Summary: Chapter 14 – Auditor of the Sales and collection cycleOctober 21, 2009

Transaction-related audit objectives (to link the 6 general transaction-related audit objectives to management assertions for classes of transactions).

o Occurrence – recorded transactions exist.o Completeness – exiting transactions are recorded.o Accuracy

o Recorded transactions are stated at the correct amounts.o Posting and summarization – recorded transactions are properly included in the

master files and are correctly summarized.o Classification – transactions included in the client’s journals are properly classified. o Cutoff (timing) – transactions are recorded on the correct dates.

Audit of the sales and collection cycle: Test of controls and collection cycleThe overall objective in the audit of the sales and collection cycle is to evaluate whether the account balances affected by the cycle are fairly presented in accordance with GAAP.

Accounts and classes of transactions in the Sales and Collection CycleThere are 5 classes of transactions in the sales and collection cycle:

1. Sales (cash & sales on account)2. Cash receipt3. Sales return and allowances4. Write-off of uncollectible accounts5. Estimate of bad debt expense

Business Functions in the Cycle and Related Documents and Records1. Processing customer order (customer order, Sales order)2. Granting credit 3. Shipping goods (Shipping document)4. Billing & recording sales (Sales invoice, sales transaction file, sales journal, AR master file,

AR TB, monthly statement)5. Processing and recording cash receipt (Remittance advice, prelisting of cash receipt, cash

receipt transaction file, cash receipt journal)6. Processing and recording sales returns and allowances (Credit memo, sales return & allowances

journal)7. Writing off uncollectible AR (uncollectible account authorization form)

Methodology for Designing Tests of Controls and Substantive tests of transactions for sales1. Understand IC – sales2. Assess planned control risk- sales

Adequate separation of duties Proper authorization Adequate documents and records Pre-numbered of documents Monthly statements Internal verification procedures

3. Determine extent of testing control

4. Design tests of control & substantive tests of transactions to meet transaction-related audit objective

Recorded sales occurred – 3 types of misstatements (sales included in the journals for which no shipment was made, sales recorded more than once, shipment made to nonexistent customers and recorded as sales)

Existing sales transactions are recorded – auditor needs to understand the difference between tracing from source documents to the journals (= test for omitted transactions) and vouching from the journals back to source documents (= test for nonexistent transactions).

Sales are accuracy recorded : concerns 1. shipping the amount of goods ordered, 2. accurately billing for the amount of goods shipped, and 3. accurately recording the amount billed in the accounting records.

Sales transactions are correctly included in the master file and correctly summarized. Recorded sales are correctly classified Sales are recorded on the correct dates.

Customer order shipping doc duplicate sales invoice sales journal GL = AR master file

Completeness start Occurrence start

Sales Returns and Allowances normally are so immaterial, the auditor can ignore.

Methodology for Designing Tests of Controls and Substantive tests of transactions for Cash Receipts

1. Determine key internal control for each audit objective2. Design tests of control for each control used to support a reduced control risk3. Design substantive tests of transactions to test for monetary misstatement for each objective

To determine to likelihood of fraud in cash receipt Determine whether cash received was recorded Prepare proof of cash receipts Test to discover lapping of accounts receivable

Audit Tests for the write-off of uncollectible accountsThe major control for preventing this fraud is proper authorization of the write off of uncollectible accounts be a designated level of a management.

Additional internal controls over account balances and presentation and disclosure1. The preparation of a periodic aged accounts receivable trial balance for review and follow-up

by appropriate management personnel.2. A policy of writing off uncollectible accounts when they are no longer likely to be collected.

Effect of results of test of controls and substantive tests of transactions (balance in AR, cash, bad debt expense, and allowance for doubtful accounts) The most significant effect of the results of the tests of controls and substantive tests of transactions is on the confirmation of AR.