Case 1.

Auditing the Revenue Cycle The Kwan Pharmaceutical Company, a drug manufacturer, occasionally receives requests from customers for credit memos. The Company has the following internal controls for recording sales returns and evaluating the adequacy of the Accounts Receivable Allowance (A/R Allowance). 1. All customer requests for credits are documented in a log and are forwarded to the Controller. 2. The Controller reviews each credit request for reasonableness and discusses it with the appropriate personnel related to the initial sale. 3. The Controller documents the credit memo on a form explaining the reason for the credit and the amount of the credit. 4. The Controller and the CFO both physically sign the credit memo paperwork. 5. The credit is issued by a separate department prior to the reduction of the A/R Allowance for the customer, or is refunded by check. 6. The Controller updates the accounting software for the credit memo. 7. On a quarterly basis, the Controller evaluates the adequacy of the A/R Allowance. Sample of the Balance Sheet (in 000s): 12/31/09 A/R A/R Allowance Net A/R 1500 (100) 1400 12/31/08 1000 (100) 900

As the Senior Auditor, it is your responsibility to design the audit plan to test Sales Returns and Allowances. Required: A. In the form of a chart for Kwan Pharmaceutical Co, design an audit program for Sales Returns (credit memo): 1) List the audit objectives to be achieved 2) List the key controls from the preceding summary 3) Suggest test of controls for each objective 4) Suggest substantive test of transactions for each objective B. Suggest testing to evaluate the adequacy of the A/R Allowance. C. What does the trend of the A/R Allowance figures suggest to you? How would you modify your testing scope to address what you see?