Auditingch5-7

5.58 Internal Control Audit Standards (AICPA solution)a. In planning an audit, an auditor's understanding of the internal control componentsshould be used to identify the types of potential misstatements that could occur, toconsider the factors affecting the risk of material misstatement, and to influence thedesign of substantive procedures.b. An auditor obtains an understanding of the design of relevant internal controlprocedures (policies and procedures) and whether they have been implemented.Assessing control risk below the maximum level further involves identifying specificcontrol procedures (policies and procedures) relevant to specific assertions that arelikely to prevent or detect material misstatements in those assertions. It also involvesperforming tests of controls to evaluate the operating design and effectiveness of theclient's control procedures.c. When seeking a further reduction in the assessed level of control risk, an auditorshould consider whether additional audit evidence s ufficient to support a furtherreduction is likely to be available, and whether it would be efficient to perform testsof controls to obtain that audit evidence.d. An auditor should document the understanding of a client's internal control systemcomponents to plan the audit. The auditor also should document the basis for theconclusion about the assessed level of control risk. If control risk is assessed at themaximum level, the auditor should document that conclusion and the reasons for it.However, if the assessed level of control risk is below the maximum level, theauditor should document the basis for the conclusion that the effectiveness of thedesign and operation of internal control procedures supports that assessed level.5.59Audit Simulation: Segregation of duties5.60 Types of audit tests6.53 The Perfect Crime?The ingenious scheme was a perfect crime for a long time. Only the greed of the embezzlerfinally tipped off the managers, who commissioned a special investigation to learn whyexpenses were high, profits low, and cash flow s mall.Ordinary everyday control activities for detection:1. Someone else taking over the embezzler's duties at vacation time might have beenless willing or able to dig out the documentation to support payment of "past due"amounts, thus leading to suspicion and maybe discovery. The embezzler avoided theproblem by clearing all the vendor payments a month before his regular vacation.2. The treasurer might have been more diligent about remembering earlier payments ofamounts later submitted as "past due," but she had other more important assignments.(In fact, the documents were just scanned and the checks were signed with amechanical signature plate.)3. Someone in charge of investigating budget variances (when they occurred) mighthave been more in tune with "thinking like a crook," but several people in severaldepartments were not that careful. The variances were not very large after the firsttwo years (although some larger ones began to show toward the end when theembezzler got greedy.)Extensive detection efforts:The embezzler was caught because he was too greedy--adverse cash flow alerted the business owner, and an investigation started.1. The investigator spent a long time reviewing the expense accounts and studyingdocumentation. He noticed fairly frequent payments of "past due" balances.2. In the course of repeated interviews with the company president, he learned about thecompany's policy of paying bills on time to obtain trade discounts. The president wassurprised to learn of the numerous incidents of past due bills.3. More searching by the investigator led to notice of five "quarterly payments" in anexpense account for the rental of a photocopy machine. This was the first obvioussign of a duplicate payment.4. The investigator asked the bank to send copies of the checks for the five payments.One proved to be payable to the embezzler. This discovery led to requests for accessto all the company's canceled checks, and the investigator then was able to findnumerous checks payable to the embezzler. The physical differences in thecompany's own checks and the embezzler's private stock were small, but they werenoticeable.5. Charges were filed. The district attorney subpoenaed the embezzler's bank accountrecords, and the bogus checks were matched with deposits.6.54 Select E ffective Extended ProceduresThese procedures are offered without explanation of the information that might be discovered.For each one, a confirmation of the suspicion might arise. One definite instance is enough tojustify proceeding with an investigation (real fraud examination), but failure to findconfirming evidence can mean (1) nothing wrong is going on, or (2) the crook is too cleverfor the auditor. All of these procedures should be conducted with care not to impugn falselythe integrity of the people under investigation.a. Count the petty cash fund on Friday morning in the presence of the supervisor andcustodian of the fund. Then, perform a second surprise count Friday afternoon beforethe custodian leaves work for the day.b. Ask the local Better Business Bureau for reports on the eight new vendors. Ask thelocal Chamber of Commerce if they are members. Look them up in the telephonebook. Telephone them, asking about business hours, product availability, and othermatters. but not in a way to arouse suspicion of investigation. Visit the businesslocation (telephone book address) to browse. Go to the local tax assessor-collectoroffice files to look up the owner of the property where the businesses are located. Ifany of the new vendors are professional people, look them up in state licensingagency directories (e.g. CPAs, attorneys, doctors). Go to the state secretary of stateoffice and look up the corporate charter to see if the purchasing agent is shown as anincorporator, officer, or director (if a large company, you can use the Standard &Poor's Register of Corporations, Directors, and Executives) . Look them up in thestate or county "assumed name" files for real names. Write a check to each business,and use the canceled check to identify the businesses' banks; then get one of thepurchasing agent's canceled payroll checks to see whether they all bank at the sameplace. (This is circumstantial evidence that needs more work, but it would be anunlikely coincidence in most cases if all of them had accounts at the same bank.)Avoid approaching the chief purchasing agent with inquiries about the new vendorapproval process because you might alert the person to the investigation.c. Select the people who have quit and determine their termination dates. In the payrollrecords, find the identification of their last paychecks (check number), then find thecanceled checks and examine the endorsement, looking for two endorsements, one ofwhich might be the payroll supervisor. Contact the terminated employees on thepretext of an exit conversation, and inquire whether they received all their paychecks,being sure to identify the last period or severance pay provision for them.d. Add the customers' subsidiary accounts and compare to the general ledger controlaccount. If clerks are giving customers proper credit in their subsidiary accounts butnot depositing the money and enabling the accounting system to credit the controlaccount, they may be out of balance. If you can identify suspicious accounts, ask thecustomers to give you originals or copies of their canceled checks so you canexamine the endorsements to see whether they appear to have been negotiated by acompany employee.e. Use the cash receipts journal date and the deposit date at the bank to see whetherthere is a pattern of delay that could indicate the cashier is holding the deposits. Lastresort is a surprise cash count at the cashier's desk to see whether cash on hand isactually on hand.7.59 RING AROUND THE REV ENUE: Overstated Sales and Accounts ReceivableThis case is a take-off on the Mattel, Inc. financial statements misstatement case.AUDIT APPROACHObjective: Obtain evidence to determine whether sales were recorded in the proper period and whether gross accounts receivable represented the amounts due from customers at year end.Control: Sales terms should be properly documented. Accounting treatment, including billing at agreed-upon prices, should follow the terms of the sale. If the risks and rewards of ownership have not been transferred to the customer, or the price has not been reliably determined, or the collectibility of the amount is seriously in doubt or not estimable, an accrual sale should not be recognized. Recorded sales should be supported by customer orders and agreements. Shipping documents should be sufficient to show actual shipment or a legitimate field warehousing arrangement.7.62 RING AROUND THE REV ENUE: Overstated Sales and Accounts Receivable(Continued)Tests of Controls: Questionnaires and inquiries should be used to determine the company'saccounting policies. If the auditors do not know about "bill and hold" practices, they shouldlearn the details. For detail procedures: Select a sample of recorded sales, and examine themfor any signs of unusual sales terms. Vouch them to customer orders and other salesagreements, if any. Vouch them to shipping documents,and examine the documents for external reliability—recognizing blank spaces (carrier name,date) and company representative's signature (two places, both company and carrier).Compare prices asked in customers' orders to prices charged on invoices. These tests followthe vouching direction—starting with data that represent the final recorded transactions (sales) and going back to find originating supporting source documents. These procedures mightreveal some transactions of the problem types—bill and hold, and overbilling. The last month of the fiscal year (although a typical seasonal low month) could be targeted for greaterattention because the sales are much higher than the previous January and because the auditors want to pay attention to sales cut-off in the last month.Select a sample of shipping documents, trace them to customer orders, and trace them toinvoices and to recording in the accounts receivable with proper amounts on the proper date.These tests follow the tracing direction—starting with data that represent the beginning oftransactions (orders, shipping) and tracing them through the company's accounting process. If extra attention is given in January for cut-off reasons, this sample might reveal some of theproblem transactions.Audit of Balance: Confirm a sample of customer accounts. Follow up exceptions noted bycustomers relating to bill and hold terms, excessive prices, and double billing. Even a fewexceptions raise red flags for the population of receivables.Use analytical comparison on comparative month's sales. Investigate any unusual fluctuations(e.g. January this year much larger than January last year, the reversal month next year withnegative sales). The January comparative increase in sales should cause auditors to extenddetail procedures on some of the month's transactions.DISCOVERY S UMMARYThe auditors performed a detail sales cut-off test on January sales, selecting a sample ofrecorded sales. However, they did not notice the significance of "bill and hold" marked on the invoices, and they did not figure out the meaning of the blank spaces and duplicate companyemployee signatures on the shipping documents.In the following year's audit, they tested sales transactions in a month when the prior year's bill and hold sales were reversed. They noticed the discrepancy but were told that it involved various billing errors. They did not connect it with reversal of the prior year's sales.The auditors confirmed a judgment sample of large accounts receivable balances. Twelve replies were received on 103 confirmations. Six of the replies were from "bill and hold" customers who listed discrepancies. The auditors followed up the six by examining sales invoices and shipping documents. They did not grasp the significance of the "bill and hold" stamps or the features of the shipping documents described earlier. Three confirmation responses indicated the customers did not owe the amounts. The auditors relied on Mattox internal documents to decide that the customers were wrong. They did not examine the sales orders that indicated that these customers had a right of cancellation.The auditors did not perform month-by-month analytical sales comparisons with the prior year. Thus they did not recognize the significant fluctuations in the comparative January sales. In the next year's audit, they did not recognize the significantcomparative decrease in month's sales for the months when the prior year bill andhold sales were reversed.。