principle of auditing

1. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 1
Audit of the Sales and
Collection Cycle
Chapter 2

2. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 2
Learning Objective 1
Identify the accounts and the
classes of transactions in the
sales and collection cycle.

3. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 3
Accounts in the Sales
and Collection Cycle
Sales
Cash
sales
Sales on
account
Cash in Bank
Cash Discounts
Taken
Sales Returns
and Allowances
Bad Debt
Expense
Accounts Receivable
Beginning Cash receipts
balance
Sales returns
Sales on and allowances
account
Charge-off of
Ending uncollectible
balance accounts

4. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 4
Accounts in the Sales
and Collection Cycle
Accounts Receivable
Beginning Cash receipts
balance
Sales returns
Sales on and allowances
account
Charge-off of
Ending uncollectible
balance accounts Bad Debt
Expense
Allowance for Uncollectible Accounts
Charge-off of Beginning
uncollectible balance
accounts
Estimate of bad
debt expense
Ending balance

5. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 5
Learning Objective 2
Describe the business functions
and the related documents and
records in the sales and
collection cycle.

6. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 6
Processing Customer Orders
Customer Order:
A request for merchandise
by a customer
Sales Order:
A document describing the
goods ordered by a customer

7. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 7
Granting Credit
Before goods are shipped, a properly
authorized person must approve credit
to the customer for sales on account.

8. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 8
Sales Transaction
Accounts
Business
Functions
Documents
and Records
Sales
Accounts receivable
Processing customer orders,
Granting credit, Shipping goods,
Billing customers and recording sales
Sales invoice, Sales journal or listing, Sales
transaction file, Accounts receivable master
file and trial balance, Monthly statements

9. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 9
Cash Receipts Transaction
Accounts
Business
Functions
Documents
and Records
Cash in bank (debits from cash receipts)
Accounts receivable
Processing and recording cash receipts
Remittance advise, Prelisting of cash receipts,
Cash receipts transaction file,
Cash receipts journal or listing

10. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 10
Sales Returns and Allowances
Transaction
Accounts
Business
Functions
Documents
and Records
Sales returns and allowances
Accounts receivable
Processing and recording
sales returns and allowances
Credit memo
Sales returns and allowances journal

11. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 11
Charge-off of Uncollectible
Accounts Transaction
Accounts
Business
Functions
Documents
and Records
Accounts receivable
Allowance for uncollectible accounts
Charging off uncollectible
accounts receivable
Uncollectible account authorization form
General journal

12. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 12
Bad Debt Expense
Transaction
Accounts
Business
Functions
Documents
and Records
Bad debt expense
Allowance for uncollectible accounts
Providing for bad debts
General journal

13. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 13
Shipping Goods
This is the first point in the cycle
where company assets are given up.
Shipping
document

14. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 14
Billing Customers
and Recording Sales
Sales invoice
Sales transaction file
Sales journal or listing
Accounts receivable master file
Accounts receivable trial balance
Monthly statement

15. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 15
Processing and Recording
Cash Receipts
Remittance advise
Prelisting of cash receipts
Cash receipts transaction file
Cash receipts journal or listing

16. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 16
Lockbox Systems and
Electronic Funds Transfer
Customer
Bank
Order/Payment
Information
Company

17. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 17
Processing and Recording
Sales Returns and Allowances
Credit memo
Sales returns and
allowances journal

18. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 18
Charging Off Uncollectible
Accounts Receivable
Uncollectible Account
Authorization Form
This is a document used internally to
indicate authority to write an account
receivable off as uncollectible.

19. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 19
Providing for Bad Debts
This provision represents a residual,
resulting from management’s
end-of-period adjustment of the
allowance for uncollectible accounts.

20. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 20
Learning Objective 3
Understand how e-commerce
activities affect the
sales and collection cycle.

21. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 21
Effect of E-Commerce on the
Sales and Collection Cycle
The Internet
The Internet and
other developing
technologies allow
companies to develop
new business models.

22. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 22
Effect of E-Commerce on the
Sales and Collection Cycle
Business-to-business (B2B)
Business-to-consumer (B2C)
Management’s assertions for sales and
collection activities remain the same.

23. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 23
Effect of E-Commerce on the
Sales and Collection Cycle
Auditors should obtain an understanding
of the design and operation of key internal
controls over e-commerce revenues.
Evidence for e-commerce activities
is likely to be in electronic form.

24. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 24
Learning Objective 4
Understand internal control
and design and perform tests
of controls and substantive
tests of transactions for sales.

25. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 25
Methodology for Designing Controls
and Substantive Tests: Sales
Understand internal
control – sales
Assess planned
control risk – sales
Evaluate cost-benefit
of testing controls.
Design tests of controls
and substantive tests
of transactions for sales
to meet transaction-
related audit objectives.
Audit procedures
Sample size
Items to select
Timing

26. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 26
Understanding Internal
Control – Sales
Study the client’s flowcharts,
prepare an internal control
questionnaire, and perform
walk-through tests of sales.

27. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 27
Assess Planned
Control Risk – Sales
Adequate separation
of duties
Proper authorization
Adequate documents
and records Prenumbered
documents
Monthly statements
Internal verification
procedures

28. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 28
Internal Verification
Procedures
Evaluate cost-benefit
of testing controls.
Design tests of
controls for sales.

29. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 29
Transaction-Related Audit
Objectives for Sales
Existence:
Recorded sales are for shipments actually made.
Accuracy:
Recorded sales are for the amount shipped.
Completeness:
Existing sales transactions are recorded.

30. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 30
Design Substantive Tests
of Transactions for Sales
Classification:
Sales transactions are properly classified.
Timing:
Sales are recorded on the correct dates.
Posting and summarization:
Sales transactions are properly included
in the accounts receivable master file.

31. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 31
Direction of Tests for Sales
Customer
order
Shipping
document
Duplicate
sales invoice
Sales
journal
General
ledger
Accounts
receivable
master file
=
Completeness Start
Existence Start

32. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 32
Summary of Methodology
for Sales
Column 1: Transaction-related audit objectives
Column 2: Key internal controls
Column 3: Test of controls
Column 4: Weaknesses
Column 5: Substantive tests of transactions

33. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 33
Learning Objective 5
Apply the methodology for
controls over sales transactions
to controls over sales
returns and allowances.

34. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 34
Sales Returns
and Allowances
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.

35. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 35
Sales Returns
and Allowances
There are, however, two important differences.
Materiality
Emphasis on
objectives

36. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 36
Learning Objective 6
Understand internal control and
design and perform tests of
controls and substantive tests
of transactions for cash receipts.

37. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 37
Tests of Controls and Substantive Tests
of Transactions for Cash Receipts
 Determine whether cash received was recorded
 Prepare proof of cash receipts
 Test to discover lapping of accounts receivable

38. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 38
Learning Objective 7
Apply the methodology for controls
over the sales and collection cycle
to write-offs of uncollectible
accounts receivable.

39. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 39
Audit Tests for
Uncollectible Accounts
Existence of recorded write-offs is the most
important transaction-related audit objective.
What is a major concern in testing accounts
charged off as uncollectible?
– covering up a defalcation by charging off
accounts receivable that have been collected

40. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 40
Additional Internal Controls
Over Account Balances
Realizable value
Rights and obligations
Presentation and disclosure

41. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 41
Effect of Results of Controls and
Substantive Tests of Transactions
The parts of the audit most affected by the
tests for the sales and collection cycle are:
Accounts
receivable
Cash
Bad debt
expense
Allowance for
doubtful accounts

42. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 42
End of Chapter 2