CASE 16-36 (oBJECTIVES 16-1, 16-3, 16-4, 16-5) You are auditing the sales and co

ID: 2583060 • Letter: C

Question

CASE 16-36 (oBJECTIVES 16-1, 16-3, 16-4, 16-5) You are auditing the sales and collection cycle for the Smalltown Regional Hospital, a small not-for-profit hospital. The hospital has a reputa- tion for excellent mcdical services and deficient rccord 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 not time for internal verification or careful performance. In previous years, your CPA 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, county taxes have made up deficits, but in the past ycar, the county has also 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 re- ceipts, accounts receivable, and bad debts. a. Identify the major factors affecting client business risk and acceptable audit risk for Required this audit b. What inherent risks are you concerned about? c. What risks would you consider to be significant risks? d. For each of the following, explain whether you plan to emphasize the tests in the audit of the sales and collection cycle and give reasons: (1) Tests of controls (2) Substantive tests of transactions (3) Substantive analytical procedures (4) Tests of details of balances Chapter 16 COMPLETING THE TESTS IN THE SALES AND COLLECTION CYCLE: ACCOUNTS RECEIVABLE

Explanation / Answer

a. Major factors affecting client business risk and acceptable audit risk:

· Human errors in billing of sales

· Weak record keeping

· Shortage of Accounting personnel

· Weak internal controls

· Misstatements in sale receipts

· Low response rates

· Pending confirmations in accounts receivables

· Weak debtor controls

b. Inherent Risks

· Errors in recording of transactions

· Unintentional errors in billing

· Inappropriate cash receipts

· Fallacy in accounts receivables

c. Significant Risks

· Constant mistakes in recording of sales

· Weak internal controls

· Regular misstatements in record of receivables

· Weak debtor collection controls

TESTS

REASONS

(1) Tests of Controls

Well, it is evident that client’s internal controls are weak, so such tests may be ignored.

(2) Substantive tests of transactions

This test should be conducted as there are weak internal controls in recording of transactions.

(3) Substantive analytical procedures

This test may be conducted to identify any potential threats to the business and for planning other audit procedures to mitigate such detected risks.

(4) Tests of details of balances

This test may be avoided as possibility of fraud is minimum at the client’s place.