Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions

Audit of the Sales and Audit of the Sales and Collection Cycle:Collection Cycle:Tests of Controls and Tests of Controls and Substantive Tests of Substantive Tests of TransactionsTransactions

Chapter 14Chapter 14

Overview of Accounts in the Sales and Overview of Accounts in the Sales and Collection CycleCollection Cycle

SalesSales

CashCashsalessales

Sales onSales onaccountaccount

Accounts ReceivableAccounts Receivable

Cash receiptsCash receipts

Sales returnsSales returnsand allowancesand allowances

Charge-off ofCharge-off ofuncollectibleuncollectibleaccountsaccounts

BeginningBeginningbalancebalance


EndingEndingbalancebalance

Cash in BankCash in Bank

Cash DiscountsCash DiscountsTakenTaken

Bad DebtBad DebtExpenseExpense

Sales ReturnsSales Returnsand Allowancesand Allowances

Accounts in the Sales and Collection CycleAccounts in the Sales and Collection Cycle

Accounts ReceivableAccounts Receivable

Cash receiptsCash receipts

Sales returnsSales returnsand allowancesand allowances





Allowance forAllowance forUncollectible AccountsUncollectible Accounts



Estimate ofEstimate ofbad debtbad debtexpenseexpense


Bad DebtBad DebtExpenseExpense

Analysis of the Sales and Collection CycleAnalysis of the Sales and Collection Cycle

• Excellent format for analysis:Excellent format for analysis:• Business FunctionsBusiness Functions• Accounts involvedAccounts involved• Documents and RecordsDocuments and Records

• Think Accounting Information SystemsThink Accounting Information Systems

Sales TransactionSales Transaction

AccountsAccounts

SalesSales AccountsAccounts receivablereceivable

Business functionsBusiness functions

Processing customerProcessing customer ordersorders Granting creditGranting credit

Shipping goodsShipping goods Billing customersBilling customers and recording salesand recording sales

Documents and recordsDocuments and records

Customer orderCustomer order Sales orderSales order Customer order or salesCustomer order or sales orderorder Shipping documentShipping document Sales invoiceSales invoice Sales transaction fileSales transaction file Sales journal or listingSales journal or listing Accounts receivableAccounts receivable master filemaster file Accounts receivableAccounts receivable trial balancetrial balance Monthly statementsMonthly statements

Cash Receipts TransactionCash Receipts Transaction

AccountsAccounts

Cash in bankCash in bank (debits from(debits from cash receipts)cash receipts) AccountsAccounts receivablereceivable


Processing andProcessing and recording cashrecording cash receiptsreceipts


Remittance adviceRemittance advice Prelisting of cashPrelisting of cash receiptsreceipts Cash receiptsCash receipts transaction filetransaction file Cash receipts journal orCash receipts journal or listinglisting

Sales Returns and Allowances TransactionSales Returns and Allowances Transaction

AccountsAccounts

Sales returnsSales returns andand allowancesallowances AccountsAccounts receivablereceivable


Processing andProcessing and recording salesrecording sales returns andreturns and allowancesallowances


Credit memoCredit memo Sales and returns andSales and returns and allowances journalallowances journal

Charge-off of Uncollectible Accounts Charge-off of Uncollectible Accounts TransactionTransaction

AccountsAccounts

AccountsAccounts receivablereceivable Allowance forAllowance for uncollectibleuncollectible accountsaccounts


Charging offCharging off uncollectibleuncollectible accountsaccounts receivablereceivable


Uncollectible accountUncollectible account authorization formauthorization form General journalGeneral journal

Bad Debt Expense TransactionBad Debt Expense Transaction

AccountsAccounts

Bad debtBad debt expenseexpense Allowance forAllowance for uncollectibleuncollectible accountsaccounts


Providing for badProviding for bad debtsdebts


General journalGeneral journal

Processing Customer OrdersProcessing Customer Orders

Customer Order:Customer Order:A request for merchandise by a customerA request for merchandise by a customer

Sales Order: Sales Order: A document describing the goods orderedA document describing the goods orderedby a customerby a customer

Granting CreditGranting Credit

Before goods are shipped, a properlyBefore goods are shipped, a properlyauthorized person must authorized person must approve creditapprove creditto the customer for sales on account.to the customer for sales on account.

Shipping GoodsShipping Goods

This is the first point in the cycleThis is the first point in the cyclewhere company assets are given up.where company assets are given up.

Billing Customers and Recording SalesBilling Customers and Recording Sales

Sales invoiceSales invoice

Sales transaction fileSales transaction file

Sales journal or listingSales journal or listing

Accounts receivable master fileAccounts receivable master file

Accounts receivable trial balanceAccounts receivable trial balance

Monthly statementMonthly statement

Processing and Recording Cash ReceiptsProcessing and Recording Cash Receipts

Remittance adviceRemittance advice

Prelisting of cash receiptsPrelisting of cash receipts

Cash receipts transaction fileCash receipts transaction file

Cash receipts journal or listingCash receipts journal or listing

Processing and Recording Sales Returns Processing and Recording Sales Returns and Allowancesand Allowances

Credit memoCredit memo

Sales returns and allowances journalSales returns and allowances journal

Charging Off UncollectibleCharging Off UncollectibleAccounts ReceivableAccounts Receivable

Uncollectible account authorization formUncollectible account authorization form

This is a document used internally toThis is a document used internally toindicate authority to write an accountindicate authority to write an accountreceivable off as uncollectiblereceivable off as uncollectible..

Providing for Bad DebtsProviding for Bad Debts

This provision represents a residual,This provision represents a residual,resulting from management’sresulting from management’send-of-period adjustment of theend-of-period adjustment of theallowance for uncollectible accountsallowance for uncollectible accounts..

Effect of E-Commerce on the Sales and Effect of E-Commerce on the Sales and Collection CycleCollection Cycle

The Internet and other developingThe Internet and other developingtechnologies allow companies totechnologies allow companies todevelop new business models.develop new business models.


Business-to-business (B2B)Business-to-business (B2B)

Business-to-consumer (B2C)Business-to-consumer (B2C)

Management’s assertions for sales andManagement’s assertions for sales andcollection activities remain the same.collection activities remain the same.


Auditors should obtain an understandingAuditors should obtain an understandingof the design and operation of key internalof the design and operation of key internalcontrols over e-commerce revenues.controls over e-commerce revenues.

Evidence for e-commerce activities isEvidence for e-commerce activities islikely to be in electronic form.likely to be in electronic form.

Methodology for Designing Controls and Methodology for Designing Controls and Substantive TestsSubstantive Testsof Sales Transactions for Salesof Sales Transactions for Sales

Understand internalUnderstand internalcontrol – sales.control – sales.

Audit proceduresAudit procedures

Sample sizeSample size

Items to selectItems to select

TimingTiming

Assess plannedAssess plannedcontrol risk – sales.control risk – sales.

Determine extent ofDetermine extent oftesting controls.testing controls.

Design tests of controls andDesign tests of controls andsubstantive tests of transactionssubstantive tests of transactionsfor sales to meet transactionfor sales to meet transaction-related audit objectives.-related audit objectives.

Understand Internal Control – SalesUnderstand Internal Control – Sales

Study the client’s flowcharts, prepareStudy the client’s flowcharts, preparean internal control questionnaire, andan internal control questionnaire, andperform walk-through tests of sales.perform walk-through tests of sales.

Study the client’s flowcharts, prepareStudy the client’s flowcharts, preparean internal control questionnaire, andan internal control questionnaire, andperform walk-through tests of sales.perform walk-through tests of sales.

Assess Planned Control Risk – SalesAssess Planned Control Risk – Sales

1. Framework for assessing control risk1. Framework for assessing control risk

2. Identify key internal controls and deficiencies 2. Identify key internal controls and deficiencies

3. Associate controls and deficiencies with the3. Associate controls and deficiencies with the objectives objectives

4. Assess control risk for each objective4. Assess control risk for each objective

Proper authorizationProper authorization

Assess Planned Control Risk – SalesAssess Planned Control Risk – Sales

Internal verificationInternal verification proceduresprocedures

PrenumberedPrenumbereddocumentsdocuments

Monthly statementsMonthly statements

Adequate documentsAdequate documentsand recordsand records

Adequate separationAdequate separationof dutiesof duties

Determine Extent of Testing ControlsDetermine Extent of Testing Controls

Audits of publicAudits of public companiescompanies

Audits of nonpublic Audits of nonpublic companiescompanies

Transaction-Related AuditTransaction-Related AuditObjectives for SalesObjectives for Sales

Existence:Existence:Recorded sales are for shipments actually made.Recorded sales are for shipments actually made.

Accuracy:Accuracy:Recorded sales are for the amount shipped.Recorded sales are for the amount shipped.

Completeness:Completeness:Existing sales transactions are recorded.Existing sales transactions are recorded.

Transaction-Related AuditTransaction-Related AuditObjectives for SalesObjectives for Sales

Classification:Classification:Sales transactions are properly classified.Sales transactions are properly classified.

Timing:Timing:Sales are recorded on the correct dates.Sales are recorded on the correct dates.

Posting and summarization:Posting and summarization:Sales transactions are properly includedSales transactions are properly includedin the accounts receivable master file.in the accounts receivable master file.

Direction of Tests for SalesDirection of Tests for Sales

CompletenessCompletenessstartstart

ExistenceExistencestartstart

CustomerCustomerorderorder

ShippingShippingdocumentdocument

DuplicateDuplicatesalessales

invoiceinvoice

SalesSalesjournaljournal

GeneralGeneraljournaljournal

AccountsAccountsreceivablereceivablemaster filemaster file

==

Summary of Methodology for SalesSummary of Methodology for Sales

Transaction-related audit objectives (Column 1)Transaction-related audit objectives (Column 1)Key existing controls (Column 2)Key existing controls (Column 2)Tests of control (Column 3)Tests of control (Column 3)Deficiencies (Column 4)Deficiencies (Column 4)Substantive tests of transactions (Column 5)Substantive tests of transactions (Column 5)

Sales Returns and AllowancesSales Returns and Allowances

The transaction-related audit objectives andThe transaction-related audit objectives andclient’s methods of controlling misstatementsclient’s methods of controlling misstatementsare essentially the same for processing creditare essentially the same for processing creditmemos as those described for sales.memos as those described for sales.

Sales Returns and AllowancesSales Returns and Allowances

There are, however, two important differences.There are, however, two important differences.

MaterialityMateriality Emphasis onEmphasis onobjectivesobjectives

Tests of Controls and Substantive Tests of Tests of Controls and Substantive Tests of Transactions for Cash ReceiptsTransactions for Cash Receipts

Determine whether cash received was recorded.Determine whether cash received was recorded. Prepare proof of cash receipts.Prepare proof of cash receipts. Test to discover lapping of accounts receivable.Test to discover lapping of accounts receivable.

Audit Tests for Uncollectible AccountsAudit Tests for Uncollectible Accounts

Existence of recorded write-offs is the mostExistence of recorded write-offs is the mostimportant transaction-related audit objective.important transaction-related audit objective.

What is a major concern in testing accountsWhat is a major concern in testing accountscharged off as uncollectible?charged off as uncollectible?

– – covering up a defalcation by charging offcovering up a defalcation by charging offaccounts receivable that have been collectedaccounts receivable that have been collected

Additional Internal Controls Over Account Additional Internal Controls Over Account BalancesBalances

Realizable valueRealizable value

Credit approvalCredit approval

Aged accounts receivable trial balanceAged accounts receivable trial balance

Charging off uncollectiblesCharging off uncollectibles

Additional Internal Controls Over Account Additional Internal Controls Over Account BalancesBalances

Rights and obligationsRights and obligations

Presentation and disclosurePresentation and disclosure

Effect of Results of Controls andEffect of Results of Controls andSubstantive Tests of TransactionsSubstantive Tests of Transactions

The parts of the audit most affected by theThe parts of the audit most affected by thetests for the sales and collection cycle are:tests for the sales and collection cycle are:

Accounts receivableAccounts receivable

Bad debt expenseBad debt expense

CashCash

Allowance forAllowance fordoubtful accountsdoubtful accounts

Types of Audit Tests for the Sales and Types of Audit Tests for the Sales and Collection CycleCollection Cycle

SalesSalesAccountsAccounts

ReceivableReceivableCash inCash in

BankBankSalesSales

transactionstransactionsCash receiptsCash receiptstransactionstransactions



TOCTOC + + STOTSTOT + + APAP + + TDBTDB= Sufficient competent evidence per GAAS= Sufficient competent evidence per GAAS

Audited byAudited byTOCTOC, , STOTSTOT, and , and APAP

Audited by Audited by APAP and and TDBTDB

Audited byAudited byTOCTOC, , STOTSTOT, and , and APAP

Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions

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