AUDITING

BAC2664 (New), BAC2287(Old)

Topic 7, Lecture 8
Audit of Sales and Collection
Cycle

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 Audit of Sales and Collection Cycle

• Tests of Controls and Substantive Tests of

transactions
• Nature of the sales and collection cycle
• Business function, documents and records
• Internal Controls
• Objective of audit on sales and account
receivable
• Test on real transaction
• Audit tests for uncollectible accounts
• Balance confirmation including debtors’
balances
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 Overview of the Sales Cycle
Two classes of transactions (credit sales and cash receipts) are processed by the
accounting system, in different manner.

The transactions cycle and classes of transaction for credit cycle includes:
4 Receiving order from customer – written order, telephone, mail, facsimile
5 Grant credit – approval from credit department (credit standing, credit limit)
6 Deliver goods – authority to dispatch/deliver goods to customer
7 Billing – after satisfactory delivery of goods to customer
8 Receive cash – customer settles debts by cheques/cash, within credit term

The sales cycle ends when customer makes payment.

In addition, different internal controls are applied to ensure:

13 Complete processing of transactions
14 Transactions are processed accurately, and
15 Only valid transactions are processed.

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 The Account Balance in the Sales
Cycle
Credit Sales:
Debit: Sales Ledger Control Account
Credit: Sales

Customer Pays by Cheque:

Debit: Bank Account
Credit: Sales ledger Control Account

The accounts pertinent to the test of details of transactions

are sales account and bank account. Test of details of
balances are performed on sales ledger control account
and its detail counterpart, the sales ledger.

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 Sales Activities, Documents, and
Records
Activity Document Record
Authorization
1 Accepting and processing Sales order
customer order Approved customer list
2 Approving customer credit Approved sales order
3 Delivery of goods
Delivery note, Sales
4 Billing of customer
invoice
Recording
1 Journalizing and posting of Sales invoice
sales
Sales journal
2 Summarizing journal Sales ledger
entries, posting
summary
General ledger
Custody
Access to documents,
records – limited to
authorized personnel
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 Sales Department
Activity/Responsibility:
Accepting and processing customer order
(1) match the order to an approved customer list
(2) issue sales order

Possible errors and irregularities, when issuing sales order:

(1) sales order could be issued for sale to a fictitious or undesirable customer
(2) sales order does not agree with the customer purchase order pertaining to the
specification and quantity of the items ordered
(3) sales orders are misplaced

Control procedures:
(1) matched particulars of customer to an approved customers list
(2) matched particulars of sales order with customer purchase order
(3) sales orders are pre-numbered

All sales orders are submitted to credit department for the approval of credit.
Customers purchase orders are temporarily kept on file (sort according to
sales order number) pending credit approval by credit dept.

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 Credit Department
Activity/Responsibility:
Approving customer credit
(3) Establishing credit standing for new customers
(4) Evaluating credit to existing customers

Possible errors and irregularities, when issuing sales order:

(1) Potential risk of excessive un-collectable accounts and bad debts could happen if sales
order by-passed the credit approval procedures or approved without making reference
to careful investigation

Control procedures:
(9) To account the numerical sequence of approved sales order

Once approved, copy 1 is kept on file in alphabetical order for future reference, and the rest
returned to sales dept.

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 Sales Department
Activity/Responsibility:
Accepting and processing customer order received from the credit
dept.
(3) Customer purchase order temporarily filed according to sales order number,
stapled with copy 4 of approved sales order
(4) File permanently the numerical sequence of sales orders number
(5) Copy 2, sent to the store dept to authorize them to deliver the goods
(6) Copy 3, is sent to billing dept, as an acknowledgement that the goods is in
the delivery process

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 Stores
Activity/Responsibility:
(2) Packing of goods to customer
(3) Delivery of goods

Possible errors and irregularities in this area:

• Goods delivered may not agree with customer order
• Goods may be delivered to unauthorized customer

Control procedures:
• Delivery note should be matched with approved sales order before
authorization to deliver is given
• Delivery note should be pre-numbered in order to ensure all goods are
delivered are billed

Delivery note copy 3, and approved sales order copy 3, are stapled and filed
numerically. Delivery note copy 1, is sent together with goods to the
customer. Delivery note copy 2, is sent to billing dept to authorize them to
prepare the sales invoice.

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 Billing Department
Activity/Responsibility:
(2) Billing the customer
(3) Demanding the customer for payment
(4) Keeping in a safe place the supporting document (approved sales order and delivery
note) and ensuring their sequence.

Possible errors and irregularities in this area include:

(7) Goods actually delivered are not billed
(8) Amount billed may not be incorrect

Control procedures:
• Account for pre-numbered delivery notes to determine all delivery are billed
• Match sales invoice with delivery note and approved sales order to determine the
validity of transactions

Sales invoice copy 3, delivery note copy 2, and approved sales order copy 2, are
stapled and filed numerically. Sales invoice copy 1, is sent to the customer;
copy 2, is sent to accounts dept for recording to the sales journal and sales
ledger.

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 Accounts Department
Activity/Responsibility:
(2) Journalizing sales invoice
(3) Posting the sales to sales ledger
(4) Monitor the amount owing

Possible errors and irregularities in this area include:

• Sales not recorded
• Sales are recorded to wrong account
• Sales are recorded in the wrong financial year

Control procedures:
• Account for pre-numbered sales invoice
• Establish proper chart of account
• Establish internal verification of pricing, extensions and footings
• Establish proper cut-off, i.e., all delivery not issued before the year end are not billed in
the following year.
Sales invoice copy 2, are filed numerically.

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 Cash Receipts
Activity Document Record
Authorization
Cheque
Receiving and processing
payment from credit customer Remittance advice
Receipts from cash sales Cash, Cash count sheet
Bank-in Bank-in slip
Acknowledging receipts from Official receipts
credit customer
Recording
Journalizing and posting the
Official receipts Cash book
receipts
Summarizing the journal entries Sales ledger
General ledger
Custody
Access to documents and
records are limited to authorized
personnel

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 Mail Room
Activity/Responsibility:
Receiving and processing payment from credit customers.
(3) All mails are received by the mail room
(4) Segregate ordinary mails and payment made by
customers
(5) Preparation of prelist of mail receipts (particulars
obtained from the cheques and remittance advices)
(6) Cheques. Supported with the prelist of mail receipts
and remittance advice are sent to cashier.

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 Cashier
Activity/Responsibility:
Cash sales
• Compare the cash register reading with actual
cash receipts
• Prepare cash count sheet (to show the
denominations)

Control procedures:
• Custody of cash and cash count sheet
• Second copy of cash count sheet is sent to
accounts dept.
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 Cashier
Activity/Responsibilities:
Deposit of cash and cheques
• Prepare a deposit slip
• Bank-in
• Cash count sheet, prelist of mail receipts
are kept according to the date of deposit

Bank will validate deposit slip.

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 Cashier
Activity/Responsibilities:
Confirm amount deposited with amount as
per cash count sheet and prelist of mail
receipts
• Bank validated copy of deposit slip are
matched with the cash count sheet,
prelist of mail receipts
• Cashier further process the remittance
advice
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 Cashier
Activity/Responsibilities:
Acknowledging receipts from credit customers
• Official receipts are prepared based on
remittance advice
• Approved official receipt, copy 1, is sent to the
customer for acknowledging receipt
• Copy 2, is sent to accounts dept
• Copy 3 and remittance advice is filed in
sequence of official receipt number
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 Accounts Department
Activity/Responsibilities:
Journalizing and posting the receipts
(3) Particulars from the cash count sheet
(copy 2) and official receipts are used for
posting to the cash book and sales
ledger
(4) Cash count sheet are kept by date; and
the official receipt are kept by serial
number
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 Accounts Department
Activity/Responsibilities:
Summarizing the journal entries and posting
the summary
(1) Accounts clerk obtains the total sales (for
the month) from the sales journal, and the
total cash receipts from the cash book,
and posts them to the general ledger

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 Subsequent Accountability
Activity Record

Agreeing general ledger balance with General ledger

debtor balances in sales ledger Sales ledger
Debtors reconciliation statement

Preparing aging report and monthly Sales ledger

statement of account Aging Report
Statement of account

Preparing bank reconciliation Cash book

statement
Bank statement
Bank reconciliation statement

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 Accounts Department
Activity/Responsibilities:
Agreeing general ledger balances with the debtors’
balances in sales ledger
(3) accuracy of recording are determined on
monthly basis by verifying agreement of total
balances in sales ledger with the sales ledger
control account in general ledger
(4) Errors in recording are highlighted in the
debtors reconciliation statement

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 Accounts Department
Activity/Responsibilities:
Preparing aging report and statement of accounts
(3) Statement of accounts are prepared and sent
to debtors on a monthly basis to enable them
to check and confirm on the entries made in
the account
(4) Statements of account highlight the age of the
debts
(5) Sales ledger are further analysed into debtors
aging report
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 Accounts Department
Activity/Responsibilities:
Preparing bank reconciliation statement every month for
the following reasons:
(3) Differences between the balances as per bank
statement and cash book are valid ones
(4) Differences in balances are not a result of errors made
by the book-keeper or the bank
(5) Ensure that there has been no delay in preparing
receipts into the bank account
(6) Irregular items such as dishonoured cheques shown in
the bank statement, are dealt with in the accounting
records expediently
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 Internal Control Questionnaire for
Sales (Yes or No Answer)
Does the system ensure that sales invoices are correctly made out to
all goods leaving the premises or for services rendered?
2 Is the numerical continuity of renumbered delivery notes and sales orders
independently accounted for?
3 Are delivery notes and sales orders compared with invoices?
4 Are shipping and billing functions segregated from cash receipts?
5 Are daily/weekly delivery note independently prepared and received?
6 Are customer invoices mailed by the billing department?
7 Are prices, quantities, extensions, and freight checked?
8 Are invoice terms and quantities compared to the customer order?
9 Are standard price lists used and exceptions approved?
Do procedures such that all invoices made out are correctly recorded
in the books of accounts?
• Is numerical continuity of pre-numbered sales invoices checked and traced to sales
journal and sales ledger postings?
• Are sales invoices promptly recorded?
• Are customers billing, sales recording, sales ledgers, collections, and shipping
functions separated?
• Is the monthly total sales journal balanced, posted to general ledger and reconciled
with total debtor posting?

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 Internal Control Questionnaire for
Cash Receipts (Yes or No Answer)
Is the system such that cash receipts cannot be misappropriated
without prompt detection?
2 Are cashier, sales recording, sales ledger, and general ledger function separated?
3 Are remittance advices used?
4 Are cheques stamped ‘Account Payee Only’ when received?
5 Are cheques received through mail sent directly to the cashier, after being listed
individually and control total taken?
6 Are prelisted receipts subsequently compared with cash receipts deposited and
posted?
7 Are receipts deposited intact and promptly?
8 Is the numerical continuity of renumbered receipts or remittance advices checked?
9 Are invoice copies locked in registers and independently prepared?
10 Is the cash book independently prepared?
11 Is it forbidden to make disbursements from cash receipts?

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 Evaluation of the Internal Control:
The Test of Control
ISA 400 (AI 400), Risk Assessments and Internal Control, paragraph
27, defines the procedures pertaining to the interim audit:
“Test of control are performed to obtain audit evidence about the
effectiveness of the:
(c) Design of the accounting and internal control systems, that is,
whether they are suitably designed to prevent or detect and
correct material misstatements: and
(d) Operation of the internal controls throughout the period.”

In the test of control, the auditor is concerned with the following

assertions:
1 Existence: the control exists
2 Effectiveness: the control is operating effectively
3 Continuity: the control has so operated throughout the period of
intended reliance.

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Relationship Between Management Assertions
and Objectives of Test of Control

Management Assertions Objectives of Tests of

Control

Existence of Validity
Occurance Authorization
Completeness Completeness

Valuation of Accuracy
Allocation Classification
Timing
Posting, Summarization

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Correlation Between Accounting System, Test
of Control, Test of Details of Transactions

Auditors would like to ensure those controls that provide

evidence with regards to:
2 Only valid authorized transactions are recognized in
the accounting system
3 Documents are recognized sequentially
4 Amount stated in documents are accurately added
5 Transactions are classified into the correct journals
and ledger (including amounts)
6 Transaction are included in journal on timely basis,
and
7 Posting and summarizing are correctly done on timely
basis.
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 Test of Controls - Sales
Audit Objectives:
The audit of sales should be sufficiently comprehensive to
determine whether:
3 Customer are properly charged for all goods delivered
4 Sales have been correctly recorded in the books

Audit Procedures over Control of invoice books :

• Vouch invoice books purchased with printed invoices
• Verify that invoice books issued have been properly recorded in
register
• At the time of audit, count un-issued invoice books and agree with
the register.

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 Test of Controls – Sales continued

For 1 – 3 months:
1 Account the numerical sequence of sales invoices
2 List any missing sales invoices.
3 Cast total column of sales journal from which items are individually posted
(a) check posting from SJ to GL
(b) check posting from SJ to Debtors Control Account

Trace 30 items, say 10% of sales invoices to SJ. Test sales invoices to
the records below:
9 Credit approval documentation
10 Stores quantity records, to make sure that all goods despatched have been
invoiced
11 Delivery note, to investigate any occurrences if unusual lags between date of
delivery and date of billing, and any instances where billing occurs before
delivery
12 Standard price list. Check arithmetic of sales invoices
13 Check posting to debtors ledger.

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 Test of Controls – Sales continued

Select 30 items, say 10% debtors accounts:

2 Scrutinize and ensure that any old unpaid items are being
properly followed up by the client
3 Cast each account selected

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 Test of Controls – Cash Receipts
Audit Objectives:
Audit of cash received should be sufficiently
comprehensive to determine whether:
• Cash should have been received has actually been received, or
• Cash have been correctly recorded in the books.

Audit Procedures for control of official receipt books:

• Vouch official receipt books purchased with printed invoices.
• Verify that printed and the range of serial number have been
properly recorded in register
• At the time of audit, count un-issued official receipt books and
agree with the register.

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 Test of Controls – Cash Receipts
continued

For 1 – 3 months:
2 Account the numerical sequence of official receipts
3 List any missing official receipts
4 Cast cash sales and debtor’s receipts column of each cash
receipts journal from which items are individually posted:
(a) check posting the total for both columns from cash receipts
journal to GL
(b) check posting the total for debtors receipts from cash receipts
journal to debtors control account.

Attend at the opening of incoming post to watch the procedure for

remittances.

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 Test of Controls – Cash Receipts
continued

For 5 – 10 days per quarter:

2 Trace receipts from the following sources into each receipts
journal:
(a) cash register tally rolls
(b) remittance advices
5 Check arithmetic for each type of document traced above:
(a) trace official receipts to each receipts journal
(b) check posting to debtor ledger

For 1 – 3 months:
10 Check cash received with bank statements, noting that deposits are
credited without delay
11 Clear receipts side of bank statement and find out why un-ticked
receipts are not entered on debit side of cash book.

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 Substantive Tests
ISA 500 (AI 500), Audit Evidence, paragraph 6,
defines the procedures pertaining to the final
audit:
“Substantive procedures means tests performed to
obtain audit evidence to detect material
misstatements in the financial statements and
are of two types:
(a) test of details of transactions and balances,
and
(b) analytical procedures

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 Substantive Tests continued

During the substantive tests, auditors

examine for the ‘substances’ that make up
the account balances, e.g., the
substances that make up account
receivables are sales, receipts, discounts,
bad debts written-off.
Any misstatement detected on any of the
substance should be corrected or
disclosed in the financial statements.

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 Substantive Tests continued

For account receivables, the following

methods of obtaining evidence are used in
substantive tests:
1 Documentation
2 Inquiries of client
3 Confirmation
4 Arithmetical accuracy, and
5 Analytical review
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 Substantive Tests continued

If the balance RM48,500 consists of debts that are

doubtful, it needs to be adjusted to comply with the
prudence concept and disclosed in the notes to the
financial statements.
Finally, the conclusion derived from substantive tests on
accounts receivable would support or refute the following
management assertions:
1 Existence or occurrence
2 Rights and obligations
3 Completeness
4 Valuation or allocations, and
5 Presentation and disclosure.
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 Substantive Tests continued

To promote efficiency, tests of details of

transactions are performed at the same
time as test of control. The nature and
extent of test of details of balances should
be determined by the results of the
auditor’s tests of control and tests of
details of transactions.

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 Relationship Between Management Assertions
and Objectives of Substantive Tests

Management Assertions Objectives of Substantive

Procedures – Tests of
Details of Balances

Existence or Occurrence Existence

Rights and Obligations Ownership
Completeness Completeness
Valuation or Allocation Accuracy
Classification
Cut-off
Detail Tie-in
Realisable value
Presentation and Disclosure Presentation and Disclosure

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 Correlation Between Accounting System and
Substantive Tests – Tests of Details of Balances

Verification of Cash Balances (cash at bank

and cash in hand)
1 Cash at bank:
in checking the balance of cash at bank,
auditor must obtain sufficient appropriate
audit evidence – achieved if the evidence
are relevant to the audit objective of test of
details of balances.
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 Verification of Cash at Bank

Management Audit Objectives Substantive

Assertions of Test of Details Audit Procedures
of Balances

Existence Existence 1 Obtain a list of

balances with
banks
2 Compare the
figures of the
current year

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Verification of Cash at Bank continued

Completeness Completeness 1 obtain bank

reconciliation from
client
2 agree cash book
balances as per bank
reconciliation to cash
account in GL
3 agree bank
balances as per bank
reconciliation to bank
statements
4 Substantiate the
reconciliation items for
each bank
reconciliation 43
Verification of Cash at Bank continued

5 investigate
outstanding items not
cleared at time of
audit
6 verify to bank slips
for lodgement
outstanding to ensure
it is actually lodged
with the bank
7 investigate on any
significant transfer of
funds occurred near
validation date

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Verification of Cash at Bank continued

Valuation and Accuracy Obtain confirmation

Allocation letters from the
bankers

Ensure cash have

Classification
been properly
classified according to
chart of accounts

Cut-off Obtain and trace cash

cut-off information into
cash books, bank
statements,
reconciliations
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Verification of Cash at Bank continued

Detail tie-in Figures of cash book

balances tie with cash
book figures in GL

Rights and Obligation Bank accounts are in

Ownership
client’s name

Presentation and Presentation and

Disclosure 1 Review loan
Disclosure
agreements, minutes,
to ensure restrictions
on use and availability
of bank and cash

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Verification of Cash at Bank continued

2 Ensure bank
balance is the balance
that should be, and no
window dressing
3 ensure proper
disclosure in respect
of securities and
guarantees
4 ensure comparative
figures agree with last
year’s financial
statements

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 Verification of Cash in Hand
In handling the cash in hand, the appropriate methods in
obtaining audit evidence is by counting the cash. Than,
the auditor should require the client’s personnel to
prepare a confirmation letter to confirm the balance of
cash in hand as per cash count.
Through the procedures mentioned, the auditor would
achieve the following objectives:
1 Existence
2 Completeness
3 Accuracy
4 Ownership
Auditor should ensure proper classification as cash in
hand.

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 Verification of Trade Debtors
The audit of trade debtors balance is to
ensure trade debtors are fairly stated in
the FS, really exist and realisable. The
audit would confirm the accounting
policies applied in respect of trade debtors
balances are in accordance with the
policies stated in the client’s FS and are
consistent with those applied in the
previous year.
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 Audit Procedures for Debtors
Balances
Management Audit Objectives of Substantive Audit
Assertions Tests of Details of Procedures
Balances

Existence Existence
1 Obtain a list of
debtor together
with a list of
provision for
doubtful debts
2 agree figures in
GL
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 Audit Procedures for Debtors
Balances continued

Completeness Completeness 1 ensure all year end

transactions in respect
of debtors are
accounted for, and
debtors are recorded
in the accounting
period have actually
been recorded
2 Ensure supporting
documents are in
sequential order
(obtain explanation for
missing number)

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 Audit Procedures for Debtors
Balances continued

Valuation and Accuracy 1 review all debtor

Allocation balances, check or test
the additions of the list
and reconciliation
2 examine supporting
documents
3 determine whether
doubtful debts
accounts are complete
4 ensure attention
given to – long
outstanding balances,
large balances,
inability to comply with
credit terms by
customers
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Audit Procedures for Debtors
Balances continued

5 discuss with
management to ensure
determination of
doubtful debts and
related provisions are
consistent with past
years
6 examine supporting
documents for write-off
balances; determine
whether the write-off
were properly
authorized

Debtors figures are

Classification classified properly
according to chart of 53
accounts
 Audit Procedures for Debtors
Balances continued

Cut-off Obtain and trace

debtors cut-off
information into SJ and
SL

Detail tie-in
Figures of debtor
balances in subsidiary
ledger tie with debtors
figures in the GL
Rights and Obligations Ownership
Send confirmation
letters and determine
the method of
confirmation either
positive or negative

54
 Audit Procedures for Debtors
Balances continued

Presentation and Presentation and 1 inquire whether any

Disclosure Disclosure debtor have been
pledged as security
2 ensure comparative
figures agree with last
year’s FS
3 consider whether
significant credit
balances should be
classified as creditors

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 References
1 Audit Text – Chapters
2 Lecture Notes
3 Tutorial Questions
4 Past Examination Questions
5 Relevant Articles – MIA, MICPA, ACCA

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