SCAD V: Parts 2 and 3 - Assessing Control Risk I. Part 3: Understand Client s Internal Control System (IC pages 1 and 2) A. Gather Information 1. Flowcharts 2. Documents/walkthrough 3. Identify controls and environment B. Preliminary Assessment 1. Look at what is being done: a. Identify the type of control activity. b. Identify the management assertion(s) reasonably assured by the internal control. 2. Reverse the process: a. Determine what management assertions should be present for the accounting function under consideration. b. Identify the control needed to reasonably assure the protection of the assertion. Or After completing A ask what s missing (i.e., What management assertion(s) are unprotected; how could the accounting system fail to meet the TRAOs). The key is to make sure that the internal control system prevents or detects deviations from EACH of management s assertions (or the TRAO s). 3. Assess control risk (H, M, L) for each assertion (or objective) for each accounting function (in this case, Sales and Collection). See example workpaper IC 50/1. II. Part 4: Tests of Controls and Substantive Tests of Transactions (IC pages 3 and 4) A. Perform the tests of controls and substantive tests of transactions as proscribed in the audit program. 1. Decide the type of sampling to use for each procedure. 2. Decide on the format of the workpapers. See example worksheet attached. 3. SCAD V program notes: a. Selecting samples: Select range - CAUTION data provided includes a year and one-quarter. Sample - Simple random sample (enter Sample size). Save - - File name: Use somethingdesccriptive.xls - Pull up in spreadsheet program and design spreadsheet into working paper. - Added: Reference, completed by, and date, Heading, Columns - Adjustments: Landscape, column width, gridlines. B. Analyze the results of the tests (Chapter 15). C. Decide on the final control risk for the Sales and Collection cycle. To do on this group day: 1. Assign procedures 1 through 5 and 13 through 25 2. Do procedure 11 as a group get partner approval To be done while discussing chapter 15: Procedures 10 and 12 Need to bring the SCAD audit program to class To do on next group day: Procedures 6, 7, and 26.
Evaluation of Control Structure Sales and Collections Procedure Done by Date Reference 1. Design a flowchart for the sales and collections cycle. 2. Develop a list of and briefly describe the documents available in the client s sales and collections system. Note potential evidence of controls. 3. Review the case scenario and evaluate the client s control environment. Summarize your conclusions and reasoning in a brief paragraph. 4. Using the case scenario identify the client s internal control strengths and weaknesses for each of the following: a. Existence: Recorded transactions in KSP 10/31/X2 IC 50/1 the sales/billing/collection cycle are valid. b. Completeness: This assertion states that the financial records include all transactions that have occurred. c. Valuation/Allocation: This assertion states that sales and related accounts are properly valued. d. Rights and Obligations: This assertion states that at a given date recorded assets are the rights of the entity and liabilities are the obligations of the entity. e. Presentation and Disclosure: This assertion states that components of the financial statements, including footnotes, are properly classified, described, and disclosed. 5. For each of the management assertions (a through e) assess control risk as either high, medium, or low based on the above IC 50/1 to identified internal control strengths and weaknesses. 6. Make an overall assessment (high, medium, or low) of control risk for the IC 10 sales and collection cycle. 7. Make a list of recommendations to management for changes to the current IC 11 internal control system. (For reference see SCAD V: Assignment 4) & date IC/1 of 4
Control Risk Summary Sales and Collection Cycle IC 50/1 Prepared by KSP Date 10/31/X2 Existence: Recorded transactions in the sales/billing/collection cycle are valid. Strengths: 1. Committee approves extension of credit before shipment. 2. Contracts, prices and terms authorized by Steven Williams. 3. Merchandise is shipped only upon the receipt of the sales order copy as authorization. 4. Order recorded in log and signed by delivery person. 5. Separation of duties in billing, recording, cash handling. 6. Copy of invoice sent to customer. 7. Prenumbered sales invoices. 8. Officer authorizes sales return. 9. Controller authorizes write-offs, secretary makes entries. 10. Receptionist restrictively endorses checks. 11. Monthly statements sent to customers. 12. Only employees with jobs requiring computer data entry or access to file information are given passwords. 13. Direct write access to data files requires passwords of two key employees to be entered simultaneously. Weaknesses: 1. No systematic changing of passwords. 2. There is no apparent rotation of duties or assignment of vacation coverage. 3. No systematic accounting for prenumbered documents. 4. Bookkeeper enters controller's initials. 5. No prelisting of checks. 6. Lack of segregation of duties for bank reconciliation and cash handling. 7. Passwords are required to enter the system, but after entry the system is not segregated and users are not restricted to specifically authorized programs or data files. Initial Control Risk Assessment for the Existence Assertion: Low - Medium
Evaluation of Control Structure Procedure Done by Date 8. For control risk assertions assessed as medium or low, develop tests of controls. 9. Develop substantive tests of transactions appropriate for planned CR. 10. Specify your tolerable exception rate for each test of control and substantive tests of transaction. 11. Specify your tolerable misstatement for accounts receivable and allowance for doubtful accounts. 12. Determine the appropriate sample size and method of sample selection for test of controls and substantive tests of transactions (discuss reasoning for all judgmental decisions and identify sample population). (For reference see SCAD V: Assignment 5) Reference KSP 10/31/X2 IC/3 of 4 & IC/4 of 4 KSP 10/31/X2 IC/3 of 4 & IC/4 of 4 IC/2 of 4 & date
Test of Controls and Substantive Tests of Transactions Sales and Collection Cycle Procedures Done by Date Reference Sales Transactions: General: 13. Review entries in the sales journal for reasonableness. Examine support for unusual items noted. 14. Trace totals in the sales journal to proper posting in the general ledger. 15. Review general ledger sales account for posting from sources other than the sales journal. 16. Review appropriate analytical procedures related to the sales balance for impact on assessment of control risk. Sales Transactions: 17. On a test basis, account for the numeric sequence of sales invoices in the sales journal. 18. Select a random sample of sales invoices from the client's computerized listing of sales transactions in the sales journal. a) Trace to entries in accounts receivable subsidiary ledger. b) Examine supporting documents (bill of lading, sales order) for inclusion and agreement. c) Vouch prices to approved price list. d) Test arithmetic accuracy of invoice. e) Determine if credit was properly approved. f) Note evidence of verification of extensions. g) Verify that Bill of Lading, Sales Invoice, and Sales Journal dates agree. 19. On a test basis, account for the numeric sequence of shipping documents from the delivery advice file. IC/3 of 4 and date
Test of Controls and Substantive Tests of Transactions (Assignment 6) Procedures Done by Date Reference 20. Select a random sample of shipping documents from the client's computerized listing of shipments. a. Agree the items to entry in the sales journal. b. Agree to invoices in sales invoice package file. 21. Select a sample of shipping documents from the last 3 business days of the current year and the first 3 business days of the next fiscal year. Trace to the sales journal, comparing dates, to determine that sales are recorded in the proper time period. IC/4 of 4 & date Cash Receipts Transactions: General: 22. Review entries in the cash receipts journal for reasonableness. Examine support for unusual items noted. 23. Trace totals to proper posting in the general ledger. 24. Review general ledger cash account for debit postings from source other than cash receipts. Cash Receipts Transactions: 25. Select random sample of receipts recorded in the cash receipts journal. a. Trace to posting in the accounts receivable subsidiary ledger. b. Determine whether discounts were granted in accordance with sales terms by noting dates and recomputing amounts. c. Where applicable, determine if interest was assessed in accordance with the terms of related sales. Conclusion: 26. Summarize you opinion regarding the sales balance based on the work performed in this audit program. (For reference see SCAD V: Assignment 6)
Source: Sa les Jo urnal Sample Type: Si mple R andom Population: 3034 Sample Size: 10 Millenium Microsystems, Inc. IC 100/1 Test of controls - Sales and collection cycle KSP 10/31/X2 Itm Ord Date Invc Cust Order Ship Amount A b c d E f g 1 9 X1/03/09 1929 1075 2083 1967 14780 2 4 X1/04/10 2110 1036 2266 2150 12660 3 6 X1/07/05 2556 1229 2713 2597 6380 4 2 X1/08/05 2728 1030 2885 2769 38644 5 5 X1/11/18 3283 1094 3445 3329 29795 6 10 X1/12/01 3353 1228 3515 3399 4620 7 7 X1/12/15 3465 1016 3628 3512 35577 8 3 X1/12/15 3477 1114 3640 3524 3624 9 1 X1/12/16 3494 1059 3657 3541 8700 10 8 X1/12/29 3588 1141 3751 3635 4480