Chapter 14 Audit of the Sales and Collection Cycle.ppt

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©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
Audit of the Sales and
Collection Cycle:
Tests of Controls and
Substantive Tests of
Transactions
Chapter 14

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Learning Objective 1
Identify the accounts and the
classes of transactions in the
sales and collection cycle.

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Accounts in the Sales and
Collection Cycle
Sales
Cash
sales
Sales on
account
Accounts Receivable
Cash receipts
Sales returns
and allowances
Charge-off of
uncollectible
accounts
Beginning
balance
Sales on
account
Ending
balance
Cash in Bank
Cash Discounts
Taken
Bad Debt
Expense
Sales Returns
and Allowances

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Accounts in the Sales and
Collection Cycle
Accounts Receivable
Cash receipts
Sales returns
and allowances
Charge-off of
uncollectible
accounts
Beginning
balance
Sales on
account
Ending
balance
Allowance for
Uncollectible Accounts
Charge-off of
uncollectible
accounts
Beginning
balance
Estimate of
bad debt
expense
Ending
balance
Bad Debt
Expense

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Describe the business functions
and the related documents and
records in the sales and
collection cycle.

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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

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Cash Receipts Transaction
Accounts
 Cash in bank
(debits from
cash receipts)
 Accounts
receivable
Business functions
 Processing and
recording cash
receipts
Remittance advice
 Prelisting of cash
receipts
 Cash receipts
transaction file
 Cash receipts journal or
listing

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Sales Returns and Allowances
Transaction
Accounts
 Sales returns
and
allowances
 Accounts
receivable
Business functions
 Processing and
recording sales
returns and
allowances
 Credit memo
 Sales and returns and
allowances journal

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Charge-off of Uncollectible
Accounts Transaction
Accounts
 Accounts
receivable
 Allowance for
uncollectible
accounts
Business functions
 Charging off
uncollectible
accounts
receivable
 Uncollectible account
authorization form
 General journal

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Bad Debt Expense Transaction
Accounts
 Bad debt
expense
 Allowance for
uncollectible
accounts
Business functions
 Providing for bad
debts
 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 properly
authorized person must approve credit
to the customer for sales on account.

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Shipping Goods
This is the first point in the cycle
where company assets are given up.

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Billing Customers and Recording
Sales
Sales invoice
Sales transaction file
Sales journal or listing
Accounts receivable master file
Accounts receivable trial balance
Monthly statement

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Processing and Recording Cash
Receipts
Remittance advice
Prelisting of cash receipts
Cash receipts transaction file
Cash receipts journal or listing

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Processing and Recording Sales
Returns and Allowances
Credit memo
Sales returns and allowances journal

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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.

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Providing for Bad Debts
This provision represents a residual,
resulting from management’s
end-of-period adjustment of the
allowance for uncollectible accounts.

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Understand how e-commerce
activities affect the sales
and collection cycle.

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Effect of E-Commerce on the
Sales and Collection Cycle
The Internet and other developing
technologies allow companies to
develop new business models.

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Business-to-business (B2B)
Business-to-consumer (B2C)
Management’s assertions for sales and
collection activities remain the same.

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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.

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

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Methodology for Designing
Controls and Substantive Tests
of Sales Transactions for Sales
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 and
substantive tests of transactions
for sales to meet transaction
-related audit objectives.

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

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Assess Planned Control Risk –
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

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Proper authorization
Assess Planned Control Risk –
Sales
Internal verification
procedures
Prenumbered
documents
Monthly statements
Adequate documents
and records
Adequate separation
of duties

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Determine Extent of Testing
Controls
Audits of public
companies
Audits of nonpublic
companies

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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.

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Transaction-Related Audit
Objectives 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.

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Direction of Tests for Sales
Completeness
start
Existence
start
Customer
order
Shipping
document
Duplicate
sales
invoice
Sales
journal
General
journal
Accounts
receivable
master file
=

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Summary of Methodology for
Sales
Transaction-related audit objectives (Column 1)
Key existing controls (Column 2)
Tests of control (Column 3)
Deficiencies (Column 4)
Substantive tests of transactions (Column 5)

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

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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.

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There are, however, two important differences.
Materiality
Emphasis on
objectives

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

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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.

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

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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

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Additional Internal Controls Over
Account Balances
Realizable value
Credit approval
Aged accounts receivable trial balance
Charging off uncollectibles

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Additional Internal Controls Over
Account Balances
Rights and obligations
Presentation and disclosure

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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
Bad debt expense
Cash
Allowance for
doubtful accounts

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Types of Audit Tests for the Sales
and Collection Cycle
Sales
Accounts
Receivable
Cash in
Bank
Sales
transactions
Cash receipts
transactions
Ending
balance
Ending
balance
TOC + STOT + AP + TDB
= Sufficient competent evidence per GAAS
Audited by
TOC, STOT, and AP
Audited by AP and TDB
Audited by
TOC, STOT, and AP

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End of Chapter 14

Chapter 14 Audit of the Sales and Collection Cycle.ppt

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