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2012 Prentice Hall Business Publishing,Auditing 14/e,Arens/Elder/Beasley 5 - 5

Audit of the Sales and

Collection Cycle: Tests ofControls and Substantive

Tests of Transactions

Chapter 14


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Learning Objective 1

Identify the accounts and the classes oftransactions in the sales and collection

cycle.


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Accounts in the Sales andCollection Cycle


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Describe the business functions and therelated documents and records in the

sales and collection cycle.


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Sales Transaction

Accounts

SalesAccounts

receivable

Business Functions

Processingcustomer orders

Granting creditShipping goodsBilling customersand recordingsales

Documents and Records

Customer orderSales orderCustomer order or

sales orderShipping documentSales invoiceSales transaction fileSales journal or listing

Accounts receivablemaster file

Accounts receivabletrial balance

Monthly statements


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Cash Receipts Transaction

Cash in bank(debits from

cash receipts)Accounts

receivable

Processing andrecording cash

receipts

Remittance advicePrelisting of cash

receiptsCash receiptstransaction file

Cash receipts journalor listing

Accounts Business Functions Documents and Records


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Sales Returns and AllowancesTransaction

Sales returnsand

allowancesAccounts

receivable

Processing andrecording sales

returns andallowances

Credit memoSales and returns and

allowances journal



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Write-off of UncollectibleAccounts Transaction

Accountsreceivable

Allowance foruncollectibleaccounts

Writing offuncollectible

accountsreceivable

Uncollectible accountauthorization form

General journal



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Bad Debt Expense Transaction

Bad debtexpense

Allowance foruncollectibleaccounts

Providing for baddebts

General journal



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Processing Customer Orders

Customer Order: A request for merchandise by a customer

Sales Order: A document describing the goods ordered

by a customer


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Granting Credit

Before goods are shipped, a properlyauthorized person must approve credit

to the customer for sales on account


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Shipping Goods

This is the first point in the cycleat which the company gives up assets.

One type of shipping document is abill of lading.

Bills of lading are often transmitted oncegoods have been shipping


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Billing Customers and RecordingSales

Salestransaction

file

Salesjournal

Accountsreceivable

file

Accountsreceivable

trial balance


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Processing and Recording CashReceipts

Remittance advice

Cash receiptstransaction

file

Cash receipts listing

Prelistingof

Cashreceipts


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Processing and Recording SalesReturns and Allowances

Credit memo

Sales returns and allowances journal


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Writing Off UncollectibleAccounts Receivable

Uncollectible account authorization form

This is a document used internally toindicate authority to write an accountreceivable off as uncollectible


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Providing for Bad Debts

This provision represents a residual,resulting from managements

end-of-period adjustment of theallowance for uncollectible accounts


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

tests of transactions for sales.


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Methodology for Designing Controlsand Substantive Tests

Understand internal control sales

Audit procedures

Sample size

Items to select

Timing

Assess planned control risk sales

Determine extent of testing controls

Design tests of controls andsubstantive tests of transactions

for sales to meet transaction-related audit objectives


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Understand Internal ControlSales

Study the clients flowcharts, preparean internal control questionnaire, and

perform walk-through tests of sales.


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Assess Planned Control RiskSales

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


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Assess Planned Control RiskSales

Adequate separation of duties

Proper authorization

Adequate documents and records

Pre-numbered documents

Monthly statements

Internal verification procedures


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Determine Extent of TestingControls

Control

risk

Controleffectiveness


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Direction of Tests for Sales


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Transaction-related AuditObjectives for Sales

Occurrence:Recorded sales are for shipments actually made.

Accuracy:Recorded sales are for theamount shipped.

Completeness:Existing sales transactions are recorded.


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Transaction-related AuditObjectives for Sales

Classification:Sales transactions are correctly classified.

Timing:Sales are recorded on thecorrect dates.

Posting and summarization:Sales transactions are correctly includedin the accounts receivable master file.


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COSO Report Identifies RevenueMisstatement Techniques

Bill and hold

Impropersales cutoff

Sham sales

Prematurerevenue

recognition

Conditional sales

Round-trippingloans as sales

Fraudulent

Techniques

Improper% of completion

Unauthorizedshipments

Consignmentsales


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Summary of Methodologyfor 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


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Apply the methodology for controls oversales transactions to controls over sales

returns and allowances.


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Sales Returns and Allowances

The transaction-related audit objectives andclients methods of controlling misstatements

are essentially the same for processing creditmemos as those described for sales.


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Sales Returns and Allowances

There are, however, two important differences:

Emphasis

onobjectives

Materiality


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Understand internal control, and designand perform tests of controls and

substantive tests of transactions for cashreceipts.

Tests of Controls and Substantive


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Tests of Controls and SubstantiveTests of Transactions for Cash

ReceiptsDetermine whether cash received was recorded

Prepare proof of cash receipts*

Test to discover lapping of accounts receivable*

* Only performed when fraud is suspected


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Apply the methodology for controls over thesales and collection cycle to write-offs of

uncollectible accounts receivable.


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Audit Tests for the Write-Offof Uncollectible Accounts

Occurrence transaction-related audit objective

Proper authorization of the write-off ofuncollectible accounts

Verification of accounts written off


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Effect of Results of Controls andSubstantive Tests of Transactions

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

Accountsreceivable

Cash

Allowance for

doubtful accounts

Bad debt expense


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Types of Audit Tests for theSales and Collection Cycle

SalesAccountsReceivable

Cash inBank

Salestransactions

Cash receiptstransactions

Endingbalance

Endingbalance

TOC + STOT + AP + TDB= Sufficient appropriate evidence

Audited byTOC, STOT, and AP

Audited by AP and TDB

Audited byTOC, STOT, and AP


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2012 P ti H ll B i P bli hi A diti 14/ A /Eld /B l 5 5

End of Chapter 14