Chapter 14 Audit of the Sales and Collection Cycle:

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1 Chapter 14 Audit of the Sales and Collection Cycle: Tests of Control and Substantive Tests of Transactions

2 Identify the accounts and the classes of transactions in the sales and collection cycle. Describe the business functions and the related documents and records in the sales and collection cycle. Understand internal control, and design and perform tests of controls and substantive tests of transactions for sales. 14-2

Describe the business functions and the related documents and records in the

3 Apply the methodology for controls over sales transactions to controls over sales returns and allowances. Understand internal control, and design and perform tests of controls and substantive tests of transactions for cash receipts. Apply the methodology for controls over the sales and collection cycle to write-offs of uncollectible accounts receivable. 14-3

Understand internal control, and design and perform tests of controls and substantive

4 1 Identify the accounts and the classes of transactions in the sales and collection cycle. 14-4

5 14-5

6 2 Describe the business functions and the related documents and records in the sales and collection cycle. 14-6

7 Accounts Sales Accounts receivable Business Functions Documents and Records Processing customer orders Granting credit Shipping goods Billing customers and recording sales Customer order Sales order Customer order or sales order Shipping document Sales invoice Sales transaction file Sales journal or listing Accounts receivable master file Accounts receivable trial balance Monthly statements 14-7

order Customer order or sales order Shipping document Sales invoice Sales transaction file Sales

8 Accounts Cash in bank (debits from cash receipts) Accounts receivable Business Functions Documents and Records Processing and recording cash receipts Remittance advice Prelisting of cash receipts Cash receipts transaction file Cash receipts journal or listing 14-8

and recording cash receipts Remittance advice Prelisting of cash

9 Accounts Sales returns and allowances Accounts receivable Business Functions Documents and Records Processing and recording sales returns and allowances Credit memo Sales and returns and allowances journal 14-9

Processing and recording sales returns and

10 Accounts Accounts receivable Allowance for uncollectible accounts Business Functions Documents and Records Writing off uncollectible accounts receivable Uncollectible account authorization form General journal 14-10

and Records Writing off uncollectible accounts

11 Accounts Bad debt expense Allowance for uncollectible accounts Business Functions Documents and Records Providing for bad debts General journal 14-11

12 Customer Order: A request for merchandise by a customer Sales Order: A document describing the goods ordered by a customer 14-12

13 Before goods are shipped, a properly authorized person must approve credit to the customer for sales on account 14-13

14 This is the first point in the cycle at which the company gives up assets. One type of shipping document is a bill of lading. Bills of lading are often transmitted once goods have been shipped 14-14

15 Sales transaction file Sales journal Accounts receivable file Accounts receivable trial balance 14-15

16 Prelisting of Cash receipts Cash receipts transaction file 14-16

17 Credit memo Sales returns and allowances journal 14-17

18 Uncollectible account authorization form This is a document used internally to indicate authority to write an account receivable off as uncollectible 14-18

19 This provision represents a residual, resulting from management s end-of-period adjustment of the allowance for uncollectible accounts 14-19

20 3 Understand internal control, and design and perform tests of controls and substantive tests of transactions for sales

21 Understand internal control sales Assess planned control risk sales Determine extent of testing controls Design tests of controls and substantive tests of transactions for sales to meet transactionrelated audit objectives Audit procedures Sample size Items to select Timing 14-21

22 Study the client s flowcharts, prepare an internal control questionnaire, and perform walk-through tests of sales

23 1. Framework for assessing control risk 2. Identify key internal controls and deficiencies 3. Associate controls and deficiencies with the objectives 4. Assess control risk for each objective 14-23

24 Adequate separation of duties Proper authorization Adequate documents and records Pre-numbered documents Monthly statements Internal verification procedures 14-24

25 Control effectiveness Control risk 14-25

26 14-26

27 Occurrence: Recorded sales are for shipments actually made. Completeness: Existing sales transactions are recorded. Accuracy: Recorded sales are for the amount shipped

28 Posting and summarization: Sales transactions are correctly included in the accounts receivable master file. Classification: Sales transactions are correctly classified. Timing: Sales are recorded on the correct dates

29 Sham sales Improper sales cutoff Premature revenue recognition Improper % of completion Conditional sales Round-tripping loans as sales Fraudulent Techniques Consignment sales Unauthorized shipments Bill and hold 14-29

30 Identify key transaction-related audit objectives Determine key existing controls Design tests of controls to verify effectiveness Evaluate any control deficiencies Determine extent of substantive tests of transactions 14-30

31 4 Apply the methodology for controls over sales transactions to controls over sales returns and allowances

32 The transaction-related audit objectives and client s methods of controlling misstatements are essentially the same for processing credit memos as those described for sales

33 There are, however, two important differences: Materiality Emphasis on objectives 14-33

34 5 Understand internal control, and design and perform tests of controls and substantive tests of transactions for cash receipts

35 Determine whether cash received was recorded Prepare proof of cash receipts* Test to discover lapping of accounts receivable* 14-35

36 6 Apply the methodology for controls over the sales and collection cycle to write-offs of uncollectible accounts receivable

37 Occurrence transaction-related audit objective Proper authorization of the write-off of uncollectible accounts Verification of accounts written off 14-37

38 The parts of the audit most affected by the tests for the sales and collection cycle are: Accounts receivable Allowance for doubtful accounts Bad debt expense Cash 14-38

39 Sales Accounts Receivable Sales Cash receipts transactions transactions Audited by TOC, STOT, and AP Ending balance Ending balance Audited by AP and TDB Audited by TOC, STOT, and AP TOC + STOT + AP + TDB = Sufficient appropriate evidence Cash in Bank 14-39

40 14-40

41 Copyright All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America

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

Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions Chapter 14 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 14-1 Learning Objective