The Riverside Company
THE REVENUE AND CASH RECEIPTS CYCLE
Susan Ramirez, a supervising senior auditor with the CPA firm of Alvarez and Collins, has been assigned to the Riverside Company engagement. Her primary responsibility is evidence gathering in connection with the examination of financial statements for the year ending December 31, 2012. One of the audit areas that concern Ramirez is the accounts receivable balance generated by the distributorship side of the company. On December 31, 2011, this account made up 20% of the client's total assets, and analytical procedures applied to the September 30, 2012 trial balance revealed several ominous signs relating to the current receivables in the distributorship side of the business. The average age of the outstanding accounts had jumped from 43.8 days, at September 30, 2011, to 53.0 days, as of the present September 30. Considering the company's sales terms, this calculation indicated to Ramirez that the average balance was presently overdue. In addition, the company's write-off of accounts had increased dramatically. For the first nine months of 2011, only $10,600 in receivables were judged to be bad, while $28,300 were considered uncollectible during the same period in 2012. Consequently, she viewed the inherent risk in this area to be quite high.
In the latter part of October, Ramirez discussed her findings to date with Josh Turner and Adrian Garcia, audit partner and audit manager for the engagement. At that meeting, Ramirez outlined the critical areas as she perceived them within the Riverside examination. She also reminded Turner and Garcia of the initial brainstorming meeting and several potential issues identified. She indicated that one of these potential problems was the company's accounts receivable. Because of her concern, Ramirez spent considerable time reviewing with Turner and Garcia the revenue and cash receipts cycle. All three were aware that receivables provide special opportunities for fraud, including theft and the reporting of fictitious sales.
Because of the high level of inherent risk for receivables, the three wanted to ensure that an appropriate audit strategy was pursued in auditing the receivables.
Consequently, Ramirez was assigned to conduct a preliminary evaluation of the internal controls over accounts receivables. On November 3, 2012, Ramirez visited the Riverside headquarters to discuss internal control matters with several responsible officials. Her first conversation was with Brad Parker, assistant to the president.
AUDITOR: Who has access to the accounts receivable subsidiary ledger?
PARKER: I do, since I maintain the ledger, but in our company, all records are really open. I imagine that anyone who needed information could come in and look at them
AUDITOR: How often do you age the accounts receivable?
PARKER: Only at the end of the year. However, I can easily review a specific account and determine its age at any time that I want.
AUDITOR: Is the subsidiary ledger ever tested by anyone else within the Riverside organization?
PARKER: The independent auditors examine it at least once a year. No other testing would seem necessary
AUDITOR: If a customer complains that an invoice is incorrect, who is responsible for investigating the matter?
PARKER: The Treasurer's office opens all mail. They have been directed to send any such complaints to me. I pull the sales invoices from my file and see what the trouble is. I personally get in touch with the customers to settle the problem.
AUDITOR: How do you verify credit approval?
PARKER: The sales representatives' file reports providing credit data gathered about potential clients. Rogers reviews this information and sets a maximum Credit figure. If the account ever becomes overdue or if the customer exceeds this limit, further shipments are halted unless approval is made by Rogers.
AUDITOR: How often does Rogers approve a sale to such customers?
I really do not know. The invoice goes directly from Rogers to the Sales Division.
AUDITOR: How are the company's sales representatives paid?
PARKER: On a percentage commission based on their total sales.
AUDITOR: Is any subsequent review made of these credit reports?
PARKER: No. If payment is made, the company is considered a good credit risk. Any customer that does not pay is a bad risk.
AUDITOR: Sales have risen; has Riverside's credit policy been eased recently?
PARKER: Not really; the sales representatives are excellent. They have been building a good group of new customers.
AUDITOR: The average age of accounts receivable in the distributorship side of the company has increased to over 53 days, which means that the average account is currently overdue. Why is that?
PARKER: The stores that sell Cypress products are stocking up prior to Christmas.
Sales are a little slow for them right now, so their payments are sometimes delayed. Our collections will be just fine again right after the Christmas rush.
AUDITOR: Why have so many receivables been written off this year?
PARKER: I am not sure. We may have been holding on to some accounts in hopes of collecting. Of course, we are also selling more; we probably generate more bad debts.
AUDITOR: How do you determine bad debt expense?
PARKER: We estimate our uncollectible accounts at the end of each year based on
0.7% of net credit sales made by the distributorship.
AUDITOR: How did Riverside arrive at 0.7%?
PARKER: I don't know. I think we have always used that figure.
AUDITOR: How is the decision made as to which specific accounts will actually be written off as uncollectible?
PARKER: After 60 days without payment, the Sales Division pulls its copy of the sales invoice and re-bills the customer. Thirty days later, a third bill is mailed and the Sales Division notifies me. I contact the sales representative, who then puts pressure on the customer. Subsequently, the sales representative reports directly to me concerning possible payment. Based on this information, I make the decision as to whether the account is collectible. Unless an obvious problem exists, we don't even think about writing off balances until they are five or six months old.
AUDITOR: Does the Sales Division send any invoices after the third one is mailed at 90 days?
PARKER: No, any further billing is done by me.
AUDITOR: Does Rogers or anyone else at Riverside verify the specific receivables that are deemed uncollectible?
PARKER: No, although Rogers has instructed me to remove companies from the credit list when their balance becomes 5 months old. Obviously, no further sales are made to these customers until payment is received.
AUDITOR: Can Inventory possibly be shipped to a customer without prior credit approval?
PARKER: No, either Rogers or I must initial the sales invoice and return it to the Sales Division. Without those initials the Inventory Department is not allowed to process the order.
AUDITOR: Does anyone verify that the invoices are correct as to prices, goods, extensions, etc.?
PARKER: The Sales Division rechecks quantities and descriptions. I verify the prices and extensions when I receive my copy of the sales invoice. Unfortunately, by the time I get around to extending and pricing, the invoices are already out to the customers. On several occasions, we have had to rebill a customer when I discovered an error.
AUDITOR: Could a sale be made and the invoice get lost or just not be prepared so that the customer never gets billed?
¨PARKER: I certainly hope not. Approved sales invoices are filed in the sales division. If the bill of lading never shows up. That division will eventually check into the shipment. Subsequently, the Sales Division retains a copy of the completed sales invoice. I receive a copy, and the controller gets a copy. If one of these copies were to get lost, the other two departments would follow up on the matter.
AUDITOR: What verification is made of the cash discounts that are taken by the customers?
PARKER: We are very tough on that issue. Our Sales Department recalculates all discounts. They allow credit only if deserved. If a company owes us $1,000 and pays $980, then $20 is still due unless the terms of the discount have been met.
AUDITOR: I would like to get an aged schedule of your accounts receivable as of
November 30. Will that be possible?
PARKER: It is certainly inconvenient, but I imagine we can get that done.
Instructions
Read the attached audit case (The Revenue and Cash Receipts Cycle) and answer the questions that follow. Please note that this is a WRITING assignment. As such, you are required to answer the questions in a detailed and comprehensive manner and to use appropriate grammar and writing style.
A total of 45 points are available for the actual responses to the questions and 5 points are available for presentation, clarity and grammar. Total points for the assignment are 50.
1. How much reliance you will place on this oral evidence you have acquired from Brad Parker
2. Parker states that the sales representatives are paid on a commission basis. Comment on whether or not this affects the risk of misstatement.)
3. Suggest reasons why you believe that the average age of Accounts Receivables has gone up)
4. What are the weaknesses of the bad debt expense policy (Discuss at least 2))
5. Suggest ways to improve the bad debt expense policy
6. Why do you believe that there has been an increase in the write-off of bad debts this year?)
7. Comment on the strengths and weaknesses of the overall control over receivables)
8. Judging from the conversation with Parker, do you think you would recommend testing the controls? Why or why not?)
9. Suggest an audit strategy for auditing receivables. Your strategy should include)
10. Whether it is going to be a substantive or reliance strategy
11.The timing of your audit tests (assume that interim tests could be carried out in November or year-end tests at the end of December)
Extent of audit testing (more or less tests)
12. Whether or not you will confirm accounts receivables and if so, the nature of confirmations)
13. What type of evidence will be provided by the confirmations and its level of reliability
14. Assume that you do decide to confirm accounts receivable, explain how you would go about the task. In your explanation be sure to address
15. Any sampling procedures you would use and how you would reduce sampling risk
How you would handle the sending of the confirmations and the receipt of any responses
How you would handle non-responses
How you would handle exceptions
16.In addition to the assertion that you would test by performing the confirmations, state and discuss one other assertion which you would consider testing and explain the procedures you would use to test it