A Ssignment 2 Applying The Audit Process Internal Controls Audit Risk And Procedures 2802280

Assignment #2: Applying the Audit Process (Internal Controls/ Audit Risk and Procedures)

Selected Cases

I. Identify internal controls and tests of controls/Prepare an audit program.

The Meyers Pharmaceutical Company, a drug manufacturer, has the following internal controls for billing and recording accounts receivable:

An incoming customer’s purchase order is received in the order department by a clerk who prepares a prenumbered company sales order form on which is inserted the pertinent information, such as the customer’s name and address, customer’s account number, quantity, and items ordered. After the sales order form has been prepared, the customer’s purchase order is attached to it.

The sales order form is then passed to the credit department for credit approval. Rough approximations of the billing values of the orders are made in the credit department for those accounts on which credit limitations are imposed. After investigation, approval of credit is noted on the form.

Next, the sales order form is passed to the billing department, where a clerk uses a computer to generate the customer’s invoice. It automatically multiplies the number of items times the unit price and adds the extended amounts for the total amount of the invoice. The billing clerk determines the unit prices for the items from a list of billing prices. The invoice copies are designated as follows:

Customer’s copy.

Sales department copy, for information purposes.

File copy.

Shipping department copy, which serves as a shipping order. Bills of lading are also prepared as carbon copy by-products of the invoicing procedure.

The shipping department copy of the invoice and the bills of lading are then sent to the shipping department. After the order has been shipped, copies of the bill of lading are returned to the billing department. The shipping department copy of the invoice is filed in the shipping department.

In the billing department, one copy of the bill of lading is attached to the customer’s copy of the invoice and both are mailed to the customer. The other copy of the bill of lading, together with

the sales order form, is then attached to the invoice file copy and filed in invoice numerical order.

As the computer generates invoices, it also stores the transactions in an electronic file that is used to update the accounting records daily. A summary report is generated and all journals and ledgers are printed for a hardcopy of the records.

Periodically, an internal auditor traces a sample of sales orders all the way through the system to the journals and ledgers, testing both the procedures and dollar amounts. The procedures include comparing control totals with output, recalculating invoices and re-footing journals, and tracing totals to the master file and general ledger.


  1. a) List the internal controls over sales for each of the six transaction-related audit objectives.

  1. b) For each control, list a useful test of control to verify the effectiveness of the control.

  1. c) For each transaction-related audit objective for sales, list appropriate substantive tests of transactions audit procedures, considering internal controls.

  1. d) Combine the audit procedures from parts b and c. into an efficient audit program for sales.

    II. Audit Risk and Procedures

    You are auditing the sales and collection cycle for the Smalltown Regional Hospital, a small not-for-profit hospital. The hospital has a reputation for excellent medical services and deficient record keeping. The medical people have a tradition of doing all aspects of their job correctly, but because of a shortage of accounting personnel, there is not time for internal verification or careful performance. In previous years, your CPA firm has found quite a few misstatements in billings, cash receipts, and accounts receivable. As in all hospitals, the two largest assets are accounts receivable and property, plant, and equipment.

    The hospital has several large loans payable to local banks, and the two banks have told management that they are reluctant to extend more credit, especially considering the modern hospital that is being built in a nearby city. In the past, county taxes have made up deficits, but in the past year, the county has also been incurring deficits because of high unemployment.

    In previous years, your response from patients to confirmation requests has been frustrating at best. The response rate has been extremely low, and those who did respond did not know the purpose of the confirmations or their correct outstanding balance. You have had the same experience in confirming receivables at other hospitals.

    You conclude that control over cash is excellent and the likelihood of fraud is extremely small. You are less confident about unintentional errors in billing, recording sales, cash receipts, accounts receivable, and bad debts.


  1. a) Identify the major factors affecting client business risk and acceptable audit risk for this audit.

  1. b) What inherent risks are you concerned about?

  1. c) What risks would you consider to be significant risks?

  1. d) For each of the following, explain whether you plan to emphasize the tests in the audit of the sales and collection cycle and give reasons:

    1. Tests of controls

    2. Substantive tests of transactions

    3. Substantive analytical procedures

    4. Tests of details of balances


  • • Complete Part I using Excel or Word.

    1. • Complete Part II using Word. o Any references used must be cited in-text in APA format with the full reference listed on a separate reference page.

    2. • You must upload all your files at one time (you cannot upload one file and then come back later and upload another.)

      Clearly and fully addresses the question correctly. Connects to concepts presented in the textbook.

      Clearly uses proper grammar, Answers are supported by proper citations

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