Accounting Chapter 12 And Chapter 13

The following are partial descriptions of internal controls for companies engaged in the manufacturing business:

  1. When Mr.      Clark orders materials, an electronic copy of the purchase order is sent      to the receiving department. During the delivery of materials, Mr. Smith,      the receiving clerk, records the receipt of shipment on this purchase      order and then sends the purchase order to the accounting department,      where it is used to record materials purchased and accounts payable. The      materials are transported to the storage area by forklifts. The additional      purchased quantities are recorded on storage records.
  2. Every      day, hundreds of employees clock in using their employee identification      cards at Generous Motors Corporation. The data on these time records is      used in the preparation of the labor cost distribution records, the      payroll journal, and the electronic payments and payroll checks. The      treasurer, Angela Lee, compares the payroll journal with the payroll      records, signs the checks, and returns the payroll notifications and      checks to Charles Strode, the supervisor of the computer department. The      payroll checks and payment notices are distributed to the employees by      Strode.
  3. The      smallest branch of Connor Cosmetics employs Mary Cooper, the branch      manager, and her sales assistant, Janet Hendrix. The branch uses a bank      account to pay expenses. The account is kept in the name of “Connor      Cosmetics—Special Account.” To pay expenses, checks must be signed by      Cooper or by the treasurer, John Winters. Cooper receives the cancelled      checks and bank statements. She reconciles the branch account herself and      files cancelled checks and bank statements in her records. She also      periodically prepares reports of cash disbursements and sends them to the      home office.


  1. Required List the deficiencies in internal control for      each of these situations. To identify the deficiencies, use the      methodology that was discussed in this chapter.
  2. For each deficiency, state the type(s) of      misstatement(s) that is (are) likely to result. Be as specific as      possible.
  3. How would you improve internal controls for each of the      three companies?*

12-25: The following are independent situations for which you will recommend an appropriate audit report on internal control over financial reporting as required by PCAOB auditing standards:

1. The auditor identified a material misstatement in the financial statements that was not detected by management of the company.

2. The auditor was unable to obtain any evidence about the operating effectiveness of internal control over financial reporting.

3. The auditor identified several significant deficiencies in internal control. Because of these significant deficiencies, the auditor believes that there is a reasonable possibility that internal control will not prevent or detect material misstatements on a timely basis.

4. The auditor determined that a deficiency in internal control exists that will not prevent or detect a material misstatement in the financial statements.

5. During interim testing, the auditor identified and communicated to management a significant control deficiency. Management immediately corrected the deficiency and the auditor was able to sufficiently test the newly instituted internal control before the end of the fiscal period.

6. As a result of performing tests of controls, the auditor identified a significant deficiency in internal control over financial reporting; however, the auditor does not believe that it represents a material weakness in internal control.


For each situation, state the appropriate audit report from the following alternatives:

1. • Unqualified opinion on internal control over financial reporting

2. • Qualified or disclaimer of opinion on internal control over financial reporting

3. • Adverse opinion on internal control over financial reporting

12-27: Most grocery stores use bar code scanning technologies that interface with cash registers used to process customer purchases. Cashiers use the scanners to read bar code labels attached to each product, which the system then uses to obtain unit prices, calculate transaction totals, including sales taxes, and update perpetual inventory databases. Similarly, cashiers scan bar codes on coupons or member discount cards presented by the customer to process discounts. Along with the scanning technologies, groceries use point-of-sale technologies that allow customers to swipe debit and credit cards for payment, while still maintaining the ability for customers to pay with cash.


a. Which financial statement accounts are impacted by the use of these technologies in a typical grocery store?

b. Identify risks inherent to this business process in a grocery store that might affect the financial statement accounts identified in part a. For each risk, describe how these technologies help reduce the inherent risk.

c. How might an auditor use technology to test the operating effectiveness of a bar code scanner–based check-out system?

13-26: The following are independent internal controls commonly found in the acquisition and payment cycle. Each control is to be considered independently.

1. Before a check is prepared to pay for acquisitions by the accounts payable department, the related purchase order and receiving report are attached to the vendor’s invoice being paid. A clerk compares the quantity on the invoice with the receiving report and purchase order, compares the price with the purchase order, recomputes the extensions, re-adds the total, and examines the account number indicated on the invoice to determine whether it is correctly classified. He indicates his performance of these procedures by initialing the invoice.

2. At the end of each month, an accounting clerk accounts for all prenumbered receiving reports (documents evidencing the receipt of goods) issued during the month and traces each one to the related vendor’s invoice and acquisitions journal entry. The clerk’s tests do not include testing the quantity or description of the merchandise received.

3. The cash disbursements clerk is prohibited from handling cash. The bank account is reconciled by another person even though the clerk has sufficient expertise and time to do it.

4. Before a check is signed by the controller, she examines the supporting documentation accompanying the check. At that time, she initials each vendor’s invoice to indicate her approval.

5. After the controller signs the checks, her secretary writes the check number and the date the check was issued on each of the supporting documents to prevent their reuse.


a. For each of the internal controls, state the transaction-related audit objective(s) the control is meant to fulfill.

b. For each control, list one test of control the auditor could perform to test the effectiveness of the control.

c. For each control, list one substantive test the auditor could perform to determine whether financial misstatements are actually taking place.

13-28: Following are evidence decisions for the three audits described in Figure 13-3 :

§ Audit A Ineffective client internal controls

§ Audit B Very effective client internal controls

§ Audit C Somewhat effective client internal controls

Evidence decision:

1. The auditor decided it was possible to assess control risk below the maximum.

2. The auditor identified effective controls and also identified some deficiencies in controls.

3. The auditor performed extensive positive confirmations at the balance sheet date.

4. The auditor performed tests of controls.

5. The auditor performed extensive tests of controls and minimal substantive tests.

6. The auditor performed substantive tests.

7. This audit was likely the least expensive to conduct.

8. The auditor confirmed receivables at an interim date.


a. Explain why Audit B represents the maximum amount of reliance that can be placed on internal control. Why can’t all the audit assurance be obtained by tests of controls?

b. Explain why the auditor may not place the maximum extent of reliance on controls in Audit B and Audit C.

c. For each of the eight evidence decisions, indicate whether the evidence decision relates to each of the audits described above. Every evidence decision relates to at least one of the audits, and some may relate to two or all three audits.

13-32: The following are parts of a typical audit for a company with a fiscal year-end of July 31.

1. Understand internal control and assess control risk.

2. Perform substantive analytical procedures for accounts payable.

3. Confirm accounts payable.

4. Perform tests of controls and substantive tests of transactions for the acquisition and payment and payroll and personnel cycles.

5. Perform other tests of details of balances for accounts payable.

6. Perform tests for review of subsequent events.

7. Accept the client.

8. Issue the audit report.

9. Set acceptable audit risk and decide preliminary judgment about materiality and performance materiality.


a. Identify the phase of the audit in which each activity occurs.

b. Put parts 1 through 9 of the audit in the sequential order in which you would expect them to be performed in a typical audit.

c. Identify those parts that will frequently be done before July 31.

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