Chapter 16

Multiple-Choice Questions
1. easy a Which of the following is not a balance-related audit objective evaluated in the audit of accounts receivable? a. Timing b. Realizable value c. Completeness d. Accuracy The two primary classes of transactions in the sales and collection cycle are: a. sales and sales discounts. b. sales and cash receipts. c. sales and sales returns. d. sales and accounts receivable. The appropriate evidence to be obtained from tests of details must be decided on a(n): a. efficiency basis. b. effectiveness basis. c. audit objectives basis. d. none of the above. Which of the following is not a balance-related audit objective evaluated in the audit of accounts receivable? a. Occurrence b. Completeness c. Rights d. Accuracy Tests of which balance-related audit objective are normally performed first in an audit of the sales and collection? a. Accuracy b. Completeness c. Rights d. Detail tie-in For most audits, inherent risk for accounts receivable is moderate or low except for which balance-related audit objectives? a. Timing and realizable value. b. Completeness and existence. c. Existence and accuracy. d. Realizable value and cutoff. Which of the following types of receivables would not deserve the special attention of the auditor? a. Accounts receivables with credit balances. b. Accounts that have been outstanding for a long time. c. Receivables from affiliated companies. d. Each of the above would receive special attention.

2. easy b

3. easy c

4. easy a

5. easy d

6. easy d

7. easy d

Arens/Elder/Beasley

8. easy b

A listing of the balances in the accounts receivable master file at the balance sheet date, by total balance outstanding and by the amount of time the component parts have been outstanding, is the: a. customer list. b. aged trial balance. c. accounts receivable ledger. d. schedule of accounts receivable. Testing the information on the aged trial balance for detail tie-in is a necessary audit procedure, which would normally include: Test-footing the total column and the columns depicting the aging Yes No Yes No Comparing the total of the aged trial balance with the general ledger accounts receivable account Yes No No Yes

9. easy a

a. b. c. d. 10. easy c

Auditors are often concerned with three aspects of internal controls related to the sales and collection cycle. Which of the following is not one of those controls? a. Controls that detect or prevent embezzlements. b. Controls over cutoff. c. Controls over acquisitions. d. Controls related to the allowance for doubtful accounts. Cutoff misstatements occur when: The auditor fails to obtain the endof-year bank statement directly from the bank, obtaining instead the statement which includes the two succeeding weeks Yes Yes No No Subsequent period transactions are recorded in the current period Yes No Yes Yes Current period transactions are recorded in the subsequent period No Yes Yes No

11. easy c

a. b. c. d. 12. easy a

Cutoff misstatements occur: a. either by error or fraud. b. by error only. c. by fraud only. d. randomly without causes related to errors or fraud. Generally accepted accounting principles require that material sales returns and allowances be: a. recorded in the period when the merchandise is returned. b. recorded in the period when the credit memo is issued. c. matched with related sales. d. recorded as a debit to the sales account. Communication addressed to the debtor requesting him or her to confirm whether the balance as stated on the communication is correct or incorrect is a: a. representation letter. b. negative confirmation. c. bank confirmation. d. positive confirmation.

13. easy c

14. easy d

Arens/Elder/Beasley

15. easy a

A type of positive confirmation known as a blank confirmation: a. requests the recipient to fill in the amount of the balance. b. is considered less reliable than the regular positive confirmation. c. generates as high a response rate as the regular positive confirmation form. d. is used when the auditor is confirming several small balances. For sales, the occurrence transaction-related audit objective affects the ______ balance-related audit objective. a. existence b. completeness c. rights d. detail tie-in For cash receipts, the occurrence transaction-related audit objective affects the ______ balancerelated audit objective. a. existence b. completeness c. rights d. detail tie-in Which of the following is likely to be determined first when performing tests of details for accounts receivable? a. Recorded accounts receivable exist. b. Accounts receivable in the aged trial balance agree with related master file amounts, and the total is correctly added and agrees with the general ledger. c. Accounts receivable are owned. d. Existing accounts receivable are included. Analytical procedures are substantive tests and, if the results of the analytical procedures are favorable, the auditor will: a. reduce the extent of tests of details of balances. b. reduce the extent of tests of controls. c. reduce the tests of transactions. d. reduce all of the other tests. The most effective test of details of accounts receivable is the: a. detail tie-in of the records. b. analysis of the allowance for doubtful accounts. c. confirmation of accounts receivable. d. examination of sales invoices. Tests of details of balances are directed to: a. balance sheet accounts for all cycles. b. income statement accounts for all cycles. c. balance sheet accounts for some cycles and income statement accounts for other cycles. d. all general ledger accounts for all cycles. The most important test of details of balances for accounts receivable is: a. confirmations. b. recalculation of the aged receivables and uncollectible accounts. c. tracing credit memos for returned merchandise to receiving room reports. d. tracing from shipping documents to journals to the accounts receivable ledger. The most important test of details of balances to determine the existence of recorded accounts

16. medium a

17. medium b

18. medium b

19. medium a

20. medium c

21. medium a

22. medium a 23.

Arens/Elder/Beasley

medium d

receivable is: a. tracing details of sales invoices to shipping documents. b. tracing the credits in accounts receivable to bank deposits. c. tracing sales returns entries to credit memos issued and receiving room reports. d. the confirmation of customers balances. When should auditors not perform alternative procedures in testing the accounts receivable balance? a. When customers do not return positive confirmation requests. b. When customers do not return negative confirmation requests. c. When confirmations are deemed to be ineffective as an audit procedure. d. When confirmations are too costly to use. Because of its central role in auditing of accounts receivable, the ______________ is one of the first items tested. a. accounts receivable master file b. customer file c. aged trial balance d. sales register If accounts receivable accounts with credit balances are significant, they should be: a. written off. b. moved to the debit side. c. reclassified as accounts payable. d. corrected by making adjusting entries. Most tests of accounts receivable are based on what schedule, file, or listing? a. Sales master file. b. Aged accounts receivable trial balance. c. Accounts receivable master file. d. Accounts receivable general ledger account. If the clients internal control for recording sales returns and allowances is evaluated as ineffective: a. a larger sample is needed to verify cutoff. b. sampling is not appropriate. c. all sales returns must be traced to supporting documentation. d. all sales returns must be confirmed with the customer. A customer mails and records a check to a client for payment of an unpaid account on December 30. The client receives and records the amount on January 2. The records of the two organizations will be different on December 31. This represents a. b. c. d. A cutoff misstatement Yes No Yes No A timing difference Yes No No Yes

24. medium b

25. medium c

26. medium c

27. medium b

28. medium a

29. medium d

30. medium c

Which of the following audit procedures would not likely detect a clients decision to pledge or factor accounts receivable? a. A review of the minutes of the board of directors meetings. b. Discussions with the client. c. Confirmation of receivables. d. Examination of correspondence files. When do most companies record sales returns and allowances?

31.

Arens/Elder/Beasley

medium b

a. b. c. d.

During the month in which the sale occurs. During the accounting period in which the return occurs. Whenever the customer contacts the company regarding the credit. During the month after the sale occurs.

32. Medium a

Cutoff misstatements can occur for: a. b. c. d. Sales Yes No Yes No Sales returns and allowances Yes No No Yes

33. medium b

The most important aspect of evaluating the clients method of obtaining a reliable cutoff is to: a. perform extensive detailed testing of cutoff. b. evaluate the clients control procedures around cutoff. c. confirm a sample of transactions near period end with customers. d. confirm transaction with customers. A positive confirmation is more reliable evidence than a negative confirmation because: a. fewer confirmations can be sent out. b. the auditor has a document which can be used in court. c. the debtors lack of response indicates agreement with the stated balance. d. follow-up procedures are performed if a response is not received from the debtor. The advantage of using the negative form of confirmations is that: a. larger sample sizes can be used without increasing the costs above what would have been required for positive confirmations. b. a non-response from the customer proves that the balance is correct. c. follow-up procedures are scheduled automatically. d. they provide greater reliance. Which of the following procedures do most auditors perform when auditing the allowance for doubtful accounts? a. Send positive confirmations. b. Inquire of the clients credit manager. c. Send negative confirmations. d. Examine sales invoices. When positive confirmations are used, auditing standards require follow-up procedures for confirmations not returned by the customer. In such a situation, which of the following would not be classified as an alternative procedure? a. Send a second confirmation request. b. Examine subsequent cash receipts to determine if the receivable has been paid. c. Examine shipping documents to verify that the merchandise was shipped. d. Examine customers purchase order and the duplicate sales invoice to determine that the merchandise was ordered. Generally accepted accounting principles require that sales returns and allowances be matched with related sales: a. if practical. b. if required by industry practice. c. if the amounts are material. d. any of the above. For which of the following accounts is cutoff least important? a. Sales

34. medium d

35. medium a

36. medium b

37. medium a

38. medium c

39. medium

Arens/Elder/Beasley

b. c. d.

Sales returns and allowances Cash collections Inventory

40. medium a

What are the possible disadvantages of evaluating the allowance for doubtful accounts by reviewing individual non-current balances only? Current accounts receivable may be ignored Yes No Yes No It is difficult to compare results of the current and prior years Yes No No Yes

a. b. c. d. 41. medium b

Which of the following most likely would be detected by a review of a clients sales cutoff? a. Excessive sales discounts. b. Unrecorded sales for the year. c. Unauthorized goods returned for credit. d. Lapping of year-end accounts receivable. The positive (as opposed to the negative) form of receivables confirmation is preferred when: a. internal control surrounding accounts receivable is considered to be effective. b. there is reason to believe that a substantial number of accounts may be in dispute. c. a large number of small balances are involved. d. there is reason to believe a significant portion of the requests will be made. 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. How might the auditor determine whether a client has limited rights to accounts receivable? a. b. c. d. Review minutes from board of directors meetings Yes No Yes No Inquiries of the client Yes No No Yes

42. medium b

43. medium a

44. Medium a

45. medium c

Confirmation of accounts receivable balances normally provides evidence concerning the: a. valuation of the balances. b. rights of the balances. c. existence of the balances. d. completeness of the balances. If the auditor decides not to confirm accounts receivable, the auditor should: a. always use alternative procedures to audit the accounts receivable. b. include copies of customer statements in the audit files. c. document the reasons for such a decision in the audit files. d. include copies of customer sales invoices in the audit files. The understatement of sales and accounts receivable is best uncovered by: a. confirming receivables. b. reviewing the aged trial balance.

46. medium c

47. challenging c

Arens/Elder/Beasley

c. d. 48. challenging a

test of transactions for shipments made but not recorded. reconciling the accounts receivable general ledger account with the schedule of accounts receivable.

You are reviewing sales to discover cutoff problems. If the clients policy is to record sales when title to the merchandise passes to the buyer, then the books and records would contain errors if the December 31 entries were for sales recorded: a. before the merchandise was shipped. b. at the time the merchandise was shipped. c. several days subsequent to shipment. d. at a time after the point at which title passed. A procedure to test for a cash receipts cutoff error is: a. reconciling the bank statement. b. performing a four-column proof-of-cash. c. observing the counting of cash at the balance sheet date. d. tracing recorded cash receipts to bank deposits on the bank statement of a different period. The most reliable evidence from confirmations is obtained when they are sent: a. as close to the balance sheet date as possible. b. at various times throughout the year to different segments of the sample, so that the entire sample is representative of account balances scattered throughout the year. c. several months before the year-end, so the auditor will have adequate time to perform alternate procedures if they are required. d. at various times throughout the year to the same group in the sample, so that the sample will not have a time bias. Which of the following is the least important consideration in determining the sample size of confirmations? a. The types of confirmations being sent; that is, positive or negative. b. The results of related analytical procedures. c. Total annual credit sales. d. The auditors assessment of detection risk. An auditor learns that collections of accounts receivable during the first ten days of January were debited to cash and credited to accounts receivable as of December 31. The effect generally will be to: a. overstate the current ratio with no effect on working capital at December 31. b. overstate both working capital and the current ratio at December 31. c. overstate working capital with no effect on the current ratio at December 31. d. leave both working capital and the current ratio unchanged at December 31. For effective internal control, employees maintaining the accounts receivable subsidiary ledger should not also approve: a. employee overtime wages. b. credit granted to customers. c. write-offs of customer accounts. d. cash disbursements. For most audits, a proper cash receipts cutoff is less important than the sales cutoff because the improper cutoff of cash: a. is detected and correct when cash is separately audited. b. is unlikely to have a material impact on the balance sheet or the income statement. c. affects on the cash and accounts receivable balances on the balance sheet and does not affect net income. d. rarely occurs given the control consciousness of most entities.

49. challenging d

50. challenging a

51. challenging a

52. challenging d

53. challenging c

54. challenging c

Arens/Elder/Beasley

55. medium b

Negative confirmations of receivables are less effective than positive confirmations of receivables because: a. they do not produce evidence that is statistically quantifiable. b. the auditor cannot infer that all non-respondents have verified their account information. c. some recipients may report incorrect balances that require extensive follow-up. d. a majority of recipients usually lack the willingness to respond objectively. An auditor would be least likely to use confirmations in connection with the examination of: a. inventories. b. long-term debt. c. property, plant, and equipment. d. stockholders equity. An auditor selects a sample from the file of shipping documents to determine whether invoices were prepared. This test is performed to satisfy the audit objective of: a. accuracy. b. existence. c. control. d. completeness. When performing tests of controls and tests of transactions for sales, the auditor generally defines the population as: a. all accounts receivable transactions for the year. b. all sales invoices for the year. c. all cash receipts transactions for the year. d. all sales invoices less sales return credit memos.

56. medium c

57. medium d

58. challenging b

Essay Questions
59. easy Auditing standards require the confirmation of accounts receivable in normal circumstances. What are the three exceptions to this requirement? Answer: The three exceptions are: 1. Accounts receivable are immaterial. 2. The auditor considers confirmations ineffective evidence because response rates will likely be inadequate or unreliable. 3. The combined level of inherent risk and control risk is low and other substantive evidence can be accumulated to provide sufficient evidence. 60. easy Describe the differences between positive and negative confirmations. Which type is generally viewed as more reliable? Answer: A positive confirmation requests the recipient to respond regardless of whether the balance as stated on the confirmation is correct or incorrect. In contrast, a negative confirmation requests the recipient to respond only if the balance as stated on the confirmation is incorrect. Positive confirmations are more reliable because the auditor can perform followup procedures if a response is not received from the customer.

Arens/Elder/Beasley

61. medium

A threefold approach is typically followed when determining the reasonableness of cutoff. Briefly describe the threefold approach. Answer: First, auditors should decide on the appropriate cutoff criteria. Second, they must evaluate whether the client has established adequate procedures to ensure a reasonable cutoff. Finally, auditors must test whether a reasonable cutoff was obtained.

62. medium

Discuss the alternative procedures an auditor can perform to test the existence objective for accounts receivable when customers do not respond to confirmation requests. Answer: For any positive confirmation not returned, the auditor can examine the following to verify the existence of individual sales transactions making up the ending balance in accounts receivable: Subsequent cash receiptsevidence of the receipt of cash after the confirmation date includes examining remittance advices and entries in the cash receipts records. Duplicate sales invoices. Shipping documents. Correspondence between the customer and the client.

63. medium

Describe how the auditor tests the accuracy objective for accounts receivable. Answer: Confirmation of accounts selected from the trial balance is the most common test of details of balances for the accuracy of accounts receivable. When customers do not respond to confirmation requests, auditors examine supporting documents in the same way as described for the existence objective. Auditors perform tests of the debits and credits to individual customers balances by examining supporting documentation for shipments and cash receipts.

64. medium

Describe how the auditor tests the classification objective for accounts receivable. Answer: Normally, auditors can evaluate the classification of accounts receivable relatively easily, by reviewing the aged trial balance for material receivables from affiliates, officers, directors, or other related parties. Auditors should verify that notes receivable or accounts that should be classified as noncurrent assets are separated from regular accounts, and significant credit balances in accounts receivable are reclassified as accounts payable.

65. medium

Discuss the audit procedures performed when testing the detail tie-in objective for accounts receivable, and explain why this objective is ordinarily tested before any other objectives for accounts receivable. Answer: When testing the detail tie-in objective for accounts receivable, the total column and the columns depicting the aging on the aged trial balance are footed, and the total is compared to the general ledger. In addition, a sample of individual balances on the aged trial balance should be traced to supporting documents to verify the customers name, balance, and

Arens/Elder/Beasley

proper aging. These tests are ordinarily done before any other tests to assure the auditor that the population being tested agrees with the general ledger and accounts receivable master file. 66. medium Assuming the clients internal controls are adequate, describe how the auditor can verify proper cutoff of sales transactions. Answer: Assuming the clients internal controls are adequate, the auditor can verify proper cutoff of sales transactions by obtaining the shipping document number for the last shipment made at the end of the period and comparing this number with current and subsequent period recorded sales. 67. medium Describe how the auditor tests the rights objective for accounts receivable. Answer: The auditor can test the rights objective for accounts receivable through reviewing the clients minutes, discussions with the client, confirmation with banks, and the examination of correspondence files to determine whether receivables may have been pledged as collateral, assigned to someone else, factored, or sold. 68. medium Discuss the advantages and disadvantages of using negative accounts receivable confirmations rather than positive confirmations. Answer: The primary advantage of negative confirmations is that they are less expensive than positive confirmations because there are no second requests and no follow-up of nonresponses. The primary disadvantage of negative confirmations is that they are less reliable than positive confirmations because a nonresponse must be regarded as a correct response, even though the debtor may have ignored the confirmation request. 69. medium Briefly describe the circumstances in which it is acceptable to use negative confirmation requests. Answer: It is acceptable to use negative confirmation requests only when all of the following circumstances are present: Accounts receivable is made up of a large number of small accounts. Combined assessed control risk and inherent risk is low. There is no reason to believe that the recipients of the confirmations are unlikely to give them consideration. 70. medium Describe each of the following types of confirmations: Positive confirmation Blank confirmation form Invoice confirmation Negative confirmation Answer: Positive confirmations are communications addressed to a debtor requesting the Arens/Elder/Beasley

 71. challenging

recipient to confirm whether the balance as stated on the confirmation is correct or incorrect. Blank confirmation forms do not state the amount, but requests the recipient to fill in the balance or furnish other information. Invoice confirmations request a recipient to confirm an individual invoice rather than an entire balance. Negative confirmations are addressed to debtor, but request responses only if the information is incorrect.

What are the major factors affecting sample size for confirming accounts receivable? Answer: The factors include: tolerable misstatement, inherent risk (e.g., relative size of accounts receivable and number of accounts), control risk, achieved detection risk form other substantive tests, and the type of confirmation (e.g., negative normally requires a larger sample size).

72. challenging

When an auditor uses negative confirmations several factors must be considered. What are those factors? Answer: The auditor must carefully consider the following: The effectiveness of the clients internal controls Results of substantive tests of transactions The appropriateness of analytical procedures as evidence on the fairness of accounts receivable. Whether a large majority of recipients will give careful consideration to the confirmation.

Other Objective Answer Format Questions

73. medium Match seven of the terms (a-k) with the definitions provided below (1-7): a. b. c. d. e. f. g. h. i. j. k. c Accounts receivable balance-related audit objectives Aged trial balance Alternative procedures Blank confirmation form Cutoff misstatements Evidence planning worksheet Negative confirmation Positive confirmation Realizable value of accounts receivable Timing difference in an account receivable confirmation Invoice confirmation 1. The follow-up of a positive confirmation not returned by the debtor with the use of documentation evidence to determine whether the recorded receivable exists and is collectible.

Arens/Elder/Beasley

2.

A letter, addressed to the debtor, requesting that the recipient indicate directly on the letter whether the stated account balance is correct or incorrect and, if incorrect, by what amount. Misstatements that take place as a result of current period transactions being recorded in a subsequent period, or subsequent period transactions being recorded in the current period. A form used to help the auditor decide whether planned detection risk for tests of details of balances should be low, medium, or high for each balance-related audit objective. A letter, addressed to the debtor, requesting a response only if the recipient disagrees with the amount of the stated account balance. A reported difference in a confirmation from a debtor that is determined to be a timing difference between the clients and debtors records and therefore not a misstatement. A listing of the balances in the accounts receivable master file at the balance sheet date broken down according to the amount of time that has passed between the date of sale and the balance sheet date.

3.

4.

g j

5. 6.

7.

74. easy a 75. easy a 76. easy b 77. easy a 78. medium b 79. medium a 80. medium b

Tests of details of balances must be designed for each balance-related audit objective. a. True b. False Favorable results from analytical procedures reduce the extent to which the auditor needs to test details of balances. a. True b. False Tests of detail tie-in are normally conducted last in the audit of the sales and collections cycle. a. True b. False The criterion used by most merchandising and manufacturing clients for determining when a sale takes place is whether title to the goods has passed. a. True b. False For sales, the completeness transaction-related audit objective affects the existence balancerelated audit objective. a. True b. False For cash receipts, the occurrence transaction-related audit objective affects the completeness balance-related audit objective. a. True b. False The balance-related audit objectives of realizable value and rights are affected by assessed control risk. a. True b. False

Arens/Elder/Beasley

81. medium a 82. medium a 83. medium a 84. medium a 85. medium a 86. medium b 87. medium a 88. medium b 89. medium a 90. medium a 91. medium a 92. medium a

Tests of the presentation and disclosure-related objectives are generally done as part of the completion phase of the audit. a. True b. False Tests of details of balances focus on testing the year-end balances of balance sheet accounts. a. True b. False Confirmation of accounts receivable provide evidence related to the existence, accuracy and cutoff objectives. a. True b. False Confirmation is the most common test of details of balances for the accuracy of accounts receivable. a. True b. False Accounts receivable need not be confirmed if they are immaterial to the financial statements. a. True b. False Blank confirmations are considered less reliable than standard positive confirmations. a. True b. False Negative confirmations are less expensive, and less reliable, than positive confirmations. a. True b. False It is common to use a combination of positive and negative confirmations by sending the latter to accounts with large balances and the former to those with small balances. a. True b. False Tests of the realizable value balance-related audit objective are for the purpose of evaluating the allowance for doubtful accounts. a. True b. False If auditors consider confirmations of accounts receivable to be ineffective evidence because response rates will be very low, they need not confirm accounts receivable. a. True b. False The type of receivables confirmation is a major factor affecting sample size, with negative confirmations normally requiring a larger sample than positive confirmations. a. True b. False When sending confirmations during most audits of accounts receivable, the emphasis is often on confirming larger and older accounts. a. True b. False

Arens/Elder/Beasley

93. medium b 94. medium a 95. medium a 96. medium a

When a customer disagrees with the amount shown on an account receivable confirmation, the auditor should not ask the client to reconcile the difference. a. True b. False The accounts receivable balance-related audit objective net realizable value is not affected by assessed control risk for sales or cash receipts. a. True b. False For most audits, a proper cash receipts cutoff is less important than either the sales or the sales returns and allowances cutoff. a. True b. False Auditors must maintain control of confirmations until they are returned from the customer. a. True b. False

Arens/Elder/Beasley

97. medium a

When a customer does not return an accounts receivable confirmation, it is acceptable, without performing alternative procedures, to assume the amount is 100% overstated when generalizing from the sample to the population. a. True b. False

Arens/Elder/Beasley