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    Audit Approach

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    WRITE AN AUDIT APPROACH FOR THESE TWO PROBLEMS

    6.47 Employee Embezzlement via Cash Receipts and Payment of Personal Expenses.
    This case is designed like the ones in the chapter. They give the problem, the method,
    the audit trail, and the amount. In this case, you can assume you have received the
    informant's message. Your assignment is to write the "audit approach" portion of the
    case, organized around these sections:

    Objective: Express the objective in terms of the facts supposedly asserted in financial
    records, accounts, and statements. (Refer to the "assertions" explained in Chapter 1.)

    Control: Write a brief explanation of desirable controls, missing controls, and especially
    the kinds of "deviations" that might arise from the situation described in the case. (Refer
    to controls explained in Chapter 5.)

    Test of controls: Write some procedures for getting evidence about existing controls, especially
    procedures that could discover deviations from controls. If there are no controls
    to test, then there are no procedures to perform; then go to the next section. (Refer to test
    of control procedures explained in this chapter.) An audit "procedure" should instruct
    someone about the source(s) of evidence to tap and the work to do.

    Audit of balance: Write some procedures for getting evidence about the existence, completeness,
    valuation, ownership, or disclosure assertions identified in your objective section
    above. (Refer to balance-audit procedures explained in Chapter 3.)

    Discovery summary: Write a short statement about the discovery you expect to accomplish
    with your procedures.

    The Extra Bank Account
    Problem: Cash receipts pocketed and personal expenses paid from business account.
    Method: The Ourtown Independent School District, like all others, had red tape about
    school board approval of cash disbursements. To get around the rules, and to make timely
    payment of selected bills possible, the superintendent of schools had a school bank account
    that was used in the manner of a petty cash fund. The board knew about it and had
    given blanket approval in advance for its use to make timely payment of minor school expenses.
    The board, however, never reviewed the activity in this account. The business
    manager had sole responsibility for the account, subject to the annual audit. The account
    received money from transfers from other school accounts and from deposit of cafeteria
    cash receipts. The superintendent did not like to be bothered with details, and he often
    signed blank checks so the business manager would not need to run in for a signature all
    the time. The business manager sometimes paid her personal American Express credit
    card bills, charged personal items to the school's VISA account, and pocketed some cafeteria
    cash receipts before deposit.
    Audit trail: An informant called the state education audit agency and told the story that
    this business manager had used school funds to buy hosiery. When told of this story, the
    superintendent told the auditor to place no credibility in the informant, who is "out to get
    us." The business manager had in fact used the account to write unauthorized checks to
    "cash," put her own American Express bills in the school files (the school district had a
    VISA card, not American Express), and signed on the school card for gasoline and auto
    repairs during periods of vacation and summer when school was not in session. (As for
    the hosiery, she purchased $700 worth with school funds one year.) The superintendent
    was genuinely unaware of the misuse of funds.
    Amount: The business manager had been employed for six years, was trusted, and embezzled
    an estimated $25,000.

    Second problem
    7.50 Overstated Sales and Accounts Receivable. This case is designed like the ones in the
    chapter. Your assignment is to write the "audit approach" portion of the case, organized
    around these sections:
    Objective: Express the objective in terms of the facts supposedly asserted in financial
    records, accounts, and statements.
    Control: Write a brief explanation of desirable controls, missing controls, and
    especially the kinds of "deviations" that might arise from the situation described in
    the case.
    Test of controls: Write some procedures for getting evidence about existing controls,
    especially procedures that could discover deviations from controls. If there are no
    controls to test, then there are no procedures to perform; go then to the next section.
    A "procedure" should instruct someone about the source(s) of evidence to tap and the
    work to do.
    Audit of balance: Write some procedures for getting evidence about the existence,
    completeness, valuation, ownership, or disclosure assertions identified in your
    objective section above.
    Discovery summary: Write a short statement about the discovery you expect to
    accomplish with your procedures.
    Ring around the Revenue
    Problem: Sales were recorded early, sometimes at fictitiously high prices, overstating
    sales revenue, accounts receivable, and income.
    Method: Mattox Toy Manufacturing Company had experienced several years of good
    business. Income had increased steadily, and the common stock was a favorite among
    investors. Management had confidently predicted continued growth and prosperity.
    However, business turned worse instead of better. Competition became fierce.

    In earlier years, Mattox had accommodated a few large retail customers with the
    practice of field warehousing coupled with a "bill and hold" accounting procedure.
    These large retail customers executed noncancelable written agreements, asserting
    their purchase of toys and their obligation to pay. The toys were not actually shipped
    because the customers did not have available warehouse space. They were set aside in
    segregated areas on the Mattox premises and identified as the customers' property.
    Mattox would later ship the toys to various retail locations upon instructions from the
    customers. The "field warehousing" was explained as Mattox's serving as a temporary
    warehouse and storage location for the customers' toys. In the related bill and hold
    accounting procedure, Mattox prepared invoices billing the customers, mailed the
    invoices to the customers, and recorded the sales and accounts receivable.

    When business took the recent downturn, Mattox expanded its field warehousing
    and its bill and hold accounting practices. Invoices were recorded for customers who
    did not execute the written agreements used in previous arrangements. Some
    customers signed the noncancelable written agreements with clauses permitting
    subsequent inspection, acceptance, and determination of discounted prices. The toys
    were not always set aside in separate areas, and this failure later gave shipping
    employees problems with identifying shipments of toys that had been "sold" earlier
    and those that had not.

    Mattox also engaged in overbilling. Customers who ordered closeout toys at
    discounted prices were billed at regular prices, even though the customers' orders
    showed the discounted prices agreed to by Mattox sales representatives.
    In a few cases, the bill and hold invoices and the closeout sales were billed and
    recorded in duplicate. In most cases, the customers' invoices were addressed and
    mailed to specific individuals in the customers' management instead of the routine
    mailing to the customers' accounts payable departments.

    Audit trail: The field warehousing arrangements were well known and acknowledged
    in the Mattox accounting manual. Related invoices were stamped "bill and hold."
    Customer orders and agreements were attached in a document file. Sales of closeout
    toys also were stamped "closeout," indicating the regular prices (basis for
    salespersons' commissions) and the invoice prices. Otherwise, the accounting for sales
    and accounts receivable was unexceptional. Efforts to record these sales in January
    (last month of the fiscal year) caused the month's sales revenue to be 35 percent
    higher than the January of the previous year.

    In the early years of the practice, inventory sold under the field warehousing
    arrangements (both regular and closeout toys) was segregated and identified. The
    shipping orders for these toys left the "carrier name" and "shipping date" blank, even
    though they were signed and dated by a company employee in the spaces for the
    company representative and the carrier representative signatures.

    The lack of inventory segregation caused problems for the company. After the
    fiscal year-end, Mattox solved the problem by reversing $6.9 million of the $14
    million bill and hold sales. This caused another problem because the reversal was
    larger than the month's sales, causing the sales revenue for first month of the next year
    to be a negative number!

    Amount: Company officials' reasons for the validity of recognizing sales revenue and
    receivables on the bill and hold procedure and field warehousing were persuasive.
    After due consideration of the facts and circumstances, the company's own
    accountants agreed that the accounting practices appropriately accounted for revenue
    and receivables.

    Mattox's abuse of the practices caused financial statements to be materially
    misstated. In January of the year in question, the company overstated sales by about
    $14 million, or 5 percent of the sales that should have been recorded. The gross profit
    of $7 million on these sales caused the income to be overstated by about 40 percent.

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    Solution Preview

    THE EXTRA BANK ACCOUNT
    Objectives: Existence of the bank account must be found and known to the auditors, there must be a completeness of information about who operates this account and the method by which this account is operated, the auditor must find the value of the transactions that have taken place through this account as well as the value of the transactions that have not been reflected in the books of accounts, the auditor shall find out who has the rights to operate the account and find out the obligations of the manager who operates the account and the auditor needs to find out how the account is presented in the main books of account and find out the disclosure that are made about the disbursements from the account. .
    Control: the auditor shall focus on the entry level controls regarding the bills that are presented for payment from that account and the funds that are paid from the bank account, the auditor shall then examine the company level controls on the actions of the manager with regards to the payments made from the extra bank account, is there any person who needs to approve the payments made? , the auditor will then look at the process level controls - the auditor will examine the process of signing of checks and approval of payments from this account, finally the auditor will examine the period end financial control with regards to the extra bank account.
    Test of Controls: The auditor will check if there is a top-down approach to control, in case of the extra bank account, there was a natural control of signing of checks that was avoided and this led to ...

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    This solution gives an audit approach for two problems in detail.

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