Question

Describe two types of substantive analytical procedures often performed in the audit of the sales and collection cycle and describe how they might indicate a possible misstatement in the financial statements. Identify and select the two types of substantive analytical procedures and then choose the possible misstatement in the financial statements. compare aging categories as a percentage of net income with previous years compare bad debt expense as a percentage of net sales with precvious years compare gross margin percentage with previous years by prodect line compare individual customer balances with average customer balances compare sales by month by product line over time possible misstatments A. Misstatements in accounts receivable and related income statement accounts. B. Overstatement or understatement of allowance for uncollectible accounts and bad debt expense. C. Overstatement or understatement of allowance for uncollectible accounts and bad debt expense; also may indicate fictitious accounts receivable. D. Overstatement or understatement of sales and accounts receivable. E. Overstatement or understatement of sales returns and allowances and accounts receivable. F. Uncollectible accounts receivable that have not been provided for.

Answer 1

Tests of controls and substantive tests of transactions for the sales and collection cycle are intended to determine the effectiveness of internal controls and to test the substance of the transactions that are produced by this cycle. Such tests consist of activities such as examining sales invoices in support of entries in the sales journal, reconciling cash receipts, or reviewing the approval of credit.
The results of the tests of controls and substantive tests of transactions affect the procedures, sample size, timing, and items selected for the tests of details of balances (i.e., effective internal controls will result in reduced testing when compared to the tests of details required in the case of inadequate internal controls).

The following are analytical procedures for the sales and collection cycle, and potential misstatements uncovered by each test. Each ratio should be compared to previous years.
ANALYTICAL PROCEDURE POTENTIAL MISSTATEMENT
1. Gross margin by product line Sales cutoff errors or other misstatements involving sales; purchase cutoff errors or other misstatements involving inventory or purchases.
2. Sales returns and allowances as a percentage of gross sales by product line or segment All returns were not recorded, or shipments to customers were not in accordance with specifications and were returned (this could result in significant operating problems).
3. Trade discounts taken as a percentage of net sales Discounts that were taken by customers and allowed by the company were not recorded.
4. Bad debts as a percentage of gross sales Misstatement in determining the allowance for uncollectible accounts.
5. Days sales in receivables outstanding A problem with collections, potentially causing an understatement of bad debts and allowance for uncollectible accounts.
6. Aging categories as a percentage of accounts receivables Collection problems and understatement of allowance for uncollectible accounts.
7. Allowance for uncollectible accounts as a percentage of accounts receivable Misstatement in determining the allowance for uncollectible accounts.
8. Comparison of the balances in individual customers' accounts over a stated amount with their balances
in the previous year A problem with collections and therefore a misstatement of the allowance for uncollectible accounts, or cutoff errors or other misstatements in customer accounts.