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456 Chapter Eleven

Appendix 11B

Illustrative Audit Case: Keystone Computers & Networks, Inc. Part III: Substantive Tests—Accounts Receivable and Revenue This part of the audit case illustrates the manner in which the auditors design substantive tests of balances. The substantive tests are illustrated for two accounts—receivables and revenue. This aspect of the audit is illustrated with the following audit documentation: • ABC’s risk assessment working paper that combines the auditors’ assessments of inherent and control risks into an overall risk of material misstatement for the assertions. • The substantive audit program of accounts receivable and revenue. • The audit sampling plan for the confirmation of accounts receivable. Adams, Barnes & Cos. assessment of control risk is described in Part II of the audit case on pages 441 through 454. To refresh your knowledge of the case, review that part as well as Part I on pages 213 through 220 of Chapter 6.

Risk Assessment—Revenue Cycle
Client: Keystone Computers & Networks, Inc. Financial Statement Date: 12/31/X5

RA-8 WL 11/24/X5

Existence of receivables and occurrence of revenue transactions Completeness of receivables and revenue Rights to receivables Valuation of receivables Presentation and disclosure

Inherent Risk

Control Risk

Overall Risk of Material Misstatement

Fraud risk Moderate High Fraud risk Moderate

Moderate Low Moderate Moderate Maximum

High Low Moderate/High High Moderate

Fraud Risks: Description: Management may be motivated to overstate revenue and receivables to improve financial results due to impending sale of

Controls: Because Keystone is a nonpublic company without an independent board or audit committee, there are no significant internal

controls to prevent management from overstating results. Audit Response: The nature, timing, and extent of audit procedures will be modified as described below: a. Accounts receivable will be confirmed at year-end using a 5 percent risk of incorrect acceptance. b. A review of the monthly sales reports by salesperson will be performed to identify any unusual individual sales or sales volume. c. Credit files of customers with large receivables (over $25,000) will be reviewed for indications of fictitious customers.

Accounts Receivable, Notes Receivable, and Revenue 457

Audit Program—Substantive Tests—Accounts Receivable and Revenues

B-6 WL 11/13/X5

Client: Keystone Computers & Networks, Inc. Financial Statement Date: 12/31/X5 Performed by Procedure Sales Transactions 1. Obtain an aged trial balance of accounts receivable as of 12/31/X5. 2. Select a sample of customers’ accounts at 12/31/X5 for positive confirmation using probability-proportional-to-size sampling based on the following parameters: a. Risk of incorrect acceptance of 5%. b. Tolerable misstatement of $35,000. c. Expected misstatement of $10,000. 3. Use generalized audit software to: a. Foot the master file of accounts receivable at 12/31/X5. b. Test the client-prepared aging of accounts receivable. c. Select the specific accounts for confirmation. 4. Mail accounts receivable confirmation requests. 5. Send second requests for all unanswered confirmation requests. 6. For confirmation requests to which no reply is received perform the following alternative procedures: a. Test items subsequently paid to remittance advices which identify the specific invoices paid. If necessary, reconcile the amounts paid to sales invoices and delivery receipts. b. For items not paid, inspect the invoices and delivery receipts for the sales transactions making up the account balance. 7. Resolve exceptions noted on confirmation requests. 8. Review credit files for customers with accounts receivable above $25,000 at 12/31/X5. Investigate any indications of fictitious accounts. 9. Summarize the results of the confirmation procedures.

Initials MP

Date 1/6/X6


1/7/X6 2/12/X6 1/7/X6 1/7/X6 1/8/X6...
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