Receivables - The Assertions

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Question 18b

Dashing Co manufactures women’s clothing and its year end was 31 July 20X7. You are an audit supervisor of Jaunty & Co and the year-end audit for Dashing Co is due to commence shortly.

The draft financial statements recognise profit before tax of $2·6m and total assets of $18m. You have been given responsibility for auditing receivables, which is a material balance, and as part of the audit approach, a positive receivables circularisation is to be undertaken.

At the planning meeting, the finance director of Dashing Co informed the audit engagement partner that the company was closing one of its smaller production sites and as a result, a number of employees would be made redundant. A redundancy provision of $110,000 is included in the draft financial statements.

Required:
(b) Describe substantive procedures, other than a receivables circularisation, the auditor should perform to verify EACH of the following assertions in relation to Dashing Co’s receivables:

(i) Accuracy, valuation and allocation;

(ii) Completeness; and

(iii) Rights and obligations.

Note: The total marks will be split equally between each part. (6 marks)

Specimen
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MC Question 13

Cannavaro.com is a website design company whose year end was 31 December 20X4. The audit is almost complete and the financial statements are due to be signed shortly. Profit before tax for the year is $3·8 million and revenue is $11·2 million.

The company has only required an audit for the last two years and the board of directors has asked your firm to provide more detail in relation to the form and content of the auditor’s report.

During the audit it has come to light that a key customer, Pirlo Co, with a receivables balance at the year end of $285,000, has just notified Cannavaro.com that they are experiencing cash flow difficulties and so are unable to make any payments for the foreseeable future. The finance director has notified the audit team that he will write this balance off as an irrecoverable debt in the 20X5 financial statements.

The audit engagement partner has asked you to make an initial assessment of the materiality of the issue with the outstanding receivables balance with Pirlo Co and to consider the overall impact on the financial statements.

Which of the following correctly summarises the effect of the outstanding balance with Pirlo Co?

Material Financial statement impact
A. No Revenue is overstated
B. No Gross profit is understated
C. Yes Profit is overstated
D. Yes Going concern principle is in doubt
Specimen
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MC Question 14

Cannavaro.com is a website design company whose year end was 31 December 20X4. The audit is almost complete and the financial statements are due to be signed shortly. Profit before tax for the year is $3·8 million and revenue is $11·2 million.

The company has only required an audit for the last two years and the board of directors has asked your firm to provide more detail in relation to the form and content of the auditor’s report.

During the audit it has come to light that a key customer, Pirlo Co, with a receivables balance at the year end of $285,000, has just notified Cannavaro.com that they are experiencing cash flow difficulties and so are unable to make any payments for the foreseeable future. The finance director has notified the audit team that he will write this balance off as an irrecoverable debt in the 20X5 financial statements.

The audit engagement partner requires you to perform additional procedures in order to conclude on the level of any adjustment needed in relation to the outstanding balance with Pirlo Co.

Which TWO of the following audit procedures should be performed to form a conclusion as to whether the financial statements require amendment?

(1) Discuss with management the reasons for not amending the financial statements
(2) Review the cash book post year end for receipts from Pirlo Co
(3) Send a request to Pirlo Co to confirm the outstanding balance
(4) Agree the outstanding balance to invoices and sales orders

A. 1 and 2
B. 1 and 4
C. 2 and 3
D. 2 and 4

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MC Question 4

Which TWO of the following substantive procedures provide evidence over the EXISTENCE of trade receivables?

(1) Agreeing a sample of goods despatched notes to sales invoices and to the sales ledger
(2) Undertaking a receivables circularisation
(3) Review of post year-end cash receipts, if these relate to year-end receivables follow through to the sales ledger
(4) Recalculating the allowance for uncollectible accounts

A. 1 and 3
B. 2 and 4
C. 2 and 3
D. 1 and 4

Specimen
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Question 4b

Torres Leisure Club Co (Torres) operates a chain of health and fitness clubs. Its year end was 31 October 2014.

You are the audit manager and the year-end audit is due to commence shortly. The following matter has been brought to your attention. Torres’s trade receivables have historically been low as most members pay monthly in advance. However during the year a number of companies have taken up group memberships at Torres and hence the receivables balance is now material. The audit senior has undertaken a receivables circularisation for the balances at the year end; however, there are a number who have not responded and a number of responses
with differences.

Required:
Describe substantive procedures you would perform to obtain sufficient and appropriate audit evidence in relation to Torres’s trade receivables. (6 marks)

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Question 1d ii

Minty Cola Co (Minty) manufactures fizzy drinks such as cola and lemonade as well as other soft drinks and its year end is 31 December 2013. You are the audit manager of Parsley & Co and are currently planning the audit of Minty.

You attended the planning meeting with the engagement partner and finance director last week and recorded the minutes from the meeting shown below. You are reviewing these as part of the process of preparing the audit strategy.

Minutes of planning meeting for Minty

Minty’s trading results have been strong this year and the company is forecasting revenue of $85 million, which is an increase from the previous year. The company has invested significantly in the cola and fizzy drinks production process at the factory. This resulted in expenditure of $5 million on updating, repairing and replacing a significant amount of the machinery used in the production process.

As the level of production has increased, the company has expanded the number of warehouses it uses to store inventory. It now utilises 15 warehouses; some are owned by Minty and some are rented from third parties. There will be inventory counts taking place at all 15 of these sites at the year end.

A new accounting general ledger has been introduced at the beginning of the year, with the old and new systems being run in parallel for a period of two months.

As a result of the increase in revenue, Minty has recently recruited a new credit controller to chase outstanding receivables. The finance director thinks it is not necessary to continue to maintain an allowance for receivables and so has released the opening allowance of $1•5 million.

In addition, Minty has incurred expenditure of $4•5 million on developing a new brand of fizzy soft drinks. The company started this process in January 2013 and is close to launching their new product into the market place.

The finance director stated that there was a problem in November in the mixing of raw materials within the production process which resulted in a large batch of cola products tasting different. A number of these products were sold; however, due to complaints by customers about the flavour, no further sales of these goods have been made. No adjustment has been made to the valuation of the damaged inventory, which will still be held at cost of $1 million at the year end.

As in previous years, the management of Minty is due to be paid a significant annual bonus based on the value of year-end total assets.

Required:

Describe substantive procedures the audit team should perform to obtain sufficient and appropriate audit evidence in relation to the following three matters:

(ii) The release of the $1•5 million allowance for receivables. (3 marks)

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Question 1b

Introduction

Tinkerbell Toys Co (Tinkerbell) is a manufacturer of children’s building block toys; they have been trading for over 35 years and they sell to a wide variety of customers including large and small toy retailers across the country. The company’s year end is 31 May 2011.

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 despatched to customers. The company does not have an internal audit department.

Sales ordering, goods despatched 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 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 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 mail/email confirming the goods ordered and a likely despatch date. The order is then sorted by address of customer. The warehouse closest to the customer receives the order electronically and a despatch list and sequentially numbered goods despatch notes (GDNs) are automatically generated.

The warehouse team pack the goods from the despatch list and, before they are sent out, a second member of the team double checks the despatch list to the GDN, which accompanies the goods.

Once despatched, a copy of the GDN is sent to the accounts team at head office and a sequentially numbered sales invoice is raised and checked to the GDN. 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 would then be 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:

Describe substantive procedures the auditor should perform to confirm Tinkerbell’s year-end receivables balance. (8 marks)

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Question 1c

Introduction – audit firm

You are an audit senior in Brennon & Co, a firm providing audit and assurance services. At the request of an audit partner, you are preparing the audit programme for the income and receivables systems of Seeley Co.

Audit documentation is available from the previous year’s audit, including internal control questionnaires and audit programmes for the despatch and sales system. The audit approach last year did not involve the use of computer-assisted audit techniques (CAATs); the same approach will be taken this year. As far as you are aware, Seeley’s system of internal control has not changed in the last year.

Client background – sales system

Seeley Co is a wholesaler of electrical goods such as kettles, televisions, MP3 players, etc. The company maintains one large warehouse in a major city. The customers of Seeley are always owners of small retail shops, where electrical goods are sold to members of the public. Seeley only sells to authorised customers; following appropriate credit checks, each customer is given a Seeley identification card to confirm their status. The card must be used to obtain goods from the warehouse.

Despatch and sales system

The despatch and sales system operates as follows:

1. Customers visit Seeley’s warehouse and load the goods they require into their vans after showing their Seeley identification card to despatch staff.

2. A pre-numbered goods despatch note (GDN) is produced and signed by the customer and a member of Seeley’s despatch staff confirming goods taken.

3. One copy of the GDN is sent to the accounts department, the second copy is retained in the despatch department.

4. Accounts staff enter goods despatch information onto the computerised sales system. The  GDN is signed.

5. The computer system produces the sales invoice, with reference to the inventory master file for product details and prices, maintains the sales day book and also the receivables ledger. The receivables control account is balanced by the computer.

6. Invoices are printed out and sent to each customer in the post with paper copies maintained in the accounts department. Invoices are compared to GDNs by accounts staff and signed.

7. Paper copies of the receivables ledger control account and list of aged receivables are also available.

8. Error reports are produced showing breaks in the GDN sequence.

Information on receivables

The chief accountant has informed you that receivables days have increased from 45 to 60 days over the last year. The aged receivables report produced by the computer is shown below:

number of range of debt total debt $ current $ 1 to 2 more than 2
receivables months old $ months old $
15 less than $0 (87253) (87253)
197 $0 to $20000 2167762 548894 643523 975345
153 $20001 to $50000 5508077 2044253 2735073 728751
23 $50001 or more 1495498 750235 672750 72513
------ ------------ ------------ ----------- -----------
388 9084084 3256129 4051346 1776609
------ ------------ ------------ ----------- ------------

In view of the deteriorating receivables situation, a direct confirmation of receivables will be performed this year.

Required:

State and explain the meaning of four assertions that relate to the direct confirmation of receivables. (4 marks)

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Question 1d

Introduction – audit firm

You are an audit senior in Brennon & Co, a firm providing audit and assurance services. At the request of an audit partner, you are preparing the audit programme for the income and receivables systems of Seeley Co.

Audit documentation is available from the previous year’s audit, including internal control questionnaires and audit programmes for the despatch and sales system. The audit approach last year did not involve the use of computer-assisted audit techniques (CAATs); the same approach will be taken this year. As far as you are aware, Seeley’s system of internal control has not changed in the last year.

Client background – sales system

Seeley Co is a wholesaler of electrical goods such as kettles, televisions, MP3 players, etc. The company maintains one large warehouse in a major city. The customers of Seeley are always owners of small retail shops, where electrical goods are sold to members of the public. Seeley only sells to authorised customers; following appropriate credit checks, each customer is given a Seeley identification card to confirm their status. The card must be used to obtain goods from the warehouse.

Despatch and sales system

The despatch and sales system operates as follows:

1. Customers visit Seeley’s warehouse and load the goods they require into their vans after showing their Seeley identification card to despatch staff.

2. A pre-numbered goods despatch note (GDN) is produced and signed by the customer and a member of Seeley’s despatch staff confirming goods taken.

3. One copy of the GDN is sent to the accounts department, the second copy is retained in the despatch department.

4. Accounts staff enter goods despatch information onto the computerised sales system. The  GDN is signed.

5. The computer system produces the sales invoice, with reference to the inventory master file for product details and prices, maintains the sales day book and also the receivables ledger. The receivables control account is balanced by the computer.

6. Invoices are printed out and sent to each customer in the post with paper copies maintained in the accounts department. Invoices are compared to GDNs by accounts staff and signed.

7. Paper copies of the receivables ledger control account and list of aged receivables are also available.

8. Error reports are produced showing breaks in the GDN sequence.

Information on receivables

The chief accountant has informed you that receivables days have increased from 45 to 60 days over the last year. The aged receivables report produced by the computer is shown below:

number of range of debt total debt $ current $ 1 to 2 more than 2
receivables months old $ months old $
15 less than $0 (87253) (87253)
197 $0 to $20000 2167762 548894 643523 975345
153 $20001 to $50000 5508077 2044253 2735073 728751
23 $50001 or more 1495498 750235 672750 72513
------ ------------ ------------ ----------- -----------
388 9084084 3256129 4051346 1776609
------ ------------ ------------ ----------- ------------

In view of the deteriorating receivables situation, a direct confirmation of receivables will be performed this year.

Required:

(i) Describe the procedures up to despatch of letters to individual receivables in relation to a direct confirmation of receivables. (5 marks)

(ii) Discuss which particular categories of receivables might be chosen for the sample. (5marks)

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