Question

1. 11A–1.

   A summary of the controls for the revenue and cash receipts cycle of Keystone Computers & Networks, Inc., appears in this appendix.

1. For the following three controls over sales, indicate one type of error or fraud that the control serves to prevent or detect. Organize your solution as follows:

Control	Error or Fraud Controlled
Application controls are applied when customer orders are entered by the sales order clerk. The computer assigns numbers to sales invoices when they are prepared. Monthly statements are mailed to customers.

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2. For the following three controls over cash receipts, indicate one type of error or fraud that the control serves to prevent or detect. Organize your solution as follows:

Control	Error or Fraud Controlled
Cash receipts are prelisted by the receptionist. The accounting manager reconciles control totals generated by the accounts receivable computer program. The computer summaries of cash collections and cash sales are reconciled to prelistings of cash receipts and cash deposits by the accounting manager.

• 11A–2.

  As indicated on the control risk assessment working paper Schedule IC-20 (its last section prior to the Assessed Level of Control Risk), the auditors identified two weaknesses in internal control over the revenue cycle of KCN. Describe the implications of each of the two weaknesses in terms of the type of errors or fraud that could result.

• Risk of assessing control risk too low—5 percent

• Tolerable deviation rate—15 percent

• Expected deviation rate—1 percent

1. Describe the characteristic that a control must possess in order to be tested with audit sampling.

2. Assume that the auditors decided to use audit sampling to test the operating effectiveness of the procedures for matching sales invoices with delivery receipts. Determine the required sample size, using the following parameters.

3. Prepare a working paper similar to Schedule IC-15 documenting the planned audit procedure described in requirement (b).

• 11A–3.

  As indicated on Schedule IC-15, the auditors decided to apply audit sampling to three controls for the revenue and cash receipts cycle.
  A) Describe the characteristic that a control must possess in order to be tested with audit sampling.
  
  
  

  11B–2.

  Assume that you have been assigned to the audit of Keystone after audit planning has occurred. Review the planning information in Appendix 6C of Chapter 6 and the audit plan for the accounts receivable and revenue (Schedule B-6). The manager on the engagement has given you the task of reviewing the monthly revenue report on Schedule B-11.

• Based on your review of the report, describe any unusual relationships that might indicate a risk of misstatement of revenues based on your knowledge of the company derived from a review of the information on Schedule B-12.

• Identify any procedures on the audit plan for receivables and revenue that might address the risk(s) identified in part (a).

Answer 1

Revenue cycle controls

11A–1.

Sales controls:

Control	Error or Fraud Controlled
Application controls are applied when customer orders are entered by the sales order clerk.	Controls errors in the delivery & billing of sales transactions
The computer assigns numbers to sales invoices when they are prepared.	Controls the recording of sales to ensure completeness & accuracy
Monthly statements are mailed to customers.	Controls the recording of false & inaccurate sales to customer accounts

Cash receipt controls:

Control	Error or Fraud Controlled
Cash receipts are prelisted by the receptionist.	Controls errors when recording of cash.
The accounting manager reconciles control totals generated by the accounts receivable computer program.	Controls the embezzlement of cash receipts & errors in accounts receivables records
The computer summaries of cash collections and cash sales are reconciled to prelistings of cash receipts and cash deposits by the accounting manager.	Controls the look of cash & recording of cash receipts and cash sales.

Internal control weaknesses

11A–2.

1. Sales invoices are prepared and mailed prior to delivery of goods

Implications: Errors may occur where different quantities of goods may be delivered than what had been ordered, or goods may not be delivered at all. Sales and accounts receivable may be overstated for the year.

2. Accounts receivable are not written off on a regular basis

Implications: Receivables need to be monitored, otherwise the company may currently be selling goods on credit to customers who have poor credit. Allowance for Doubtful Accounts might end up being inadequate, with Bad Debt Expense being understated.

(A) Characteristic that a control must possess:

Audit sampling can be used when there is some sort of evidence of performance of the internal control procedure

• Completed document
• Initials of the person performing the procedure

Evidence of performance allows the auditors to determine whether the control procedure was applied to each item included in the sample.

(B) Sample Size required

Given parameters:

Risk of assessing control risk too low: 5%

Tolerable deviation rate: 15%

Expected deviation rate: 1%

30 with 1 allowable deviations

(C)

KEYSTONE COMPUTERS & NETWORKS, INC.
Attributes Sampling Summary—Revenue Cycle
December 31, 20X5
Objectives of test:
To test the operating effectiveness of the procedures for matching sales invoices with delivery receipts.
	Test	Population		Size
	1	Sales Invoices
Sampling unit: Individual reports
Random selection procedure: Random number table
Risk of assessing control risk too low: 5%
Sl.No.	Attributes Tested	Planning Parameters			Sample Results
		Tolerable Deviation Rate	Expected Deviation Rate	Sample Size	Number of Deviations	Achieved Maximum Rate
1	Matching of sales invoices with delivery receipts	15%	1%	30%