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

(1)

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

Tests of Transactions Tests of Transactions

Chapter 14

(2)

Learning Objective 1 Learning Objective 1

Identify the accounts and the classes Identify the accounts and the classes

of transactions in the sales and of transactions in the sales and

collection cycle.

(3)

Accounts in the Sales and Accounts in the Sales and

Collection Cycle

(4)

Describe the business functions and Describe the business functions and

the related documents and records in the related documents and records in

the sales and collection cycle.

(5)

Sales Transaction Sales Transaction

Accounts

Sales

Accounts receivable

Business Functions

Processing

customer orders Granting credit Shipping goods Billing customers and recording sales

Documents and Records

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

(6)

Cash Receipts Transaction Cash Receipts Transaction

Cash in bank (debits from cash receipts) Accounts

receivable

Processing and recording cash receipts

Remittance advice Prelisting of cash receipts

Cash receipts transaction file

Cash receipts journal or listing

Accounts Business FunctionsDocuments and Records

(7)

Sales Returns and Sales Returns and

Allowances Transaction Allowances Transaction

Sales returns and

allowances Accounts

receivable

Processing and recording sales returns and

allowances

Credit memo

Sales and returns and allowances journal

(8)

Write-off of Uncollectible Write-off of Uncollectible

Accounts Transaction Accounts Transaction

Accounts receivable Allowance for uncollectible accounts

Writing off

uncollectible accounts

receivable

Uncollectible account authorization form General journal

(9)

Bad Debt Expense Bad Debt Expense

Transaction Transaction

Bad debt expense

Allowance for uncollectible accounts

Providing for bad debts

General journal

(10)

Processing Customer Orders Processing Customer Orders

Customer Order:

 A request for merchandise by a customer Sales Order:

 A document describing the goods ordered by a customer

(11)

Granting Credit Granting Credit

Before goods are shipped, a properly

authorized person must approve credit to the customer for sales on account

(12)

Shipping Goods Shipping Goods

 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 shipping

(13)

Billing Customers and Billing Customers and

Recording Sales Recording Sales

Sales

transaction file

Sales journal

Accounts receivable

file

Accounts receivable

trial balance

(14)

Processing and Recording Processing and Recording

Cash Receipts Cash Receipts

Remittance advice

Cash receipts

Prelisting of

Cash receipts

(15)

Processing and Recording Processing and Recording

Sales Returns and Sales Returns and

Allowances Allowances

 Credit memo

Sales returns and allowances journal

(16)

Writing Off Uncollectible Writing Off Uncollectible

Accounts Receivable Accounts Receivable

Uncollectible account authorization form

This is a document used internally to indicate authority to write an account receivable off as uncollectible

(17)

Providing for Bad Debts Providing for Bad Debts

This provision represents a residual, resulting from management’s

end-of-period adjustment of the

allowance for uncollectible accounts

(18)

Understand internal control, and Understand internal control, and

design and perform tests of controls design and perform tests of controls

and substantive tests of transactions and substantive tests of transactions

for sales.

(19)

Methodology for Designing Methodology for Designing Controls and Substantive Tests Controls and Substantive Tests

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 transaction-

related audit objectives

(20)

Understand Internal Control Understand Internal Control

– Sales – Sales

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

(21)

Assess Planned Control Risk Assess Planned Control Risk

– Sales – Sales

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

(22)

Assess Planned Control Risk Assess Planned Control Risk

– Sales – Sales

Adequate separation of duties

Proper authorization

Adequate documents and records

Pre-numbered documents

Monthly statements

(23)

Determine Extent of Testing Determine Extent of Testing

Controls Controls

Control risk

Control

effectiveness

(24)

Direction of Tests for Sales

(25)

Transaction-related Audit Transaction-related Audit

Objectives for Sales Objectives for Sales

Occurrence:

Recorded sales are for shipments actually made.

Accuracy:

Recorded sales are for the amount shipped.

Completeness:

Existing sales transactions are recorded.

(26)

Transaction-related Audit Transaction-related Audit

Objectives for Sales Objectives for Sales

Classification:

Sales transactions are correctly classified.

Timing:

Sales are recorded on the Posting and summarization:

Sales transactions are correctly included in the accounts receivable master file.

(27)

COSO Report Identifies COSO Report Identifies

Revenue Misstatement Revenue Misstatement

Techniques Techniques

Bill and hold Improper

sales cutoff Sham sales

Premature revenue recognition

Conditional sales

Round-tripping loans as sales

Fraudulent Techniques

Improper

% of completion

Unauthorized shipments

Consignment sales

(28)

Summary of Methodology Summary of Methodology

for Sales for Sales

 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

(29)

Learning Objective 4 Learning Objective 4

Apply the methodology for controls Apply the methodology for controls

over sales transactions to controls over sales transactions to controls

over sales returns and allowances.

(30)

Sales Returns and Sales Returns and

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.

(31)

Sales Returns and Sales Returns and

There are, however, two important differences:

Emphasis on objectives Materiality

(32)

Understand internal control, and Understand internal control, and

design and perform tests of controls design and perform tests of controls

and substantive tests of and substantive tests of

transactions for cash receipts.

(33)

Tests of Controls and Tests of Controls and

Substantive Tests of Substantive Tests of

Transactions for Cash Receipts Transactions for Cash Receipts

 Determine whether cash received was recorded

 Prepare proof of cash receipts*

Test to discover lapping of accounts receivable*

* Only performed when fraud is suspected

(34)

Apply the methodology for controls Apply the methodology for controls

over the sales and collection cycle to over the sales and collection cycle to

write-offs of uncollectible accounts write-offs of uncollectible accounts

receivable.

(35)

Audit Tests for the Write-Off Audit Tests for the Write-Off

of Uncollectible Accounts of Uncollectible Accounts

 Occurrence transaction-related audit objective

 Proper authorization of the write-off of uncollectible accounts

 Verification of accounts written off

(36)

Effect of Results of Controls and Effect of Results of Controls and

Substantive Tests of Substantive Tests of

Transactions Transactions

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

Accounts receivable

Allowance for doubtful accounts

(37)

Types of Audit Tests for the Types of Audit Tests for the

Sales and Collection Cycle Sales and Collection Cycle

Sales Accounts

Receivable Cash in

Sales Bank

transactions Cash receipts transactions

Ending

balance Ending balance

TOC + STOT + AP + TDB

= Sufficient appropriate evidence

Audited by

TOC, STOT, and AP

Audited by AP and TDB

Audited by

TOC, STOT, and AP

(38)

End of Chapter 14