Section 10 Planning and Performing Auditing Procedures in the ...

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INStRUCtoR RESoURCE MaNUal — Do Not CoPy oR REDIStRIbUtE

Planning and Performing audit Procedures in the Revenue and Expenditure Cyclesan audit Simulation

10.1 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . 299 Identification of Tests of Controls for the

Revenue Cycle (Sales and Cash Receipts)

10.2 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . 309 Identification of Substantive Tests for the


10.3 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . 319 Selection of Audit Tests and Risk Assessment for the


10.4 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . 333 Performance of Tests of Transactions for the

Expenditure Cycle (Acquisitions and Cash Disbursements)

10.5 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . 347 Performance of Tests of Balances for the

Expenditure Cycle (Acquisitions and Cash Disbursements)

CASeS INCLUDeD IN ThIS SeCTION

Solutions to the cases in this section are still being updated and

will be posted by August 31.

299Copyright © 2009 by Pearson Education, Inc., Upper Saddle River, NJ 07458


The case was prepared by Mark S. Beasley, Ph.D. and Frank A. Buckless, Ph.D. of North Carolina State University and Steven M. Glover, Ph.D. and Douglas F. Prawitt, Ph.D. of Brigham Young University, as a basis for class discussion. SSD is a fictitious company. All characters and names repre-sented are fictitious; any similarity to existing companies or persons is purely coincidental.

Southeast Shoe Distributor, Inc.Identification of tests of Controls for the Revenue Cycle(Sales and Cash Receipts)Mark S. Beasley · Frank A. Buckless · Steven M. Glover · Douglas F. Prawitt

To illustrate the purpose for obtaining an under-[1]

standing of an entity’s internal controls.To highlight documents and records commonly [2]

used with sales and cash receipts transactions.To provide hands-on experience with identify-[3]

ing control activities related to sales and cash receipts transactions.To provide hands-on experience with designing [4]

tests of controls related to sales and cash receipts transactions.

To illustrate the linkage of entity control activi-[5]

ties to audit firm tests of controls.To illustrate the linkage of entity control activi-[6]

ties to management assertions.To illustrate the linkage of tests of controls to [7]

management assertions.To provide hands-on experience with audit [8]

documentation.

INSTRUCTIONAL ObjeCTIveS

KEY FACTSSoutheast Shoe Distributor, Inc. (SSD) is a closely owned company founded ten years ago. ��SSD purchases and sells designer label and name brand men, women, and children shoes to 123 ��retail stores located in small to medium size communities.SSD has one warehouse located in Atlanta, Georgia.��Net sales last year were $7,311,214 and sales generally are the strongest in the second and fourth ��calendar year quarters.SSD is required to have an audit of its financial statements to fulfill requirements of its loan ��agreements.The audit manager, Susan Mansfield, reviewed SSD’s control environment, risk assessment ��policies, and assessed them as strong.A staff auditor, Bill Zander, reviewed SSD’s information system and control activities and ��documented his understanding in the flowcharts provided.The audit manager, Susan Mansfield, has decided not to document nor perform tests of controls ��related to SSD’s sales returns and allowances and write-offs of customer accounts as they are not material.Documents and records used with respect to sales transactions are Customer Order, Sales ��Invoice, Bill of Lading, Monthly Customer Statement, Standardized Price File, Standardized Chart of Accounts, Sales Register, Accounts Receivable Master File, and General Ledger.Documents and records used with respect to cash receipt transactions are Customer Check, ��Sales Invoice (Remittance Advice), Deposit Slip, Cash Receipt Summary, Bank Statement, Standardized Chart of Accounts, Cash Receipts Journal, Accounts Receivable Master File, and General Ledger.

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Section 10: Planning and Performing audit Procedures in the Revenue and Expenditure Cycles–an audit Simulation


USE OF CASE This is the first of three cases addressing the development of an audit approach for the revenue cycle of SSD. At first glance, many students may be intimidated by this assignment. Therefore, it is important to provide students with some background information prior to asking them to complete this assignment. This assignment works well in an undergraduate or graduate course when the audit of the revenue (sales and collection) cycle or tests of controls are discussed. This assignment can be simplified for students by instructing them to identify one or two tests of controls for each control activity identified. This simplification should only be considered if the instructor does not intend to have students complete the third SSD audit planning case assignment. Additionally, students can be asked to complete audit steps 5 through 7 separately.

An effective approach for this case is to discuss and complete audit steps 5 through 7 for sales transactions as an “in-class” activity. Students can then be asked to complete audit steps 5 through 7 for cash collection transactions outside-of-class. At a minimum, the instructor should review the flowcharts, control activities matrices, and tests of controls matrices with students prior to asking them to complete the assignment.

Students will commonly provide diverse answers for this assignment. This provides an opportunity to highlight the subjective nature of some of these judgments as well as to point out that many audit approaches would be considered reasonable.

The suggested approach is amenable to using small cooperative learning groups. For example, students could be asked to individually identify a control activity related to the existence of sales transactions, share it with another student, and then share it with the whole class (called Think-Pair-Share). It is important that students be randomly selected by the instructor to share their answers with the class to maintain individual student accountability for the learning process. This basic process can continue for the remaining management assertions. A group activity for the “out-of-class” activity would be to have students compare their answers in small groups and then ask them to share their answers with the whole class (called Homework Review). Again, it is important that the instructor randomly select students to share their answers with the class to maintain student accountability. Students can also be asked to complete the “out-of-class” activities in pairs or small groups.

PROFESSIONAL STANDARDS Relevant professional standards for this assignment are AU Section 319, “Consideration of Internal Control in a Financial Statement Audit,” AU Section 325, “Communication of Internal Control Related Matters Noted in An Audit,” AU Section 326, “Audit Evidence,” and AU Section 339, “Audit Documentation.”

SUGGeSTeD SOLUTION

Note: Due to the subjective nature of some of the judgments alternative solutions could be considered equally acceptable.

Identify SSD’s control activities by completing step 5 of the audit program R 1-1. Document [1]

your work in audit schedules R 1-1, R 31-1, R 31-2, R 32-1 and R 32-2 (Note: you should assume that only the control activities identified in the flowcharts exist).

A solution to the assignment is provided using schedules similar to the schedules provided to students on the pages that follow.

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Case 10.1: Southeast Shoe Distributor, Inc.


[2] Identify potential tests of controls by completing step 6 of the audit program R 1-1. Document your work in audit schedules R 1-1, R 40-1, R 40-2, R 41-1 and R 41-2 (Note: number your tests similar to the example provided).

A solution to the assignment is provided using schedules similar to the schedules provided to students on the pages that follow. Note that the solution lists potential tests of controls that could be performed. It is very unlikely that an auditor would decide to perform all these tests. Additionally, the solution does not indicate whether the test should be performed on the entire population or a sample of the population.

Complete step 7 of the audit program R 1-1 by identifying any internal control deficiencies [3]

SSD may have and document your work in audit schedule R 1-1 and R 33.

A solution to the assignment is provided using schedules similar to the schedules provided to students on the pages that follow.

How would your work differ if SSD was a public company? What other factors would you need [4]

to consider?

An audit for a non-public entity is required to be completed in accordance with auditing standards issued by the Auditing Standards Board (ASB) of the AICPA. These standards require examination of controls for the purpose of planning the nature, extent, and timing of substantive testing. Public entities are required to have audits conducted in accordance with the auditing standards of the Public Company Accounting Oversight Board (PCAOB). In addition to providing assurance on the entity’s financial statements an auditor is also required to provide assurance on the entity’s internal controls. To provide assurance on an entity’s internal controls the auditor must perform tests of controls related to all significant account balances, classes of transactions and disclosures and related assertions in the financial statements.

For each internal control deficiency you listed in audit schedule R 33 (requirement 3), identify [5]

at least one control activity that would remediate the deficiency.

Control Deficiency Remediating Control Activity1) The client does not internally verify the

proper general ledger account classification for sales and cash receipt transactions.

Independent review of posting to the G/L.

2) The client does not internally verify the amounts recorded on sales invoices.

Clerical testing of amounts on sales invoices.

3) The client does not reconcile the sales and cash receipts journal to the general ledger.

Independent reconciliation of the sales and cash receipts journal to the general ledger.

4) The client does not internally verify sales discounts taken by customers.

Verification of sales discounts before recording.

Describe the importance of SSD’s control activities given its large number of customers and [6]

vendors.

SSD would have a high volume of sales, cash receipts, purchasing, and cash disbursement transactions given the large number of customers and vendors involved with its business. The likelihood of errors occurring with these transaction processes would be very high without standardized processes that include appropriate control activities that are consistently applied.

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Southeast Shoe Distributor, Inc.Identification of Substantive tests for the Revenue Cycle(Sales and Cash Receipts)Mark S. Beasley · Frank A. Buckless · Steven M. Glover · Douglas F. Prawitt

KEY FACTSSoutheast Shoe Distributor, Inc. (SSD) is a closely owned company founded ten years ago. ��SSD purchases and sells designer label and name brand men, women, and children shoes to 123 ��retail stores located in small to medium size communities. SSD has one warehouse located in Atlanta, Georgia. ��Net sales last year were $7,311,214 and sales generally are the strongest in the second and fourth ��calendar year quarters. SSD is required to have an audit of its financial statements to fulfill requirements of its loan ��agreements. A staff auditor, Bill Zander, reviewed SSD’s information system and control activities and ��documented his understanding in the flowcharts provided. The audit manager, Susan Mansfield, has decided not to document the company’s policies and ��procedures related to sales returns and allowances and uncollectible accounts as they are not material. Documents and records used with respect to sales transactions are Customer Order, Sales ��Invoice, Bill of Lading, Monthly Customer Statement, Standardized Price File, Standardized Chart of Accounts, Sales Register, Accounts Receivable Master File, and General Ledger. Documents and records used with respect to cash receipt transactions are Customer Check, ��Sales Invoice (Remittance Advice), Deposit Slip, Cash Receipt Summary, Bank Statement, Standardized Chart of Accounts, Cash Receipts Journal, Accounts Receivable Master File, and General Ledger.

USE OF CASE This case is the second of three cases addressing the development of an audit approach for the revenue cycle of SSD, At first glance, many students may be intimidated by this assignment. Therefore, it is important to provide students some background information prior to asking them to complete this assignment. This assignment works well in an undergraduate or graduate course

10.2C a S E

To illustrate documents and records used with [1]

sales and cash collection activities. To provide hands-on experience with developing [2]

substantive tests for revenue cycle accounts.

To illustrate the linkage of substantive tests to [3]

management assertions. To provide hands-on experience with audit [4]

documentation.


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when the audit of the revenue (sales and collection) cycle or substantive tests are discussed. This assignment can be simplified for students by instructing them to complete audit steps 3a, 3b, and 3c separately. An effective approach for this case is to discuss and complete audit step 3 for sales transactions as an “in-class” activity. Students can then be asked to complete audit step 3 for cash collection transactions and accounts receivable “outside-of-class.” At a minimum, the instructor should review the flowcharts and audit tests matrices with students prior to asking them to complete the assignment. Students will commonly provide diverse answers for this assignment. This provides an opportunity to highlight the subjective nature of some of these judgments as well as to point out that many audit approaches would be considered reasonable.

The suggested approach is amenable to using small cooperative learning groups. For example, students could be asked to individually identify a substantive test related to the existence of sales transactions, share it with another student, and then share it with another group (called Think-Pair-Share). The instructor should walk around the class to ensure that all students are completing the task and resolve conflicts. This basic process can continue for the remaining management assertions. An “in-class” group activity for the “out-of-class” assignment would be to have students compare their answers in small groups and then ask them to share their answers with the whole class (called Homework Review). Again, it is important that the instructor randomly select students to share their answers with the class to maintain student accountability. Students can also be asked to complete the “out-of-class” activities in pairs or small groups.

PROFESSIONAL STANDARDS Relevant professional standards for this assignment are AU Section 313, “Substantive Tests Prior to the Balance-Sheet Date,” AU Section 326, “Audit Evidence,” AU Section 29 “Analytical Procedures,” AU Section 330, “The Confirmation Process," and AU Section 339, “Audit Documentation.”

SUGGeSTeD SOLUTION


Complete audit steps 1 and 2 from the audit program R 1-2 to obtain an understanding of the [1]

documents and records used by SSD for sales and cash transactions. Document completion of your work in audit schedule R 1-2.

A solution to the assignment is documented on audit schedules similar to the audit schedules provided to students on the pages that follow.

Identify potential substantive tests by completing steps 3a, 3b, and 3c from the audit program [2]

R 1-2. Document your work in audit schedules R 1-2, R 42-1, R 42-2, R 43 and R 44 and number your tests by following the examples provided. Each of these steps can be completely separately at the discretion of your instructor.

A solution to the assignment is documented on audit schedules similar to the audit schedules provided to students on the pages that follow. Note that the solution represents potential substantive tests that could be performed. It is very unlikely that an auditor would decide to perform all these tests. Additionally, the solution does not indicate whether the substantive tests should be performed on the entire population or a sample of the population.

What are some of the factors that influence the level of assurance obtained through substantive [3]

audit tests?

The assurance provided by audit tests depends on the sufficiency and competence of the evidence obtained. AU Sections 313 and 326 of the AICPA Professional Standards suggest

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that the effectiveness of internal control and the relevance, source, objectivity, and timing of the information used in audit testing will influence the level of assurance provided. Auditing tests will only be as good as the information used to conduct testing.

For a given account, why might an auditor choose to:[4]

a) not conduct substantive tests?If an account has effective internal controls, is very low risk, and is not considered material, it is possible that the auditor might obtain sufficient assurance through tests of controls or analytical procedures. However, most important accounts will require that the auditor conduct some substantive tests to obtain a reasonable level of assurance.

b) conduct only substantive tests? Sometimes an account may contain a low number of transactions, such that the auditor will substantively test all transactions. In such a case, there may be no need for tests of controls or analytical procedures.

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Reference: Prepared by: Date: Reviewed by:

Southeast Shoe Distributor, Inc.

Revenue Cycle Planning Audit Program – Identification of Substantive Tests

Year Ended: December 31, 2006

Audit Procedures Initial Date

W/P

Ref.

1. Obtain an understanding of the documents and records used for sales and cash receipts transactions by reviewing the flowcharts documenting our understanding.

2. Obtain an understanding of the documents and records used for recording adjustments to sales, cash receipts, and accounts receivable by discussing with client personnel.

3. Use the planning audit test matrices to identify potential a. substantive tests of transactions, b. tests of balances, c. and analytical tests related to revenue cycle

accounts.

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Southeast Shoe Distributor, Inc.Selection of audit tests and Risk assessment for the Revenue Cycle (Sales and Cash Receipts)Mark S. Beasley · Frank A. Buckless · Steven M. Glover · Douglas F. Prawitt

KEY FACTS Southeast Shoe Distributor, Inc. (SSD) is a closely owned company founded ten years ago. ��SSD purchases and sells designer label and name brand men, women, and children shoes to 123 ��retail stores located in small to medium size communities. SSD has one warehouse located in Atlanta, Georgia. ��Net sales last year were $7,311,214 and sales generally are the strongest in the second and fourth ��calendar year quarters. SSD is required to have an audit of its financial statements to fulfill requirements of its loan ��agreements. The audit manager, Susan Mansfield, reviewed SSD’s control environment, risk assessment ��policies, and assessed them as strong. The audit manager, Susan Mansfield, has decided not to document nor perform tests of controls ��related to SSD’s sales returns and allowances and write-offs of customer accounts as they are not material. The audit manager, Susan Mansfield, determined that tolerable misstatement should be $40,000 ��for the revenue cycle. The audit manager, Susan Mansfield, determined that acceptable audit risk should be low. ��A staff auditor, Bill Zander, assessed inherent risk related to sales, cash receipts, and accounts ��receivable and prepared the inherent risk section of the audit risk matrix. Documents and records used with respect to sales transactions are Customer Order, Sales ��Invoice, Bill of Lading, Monthly Customer Statement, Standardized Price File, Standardized Chart of Accounts, Sales Register, Accounts Receivable Master File, and General Ledger. Documents and records used with respect to cash receipt transactions are Customer Check, ��Sales Invoice (Remittance Advice), Deposit Slip, Cash Receipt Summary, Bank Statement, Standardized Chart of Accounts, Cash Receipts Journal, Accounts Receivable Master File, and General Ledger.

10.3C a S E

To provide hands-on experience with develop-[1]

ing an audit approach for financial statement accounts related to sales and cash receipts activi-ties. To illustrate the relationship between tests of [2]

controls, substantive tests of transactions, tests of balances, and analytical tests.

To illustrate factors that affect audit evidence [3]

decisions. To illustrate the linkage between risk assess-[4]

ments and audit evidence decisions. To provide hands-on experience with audit [5]

working papers.


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USE OF CASE This case assignment can only be completed if the prior two audit planning case assignments related to Southeast Shoe Distributor (SSD) are completed. Many students will be intimidated by this assignment. Therefore, it is important to provide students some background information prior to asking them to complete this assignment “outside-of-class.” This assignment works well in an undergraduate or graduate course when the audit of the revenue (sales and collection) cycle is discussed or when audit tests are discussed.

One approach for completing this assignment is to have students select audit tests and assess risk for one or two assertions as an “in-class” activity and then compete the remaining assertions as an “out-of-class” activity. At a minimum, the instructor should review this assignment with students prior to asking them to complete it as an “out-of-class” assignment. Students will commonly provide diverse answers for this assignment. This provides an opportunity to highlight the subjective nature of some of these judgements as well as to point out that many audit approaches would be considered reasonable.

The suggested approach is amenable to using small cooperative learning groups. For example, students could be asked to form a four person group to select audit tests and assess risk for one assertion (called Discussion Group). The instructor could then call upon one student to share her/his group solution with the class. It is important that students be randomly selected by the instructor to share their answers with the rest of class to maintain individual student accountability for the learning process. The instructor can continue this basic process for as many other assertions as desired. An “in-class” cooperative learning activity for the “out-or-class” assignment would be to have students compare their answers in small groups and then ask them to share their answers with the whole class (called Homework Review). Again, it is important that the instructor randomly select students to share their answers with the class to maintain student accountability. Students can also be asked to complete the “out-of-class” assignment in pairs or small groups.

PROFESSIONAL STANDARDS Relevant professional standards for this assignment are AU Section 312, “Audit Risk and Materiality in Conducting an Audit,” AU Section 313, “Substantive Tests Prior to the Balance- Sheet Date,” AU Section 319, “Consideration of Internal Control in a Financial Statement Audit,” AU Section 326, “Audit Evidence,” AU Section 329, “Analytical Procedures,” AU Section 330, “The Confirmation Process,” AU Section 339, “Audit Documentation,” and AU Section 350, “Audit Sampling.”

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SUGGeSTeD SOLUTION


Complete step 3 of the audit program R 1-3 by selecting specific audit tests from your work [1]

in the previous two SSD audit case assignments (see R 40-1, R 40-2, R 41, R 42, and R 43). Document your work in audit schedules R 1-3, R 40-1, R 40-2, R 41, R 42, and R 43.

A solution to the assignment is documented on audit schedules similar to the audit schedules provided to students on the pages that follow. Note that the solution does not indicate whether the substantive tests should be performed on the entire population or a sample of the population.

Assess planned control and detection risk by completing step 4 of the audit program R 1-3. [2]

Document completion of your work in audit program R 1-3. Record your assessment in audit schedule R-50. Document in audit schedules R 50-2 and R 50-3 the specific tests by number that you have chosen, the assertion(s) covered by each test, and the level of assurance (high, medium, or low risk) provided.

A solution to the assignment is documented on audit schedules similar to the audit schedules provided to students on the pages that follow.

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Audit Procedures Initial Date

W/P

Ref.

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Southeast Shoe Distributor, Inc.Performance of tests of transactions for the Expenditure Cycle(acquisitions and Cash Disbursements)Mark S. Beasley · Frank A. Buckless · Steven M. Glover · Douglas F. Prawitt

KEY FACTS Southeast Shoe Distributor, Inc. (SSD) is a closely-owned company founded ten years ago. ��SSD purchases and sells designer label and name brand men’s, women’s, and children’s shoes to ��123 retail stores located in small to medium size communities. SSD has one warehouse located in Atlanta, Georgia. ��Net sales last year were $7,311,214 and sales generally are the strongest in the second and fourth ��calendar year quarters. SSD is required to have an annual audit of its financial statements to fulfill loan requirements. ��The audit senior, Jorge Hernandez, reviewed SSD’s policies and procedures related to purchases ��and cash disbursements and prepared the flowcharts on audit schedules E 20-1, E 20-2, E 21. Documents and records used to document purchase transactions are Purchase Requisition, ��Purchase Order, Receiving Report, Vendor Invoice, Voucher, Exception Report for Receiving Reports, Standardized Chart of Accounts, Purchase Journal, Accounts Payable Master File, and General Ledger. Documents and records used with respect to cash disbursement transactions include Signed ��Check, Bank Statement, Standardized Chart of Accounts, Cash Disbursements Journal, Accounts Payable Master File, and General Ledger. Receiving Reports are only generated for purchases of inventory and fixed assets, and Purchase ��Orders are not generated for recurring services, such as utilities and cleaning. A staff auditor, Joy Avery, selected the audit samples and completed audit procedures 2, 3, 5, 6, ��and 7. Joy’s work is documented on audit schedules E 1-1, E 1-2, E 30, E 32, E 33, E34, E 40, E 41, E 42, E 43, and E 44.

10.4C a S E

To highlight documents and records commonly [1]

used with purchasing and cash disbursement transactions. To illustrate common control activities related to [2]

purchasing and cash disbursement transactions. To highlight potential tests of controls and sub-[3]

stantive tests of transactions related to purchas-ing and cash disbursement transactions. To illustrate the linkage of substantive tests of [4]

transactions to management assertions.

To illustrate the linkage of entity control activi-[5]

ties to management assertions and audit firm tests of controls. To provide hands-on experience with perform-[6]

ing and evaluating tests of controls and substan-tive tests of transactions related to purchasing and cash disbursement transactions. To provide hands-on experience documenting [7]

audit work.


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Joy Avery, staff auditor, noted that the control activity related to unaccounted receiving reports ��was not operating as expected. As a result the substantive test related to the completeness of purchases was expanded (from 40 to 60 sample items). No deviations or misstatements were noted for the audit tests performed related to cash ��disbursements. Students were told that there were no deviations or misstatements related to the first 35 ��purchase journal entries tested (procedure 1) and the first 35 receiving report documents tested (procedure 4). Additionally students were told to assume that no deviations or misstatements were found for the last five purchase journal entries related to audit test 1g and h. Finally, students were told that there was no systematic pattern or intent to commit a fraud based on a review and discussion with client personnel concerning observed deviations and exceptions. The Georgia Power invoice (voucher 8063) was not initialed by the executive secretary, Karen ��Tucci. The purchase transaction associated with Receiving Report 2801 was not recorded in the ��Purchase Journal. The misstatement amount was approximately $1,008.00 understatement.

USE OF CASE This is the first of two cases addressing the performance of audit procedures for the expenditure cycle of SSD. This case focuses on the performance of tests of transactions while the second case focuses on the performance of tests of balances. This assignment works well in an undergraduate or graduate course after audit sampling is discussed. Most students will not be familiar with completing audit schedules. Therefore, it is important to review the assignment with students prior to asking them to complete it.

An effective approach for this case is to first have students identify the management assertion(s) and the nature of the audit test (analytical test, test of control, or substantive test of transaction) related to each audit procedure listed in the audit program (E 1-1 and E 1-2) as an “in-class” activity. This activity reminds students that the objective of performing audit procedures is to test the management assertions embodied in the financial statements. This task also allows the instructor to highlight the dual-purpose nature of many tests of transactions. A work-sheet for this “in-class” activity is provided at the back of the instructional notes. Next, students can review the audit schedules and explain the objectives of audit schedules E 40, E 41, E 42, E 43, and E 44 as an “in-class” activity. This second activity helps to ensure that students understand the documentation objectives for the case assignment. Students should be ready to complete audit procedures 1a-h and 4a (listed on Audit Program E 1-1) as an “out-of-class” activity once the “in-class” activities are completed.

The suggested approach is amenable to using small cooperative learning groups. For example, students could be paired with another student to identify the type of audit test and management assertion tested by each audit procedure. The task of explaining the answer for the first audit procedure is assigned to one student while the other student checks the accuracy and provides feedback as needed. The tasks of explaining and checking the answer for the second audit procedure are rotated. The pairs then check their answers and resolve differences for the first two audit procedures with another group. This basic process continues until all audit procedures are completed (called Drill-Review Pairs). A group activity for the second “in-class” activity could be to ask students to individually explain audit schedule E 40 and then share their answer with another student. Following that, the instructor could select students to share their answer with the whole class (this technique is called Think-Pair-Share). This basic process can continue for explaining the remaining audit schedules (E 41, E 42, E 43, and E 44). The “out-of- class” activity can be reviewed by having students compare their answers in small (2 to 4 person) groups. Students can then be selected to share their answers with the whole class. Random selection of students by the instructor helps to maintain individual student accountability for the learning task. The “out-of-class” assignment can also be completed by students in pairs or small groups.

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PROFESSIONAL STANDARDS Relevant professional standards for this assignment are AU Section 319, “Consideration of Internal Control in a Financial Statement Audit,” AU Section 326, “Audit Evidence,” AU Section 339, “Audit Documentation,” and AU Section 350, “Audit Sampling.”

MATERIAL FOR DISCUSSION ITEMSSolutions for the “in-class” discussion items noted above.

Objective of audit schedule E 40: To document the sample selection method and sample items for audit procedures 6a-e.

Objective of audit schedule E 41: To document the results of the tests of controls for cash disbursements (audit procedures 6a-e).

Objective of audit schedule E 42: To document the results of audit procedure 5.

Objective of audit schedule E 43: To document the results of audit procedures 7a-c.

Objective of audit schedule E 44: To document the results of the substantive tests of transactions for cash disbursements (audit procedures 6b-e).

Linkage of audit procedures to audit tests and management assertions. Tables linking audit procedures to audit tests and management assertions are provided on the next several pages. This table is similar to the blank table provided at the end of the instructional notes.

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SUGGeSTeD SOLUTION

Review the flowcharts on audit schedules E 20-1 and E 20-2 and become familiar with [1]

the accounting documents and records used with purchases. Also review Joy Avery’s work documented on audit schedules E 1-1, E 1-2, E 30, E 32, E 33, E 34, E 40, E 41, E 42, E 43, and E 44 in order to understand the work you will perform and how to document your work in the audit schedules. Note that purchase orders are not required to be generated for recurring services such as utilities and cleaning.

A solution to the assignment is documented on the following audit schedules, which are similar to the audit schedules provided to students.

Complete steps 1a-h from the audit program E 1-1. Assume you have already completed [2]

step 1g and h and no deviations were found. Also assume that you have already tested 35 of the selected sample items, observing no misstatements. The documents and records for the remaining five sample items are provided behind the “Purchase Journal for Audit Procedure 1.” Additionally, note that the audit firm has a policy of using the same audit sample for planned tests of controls and substantive tests of transactions (dual-purpose tests) whenever possible to maximize audit efficiency. Thus, the results of the test-of-controls aspect of audit steps 1a-h should be documented in audit schedules E 1-1 and E 31, whereas the substantive test aspect should be documented in audit schedules E 1-1 and E 35.


Complete step 4a from the audit program E 1-1. Assume you have already completed this step [3]

for 55 of the 60 sample items and no deviations or misstatements were found. The documents and records for the remaining five sample items are provided behind the “Purchase Journal for Audit Procedure 4.” Document the results of your work in audit schedules E 1-1 and E35.


Document any adjusting entries you propose on audit schedule E 11 for any observed [4]

misstatements. You should assume that there was no systematic pattern or intent to commit a fraud based on a review and discussion with client personnel concerning observed deviations and misstatements.


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Southeast Shoe Distributor, Inc.Performance of tests of balances for the Expenditure Cycle(acquisitions and Cash Disbursements)Mark S. Beasley · Frank A. Buckless · Steven M. Glover · Douglas F. Prawitt

KEY FACTS Southeast Shoe Distributor, Inc. (SSD) is a closely-owned company founded ten years ago. ��SSD purchases and sells designer label and name brand men’s, women’s, and children’s shoes to ��123 retail stores located in small to medium size communities. SSD has one warehouse located in Atlanta, Georgia. ��Net sales last year were $7,311,214 and sales generally are the strongest in the second and fourth ��calendar year quarters. SSD is required to have an annual audit of its financial statements to fulfill loan requirements. ��Documents used to support year-end accounts payable are Purchase Order, Receiving Report, ��Vendor Invoice, and Voucher. Receiving Reports are only generated for purchases of inventory and fixed assets, and Purchase ��Orders are not generated for recurring services, such as utilities and cleaning. Joy Avery, staff auditor, selected the audit sample for audit procedure 3 and performed audit ��procedures 1 and 2. Joy’s work is documented on audit schedules E 2, E 10, E 50, and E 51. No misstatements were noted for the audit tests performed by Joy Avery. ��Students were told that there were no misstatements related to the first 35 sample items tested ��(procedure 3). Additionally, students were told that there was no systematic pattern or intent to commit a fraud based on a review and discussion with client personnel concerning observed deviations and exceptions. In the previous case (case 10.4), one misstatements should have been identified while performing ��substantive tests of transactions related to purchases (the purchase transaction associated with Receiving Report 2801 was not recorded in the Purchase Journal). The misstatement amount related to Receiving Report 2801 was a $1,008.00 understatement. In the current case, the transaction associated with Voucher 9113 will appear to be erroneously ��included in the 2008 purchases journal by some students. The shipping terms are shipping point and thus title would have passed when it was in-transit and accordingly should have been included.

10.5C a S E

To highlight potential tests of balances related to [1]

accounts payable. To illustrate the linkage of tests of balances to [2]

management assertions.

To provide hands-on experience with perform-[3]

ing and evaluating tests of balances related to accounts payable. To provide hands-on experience with complet-[4]

ing audit schedules.


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USE OF CASE This is the second of two cases addressing the performance of audit procedures for the expenditure cycle of SSD. Completion of case 10.4 is not necessary to complete this case. Case 10.4 focuses on the performance of tests of transactions while this case focuses on the performance of tests of balances. This assignment works well in an undergraduate or graduate course after audit sampling is discussed. Most students will not be familiar with completing audit schedules. Therefore, it is important to review the assignment with students prior to asking them to complete it.

An effective approach for this case is to first have students identify the management assertion(s) and the nature of the audit test related to each audit procedure listed in the audit program (E 2) as an “in-class” activity. This activity reminds students that the objective of performing audit procedures is to test the management assertions embodied in the financial statements. A work-sheet for this “in-class” activity is provided at the back of the instructional notes. Another “in-class” activity is to have students review the provided audit schedules and explain the purpose of each schedule (E 10, E 11, E 50, E 51, E 52, and E 53). This second activity helps to ensure that students understand the documentation objectives for the case assignment. Students should be ready to complete audit procedure 3a (listed on Audit Program E 2) as an “out-of-class” activity once the “in-class” activities are completed.

The suggested approach is amenable to using small cooperative learning groups. For example, students could be asked to identify the type of audit test and management assertion for the first audit procedure. After a short period, students could be asked to share their answers and resolve differences with another student. After another short period, students could be asked to share their answers and resolve differences with another pair of students. This basic process continues until all audit procedures are answered (called Think-Pair-Share). The instructor should walk around the classroom to provide encouragement and ensure that all students are staying on task. A cooperative learning activity for the second “in-class” activity (called Drill-Review Pairs) is to ask students to pair up and have one student explain the objective of audit schedule E 10 to the other student. The other student has responsibility to listen and provide feedback on the explanation. The roles for explaining and listening are rotated for audit schedule E 11. After each student has had an opportunity to explain a schedule, the pairs should check their answers and resolve differences with another pair. This basic process continues for the remaining audit schedules (E 50, E 51, E 52, and E 53). Again, the instructor should walk around the classroom to provide encouragement and ensure that all students are staying on task. The “out-of-class” activity can be reviewed by having students compare their answers in small (2 to 4 person) groups. Students can then be selected to share their answers with the whole class. Randomly selecting students to share answers with the class helps to maintain individual student accountability for the learning task. The “out-of-class” assignment can also be completed by students in pairs or small groups.

PROFESSIONAL STANDARDS Relevant professional standards for this assignment are AU Section 319, “Consideration of Internal Control in a Financial Statement Audit,” AU Section 326, “Audit Evidence,” AU Section 339, “Audit Documentation” and AU Section 350, “Audit Sampling.”

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MATERIAL FOR DISCUSSION ITEMSSolutions for the “in-class” discussion items noted above.

Objective of audit schedule E 10: To list the accounts payable balances to be reported by the client in the financial statements (called lead schedule) and document the results of audit procedures 1a, 1b, and 2a.

Objective of audit schedule E 11: To summarize adjustments proposed by the audit team.

Objective of audit schedule E 50: To document the results of audit procedure 2b.

Objective of audit schedule E 51: To document the results of audit procedure 2b, 2c, and 2d.

Objective of audit schedule E 52: To document the sample selection method and sample items for audit procedure 3a.

Objective of audit schedule E 53: To document the results of audit procedure 3a.

Linkage of audit procedures to audit tests and management assertions. A table linking audit procedures to audit tests and management assertions is provided on the next page. This table is similar to the blank table provided at the end of the instructional notes.

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SUGGeSTeD SOLUTION

Complete audit procedure 3a listed on audit program E 2. The supporting documents to [1]

be examined for this audit procedure are vouchers, vendor invoices, receiving reports, and purchase orders. Assume that you have already tested 35 of the selected sample items, observing no misstatements. The documents and records for the remaining five sample items are provided behind the audit schedules. SSD’s polices only require the generation of receiving reports for purchases of inventory and fixed assets. Additionally, purchase orders are not required to be generated for recurring services such as utilities and cleaning. The results from performing audit procedure 3a should be documented on audit schedule E 53.

A solution to the assignment is documented on the following audit schedules that are similar to the audit schedules provided to the students in the casebook.

Document your adjusting entries for any observed misstatements that you propose on schedule [2]

E 11. Then update the accounts payable lead schedule on audit schedule E10. Assume that there was no systematic pattern or intent to commit a fraud based on a review and discussion with client personnel concerning observed misstatements.

A solution to the assignment is documented on the following audit schedules that are similar to the audit schedules provided to the students in the casebook.

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×

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