Question

If a company’s control risk is initially assessed as low, the auditor needs to gather evidence on the operating effectiveness of the controls. For each of the following control activities listed as (1)–(10), do the following two tasks:  

a. Describe the test of control that the auditor would use to determine the operating effectiveness of the control.

b. Briefly describe how substantive tests of account balances should be modified if the auditor finds that the control is not working as planned. In doing so, indicate (a) what misstatement could occur because of the control deficiency, and (b) how the auditor’s substantive tests should be expanded to test for the potential misstatement.  

4. The accounts receivable bookkeeper is not allowed to issue credit memos or to approve the write-off of accounts.

A)

B)

Answer 1

Introduction:- This is basic issue of segregation of duties. The person who is in charge of accounts receivable accounting should not be having a right to issue credit memos or to approve the write-off accounts due to following risks.

1. He may collude with the customer and get some benefit and issue credit memos and account for the balance

2. He may write off accounts receivable balances even thought the balance has been received from the customer and take benefit from the amount received from him. So it is always advisable to than an independent person takes part of these additional functions so that the risk of above activities will be less.

Test of controls:- Understand the segregation of duties in the accounts receivable function. Obtain the credit memos extract issued during the year and write off balances during the year. For sample cases test that these are supported by the approval of independent person. In case this test fails then the risk is high and the auditor has to design full large extent substantive procedures to minimize the risk of misstatement.

Below are the substantive procedures

1. Check the bank reconciliation statement if any unaccounted receipts exists which may be written off unknowingly and obtain the reason for that receipt

2. Obtain the list of credit memos issued during the year and check for each memo or by designing appropriate sample and check that the credit memos issued at the percentage and terms are as per companies policies.

3. The write off of balances are supported by appropriate follow ups with the customers and then a decision has taken to write off

4. The credit notes have been issued to the customers who are eligible to be paid as per their discount policy or if by mistake excess has been paid and credit note has been issued basis this excess accounting of payment

5. Check on sample basis the reason for write off of balances is clear, or any legal action against the vendor has been instituted or not.

6. Check that the write off should be reasonable with provisions made earlier, if not find out the reason for the same.