Auditing Laboratory

Arranged by:
Name : Sheila Gita Aditya
NIM : 165020307141003
Class : International Accounting Class (FA)

INTERNATIONAL UNDERGRADUATE PROGRAM IN ACCOUNTING

FACULTY OF ECONOMICS AND BUSINESS
BRAWIJAYA UNIVERSITY
MALANG
2019
 Section 10

Page 311

Case Study

Case 10.1

Southeast Shoe Distributor, Inc.

Identification of Tests of Controls for the Revenue Cycle (Sales and Cash Receipt)

 Introduction

Southeast Shoe Distributor (SSD) is a closely owned business that was founded
ten years ago by Stewart Green and Paul Williams. SSD is a distributor that purchases
and sells men’s, women’s, and children’s shoes to retail shoe stores located in small to
midsize communities. The company’s basic strategy is to obtain a broad selection of
designer label and name brand merchandise at low prices and resell the merchandise to
small one-location retail stores that have difficulty obtaining reasonable quantities of
designer and name brand merchandise. The company is able to keep the cost of
merchandise low by (1) selectively purchasing large blocks of production over-runs,
over-orders, mid- and late-season deliveries and last season’s stock from manufacturers
and other retailers at significant discounts, (2) sourcing in-season name brand and
branded designer merchandise directly from factories in Brazil, Italy, and Spain, and
(3) negotiating favorable prices with manufacturers by ordering merchandise during
off-peak production periods and taking delivery at one central warehouse.

During the year the company purchased merchandise from over 50 domestic
and international vendors, independent resellers, manufacturers and other retailers that
frequently had excess inventory. Designer and name brand footwear sold by the
company during the year include the following: Amalfi, Clarks, Dexter, Fila,
Florsheim, Naturalizer, and Rockport. At the present time, SSD has one warehouse
located in Atlanta, Georgia. Last year SSD had 123 retail shoe store customers and had
net sales of $7,311,214. Sales are strongest in the second and fourth calendar year
quarters with the first calendar year quarter substantially weaker than the rest.
  Background

SSD is required to have an audit of its annual financial statements to fulfill

requirements of loan agreements with financial institutions. This audit is to be
completed in accordance with the AICPA professional standards for the audit of
nonpublic companies. Your audit firm is currently planning for the Fiscal 2014 audit in
accordance with these professional standards. SSD has the following general ledger
accounts related to sales and cash collection activities:

 Sales
 Sales Discounts
 Sales Returns and Allowances
 Uncollectible Accounts Expense
 Accounts Receivable
 Allowance for Uncollectible Accounts

In accordance with the professional standards, Susan Mansfield, audit manager,

reviewed SSD’s control environment, risk assessment process, and monitoring system
and has assessed them as strong. Bill Zander, staff auditor, reviewed SSD’s information
system and control activities related to sales and cash receipts and prepared the enclosed
flowcharts (referenced in the top right hand corner as R 30-1, R 30-2, R 30-3, and R
30-4). The number and size of sales returns and allowances and write-offs of specific
customer accounts is relatively small. Thus Susan has decided there is no need to
document SSD’s policies nor perform tests of controls for these two business activities.
As the audit senior, you have been assigned responsibility for (1) identifying internal
control activities that assure that transactions, accounts and disclosures related to sales
and cash collection activities are not materially misstated and (2) identifying tests of
controls that would test the design and operating effectiveness of internal control
activities identified for sales and cash collection activities.
 Required :

1. Identify "what could go wrong" with SSD's sales and cash receipts activities by
completing step 5 of the audit program R 1-1. Document your work in audit schedules
R 1-1, R 31-1, R 31-2, and R 31-3 (Note: number what could go wrong similar to the
examples provided).

2. Identify SSD’s control activities by completing step 6 of the audit program R 1-1.
Document your work in audit schedules R 1-1, R 32-1, R 32-2, and R 32-3 (Note: you
should assume that only the control activities identified in the flowcharts exist and
number your control activities similar to the activity provided).

3. Identify potential tests of controls by completing step 7 of the audit program R 1-1.
Document your work in audit schedules R 1-1, R 40-1, R 40-2, and R 40-3 (Note:
number your tests similar to the example provided).

4. Complete step 8 of the audit program R 1-1 by identifying any internal control
deficiencies SSD may have and document your work in audit schedule R 1-1 and R 33.

5. How would your work differ if SSD was a public company? What other factors would
you need to consider?

6. For each internal control deficiency you listed in audit schedule R 33 (requirement 4),
identify at least one control activity that would remediate the deficiency.

7. Describe the importance of SSD’s control activities given its large number of customers
and vendors.
 Answers :

1. The answers for this question are on the schedules provided in the next page.

2. The answers for this question are on the schedules provided in the next page.

3. The answers for this question are on the schedules provided in the next page.

4. The answers for this question are on the schedules provided in the next page.

5. An audit for a non-public entity is required to be completed in accordence with the

auditing standards issued by the Auditing Standards Board (ASB) for the AICPA. These
standards require examination of controls for the purpose of planning the nature, extent,
and timing of the substantive testing. On the other hand, public entities are required to
have audits conducted in accordance with the auditing standards of the Public
Company Accounting Oversight Board (PCAOB). In addition to providing assurance
on the entity’s financial statements, an auditor is also required to provide assurance on
the entity’s internal controls. In order to provide assurance on an entity’s internal
controls, the auditor must perform tests of controls which is related to all significant
account balances, classes of transactions and disclosures, and related assertions in the
entity’s financial statements.

By law, public companies’ annual financial statements are audited each year by
independent auditors — accountants who examine the data for conformity with U.S.
Generally Accepted Accounting Principles (GAAP). The auditors con-duct a
systematic examination of a company’s accounting books, transaction records and other
relevant documents to consider whether the financial statements are fairly presented
and free from material misstatements. The auditor prepares a written report containing
an opinion on the financial statements. That opinion is filed with the SEC and is
available to investors and other interested parties.

The independent audit’s overriding goal is to provide investors, capital market

participants and policymakers with “reasonable assurance,” beyond management’s own
assertions, that the financial statements can be relied upon for investment decisions and
 other purposes.In addition to auditing financial statements, auditors often also assess
the effectiveness of a company’s internal controls over financial reporting. Internal
controls are procedures designed by the company’s management to address the risk of
material errors and misstatements in financial statements. Auditor attestation that the
controls are effective can boost investor confidence. Investors’ interests also are served
when an auditor identifies control weaknesses and management addresses the
shortcomings.

6. Answer :

Control Deficiency Remediating Control Activity

1. The client does not internally verify the Independent review of posting to the
proper general ledger account general ledger.
classification for the sales and cash
receipt transactions.
2. The client does not internally verify the Clerical testing of the amounts on the sales
amounts recorded on the sales invoices. invoices.
3. The client does not reconcile the sales Independent reconciliation of the sales and
and cash receipts journal to the general cash receipts journal to the general ledger.
ledger.
4. The client does not internally verify sales Verification of sales discounts before
discounts taken by the customers. recording.

7. Southeast Shoe Distributor (SSD) would have a high volume of sales, cash receipts,
purchasing, and cash disbursement transactions, given the large number of customers
and vendors involved with their business. The likelihood of errors occurring with these
transaction processes would be very high without standardized processes that include
appropriate control activities that are consistently applied.