Auditing the sales and collection cycle
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You are auditing the sales and collection cycle for the United Regional Hospital, a small not-for-profit hospital. The hospital has a reputation for excellent medical services and weak 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 no time for internal verification or careful performance. In previous years, your audit 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, government taxes have made up deficits, but in the past year, the government has 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.
(a) Identify the major inherent risks for this audit
(b) In the audit of the sales and receipts cycle, which types of tests are you likely to emphasize?
(c) For each of the following, explain whether you plan to emphasize the tests and give reasons:
o tests of controls
o substantive tests of transactions
o analytical procedures
o tests of details of balances
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(a) The following are major inherent risks:
(i) There are several large loans to two local banks, both which have said they are reluctant to extend more credit.
(ii) A modern hospital is being built in a nearby city, which affects the competitive environment, and therefore the
likelihood of financial failure.
(iii) The hospital has been incurring significant deficits in the past.
(iv) Taxes may not be able to make up the deficits, as they have in the past.
(v) As an operating cycle asset, accounts receivable have high IR.
(v) Misstatements are common in billings, cash receipts, accounts receivable balances, and bad debts.
(vi) Due to the high unemployment rate, there is a significant risk of increased bad debts.
(b) The major difficulty the auditor faces is the ineffective controls over sales and the unreliability of confirmations
because of the nature of the customers. The auditor should therefore plan to emphasize substantive tests of
transactions for sales and alternative procedures, especially subsequent cash receipts. The controls over cash
receipts are such that it is practical to reduce assessed control risk after a proper understanding is obtained of
internal control and tests of controls are performed. ...
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