Professional Documents
Culture Documents
Introduction
The auditor should comply with relevant ethical requirements relating to audit
engagements.
_____________________
Substantially the same as Code of ethics for Professional Accountants issued by the International
Federation of Accountants.
The auditor may also conduct the audit in accordance with both ISAs and
PSAs. however, there are currently no fundamental differences between the
IAASB pronouncement and corresponding requirements issued by the AASC and
no such differences are expected in the future .
The term ‘’scope of an audit ‘’ refer to the audit procedures deemed necessary
in the circumstances to achieve the objective of the audit. In determining the
audit procedures to be performed in conducting an audit in accordance with
Philippine Standards on Auditing ,the auditor should comply with each of the
Philippine Standards on Auditing relevant to the audit .
Professional Skepticism
The auditor should plan and perform an audit with an attitude of professional
skepticism recognizing that circumstances may exist that cause the financial
statement to be materially misstated.
_____________________
Reasonable Assurance
(a) The gathering of audit evidence , for example , in deciding the nature,
timing and extent of audit procedures ; and
(b) The drawing of conclusion based on the audit evidence gathered, for
example, assessing the reasonableness of the estimates made by
management in preparing the financial statements.
The auditor should plan and perform the audit to reduce audit risk
to an acceptably low level that is consistent with the objective of an
audit. The auditor reduces audit risk by designing and performing audit
procedures to obtain sufficient appropriate audit evidence to be able to
draw reasonable conclusions on which to base an audit opinion.
Reasonable assurance is obtained when the auditor has reduced audit
risk to an acceptably low level.
________________________
Paragraphs 15-18 of PSA 500 (revised ) ‘’Audit Evidence ,’’Discuss the use of assertions in
obtaining audit evidence .
This definition of audit risk does not include the risk that the auditor might erroneously
express an opinion that the financial statement are materially misstated .
__________________
The term ‘’management ‘’ has been used in this PSA to describe those reasonable
for the preparation and presentation of the financial statement. Other terms may
be appropriate under certain circumstances, for example, the appropriate
reference may be those charged with governance (such as the directors).
Figure 1.1 presents in highly condensed form the overview and major
components of an audit.
Audit process begins with the preliminary arrangements with the client.
Once the client has signed the engagement letter, the planning process starts as
the auditors concentrates his efforts in obtaining a detailed understanding of the
client’s business and an overall audit strategy. The auditor should PSA 300
(Revised) on “Planning an Audit of Financial Statements.” Basically, audit planning
includes understanding the client’s (1) industry environment, (2) business and
management, (3) accounting and reporting systems, and (4) internal control.
Based on the initial understanding, the auditor may decide assess control
risk at the maximum level for some assertions and below maximum for others.
Maximum control risk is defined at the greatest probability that a material
misstatement that could occur in an assertion will not be prevented or detected
on a timely basis by the entity’s internal control structure.
When gathering and evaluating audit evidence, auditors perform two basic
types of audit tests: test of controls and substantive tests.
In this phase, auditor focuses his attention on both the design and
operation of aspects of the internal control structure to determine whether the
necessary controls were functioning as intended.
The compliance tests of controls over the basic transaction cycles, namely, (1)
revenue and collection cycle, (2) expenditure cycle, and (3) financing and
investing cycle may be done in this stage. Tests of controls precede substantive
testing and performed to reduce the assessed level of control risk below the
maximum level.
Substantive tests may be performed before the balance sheet date when the
auditor can
1) Control the added audit risk that errors existing in the account at the
balance sheet date will not be detected and
2) Reduce the cost of substantive tests at the statement date.
The specific and audit objectives for substantive tests are to determine:
The nature, timing, and extent of the procedures performed in the substantive
tests depend upon the auditor’s assessed level of control risk and the resulting
detection risks he or she accepts for each assertion. For example, a minimum level
of control risk would result in a higher acceptable detection risk and therefore, in
less extensive substantive test.
The final audit phase will also include accumulation of some additional
evidence for the financial statements, summarization of the results that will
enable the auditor to prepare his audit report. This will include review for
contingent liabilities, review for subsequent events performing final analytical
procedures, evaluating the going concern assumption and obtaining a client
representation letter.
The audit report concisely describes the auditor’s responsibility, the nature
of the examination, the audit finding and his opinion on the financial statements.
If upon completion of the audit field work, the auditor decides that an opinion can
not be rendered, he must clearly disclaim an opinion and give reasons for the
disclaimer. If an opinion can be rendered, the auditor must decide whether to
issue an unqualified, qualified or adverse opinion.
[Appropriate Addressee]
Auditor’s Responsibility
Opinion
In our opinion, the financial statements present fairly, in all material respects,
The financial position of ABC company as December 31, 20X7 and of its
financial performance and its cash flow for the year ended in accordance with
Philip[pine Financial Reporting Standard s.
[Form and content of this section of the auditor’s report will vary depending on
the nature of the auditor’s other reporting responsibilities.]
[ Auditor’s signature ]
[Auditor’s address]
Chapter 2
AUDIT PLANNING
Learning objectives after studying this chapter, you should be able to;
Once the client has been obtained and the engagement letter signed by both
parties ( auditor and client ) , the planning process intensifies as the auditors
concentrate their efforts in obtaining a detailed understanding of the client’s
business in developing an overall audit strategy and assess the risks of material
misstatement of the financial statements.
PSA 200 ,’’ Objectives and General Principles Governing an Audit of Financial
Statement ‘’, paragraph 15 requires that
‘’ The auditor should plan and perform an audit with an attitude of professional
skepticism recognizing that circumstances may exist that cause the financial
statements to be materially misstated .”
The auditor-in –charge must develop a ‘’ plan of action ‘’to organize, coordinate,
and schedule activities of the audit staff. An audit plan is normally drafted prior to
starting the work at the client’s offices.
AUDIT PLANNING involves the establishment of the overall audit strategy for the
engagement and developing an audit plan, in order to reduce audit risk to an
acceptably low level. Planning involves the engagement partner and other key
members of the engagement team to benefit from their experience and insight
and to enhance the effectiveness and efficiency of the planning process .
The nature of extent of planning activities will vary according to the size and
complexity of the entity, the auditor’s previous experience with entity, and
changes in circumstances that occur during the audit engagement.
Planning is a continuous and iterative process that often begins shortly after or in
connection with the completion of the previous audit and continues until the
completion of the current audit engagement. However, in planning an audit, the
auditor considers the timing of certain planning activities and audit procedures
that need to be completed prior to the performance of further audit procedures.
For example, the auditor plans the discussion among engagement team
members, the analytical procedures to be applied as risk assessment procedures ,
the obtaining of a general understanding of the legal and regulatory framework
applicable to the entity and how the entity is complying with that framework ,
the determination of materiality , the involvement of experts and the
performance of other risk assessment procedures prior to identifying and
assessing the risks of material misstatement and performing further audit
procedures at the assertion level for classes of transactions, account balances ,
disclosures that are responsive to those risks .
Benefits of Audit Planning
________________________
PSA 315 ‘’Understanding the entity and its Environment and Assessing the
Risks of Material Misstatement “ paragraph 14-19 provide guidance on
the engagement term ‘s discussion of the susceptibility of the entity to
material misstatements of the financial statements . PSA 240 (revised) ‘’
The Auditor’s Responsibility to consider fraud in an Audit of Financial
Statement “paragraphs 24-27 provide guidance on the emphasis given
during this discussion to the susceptibility of the entity’s financial
statements to material misstatement due to fraud.
Planning Activities
c. Considering the important factor that will determine the focus of the
engagement teams efforts , such as
(a) The resources to deploy for specific audit areas, such as the use of
appropriately experienced team members for high risk areas or the
involvement of experts on complex matters:
(d) How such resources are managed , directed and supervised, such
as when team briefing and debriefing meeting are expected to be
held, how engagement partner and manager reviews are expected
to take place ( for example , on site or off site ) , and whether to
complete engagement quality control reviews.
The auditor may consider the following matters when ascertaining the
reporting objectives of the engagement, the timing of the audit and the
nature of communications required:
The entity’s timetable for reporting, such as at interim and final stages.
The organization of meetings with management and those charged
with governance to discuss the nature, extent and timing of the audit
work.
The discussion with management and those charged with governance
regarding the expected type and timing of reports to be issued and
other communications, both written and oral, including the auditor’s
report , management letters and communications to those charged
with governance .
The discussion with management regarding the expected
communications on the status of audit work throughout the
engagement and the expected deliverables resulting from the audit
procedures.
Communication with auditors of components regarding the expected
types and timing of reports to be issued and other communications in
connection with the audit of components.
The expected nature and timing of communications among
engagement team members, including the nature and timing of team
meetings and timing of the review of work performed.
Whether there are any other expected communications with third
parties, including any statutory or contractual reporting
responsibilities arising from the audit.
The auditor should develop an audit plan for the audit in order to reduce
audit risk to an acceptably low level.
Once the audit strategy has been established , the auditor is able to start
the development of a more detailed audit plan to address the various matter
identified in the audit strategy , taking in to account the need to achieve the
audit objectives through the efficient use of the auditor’s resources. Although
the auditor ordinarily establishes the audit strategy before developing the
detailed audit plan, the two planning activities are not necessarily discrete or
sequential changes to the other. Paragraphs 14 and 15 provide further guidance
on developing the audit plan.
The audit plan is more detailed than the audit strategy and includes the nature,
timing and extent of audit procedures to be performed by engagement team
members in order to obtain sufficient appropriate audit evidence to reduce audit
risk to an acceptably low level. Documentation of the audit plan also serves as a
record of the proper planning and performance of the audit procedures that can
be reviewed and approved prior to the performance of further audit procedures.
Such other audit procedures required to be carried out for the engagement
in order to comply with PSAs (for example, seeking direct communication
with the entity’s lawyers).
Planning for these audit procedures takes place over the course of the audit
as the audit plan for the engagement develops. For example, planning of
the auditor’s risk assessment procedures ordinarily occurs early in the
audit process. However, planning of the nature, timing and extent of
specific further audit procedures depends on the outcome of those risk
assessment procedures. In addition, the auditor may begin the execution of
further audit procedures for some classes of transactions, account balances
and disclosures before completing the more detailed audit plan of all
remaining further audit procedures.
The overall audit strategy and the audit plan should be updated and
changed as necessary during the course of the audit.
The auditor should plan the nature, timing and extent of direction and
supervision of engagement team members and review of their work.
The auditor plans the nature, timing and extent of direction and supervision
of engagement team members based on the assessed risk of material
misstatement. As the assessed risk of material misstatement increases, for
the area of audit risk, the auditor ordinarily increases the extent and
timelines of direction and supervision of engagement team members and
performs a more detailed review of their work. Similarly, the auditor plans
the nature, timing and extent of review of the engagement team’s work
based on the capabilities and competence of the individual team members
performing the audit work.
In audit of small entities, an audit may be carried out entirely by the audit
engagement partner (who may be a sole practitioner). In such situations,
questions of direction and supervision of engagement partner, having
personally conducted all aspects of the work, is aware of all material issues.
The audit engagement partner (or sole practitioner) nevertheless needs to
be satisfied that the audit has been conducted in accordance with PSAs.
Forming an objective view on the appropriateness of the judgments made
in the course of the audit can present practical problems when the same
individual also performed by a sole practitioner, it may be desirable to plan
to consult with other suitably-experienced auditors or the auditor’s
professional body.
Documentation
The auditor should document the overall audit strategy and the audit plan,
including any significant changes made during the audit engagement.
The auditor’s documentation of the overall audit strategy records the key
decisions considered necessary to properly plan the audit and to
communicate significant matters to the engagement team. For example,
the auditor may summarize the overall audit strategy in the form of a
memorandum that contains key decisions regarding to overall scope, timing
and conduct of the audit.
The auditor’s documentation of the audit plan is sufficient to demonstrate
the planned nature, timing and extent of risk assessment procedures, and
further audit procedures at the assertion level for each material class of
transaction, account balance, and disclosure in response to the assessed
risk. The auditor may use standard audit programs or audit completion
checklist. However, when such standard audit programs or checklist are
used, the auditor appropriately tailors them to reflect the particular
engagement circumstances.
The form and extent of documentation depend on such matters as the size
and complexity of the entity, materiality, the extent of other
documentation, and the circumstances of the specific audit engagement.
The purpose and objective of planning the audit are the same whether the audit
is an initial or recurring engagement. However, for an initial audit, the auditor
may need to expand the planning activities because the auditor does not
ordinarily have the previous experience with the entity that is considered when
planning recurring engagements. For initial audits, additional matters the auditor
may consider in developing the overall audit strategy and audit plan include the
following:
Unless prohibited by law or regulation, an arrangement to be made with
the previous auditor, for example, to review the previous auditor’s working
papers.
Any major issues (including the application of accounting principles or of
auditing and reporting standards) discussed with management in
connection with the initial selection as auditors, the communication of
these matters to those charged with governance and how these matters
affect the overall audit strategy and audit plan.
The planned audit procedures to obtained sufficient appropriate audit
evidence regarding opening balances (see paragraph 2 of PSA 510, “Initial
Engagements-Opening Balances”).
The assignment of firm personnel with appropriate levels of capabilities and
competence to respond to anticipated significant risk.
Other procedures required by the firm’s system of quality control for initial
audit engagements ( for example, the firm’s system of quality control may
require the involvement of another partner or senior individual to review
the overall audit strategy prior to commencing significant audit procedures
or to review reports prior to their issuance).
When used for planning purposes, analytical procedures assist the auditors
in planning the nature, timing, and extent of audit procedures that will be
used for the specific accounts. The approach used is one of obtaining an
understanding of the client’s business and transactions, and identifying
areas that may present higher risks. The auditors will then plan a more
thorough investigation of these potential problems areas, and perform a
more effective audit. PSA 520 requires the auditors to perform analytical
procedures as a part of the planning process for every audit.
a. Predecessor Auditor
b. Other CPAs
c. Specialist
e. Internal Auditors
Internal auditors can affect the audit in two ways. First, they can enhance
internal control. For example, if internal auditors determined that bank
reconciliations were properly prepared and all cash receipts were
deposited, the entity’s controls would enhance the reliability of the
accounting records. In such cases, independent auditors would be able to
reduce the extent of substantive testing. In deciding whether to reduce the
amount of testing for specific assertions because of work performed by
internal auditors, the independent auditor should consider (1) the
materiality of the amount, (2) the risk of misstatement, and (3) the degree
of subjectivity involved in evaluating the accumulated audit evidence. As
these factors increase, the auditor is less likely to rely on the internal
auditor’s work.
_____________________________
The phrase “material uncertainty” is used in PAS No. 1 in discussing the uncertainties related to events
or conditions which may cast significant doubt on the enterprise’s ability to continue as a going concern
that should be disclosed in the financial statements. In other financial reporting frameworks, and
elsewhere in the PAS’s, the phrase “significant uncertainties” is used in similar
Financial
Net liability or net current liability position.
Fixed-term borrowings approaching maturity without realistic prospects of
renewal or repayment: or excessive reliance on short-term borrowings to
finance long-term assets.
Indications of withdrawal of financial support by debtors and other
creditors.
Negative operating cash flows indicated by historical and prospective
financial statements.
Adverse key financial ratios.
Substantial operating losses or significant deterioration in the value of
assets used to generate cash flows.
Arrears or discontinuance of dividends.
Inability to pay creditors on due dates.
Inability to comply with the terms of loan agreements.
Change from credit to cash-on-delivery transactions with suppliers.
Inability to obtain financing for essential new product development or
other essential investments.
Operating
Loss of key management without replacement.
Loss of a major market, franchise, license, or principal supplier.
Labor difficulties or shortages of important supplies.
Other
Non-compliance with capital or other statutory requirements.
Pending legal or regulatory proceedings against the entity that may, if
successful, result in claims that are unlikely to be satisfied.
Changes in legislation or government policy expected to adversely affect
the entity.
Budget is used to measure the efficiency of the staff and to determine at each
stage of the engagement whether the work is progressing at a satisfactory rate.
An illustration of an Audit Budget and Time Summary is shown in
Figure 2.1
A major consideration affecting staff is the need for continuity from year to
year. An inexperience staff assistant is likely to become the most
experienced non partner on the engagement within a few years.
Continuity helps the CPA firm maintain familiarity with the technical
requirements and closer interpersonal relations with client personnel.
Audit work that can always be performed during the interim period
includes the consideration of internal control, issuance of management
letter, and substantive tests of transactions that have occurred to interim
date.
Performing audit work during the interim period has numerous advantages
in addition to facilitating the timely release of the audited financial
statements. The independent auditors may be able to assess internal
control more effectively by observing and testing controls at various times
throughout the year. Also, they can give early consideration to accounting
problems. Another advantage is that interim auditing creates a more
uniform work load for CPA firm. With a large client, such as San Miguel
Corporation, the auditors may have office space within the client’s
buildings and perform auditing procedures throughout the entire year.
Performance of other substantive tests is scheduled near at, and after year-
end. Consideration should be given to such factors as:
a) Deadline for submitting final audit report and filing of income tax
returns
b) Ability of the client’s staff to submit required schedules
c) Other audit clients
The overall audit plan and the audit program should be revised as
necessary during the course of the audit. Planning is continuous throughout
the engagement because of changes in conditions or expected results of
audit procedures. The reasons for significant changes would be recorded.
Pertinent current year information that auditors should review includes (1)
minutes of directors’ and stockholders’ meeting, (2) changes to articles of
incorporation or by laws, and (3) any significant contracts executed during
the year . By reading the minutes, an auditor will obtain information about
significant events that have or will have an impact on the client. For
examples, an auditor should be alert to the following:
For new clients for which historical information relating to these matters is
unavailable, the auditor should review information relating to prior years. For
example, instead of reading only the changes to the articles of incorporation and
by –laws, the auditor should read the articles of incorporation and by-laws since
the inception of the entity, maki8ng appropriate summaries for the permanent
file. The auditor should also read all contacts having an impact on the current
year.
The auditor should develop and document an audit program setting pout the
nature, timing and extent of planned audit procedures required to implement the
overall audit plan. The audit program serves as a set of instructions to assistants
involved in the audit and as a means to control and record the proper execution
of the work. The audit program may also contain the objectives for each area and
a time budget in which hours are budgeted for the various audit areas or
procedures.
1. For a sample of entries in the sales journal, compare data in the sales
journal to the approved customer order, the sales order, the shipping
document, and the sales invoice.
2. Confirm a sample of accounts receivable at year- end.
In preparing the audit program, the auditor would consider the specific
assessment of inherent and control risks and the required level of
assurance to be provided by substantive procedures. The auditor would
also consider the timing of tests of controls and substantive procedures,
the coordination of any assistance expected from the entity, the
availability of assistants and the involvement of other auditors or experts
.; other matters may also need to be considered in more detailed during
the development of the audit program.
On initial engagements, the audit program typically will develop in three
stages:
(1) The broad phases of the program can be outlined at the time of
engagement :
(2) Other details of the program can be identified after the review of
internal control structure and accounting procedures has begun; and
(3) Procedures on specific phases of the audit can be further challenged and
revised as the work progresses.
(a) The client’s size as indicated by its gross assets, sales, number of
employees.
(b) Location of client facilities.
(c) The anticipate accounting and auditing problems.
(d) The competence and experience of staff available.
CASE FACTS:
Introduction
The balance sheet and income statement for the company for
2007.
A trial balance for December 31,2008 , with comparative
amounts for 2007
The analytical ratios working paper that is partially completed.
(The ratios for 2008 have been left off.)
The audit plan for the audit of the financial statement for the
year ended December 31, 2008.
A fraud risk assessment.
Current assets
Cash Ᵽ 27
Trade receivables, less allowance for doubtful accounts of 844
Account receivable –officers 57
Inventory 696
Prepaid expenses 40
Total current assets Ᵽ1,664
Noncurrent Assets
Equipment and leasehold equipment, at cost
Office equipment Ᵽ281
Leasehold improvement 17
Ᵽ298
125
Less accumulated depreciation Ᵽ 172
Total fixed assets Ᵽ 1836
Current Liabilities
Note payable Ᵽ 309
Accounts payable 505
Current maturities of capital lease obligation 20
Accrued expenses 115
Total current liabilities Ᵽ 949
Shareholders’ equity
Ordinary shares, Ᵽ1 par value; 100000 shares authorized; 20000 Ᵽ20
Share issued and outstanding 42
Additional paid-in capital 690
Retained earnings Ᵽ752
Ᵽ1,836
An audit plan contains the overview of the engagement, outlining the nature and
characteristics of the client’s business operations and the overall audit strategy.
Normally, the audit plan is prepared before starting work at the client’s office. It
may, however be modified throughout the engagement as the auditor deem as
necessary depending on his consideration of internal control or as special
problems are encountered .
The auditor may wish to prepare a memorandum setting forth the preliminary
audit plan, particularly for large and complex entity.
It is far easier to plan for a repeat engagement than planning for a first audit of a
new client. The working papers in the previous year’s audit provide a wealth of
information useful in planning the recurring engagement. Of course, the auditor-
in-charge of a repeat engagement would have good working knowledge of the
client’s business. The auditor however should not merely duplicate last year’s
audit program but should modify his approach to the audit for any changes in the
clients’ operations, internal control structure, or business environment.
The guidance under (c) reflects the typical sequence of the audit process. Having
acquired a sufficient knowledge of the business the auditor assesses the risk of a
material misstatement in the financial statements. This assessment includes
consideration of environmental laws and regulations that may pertain to the
entity, and provides a basis for the auditor to decide whether there is a need to
pay attention to environmental matters in the course of the audit of financial
statements.
Ending Ending
Ratio 12/31/08 12/31/07 Industry
Prepared by Reviewed by
Initial Date Initial Date
Flash Technologies and Networks, Inc.
Audit Plan
December 31, 2008
Date
Prepared by: KC Lopez (Senior) August 14, 2008
Reviewed by: Jo Hernandez (Manager) August 28, 2008
Reviewed by: Ela Hector (Partner) September 5, 2008
Audit
Objective
Audit of the financial statements of Flash Technologies and Networks, Inc. (FTN) for
the year ended December 31, 2008. Also, the company’s debt agreement with
Eastern Financial Services requires the company to furnish the lender a report by
our firm on FTN’s compliance with various restrictive debt covenants.
FTN sells and installs microcomputers and networking hardware and software to
business customers. The company’s primary competitive strategy is to maintain a
high level of technical expertise and a broad range of service. The company
provides repair, maintenance, training, and software customization services. FTN
has also begun developing its own computer networking software to be sold as a
product to its customer and FTN competes with large retailers of microcomputers.
The market for microcomputers and related products is extremely competitive. The
company also competed with other value-added resellers who provide
microcomputers and software products directly to customers. To effectively
compete, the company must be able to obtain inventories of state-of-the-art
equipment on a timely basis. Because the company does not have the buying
power of some of its competitors, it generally must charge ah higher price for its
products. Its customers are willing to pay the higher price because of the high level
of expertise and service that the company provides.
Planning
Meetings
On July 20, Jo Hernadez and I met with Janelle Santos, controller, and Gian Basco,
president, of FTN to discuss the planning of the audit for the current year. On
August 2, a planning meeting was held in our office with all members of the
engagement team assigned to the audit.
Audit
Approach
The company has had no significant changes in its internal control from the prior
year. Therefore, consistent with the approach used in last year’s audit, we plan to
perform tests of controls to access control risk at less than the maximum for most
financial statement assertions.
Risks
These factors indicate that the engagement to audit FTN has high risk.
The company began offering for sale extended warranties on computers during the
current year. We need to review the method of revenue recognition to determine
whether it complies with the requirements of Pas 18, Revenue.
In the prior year, FTN began developing networking software products for sale. This
year the company has started capitalizing certain costs of development. We need
to review the method of accounting for the cost of software development to
determine whether it complies with the requirements of PAS 38, Intangibles.
Planning
Materiality
Because the firm has experienced steady growth in sales and earnings over the last
three years, we believe that operating results are the most appropriate basis for
estimating planning materiality as described below:
The range for planning materiality is from P20,000 to P110,000. Based on the
company’s steady growth in sales and earnings and the fact that the company is not
a public company, we have selected P70,000 as a reasonable materiality amount
for planning purposes.
Based on discussions with Ms. Santos, the following are tentative dates of
importance for the audit:
Procedure Performed by
Comments
1. Consider the results of the discussion among See WP-21
for
engagement personnel about the risk of material the
agenda.
misstatement due to fraud. EH
2. Consider results of inquiries of management about
the risks of fraud and how they are addressed. EH
3. Consider the results of planning analytical
procedures. EH
4. Consider the existence of fraud risk factors listed on
WP-30 through WP-35. EH
5. Consider any other information that might be relevant
to the risk of material misstatement due to fraud. EH
Overall Responses
1. The audit plan for the audit of Flash Technologies and Networks,
Inc. appears on pages 45F through 45I. Review each major section
of the audit plan and briefly describe the purpose and content of
the section.
Organize your presentation in the following manner:
2. In the audit plan for the audit Flash Technologies and Networks, Inc.,
there is a section on significant accounting and auditing matters. The
first of the matters described in this section involves the appropriate
accounting for the sale of extended warranty contracts. Research this
accounting issue and write a brief memorandum for the working
papers describing the issue and summarizing the appropriate method
of accounting for the revenue received from these contracts.
Required:
a. Research this issue and write a brief memorandum for the working papers
describing the issue and summarizing the appropriate method of
accounting for the development costs.
b. Based on your research, describe the major audit issue that you believe
will be involved in auditing the software development costs.
CASE ANALYSIS
FTN began offering extended warranties on computers during the current year.
We must determine that both revenues and expenses relating to these warranties are
properly accounted for. PAS 18, Revenue and PAS 37, Provisions, Contingent Liabilities
and Contingent Assets, provide guidance in this area both for accrual of revenue and
amortization of costs.
Related to acquisition of the warranty contract that would not have been incurred but
for the acquisition of the contract should be deferred and charged to expense in
proportion to the revenue recognized. All other costs (e.g., costs of services performed,
general and administrative, advertising expenses) should be charged to expense as
incurred.
In 2007 FTN began developing networking software product for sale. This year the company has started capitalizing
certain costs of development. PAS 38, Intangibles, provides guidance in this area. PAS makes clear that the nature of
the activity for which the software is being developed should be considered in determining whether software costs
should be include or excluded in research and development. PAS 38 indicates that to the extent that the acquisition,
development, or improvement of a process by an enterprise for use in its selling or administrative activities includes
costs for computer software, those costs are not research and development costs. Examples of such costs include
development of a general management information system and the computerized reservation system of an airline.
This does not appear to be the type of costs involved in this situation.
PAS 38 further clarifies the issues by stating that all costs incurred to establish the technological feasibility of a
computer software product to be sold, leased or otherwise marketed are research and development costs. The cost
technological feasibility of a product is established when the enterpriser has completed all planning, designing, coding,
and testing activities that are necessary to establish that the product can be produced to meet its design specifications
including functions, features and technological performance requirement. PAS 38 provides a summary of tests to
indicate whether technological feasibility has been established.
Costs incurred subsequent to establishing technological feasibility are to be capitalized. The capitalization of computer
software costs ceases when the
Product is available for general release to customers. Costs of maintenance and customer support should be charged to
expense when related revenue is recognized or when the costs are incurred, whichever occurs first.
KC Lopez
Days Inventory computed with CGS per day = cost of goods sold /365
Average Inventory =P7,397 / 365=P20
Days inventory =Average Inventory / CGS per day
=P799/P20=39.436
Total Liabilities to Net Worth Total liabilities / Shareholders’ Equity
P1,240 /P1,120=1.107
Return on Total assets Net Income / Total Assets
P458 /1,120=.194
Return on Net Worth Net Income / Shareholders’ Equity
P458 / 1,120=.409
Return on Net Sales Net Income / Net Sales
P458 /P11,602=.040
Gross Profit / Net Sales Gross Profit / Net Sales
P4,205 /P 11,602=.362
Selling, Operating and Admin. Selling, Operating and Admin. Exp./ Net Sales
Expense / net Sales P3,544 /P11,602=.305
Times Interest Earned Operating Income / Interest Expense
P661 /P 77=8.541
(b) And (c) This part of the case reveals how difficult ratio analysis is when these are no
major changes in ratios. However. The following might be considered in comparing the
current year’s ratios with those of last year’s.
Inventory Turnover
A number of the other ratios show significant changes which seem due primarily to the
increased level of profitability.
Chapter 3 Audit of the Revenue and Collection
cycle: Tests of controls and substantive
tests of Transactions
This chapter begins with an explanation of the revenue and collection cycle
and the internal control environment and objectives pertaining thereto. Then,
consideration is given to compliance tests of controls over revenue and cash
receipts transactions.
In performing the audit of the revenue and collection cycle, the auditor
should be able to:
1. Sales
2. Accounts and notes receivable
3. Sales returns and allowances
4. Cash in bank ( debits from cash receipts)
5. Sales discount
6. Allowance for uncollectible account
7. Uncollectible accounts expense
8. Inventories ( merchandise, finished goods)
Documents Used in the Revenue and Collection Cycle and their Audit
Significance
Several important documents and records are typically used in the revenue
and collection cycle.
Sold, the price including freight, insurance, price charged for merchandise.
Terms, and other relevant data. Seller should account for the
numerical sequence to help
ensure that all sales are
recorded.
Credit memo
takes the same general form as a sales should account for the
accounts receivable rather than increases. Ensure that all credit memos
are recorded.
Remittance advice
A pre numbered document used internally, Sellers should account for the
Monthly statement
Sales journal
a journal for recording sales transactions. A detailed sales journal includes each
sales transaction. It usually indicates gross sales for different classifications, such
as product lines, the entry to accounts receivable, and miscellaneous debits and
credits. The sales journal can also include sales returns and allowances
transactions.
Sales return and allowances journal
A journal similar to the sales journal except the merchandisers uses it to record
returns of merchandise or adjustments to invoice prices.
A journal for recording cash receipts from collections, each sales, and all other
cash receipts.
General journal
A journal in which are recorded all transactions for which a special journal has not
been created. Sales and collections cycle transactions frequently recorded in the
general journal include entries to estimate uncollectible accounts expense and
entries to write off accounts identified as uncollectible.
A file for recording individual sales, cash receipts, and sales returns allowances for
each customer and maintaining customer account balances.
______________________________________________________________________________________
Cycle Revenue Class of Transactions: Sales
_____________________________________________________________________________________
Recording
1. Are the daily sales journal entries agreed to daily
sales summaries?
2. Are invoices journalized in numerical sequence?
3. Is there periodic independent reconciliation of
accounts receivable control and the customers’
ledger?
4. Are postings to the subsidiary ledgers made
independent of journalizing and posting the
general ledger?
Custody
1. Are there adequate physical controls over accounts
receivable records?
2. Is there independent mailing of monthly statements to
customers?
Controls are important because of their effect on the assertions embodied in the
financial statements. Auditors identify specific assertions for each general
assertion to be tested. The general and specific audit assertions for sales and
receivables are as follows:
General Specific
DISCUSSION:
A. Existence or occurrence: recorded sales are for shipments
actually made to customers.
11. Sales must be properly classified the auditor can test this
To generated accurate segment control by determining
Reporting. Entities may requires a that the invoice copy contains
Second person too independently the signature that indicates
Review or check the account approval of accounts
Coding on invoice. Classifications used.
An audit program for tests of controls for sales is presented in figure 3.3. the audit
procedures are those include in the foregoing discussion, but they have been
restated to enable the auditor to select a minimum number of samples for
testing. It will be noted that to test for existence or occurrence, the auditor tests
from accounting records back to underlying documents that indicate that the
transaction occurred. To test whether all transactions are recorded, an auditor
compares prenumbered documents to entries in the accounting records. The
auditor can also observe the presence of some controls, rather than examine a
sample of documents to obtain evidence about a control.
Figure 3.3 Audit Program for Tests of Controls over Sales Transactions
c. Unauthorized use of
shipping orders or bills
of lading to remove
goods from premises.
3. Customer credit approval not 3. a. Goods shipped to
indicated on sales order. customers whose credit
has not been approved.
4. Selling prices not compared with 4. a. Goods billed to custome
masters price list. -ers at incorrect prices.
5. Accounting manual not used or 5. a. Transactions and events
account distribution not double- incorrectly recorded.
checked.
1-5. For a sample of entries in the sales journal, compare sales invoice copy,
customer order and shipping document.
To test the existence of sales, some auditors examine the sales invoice, the
customer’s order, the sales order bearing credit approval and the shipping
document for a sample of entries in the sales journal. If an entity has a
procedure to accumulate these documents before recording a sale, their
accumulation is an indication that the control was performed. Other
procedures may include
To determine that the entity has a right to the receivable arising from
the sales transactions recorded, the auditor examines a sample of sales
transactions and be alert for indications of consigned shipments treated as
sales. Auditors should also investigate the procedure from recording
movements of merchandise among the various units of the company.
7-9. For sample of entries in the sales journal, (a) examine sales invoice,
shipping document, and customer order for consistency of descriptions
and quantities; (b) examine sales orders for credit approval; and (c) check
prices and extensions. Foot sales journal and general ledger account.
10. For a sample of the entries in the sales journal, verify the accuracy of
account coding.
Auditors may review entries in the sales journal and the supporting
sales invoice to determine whether the sales invoice was coded correctly
and whether it results in proper presentation and disclosure of the
transaction in the financial statement.
B. AUDIT OF SALES ADJUSTMENTS TRANSACTIONS
FIGURE 3.4 shows the manual system for processing and recording
sales returns and account write-offs.
Auditors often audit cash discount in connection with a test of cash receipts transactions and
sales return and allowances in connection with sales. Oftentimes, auditors perform only
substantive tests of account balances.
For sales returns and allowances, the primary emphasis is normally on testing the existence
of recorded transactions as a means of uncovering any diversion of cash from the collection of
accounts receivable that has been covered up by a fictitious sales return or allowances is often
on testing the existence of recorded transactions, the completeness objective cannot be
ignored. Unrecorded sales returns and allowances can be material and can be used by
company’s management to overstate net income.
The other objectives, rights and obligations, valuation, and proper classification should not of
course be ignored. The same methodology for controls over sales transactions should be
applied to controls over sales returns and allowances.
WP Done
Audit Procedures Ref By Date
The foregoing test of controls over sales adjustments transaction may reveal the following weaknesses
and possible errors:
The audit objectives are essentially the same for processing credit memos for returns and allowances
as those describe for sales, with two important differences.
1. The first relate to “materiality”. If the amount of sales returns and allowances are so immaterial,
they can be ignored in the audit altogether.
2. The second relates to “ emphasis on objective.” For sales returns and allowances , the primary
emphasis is normally on testing the validity of recorded transaction as a means of uncovering any
diversion of cash from the collection of accounts receivable that has been covered by a fictitious sales
return or allowance.
Naturally, the auditor also gives due attention to the other objectives and should be able to arrive at
suitable substantive tests of transaction which are essentially the same as for sales to verify amounts.
The audit procedures that may be used for substantive tests of controls for sales returns and
allowances include:
All allowances to customers for returned or defective merchandise should be supported by serially
numbered credit memoranda signed by an officer or responsible employee having no duties relating to
handling cash or to the maintenance of customers’ ledger.
(2) Review credits for returned merchandise if supported by receiving report on the return shipment.
(3) Verify prices, extensions and footings and trace posting from the sales returns journal or other
accounting record to the customer’s accounts in subsidiary receivable ledger.
I. BASIC CONSIDERATIONS
There are a variety of sources of cash receipts. Cash receipts may result from revenue transactions,
short and long term borrowing, issuance of share capital, and sale of marketable securities, long-term
investment and other assets. The scope of this chapter is limited to cash receipts from sales
transactions which include cash sales and collections from trade customer on credit sales. Other sources
of cash receipts are discussed in the investing and financing cycles in Chapters 6.