5. a. An order entrydepartmentgenerallyreceives customers’ requeststopurchase merchandise either by telephone or in the
form of a written purchase order from the customer. Apurchase order is alegal offer to purchase goods under the terms
specified. In some entities, on receipt of an order, the order entry department generally prepares a sales order. The sales order
is the first document prepared by the merchandiser in the sales and collections cycle, and it should be prenumbered to
facilitate control over processing transactions. A copy of the sales order, acknowledging that the order has been received and is
being processed, may be mailed to the customer. Four copies of the sales order are sent to the credit department, which either
approves or denies credit and returns a copy of the sales order to the order entry department. The credit department then
sends a copy bearing credit approval (assuming it is granted) to the warehouse, the shipping department, and the billing
department. The sales order bearing credit approval serves as authorization to warehouse personnel to release goods to
shipping. Shipping personnel verify that the quantity and description of goods received from the warehouse match the copy of
the sales order received directly from order entry. Billing matches the customer order, the sales order, and the shipping
documentbeforerecordingthesale.
In some entities, when an order is received, the purchase order is sent to the credit department for approval. The credit
department’s decision is returned to the order entry department. When the credit department has approved the sale, a
multipart sales invoice is prepared. One copy serves as a shipping order, another as the bill of lading, and another is sent to
billing. The sale, however, is not recorded (entered in the sales journal) until the bill of lading isreceivedbybilling.
b. Beforegoodsareshipped,thecustomer’screditmustbeapproved. Thecredit department maintains a list of unauthorized
customers and their credit limits, which an employee must review to determine whether to accept an order. A credit
department employee signs a copy of the sales order authorizing the creditsale.
Whenanorderisreceivedfromaprospectivecustomernotonthe list or when a customer has exceeded the authorized credit limit,
the credit department generally conducts a credit investigation and makes a decision to accept or reject the order. When the
order is accepted, a copy of the sales orderissenttothewarehouseandacopyisretainedinthecreditdepartment.
c. On the basis of the sales order approved bythe credit department, warehouse personnel issue goods to the shipping
department. The accounting department, rather than warehouse personnel, maintains perpetual records for theinventory.
d. The shipping department verifies that the goods received from the warehouse to be shipped agree with the quantity and
description of goods on the sales order. The shipping department then packs the merchandise, arranges transportation with a
common carrier, and prepares a shipping document. The shipping document is a multicopy document that lists the items, gives
instructionstothecommoncarrier astowhom andto whattheaddresstoship the merchandise, and may serve as a packing slip for
the merchandise. Copies of the shipping document are given to the carrier, and copies are sent to the billing department.
Sometimes entities use a bill of lading as a shipping document; it may include a general description of the goods and a
quantityornumberofpounds.
e. Billing involves notifying the customer (by means of an invoice) of the amount due for the goods or services delivered. The
billing function is typically performed by a section of the accounting department and should be independent of sales
executives. Billing personnel should (1) account for the
sequenceofshippingdocumentstodeterminethatallshipmentsarebilled,(2) compare the details included on the sales order with
the shipping documents to serve as an independent check on shipping, (3) prepare the sales invoice from data on the shipping
document and sales order, (4) price the invoice by reference to an authorized price list obtained from the sales department, (5)
extend and foot the invoices, and (6) account for the sequence of sales orders
andshippingdocumentstoensurethatallsalesarerecorded.
Some entities prepare a turnaround document simultaneously with the sales invoice. A turnaround document is a form the
customer mails back to the merchandiser, along with payment of the invoice that facilitates handling and processing of cash
receipts. It contains information, such as the customer’s
nameandaccountnumber,andaplacetoindicatetheamountofthepayment.
Priortomailing, eachinvoice should bereviewed bya person notinvolvedin itspreparation.
Thereviewshouldcovertheproprietyandaccuracyofprices, extensions, footings, credit terms, and freight charges. The billing
department should develop a total of sales invoices and submit it directly to the clerk responsible for maintaining the accounts
receivable control account. Theaccountsreceivablesubsidiaryledgerclerkordataprocessingdepartment prepares the sales journal
and posts debits to individual accounts in the accounts receivable subsidiary ledger. Subsequent reconciliation of the accounts
receivable subsidiary ledger to the accounts receivable control account is an important aspect of internal control. Shipping
documents are used by accounting to update perpetual inventory records when they are maintained.
f. One of the best controls over cash receipts is a lockbox system in which customers mail their remittances to a post office box
controlled by a bank. The bank’sbonded employees obtainthe mail from the postoffice box, make
alistingoftheamountbycustomer,mailtheremittanceadvicesandacopyof the list to the business, and deposit the cash. When mail
containing remittances comes directlyto the entity, the first step in the control process is to obtain a listing of the cash and
checks. This listing is generally prepared bya receptionistor amailroom employee designatedto open mail. However, the
personshouldhave ahighlevel ofintegrityandnotbeotherwiseinvolved in handling cash or maintaining accounts receivable
records. The listing of cash receipts, referred to as a prelisting, serves to establish control over cash receipts. Remittance
advices are prepared if necessary, and when the listing
hasbeenprepared,thecash andremittanceadvices areseparated. Thecashis given to the cashier to prepare the bank deposit, and
the remittance advices are given to the accounts receivable clerk for preparing the cash receipts journal and updating the
accounts receivable subsidiary records. The employee preparing the prelisting also develops a total of cash receipts to send
directly to the accounting department supervisor, who maintains control overthegeneralledgeraccounts.
g. A business issues a credit memo when a customer returns merchandise or when a price adjustment is allowed. Credit memo
authorizations should bear thesignatureofanemployee withauthoritytoissueacreditmemoandshould be based on a receiving
report when merchandise has been returned, or on correspondence between the sales department and the customer when a
price adjustmenthasbeenauthorized.
h. The allowance for uncollectible accounts expense is the result of an adjusting entry, which should be approved by the
controller or chief accountant. Any entries recording uncollectible accounts expense should bear the written
authorizationofthecontroller.
i. After exhausting all reasonable efforts to collect accounts, businesses should write off accounts judged to be uncollectible.
Frequently, accounts are written off after the customer declares bankruptcy. Accounts written off should be transferred to a
separate control account, and statements should continuetobesenttothosedebtorsinanefforttocollecttheaccount.
3-6. a. A merchandiser prepares a shipping document that includes the name and address of the customer and a description of
the goods. The document is a contract betweenthe seller and the carrier andis signed bythe carrier whenit accepts the goods.
Businesses often use a bill of lading as a shipping document. Thedocumentmaybeacopyoftheinvoiceoradeliveryticket.
The signature of the carrier on the shipping document provides externally created evidence that a sale has occurred.
Accounting for the numerical sequencedeterminesthatallshipmentsarerecordedassales.
b. A customer attaches a remittance advice to a check in payment of an invoice. The document may be a turnaround document,
a part of a check, or a statement identifying the invoices being paid. Remittance advices facilitate recordingcashreceipts. If
acustomerdoesnot returnaremittanceadvice,the employee opening the mail usually prepares one. A remittance advice
indicates the date and amount of payment and the invoices paid. Remittance advices areseparatedfromcashandgiventothe
accounts receivable clerkfor postingtoaccountsreceivable.
c. Uncollectible account forms authorize an accounting clerk to write off an accountreceivable asanuncollectibleaccount. The
formprovidespermanent writtenevidencethatauthorizationwasmadeforwritingoffanaccount.
3-7. Managers may experience pressure to show high profits and may inflate sales because of the pressure to meet target
profits established by senior managers, to obtain bonuses, to retain the respect of senior managers, or even to retain their jobs.
3-8. Until arecordofcashreceived hasbeenmade,removingcashis one oftheeasiest forms of fraud to commit and among the
hardest to detect because records do not reflectwhathasoccurred.
3-9. Answerswillvary. Threepossibleexamplesarethefollowing: A cashier in a retail establishment who does not ring up a
transaction on the cash register can generally take the cash without detection. Ringing up the transaction adds the receipt to
the total cash receipts, which can be compared tothecashonhand. An employee who has access to cash receipts and
maintains accounts receivable records can record a sale at an amount lower than the invoice amount. When thecustomerpays,
theemployee takes thedifference between theinvoiceandtheamountrecordedasareceivable. An employee who makes the
cash deposit and also prepares the bank reconciliationcanwithholdcashand hidetheshortage byoverstatingdeposits in transit on
the bank statement, underfooting the list of outstanding checks, or omitting outstanding checks from the outstanding check
list. Routinely testingbankreconciliationsshoulduncoverthisformoffraud.
3-10. Auditorsarenotrequiredtoperformtestsofcontrols. However, whena clienthas effective internal control, performing tests
of controls is cost effective because it may provide a basis for the auditor to assess control risk at less than maximum.
Assigninga reducedlevel of risktocontrolriskreducesthe amount ofsubstantive testingtheauditor must perform. Substantive
tests are moreexpensive to perform thantests ofcontrols. Hence,auditors performtests ofcontrolswhentheybelieve it will enable
them to reduce the amount of substantive testing. Also, auditors may perform much of the testing of controls before year end,
thus spreading the auditwork.
3-11. Adjustments to sales include cash discounts, sales allowances or reductions in price, returns of merchandise, volume
rebates, corrections of billing errors, and write-offs of uncollectible accounts. The greatest concern from a control point of view
is that one of these types of transactions will be recorded to cover a misappropriationofcashreceipts.
3-12. Thefollowingpotentialmisstatementscouldarise: Fictitious cash receipts may be recorded, or cash receipts may be
misappropriated. Cashmaybemisappropriatedandlappingmayoccur. Bankreconciliationsmaycovershortages.
Creditspostedtocustomers’accountsmaybeoverstatedorunderstated. Entriesmaybemadetothewrongaccounts.
3-13. Auditors’ primary concern with regard to uncollectible accounts is that accounts written off have actually become
uncollectible, rather than being written off to cover a misappropriation. To prevent accounts from being written off to cover
misappropriations, any account written off must be authorized by a responsible official not involved in the granting of credit.
The auditor usually tests the effectiveness of this control by examining the approvals of accounts written off. For a sample of
accounts written off, the auditor generally examines correspondence indicating that efforts were made to collect the account
and that the accountis uncollectible. Sometimestheauditor examinescredit reports onthe accounts. The auditor should trace a
sample of the entries to the accounts receivableaccounts.
3-14. 1. (c) Mailing monthly statements to customers with outstanding accounts will detect invoices posted to the wrong
accounts. Customers whose accounts weremispostedforgoodsnotorderedwillcontestthestatements.
2. (g) Each shipping document should have a corresponding invoice when the goods are shipped. The appropriate direction of
testing is from the shipping documentstothesalesinvoices.
3. (f) Daily sales summaries are from the book of original entry – the sales journal. Comparing the summaries with the total of
invoices will detect failuretorecordallinvoices.
4. (k) Comparing control total amounts posted to the accounts receivable (subsidiary) ledger with the control total of all
invoices for the same period shoulddetectinvoicesnotposted.
5. (i) Creditapproval shouldbe received beforesalesare made. Thus, shipping to customers on an approved list should reduce the
risk of sales to customers withunsatisfactorycredit.
6. (b) An approved sales order should be presented to the storekeeper before release of goods from the warehouse to prevent
goods from being removed forunauthorizedorders.
7. (d) Requiring shipping clerks to compare the amounts and types of goods received from the warehouse with approved sales
orders ensures that goods shippedagreewiththoseorderedbycustomers.
8. (l) Comparing sales invoices with shipping documents will ensure that each invoice is supported bya shipment. Fictitious sales
– i.e., those for which no shipmentwasmade–shouldbedetected.
9. (p) The total receipts credited to customer accounts in the subsidiary ledger should equal the total receipts deposited, given
that daily receipts are depositedintact.
10. (c) Checks misappropriated (stolen) prior to forwarding to the cashier will not be posted to customer accounts (assuming
that the remittance advices werestolenaswell). Thus,customerswill complainwhentheirpaymentsfail
tobereflectedinthebalancesonthemonthlystatements.
11. (c) Mailing monthly statements to customers with outstanding accounts will detect receipts posted to the wrong accounts.
Customers whose accounts weremispostedwillcontestthestatements.
12. (p) If more than one customer account is credited for the same cash receipt, theerror
willbedetectedwhenthetotaloftheamountspostedtotheaccounts receivableledgeriscomparedwiththetotalcashreceipts.
13. (s) The bank reconciliation will detect errors in recording cash receipts (and disbursements). The balancein the ledger will
not reconcile with the amount inthebankstatement.
14. (p) If the checks are misappropriated (stolen) priorto deposit, thetotal of the amounts posted to the accounts receivable
ledger will be greater than the validatedbankdepositslip.
15. (n) Invalidsalesreturnsarepreventedbyrequiringapproval ofreturns bythe salesdepartmentsupervisor.
3-15. 1) e 2) a 3) c 4) f 3-16. 1) d 2) a 3) c 4) b 3-17. 1) a 2) a 3) d 4) d 3-18. 1) b 2) b 3) c 4) b 3-19. 1) b 2) a 3) c
3-21. 1. a. Accounting for shipping documents to determine that all shipments are billed. b. Observe procedure and, for a
sample of shipping documents, examine salesinvoices. c. Completeness
2. a. Prelistingofcashreceiptsandcashregisterproceduresaremonitored. b. Comparedeposittocashregistertotalandprelisting. c.
Completeness
3. a. A monthly statement should be mailed to customers by someone not involvedinhandlingaccountsreceivableorcash. b.
Observeprocedureandexaminefollow-upfiles. c. Existenceoroccurrence.
4. a. For goods shipped, goods should be counted and descriptions and quantities should be compared to quantities and
descriptions on sales ordersandshippingdocumentspriortoshipping. b. Observe procedure. For a sample, examine signature on
documents evidencingperformance. c. Rightsandobligations.
5. a. Accountingforallsalesinvoicenumberstoensurethatallarerecorded. b. Observe procedure. For a sequence of invoices,
account for the numericalsequence. c. Completeness
6. a. Shipping documents should be accounted for to determine that all items shippedarebilled. b. Observe procedures.
Examine invoices for a sample of shipping documents. c. Completeness
7. a. For goods shipped, goods should be counted and descriptions and quantities should be compared to quantities and
descriptions on sales ordersandshippingdocumentspriortoshipping. b. Observe procedure. For a sample, examine signature on
documents evidencingperformance. c. Rightsandobligations
8. a. Prenumbered sales invoices should be used and accounted for to determinethatallsalesarerecorded(intheproperperiod). b.
Observe procedure. Examine entries for a sequence of sales invoices in salesjournal. c. Completeness
3-22. 1. a. Existence,completeness b. Cashmaybemisappropriatedorlappingmayoccur. c. Observe separation of duties and
inquire of personnel about their responsibilities.
2. a. Existence,completeness b. Fictitious cash receipts may be recorded or cash receipts may be misappropriated. c. Observe
whether a prelisting is prepared and inquire of preparer about theproceduresfollowed.
3. a. Existence,completeness b. Cashmaybeunrecordedormisappropriated. c. Observe the procedure and inquire of personnel
who perform the procedure.
4. a. Existence b. Bankreconciliationsmayhideshortages. c. Examine bank reconciliations and determine that preparer does not
have conflictinginterests.
5. a. Valuation b. Acustomermaytakealargerdiscountthanappropriate. c. For a sample of entries in the cash receipts journal,
examine remittance advicesforapprovalofdiscountstaken.
6. a. Existence b. A validated deposit ticket is obtained for dailydeposits and compared to thecashreceiptssummary. c. For a
sample of entries in the cash receipts journal, reconcile the total to validateddeposittickets.
3-23.
Weakness RecommendedImprovement 1. There is no segregation of duties between persons responsible for collecting
admission fees and persons responsible for authorizing admission./// One clerk (hereafter referred to as the collection clerk)
should collect admission fees and issue prenumbered tickets. The other clerk (hereafter referred to as the admission clerk)
should authorize admission on receipt oftheticketorproofofmembership.
2. An independent count of paying patronsisnotmade.
The admission clerk should retain a portion of the prenumbered admission ticket(admissionticketstub).
3. There is no proof of accuracy of amountscollectedbytheclerks.
The treasurer should reconcile the admission ticket stubs with cash collected by the collection clerk each day.
4. Cash receipts records are not promptlyprepared.
Cash collections should be recorded daily by the collection clerk on a permanent record that will serve as the
firstrecordofaccountability.
5. Cash receipts are not promptly deposited.
Cash should not be left undeposited for a week. Cash should be deposited at leastonceeachday.
6. There is no proof of accuracy of amountsdeposited.
Authenticated deposit slips should be compared with daily cash collection records. Discrepancies should be promptly
investigated and resolved. In addition, the treasurer should establish a policy that includes performing analytical procedures to
cash collections.
7. There is no record of the internal accountabilityforcash.
The treasurer should issue a signed receipt for all proceeds received from the collection clerk. These receipts should be
maintained and should be periodically checked against cash collectionanddepositrecords.
3-24. The Code of Professional Conduct does not prohibit a member of the audit team from taking advantage of discounts when
purchasing goods from clients. However, auditors mayfollowstandards that are more restrictivethantheCodeof Ethics. The
purpose of this exercise is for students to consider the possibility of such a discount’s affecting the auditor’s independence.
Some auditors would decide that independence is lost if the discount was equivalent to the discount given employees. Students
should also appreciatethat auditors do not necessarily agree on acceptable behavior in this situation. Some CPA firms impose
restrictionsonemployeesregardingthismatter.
3-25. a. Basedontheinformationgiven,Honeycanusethecomputerto text extensions and footings of computerized sales records
that serve as a basisforthepreparationoftheinvoicesandsalesjournal. verify the mathematical accuracy of posting from the
sales journal to appropriateledgeraccounts determine that all sales invoices and other related documents have been
accounted for (for example, by accounting for the integrity of the numericalsequence). select sales transactions for review
(based on predetermined criteria) through a review of the sales journal or the accounts receivable subsidiaryledger. print a
working paper that lists each item selected, with relevant data insertedinapplicablecolumns. select all debits posted to the
sales account and all postings to the sales accountfromasourceotherthanthesalesjournal. perform analytical procedures on
recorded sales byuse of predetermined criteria (percentage relationship, gross margin, trends, and so forth) on a
periodicorannualbasis. compare duplicate data maintained in separate files for corrections. For example, the computer may
be used to compare the client’s records of quantitiessoldwiththeclient’srecordsofquantitiesshipped. examine records for
quality (completeness, consistency, and so forth). The quality of visible records is readily apparent to the auditor. Sloppy
recordkeeping and lack of completeness are observed by the auditor in thenormalcourseoftheaudit. Ifmachine-
readablerecordsareevaluated manually, a complete printout is needed to examine their quality. Honey
maychoosetousethecomputertoexaminetheserecordsforquality.
b. Inadditiontotheproceduresoutlinedabove,Honeyshould tracepostingsfromthesalesjournaltoinvoicecopies.
tracedatafromsalesinvoicestothesalesjournal. compare dates of recorded sales transactions with dates on shipping records.
determine that all shipping documents have been accounted for (for
example,byaccountingfortheintegrityofthenumericalsequence). examine documents for appropriate approval (for example,
granting of credit,shipmentofgoods,anddeterminationofpriceandbilling). determine the extent and nature of business
transacted with major customers (for indications of previously undisclosed relationships – related parties – and for
determination of applicability of disclosure requirementsrequiredbygenerallyacceptedaccountingprinciples).
verifythesalescutoff atthebeginningandendoftheperiodtodetermine whetherrecordedsalesrepresentrevenuesoftheperiod.
testpricingofcomparinginvoicetodailypricelist.
3-26.
a. b. c. & d. TYPEOFEVIDENCE TYPEOFTEST OBJECTIVE
1. Documentation (1)Testofcontrol Existingsalestransactions arerecorded(completeness)
2. Inquiry (4)Testofdetailsof balances
Salestransactionsare recordedintheproperperiod
3. Mechanicalaccuracy (4)Testofdetailsof balances
Accountsreceivableare mechanicallyaccurate
4. Observation (4)Testofcontrol Accountsreceivableare mechanicallyaccurate
3-27. Alpha Drug Store, Inc., Processing Cash Collections: Internal Control Questionnaire–Thefollowingquestionsshouldbelisted:
Are customers who pay by check identified via store identification card or othermeans? Does company policy prohibit
accepting checks for anything except merchandisesalesplusanominalcashamount?
Isareceiptproducedbythecashregistergiventoeachcustomer? Is the reading of each cash register taken periodicallybyan
employee who is independentofthehandlingofcashreceipts? Are cashcountsmadeonasurprisebasis byanindividual
whoisindependent ofthehandlingofcashreceipts? Isthereadingofeachcashregisterregularlycomparedtothecashreceived? Is a
summary listing of cash register readings prepared by an employee who isindependentofthephysicalhandlingofcashreceipts?
Are receipts forwarded to an independent employee who makes the bank deposits?
Areeachday’sreceiptsdepositedintactdaily? Is the summary listing of cash register receipts reconciled to the duplicate
depositslipsauthenticatedbythebank? Are entries to the cash receipts journal prepared from duplicate deposit slips
orthesummarylistingofcashregisterreadings? Are entries to the cash receipts journal compared to the deposits per bank
statement? Areareasinvolvingthephysicalhandlingofcashreasonablysafeguarded? Areemployeeswhohandlereceiptsbonded?
3-28. 1. a. Existence b. Cashmaybemisappropriatedorlappingmayoccur. c. Observe separation of duties and inquire of personnel
about their responsibilities. d. For selected days, trace entries in the cash receipts journal to validated deposit ticket, prelisting
of cash receipts, and posting to accounts receivable.
2. a. Existence b. Fictitious cash receipts may be recorded or cash receipts may be misappropriated. c. Observe whether a
prelisting is prepared and inquire of preparer about theproceduresfollowed. d. For a sample of entries inthe cash receipts
journal, tracetothe prelisting ofcashreceipts.
3. a. Completeness b. Cashmaybeunrecordedormisappropriated. c. Observe the procedure and inquire of personnel who
perform the procedure. d. For a sample of entries in the cash receipts journal, compare prelistingto thedepositticket.
4. a. Existence b. Bankreconciliationsmayhideshortages. c. Examine bank reconciliations and determine that the preparer does
not haveconflictinginterests. d. Testbankreconciliations.
5. a. Valuation b. Acustomermaytakealargerdiscountthanappropriate. c. For a sample of entries in the cash receipts journal,
examine remittance advicesforapprovalofdiscountstaken. d. For a sample of entries in the cash receipts journal, examine
remittance advicesandverifythatdiscounttakenwasappropriate.
6. a. Existence b. Thecashiermaymisappropriateaportionofthecashreceipts. c. For a sample of entries in the cash receipts
journal, reconcile the total to validateddeposittickets. d. For a sample of entries in the cash receipts journal, examine
remittance advices.