My question is from Auditing and Assurance Services: An Integrated Approach

By: Alvin A. Arens, Mark S. Beasley, Randal J. Elder, Chris E. Hogan

Page 557

Case 16-36

You are auditing the sales and collection cycle for the Smalltown Regional Hospital, a small not-for-profit hospital. The hospital has a reputation for excellent medical services and deficient 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 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 receivables. As in all hospital, 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 year, the county has also been incurring deficits because of high unemployment.

In previous years, your response from patients to confirmation request 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 receivables, and bad debts.

a. Identify the major factors affecting client business risk and acceptable audit risk for this audit.

b. What inherent risks are you concerned about?

c. What risk would you consider to be significant risk?

d. For each of the following, explain whether you plan to emphasize the test in the audit of the sales and collection cycle and give reasons:

1) Test of Controls

2) Substantive tests of transactions

3) Substantive analytical procedures

4) Test of details of balances