Friday, February 8, 2013

Chapter 11 Accounts Receivable, Notes Receivable, and Revenue

Chapter 11
Accounts Receivable, Notes Receivable, and Revenue

True / False Questions
1. The department approving a sales transaction should be the shipping department.

Difficulty: Easy
2. Accounts receivable that are written-off should not be turned over to a collection agency.

Difficulty: Easy
3. An aged trial balance of accounts receivable may provide evidence on the adequacy of the allowance for uncollectible accounts.

Difficulty: Easy
4. Confirmation of accounts receivable by direct communication with the debtor tests the existence of accounts receivable.

Difficulty: Easy
5. Confirmation requests should contain a "business reply" envelope addressed to the auditors at the client's address.

Difficulty: Medium

6. CPAs use negative accounts receivable confirmations more frequently than positive accounts receivable confirmations.

Difficulty: Medium
7. Confirmation of accounts receivable provides some assurance that no lapping or other manipulation affecting accounts receivable is being carried on.

Difficulty: Medium
8. Analytical procedures are used by auditors to gain evidence about the adequacy of the allowance for uncollectible accounts.

Difficulty: Medium
9. When it is impossible to confirm accounts receivable, the auditors may be able to satisfy themselves as to the existence of accounts receivable by alternative procedures.

Difficulty: Medium
10. Material accounts receivable from related parties should be stated separately from other receivables.

Difficulty: Easy

Multiple Choice Questions

11. To test the existence assertion for recorded receivables, an auditor would select a sample from the.
A. Sales orders file.
B. Customer purchase orders.
C. Accounts receivable subsidiary ledger.
D. Shipping documents (bills of lading) file.

Difficulty: Hard
12. Which of the following is least likely to be typically considered to be an alternate procedure for handling nonreplies to accounts receivable confirmations?
A. Examine bills of lading.
B. Physically examine items sold.
C. Examine correspondence.
D. Examine subsequent cash receipts.

Difficulty: Medium
13. Your client performed the physical count of inventory as of November 30, one month prior to year-end. Subsequently, your client closed the sales journal on 12/29/XX, two days before year end, and reported those two days' credit sales in January of the next year. Assuming the client uses a perpetual inventory system which of the following is most likely to be overstated relating to the year XX financial statements?
A. Sales.
B. Cash.
C. Inventory.
D. Accounts receivable.

Difficulty: Hard

14. Which of the following would be least likely to diminish the validity of evidence obtained through confirmation of accounts receivable?
A. The confirmations are sent on the client's letterhead.
B. The confirmations are mailed to customers by the internal auditors.
C. The client's mailroom personnel closely monitor and inspect confirmations during mailing.
D. The return address on the envelope used to send the confirmation request is that of the client.

Difficulty: Medium
15. When control risk for the existence assertion is assessed at a high level, which of the following is a likely effect with respect to the auditors' confirmation of receivables?
A. The account balances as of year end will generally be confirmed.
B. The auditors will in general use blank rather than positive confirmations.
C. The auditors will be required to confirm accounts as of an interim date (during the year under audit) and as of year end.
D. Confirmations will not in general be used as the auditor will rely primarily upon support such as vendors' invoices, purchase orders and receiving reports.

Difficulty: Medium
16. What type of error is the CPA most likely to discover when he/she examines all shipping reports dated in January of 20X1, shipped FOB shipping point, which were recorded in December of 20X0 as credit sales?
A. Accounts receivable are overstated at December 31, 20X0.
B. Accounts receivable are understated at December 31, 20X0.
C. Operating expenses are overstated for the 12 months ended December 31, 20X0.
D. Sales returns and allowance are overstated at December 31, 20X0.

Difficulty: Medium

17. Which of the following is not typically considered to be an alternate procedure for handling nonreplies to accounts receivable confirmations?
A. Examine sales invoices.
B. Inclusion of the information in the engagement letter.
C. Examine correspondence.
D. Examine any subsequent cash receipts.

Difficulty: Medium
18. Which of the following fraudulent activities most likely could be perpetrated due to the lack of effective internal control over the revenue cycle?
A. Fictitious transactions may be recorded that cause an understatement of revenues and an overstatement of receivables.
B. Claims received from customers for goods returned (and unpaid for) may be intentionally recorded in other customers' accounts permitting a misappropriation of cash.
C. Authorization of credit memos by personnel who receive cash may permit the misappropriation of cash.
D. The failure to prepare shipping documents may lead to an understatement of inventory balances.

Difficulty: Hard
19. A client might overstate December 31 accounts receivable balances by dating and recording January transactions in December. Such entries recorded in which journal are most likely to achieve this end?
A. Cash receipts.
B. Payroll.
C. Purchases.
D. Sales.

Difficulty: Medium

20. Which of the following is a likely procedure to test the adequacy of the allowance for doubtful accounts?
A. Examine cash receipts received after year-end.
B. Confirm receivables.
C. Examine dates of purchase orders.
D. Foot the receivables lead schedule.

Difficulty: Medium
21. Which of the following is most likely to be used in determining a proper amount to be included in the allowance for doubtful accounts?
A. Accounts receivable divided by Cost of goods sold.
B. Aging of accounts receivable.
C. Cash Sales divided by Accounts receivable
D. Year 2 accounts receivable compared to year one accounts receivable.

Difficulty: Medium
22. For effective internal control, the billing function should not be performed by the:
A. Sales department.
B. Accounting department.
C. Finance department.
D. Information Processing department.

Difficulty: Medium
23. Which procedure would be of most assistance to an auditor discovering a large credit sale that has erroneously been recorded twice?
A. Footing the sales journal.
B. Sending accounts receivable confirmations.
C. Tracing the total sales in the sales journal to the general ledger.
D. Observation of the physical inventory count at year-end.

Difficulty: Medium

24. An audit basically consists of having the auditor form an opinion regarding management's financial statement assertions. The auditor therefore develops general and specific program steps to apply to the accounts and transactions. In a particular case, s/he might do this by:
A. Tracing sales invoices to shipping documents to tests the completeness of reported sales.
B. Tracing shipping documents to sales invoices to test the occurrence of reported sales.
C. Tracing sales invoices to shipping documents to test the occurrence of reported sales.
D. Tracing sales invoices to shipping documents to test the completeness of recorded accounts receivable.

Difficulty: Hard
25. The confirmation of accounts receivable is most closely associated with
A. Business risk.
B. Detection risk.
C. Inherent risk.
D. Relative risk.

Difficulty: Medium
26. Analytical procedures performed during an audit indicate that accounts receivable doubled since the end of the prior year. However, the allowance for doubtful accounts as a percentage of accounts receivable remained about the same. Which of the following client explanations would satisfy the auditor?
A. A greater percentage of accounts receivable are listed in the "more than 120 days overdue" category than in the prior year.
B. Internal control activities over the recording of cash receipts have been improved since the end of the prior year.
C. The client opened a second retail outlet during the current year and its credit sales approximately equaled the older outlet.
D. The client tightened its credit policy during the current year and sold considerably less merchandise to customers with poor credit ratings.

Difficulty: Medium
Source: AICPA

27. After the CPAs have selected particular accounts receivable for confirmation:
A. As a control measure, the CPAs should carefully list the audited values of all of those accounts before turning the letters over to the client to type and mail.
B. It is important that every account selected that has a material balance ultimately be verified by confirmation or the application of alternative procedures; immaterial balances never require any follow-up through alternative procedures.
C. All requests for confirmation should be mailed in envelopes bearing the CPA firm's return address and should include a return envelope addressed to the CPA firm.
D. All differences between confirmation replies and book values should be reconciled by the CPAs, rather than the client.

Difficulty: Medium
28. Which of the following manipulations would understate receivables on the financial statements?
A. Understatement of cash sales.
B. Closing the sales journal prior to year-end.
C. Closing the cash receipts journal prior to year-end.
D. Underestimating the allowance for doubtful accounts.

Difficulty: Easy
29. You were surprised to note that approximately 95% of returned positive accounts receivable confirmations indicated that the customers thought that they owed a larger balance than the amount that had been printed by your client on the confirmation. This might be explained by the fact that:
A. The cash receipts journal was closed before year-end.
B. The cash receipts journal was held open after year-end.
C. There are many unrecorded liabilities.
D. The sales journal was held open after year-end.

Difficulty: Medium

30. An auditor who uses a transaction cycle approach to assessing control risk most likely would test control activities related to transactions involving the sale of goods to customers with the
A. Collection of receivables.
B. Purchase of merchandise inventory.
C. Payment of accounts payable.
D. Sale of long-term debt.

Difficulty: Medium
Source: AICPA
31. Which of the following fraudulent activities most likely could be perpetrated due to the lack of effective internal controls in the revenue cycle?
A. Merchandise received is not promptly reconciled to the outstanding purchase order file.
B. Obsolete items included in inventory balances are rarely reduced to the lower of cost or market value.
C. The write-off of receivables by personnel who receive cash permits the misappropriation of cash.
D. Fictitious transactions are recorded that cause an understatement of revenue and overstatement of receivables.

Difficulty: Hard
Source: AICPA
32. Which of the following procedures is least likely to help auditors to assess the adequacy of management's accounting estimate of the allowance for doubtful accounts?
A. Investigate confirmation exceptions for indication of amounts in dispute.
B. Review accounts which have been written off as uncollectible prior to year-end.
C. Investigate credit ratings for large accounts receivable.
D. Discuss with the credit manager the current status of doubtful accounts.

Difficulty: Hard

33. Which of the following is consistent with effective internal control over sales transactions?
A. The accounting department prepares a shipping report authorizing the shipment of goods.
B. The accounting department accounts for all receiving reports.
C. The billing department accounts for all shipping documents.
D. The accounts payable department annually approves the extension of credit to customers.

Difficulty: Hard
34. Tracing recorded sales transactions to the bills of lading provides evidence about the:
A. Completeness of sales transactions.
B. Collectibility of sales transactions.
C. Occurrence of sales transactions.
D. Billing of all sales transactions.

Difficulty: Medium
35. To obtain the best evidence regarding the completeness of recorded accounts receivable, the auditors:
A. Trace a sample of the bills of lading to sales invoices.
B. Confirm a sample of accounts payable.
C. Review the aging of accounts receivable.
D. Trace a sample of recorded sales to shipping documents.

Difficulty: Medium
36. Which of the following generally provides the least evidence regarding the valuation of accounts receivable?
A. Reviewing an aging of accounts receivable.
B. Examination of cash receipts subsequent to the balance sheet date.
C. Confirming current (0-30 day) year-end accounts receivable.
D. Reviewing credit files for selected account.

Difficulty: Hard

37. Which of the following would indicate the need to use positive accounts receivable confirmations?
A. A large population consisting of small balances.
B. Good internal control over accounts receivable.
C. Most accounts are with large reputable companies.
D. A large number of accounts receivable are in dispute.

Difficulty: Medium
38. Which of the following is not true about the confirmation of accounts receivable?
A. Confirmation requests should bear the auditors' return address.
B. Confirmation requests should be signed by the auditors.
C. Confirmation requests should be mailed directly by the auditors.
D. Confirmation requests should include a return envelope addressed to the office of the auditors.

Difficulty: Easy
39. Which of the following is not true about the auditors' verification of notes receivable?
A. The interest revenue on notes receivable is usually audited by independent computation.
B. Inspecting the notes is sufficient evidence of existence of the notes.
C. The auditors may evaluate the collectibility of notes by inspecting credit files.
D. Confirmation of notes payable to banks may be accomplished in conjunction with the confirmation of cash balances.

Difficulty: Medium
40. To verify that all sales that have been shipped to customers have been recorded, a test of transactions should be completed on a representative sample drawn from:
A. The sales journal.
B. The billing clerk's file of sales orders.
C. Duplicate copies of sales invoices.
D. The shipping clerk's file of duplicate copies of bills of lading.

Difficulty: Medium

41. Auditors may use positive and/or negative forms of confirmation requests for accounts receivable. Of the following, which combination is it most likely that the auditors will use?
A. The positive form for small balances, and the negative form for large balances.
B. The positive form used for large balances and the negative form for the small balances.
C. The positive form used for trade receivables and the negative form for other receivables.
D. The positive form when controls related to receivables are satisfactory, and the negative form when controls related to receivables are unsatisfactory.

Difficulty: Easy
42. The auditors obtain audit evidence for accounts receivable by using positive or negative confirmation requests. Under which of the following circumstances might the negative form of the accounts receivable confirmation be useful?
A. A substantial number of accounts are in disputes.
B. The combination of inherent risk and control risk is high.
C. Client records include a large number of relatively small balances.
D. The auditors believe that recipients of the requests are unlikely to give them consideration.

Difficulty: Easy
Source: AICPA
43. When scheduling the audit work to be performed on an engagement, the auditors should consider confirming accounts receivable balances at an interim date if:
A. Subsequent collections are to be reviewed.
B. Internal control over receivables is good.
C. Negative confirmations are to be used.
D. There is a simultaneous examination of cash and accounts receivable.

Difficulty: Medium
Source: AICPA

44. It is sometimes impossible for the auditors to use normal accounts receivable confirmation procedures. In such situations the best alternative procedure the auditors might resort to would be:
A. Examining subsequent receipts of year-end accounts receivable.
B. Reviewing accounts receivable aging schedules prepared at the balance sheet date and at a subsequent date.
C. Requesting that management increase the allowance for uncollectible accounts by an amount equal to some percentage of the balance in those accounts that cannot be confirmed.
D. Applying analytical procedures to accounts receivable and sales on a year-to-year basis.

Difficulty: Hard
Source: AICPA
45. The audit working papers often include a client-prepared, aged trial balance of accounts receivable as of the balance sheet date. This aging is best used by the auditors to:
A. Consider internal control over credit sales.
B. Test the accuracy of recorded charge sales.
C. Estimate credit losses.
D. Verify the validity of the recorded receivables.

Difficulty: Medium
Source: AICPA
46. Which of the following is not a primary objective of the auditors in the examination of accounts receivable?
A. Determine the approximate realizable value.
B. Consider the adequacy of internal control.
C. Establish the existence of receivables.
D. Determine the expected day of collection of each of the receivables.

Difficulty: Medium
Source: AICPA

47. Once a CPA has determined that accounts receivable have increased due to slow collections in a "tight money" environment, the CPA would be likely to:
A. Increase the balance in the allowance for bad debts accounts.
B. Review the going concern ramifications.
C. Review the credit and collection policy.
D. Expand tests of collectibility.

Difficulty: Hard
Source: AICPA
48. Which of the following sets of duties would ordinarily be considered basically incompatible in terms of good internal control?
A. Preparation of monthly statements to customers and maintenance of the accounts payable subsidiary ledger.
B. Posting to the general ledger and approval of additions and terminations relating to the payroll.
C. Custody of unmailed signed checks and maintenance of expense subsidiary ledger.
D. Collection of receipts on account and maintaining accounts receivable records.

Difficulty: Medium
Source: AICPA
49. Tracing copies of sales invoices to shipping documents will provide evidence that all
A. Shipments to customers were recorded as receivables.
B. Billed sales were shipped.
C. Debits to the subsidiary accounts receivable ledger are for sales shipped.
D. Shipments to customers were billed.

Difficulty: Medium
Source: AICPA

50. Which of the following is the best argument against the use of negative accounts receivable confirmations?
A. The cost-per-response is excessively high.
B. There is no way of knowing if the intended recipients received them.
C. Recipients are likely to feel that in reality the confirmation is a subtle request for payment.
D. The inference drawn from receiving no reply may not be correct.

Difficulty: Medium
Source: AICPA
51. When there are a large number of relatively small account balances, negative confirmation of accounts receivable is feasible if the combination of inherent risk and control risk is:
A. Low, and the individuals receiving the confirmation requests are unlikely to give them adequate consideration.
B. High, and the individuals receiving the confirmation requests are likely to give them adequate consideration.
C. High, and the individuals receiving the confirmation requests are unlikely to give them adequate consideration.
D. Low, and the individuals receiving the confirmation requests are likely to give them adequate consideration.

Difficulty: Medium
Source: AICPA
52. An auditor should perform alternative procedures to substantiate the existence of accounts receivable when:
A. No reply to a positive confirmation request is received.
B. No reply to a negative confirmation request is received.
C. Collectibility of the receivables is in doubt.
D. Pledging of the receivables is probable.

Difficulty: Easy
Source: AICPA

53. Johnson is engaged in the audit of a utility which supplies power to a residential community. All accounts receivable balances are small and internal control is effective. Customers are billed bi-monthly. In order to determine the validity of the accounts receivable balances at the balance sheet date, Johnson would most likely:
A. Examine evidence of subsequent cash receipts instead of sending confirmation requests.
B. Send positive confirmation requests.
C. Send negative confirmation requests.
D. Use statistical sampling instead of sending confirmation requests.

Difficulty: Medium
Source: AICPA
54. A CPA examines a sample of copies of December and January sales invoices for the initials of the person who verified the quantitative data. This is an example of a:
A. Test of a control.
B. Substantive test.
C. Cutoff test.
D. Statistical test.

Difficulty: Easy
Source: AICPA
55. Which of the following is not one of the criteria for revenue recognition?
A. Collectibility is certain.
B. Delivery has occurred or services have been rendered.
C. Evidence of an arrangement exists and is persuasive.
D. A fixed or determinable price to buyer exists.

Difficulty: Hard

56. In your review of ABC Company's financials, you note that Receivables have increased approximately 200% from the previous year, while Cash has declined. Further investigation reveals that 70% of ABC's receivables were booked within 7 days of the end of the quarter. If financial statement fraud is involved, which type is most likely?
A. Fictitious revenues
B. Timing differences
C. Improper asset valuations
D. Improper disclosures

Difficulty: Hard
57. Recognizing a loan received as revenue instead of as a liability has a positive effect on the reported financial statements for all of the following except:
A. It understates liabilities.
B. It overstates revenues
C. It overstates net income.
D. It overstates assets.

Difficulty: Hard
58. Which of the following revenue related transactions is not linked to the accounts indicated?
A. Recognize revenues too early--accounts receivable and revenue.
B. Understate allowance for doubtful accounts--Bad debt expense, allowance for doubtful accounts.
C. Don't write off uncollectible receivables--sales returns, sales discounts.
D. Don't record discounts given to customers--Cash, sales discounts, accounts receivable.

Difficulty: Medium

59. The individual looking for guidance on revenue recognition is most likely to appropriately review:
A. APB 99.
B. SAB 104.
C. ASR 44.
D. B1 Document

Difficulty: Medium
60. An auditor discovered that a client's accounts receivable turnover is substantially lower for the current year than for the prior year. This may indicate that
A. Obsolete inventory has not yet been reduced to fair market value.
B. There was an improper cutoff of sales at the end of the year.
C. An unusually large receivable was written off near the end of the year.
D. The aging of accounts receivable was improperly performed in both years.

Difficulty: Hard
Source: AICPA

Essay Questions

61. Confirmation of accounts receivable is generally accepted auditing procedure. In performing this procedure, auditors use positive confirmations or negative confirmations or a combination of both.
a. Describe three conditions which should exist for the auditors to use the negative form of request.
b. If a response is not received to an initial positive confirmation request, describe the action that should be taken by the auditors, including a discussion of alternative auditing procedures. 
a. The conditions that should exist for the auditors to use negative confirmation requests include:
1. The combined assessed level of inherent and control risk is low,
2. A large number of small balances, and
3. Reason to believe the person receiving the confirmation will give it consideration.
b. If the initial response to a positive confirmation is not received, the auditors should:
1. Send a second request.
2. Consider sending a third request or telephoning the customer.
3. For significant nonrespondents perform alternative auditing procedures including:
· Examining subsequent cash receipts.
· Vouching transactions making up the account balance to invoices and shipping documents.
· Establishing the validity of the customer.

Difficulty: Medium

62. Internal control over sales transactions is very important to the effectiveness of an organization.
a. For effective control over credit sales, describe four major functions that should be segregated.
b. In addition to adequate segregation of duties, describe two other internal controls over sales transactions. 
a. Functions that should be segregated to provide for effective internal control over sales transactions include (only four required):
· Authorization of sales.
· Credit approval.
· Issuance of merchandise from stock.
· Shipping of merchandise.
· Billing of accounts.
· Maintenance of accounting records.
b. Other internal controls over sales transactions include (only two required):
· Verification of invoices.
· Prenumbered shipping documents that are accounted for by the billing department.
· Credit approval obtained prior to shipment of goods.
· Mailing of monthly customer statements.
· Control over written-off receivables.

Difficulty: Medium

63. Fraudulent sales are occasionally recorded at year-end as a means of overstating financial results. As examples, companies may engage in inappropriate bill and hold transactions or channel stuffing.
a. Describe two conditions that might indicate the recording of fraudulent sales.
b. Define bill and hold transactions and describe the audit significance of such transactions.
c. Define channel stuffing and describe the audit significance of this practice. 
a. The following conditions may indicate the recording of fraudulent transactions:
· Unusually large increases in year-end sales to a single customer or a few.
· Large increases in revenue and receivables along with increases in gross profit margins that are inconsistent with the client's experience or industry averages.
· Inappropriate changes in accounting principles that result in an increase in recorded revenue.
· Substantial sales returns following the balance sheet date.
b. Bill and hold transactions are sales that are billed but goods are not shipped. The audit significance is that stringent accounting requirements must be met for the transaction to qualify as sales.
c. Channel stuffing involves providing large inducements to resellers to buy substantially more inventory than they can resell in a normal period of time. The audit significance is that an adequate allowance for sales returns must be established to appropriately account for the transactions.

Difficulty: Hard