Exam 12: Audit of the Revenue Cycle

You have just been assigned to manage the audit of Cheap Music Downloads Inc. (CMD), a new large client of your firm. CMD is a subsidiary of a client of your firm that manufactures audio and video equipment for international distribution. CMD has been in operation for two years. CMD runs a website that allows customers to order songs using their credit card. There are tens of thousands of small transactions daily. Once the credit card has been authorized by the credit card processing intermediary, CMD's web sales system generates a 16-digit sequential code that the customer uses to access the song via the website. CMD then records both the sale and the royalty for the song. Quarterly, CMD remits royalties to artists based on the number of copies of each song that has sold if the accumulated royalty exceeds $25 for that artist. Artist royalties that do not exceed $25.00 will be paid every two years if there has not been a payment during that time. All contracted royalty rates, artist names, and song titles are recorded in CMD's database tables. Required: Describe three internal controls that should exist over sales or royalty transactions or over the database tables. For each control: 1. State the control. 2. Describe (not just state) the audit assertion associated with the control (or state the purpose of the control). 3. Provide an audit test that you could use to test the control.

An auditor should perform alternative procedures to substantiate the existence of accounts receivable when

Gonzo is an online dating agency. Gonzo has been in business for 5 years and was able to reach revenues of $1 million last year. Given its recent expansion, Gonzo's shareholders have required that the company's financial statements be audited for the first time this year. You have been assigned to the audit team for this mandate. The senior manager has asked you to review the process description for the sales of Gonzo. You need to identify the controls in place that could be tested and used for the audit and also identify any controls that might be missing and briefly explain the impact on the audit. Gonzo's CEO has provided you with the following description of the company's processes and activities for the past year. Sales Gonzo's website is operational 24 hours per day. All of the sales for Gonzo are completed online when a customer opens a profile. Each customer pays $50 to open a profile and then pays $10 per month to keep his or her profile active. Most customers pay online with their credit cards and the sale is automatically recorded in Gonzo's sales ledger at the time of payment. Gonzo also had a promotion for the last 3 months of the year: If a new customer subscribed for one year, they could pay $100 up front to keep their profile active for the full year instead of paying $10 each month for 12 months. This proved to be a popular sales tactic as customers enjoyed the $20 savings. Website Security In the past year, one hacker managed to compromise the website and stole the credit card information of 25 Gonzo customers. To ensure quality of customer service, Gonzo reimbursed a total of $10 000 to the customers to compensate them for the amounts that were stolen as a result of the intrusion on their website. Since then, Gonzo hired a third party, Mindster Box, to improve the security of their website. Mindster Box performs monthly updates to the security features and monitors any intrusion attempts. Gonzo has not had any website security problems since hiring Mindster. Collection and Reconciliation As most of the sales are done by credit card, Gonzo receives money from large credit card companies on a by-weekly basis. When money is received, Jo-Ann, the accounting manager at Gonzo, reconciles the details of the payments received from the credit card company to the sales ledger of Gonzo. Jo-Ann has often complained that this is nearly impossible to do since Gonzo's accounting system keeps track of the payment by the website user name, which is often very different from the actual name of the person as stated on the detailed report provided by the credit card company. Jo-Ann therefore mostly relies on the statement of the credit card company to record and adjust revenues reported by Gonzo.

If accounts receivable accounts with credit balances are significant, they should be

When a company uses purchased software packages for its accounting software, such packages normally do not permit the company to change the software package's functionality. This means that the auditor will consider

The information systems audit specialist on your audit team has indicated that the general controls over program changes are excellent for all application cycles. What impact does this have on your audit of sales invoice processing?

Two accounts receivable balance-related audit objectives are not affected by assessed control risk for the sales and cash receipts classes of transactions. These objectives are

The use of the negative (as opposed to the positive) form of receivables confirmation is indicated when

Which of the following presentation and disclosure-related audit objectives has a matching transaction-related audit objective, but not a matching balance-related audit objective?

An auditor selects a sample from the file of shipping documents to determine whether invoices were prepared. This test is performed to satisfy the audit objective of

In the planning phase, Denis conducted an analytical procedure to compare the allowance for doubtful accounts balance to the accounts receivable balance. In the prior years, the allowance for the doubtful accounts/accounts receivable ratio was between 2.5% to 3.5%. This year, the number is 1.25%. What should Denis do?

Some companies use a lockbox system, whereby customers mail payments to a post office box address. The lockbox contents could be handled by a bank, another external organization, or the owner of the company. One of the advantages of using a lockbox is that it

An effective procedure to test for unbilled shipments is to trace from the

The appropriate test of controls for separation of duties is

The most difficult type of cash defalcation for the auditor to detect is that which occurs

The most reliable evidence from confirmations is obtained when they are sent

There are three main types of revenue manipulations. Which of the following revenue manipulations affects the cutoff objective?

Comparing bad debt expense as a percentage of gross sales with previous years will detect what kind of possible misstatement?

Which of the following control weaknesses could result in problems with collectability of accounts receivable?

A positive confirmation is more reliable evidence than a negative confirmation because