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

Chapter 14

Overview of Accounts in the Sales and Collection Cycle

Sales Cash sales Sales on account Accounts Receivable Beginning Cash receipts balance Sales on account Ending balance Sales returns and allowances Charge-off of uncollectible accounts Cash in Bank

Cash Discounts Taken

Sales Returns and Allowances

Bad Debt Expense

Accounts in the Sales and Collection Cycle

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

Ending balance

Charge-off of uncollectible accounts

Analysis of the Sales and Collection Cycle

Excellent format for analysis:

Business Functions Accounts involved Documents and Records

Think Accounting Information Systems

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

Cash Receipts Transaction

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

Sales Returns and Allowances Transaction

Accounts Sales returns and allowances Accounts receivable

Business functions Processing and recording sales returns and allowances

Documents and records Credit memo Sales and returns and allowances journal

Charge-off of Uncollectible Accounts Transaction

Accounts Accounts receivable Allowance for uncollectible accounts Business functions Charging off uncollectible accounts receivable Documents and records Uncollectible account authorization form General journal

Bad Debt Expense Transaction

Accounts Bad debt expense Allowance for uncollectible accounts

Business functions Providing for bad debts

Documents and records General journal

Processing Customer Orders

Customer Order: A request for merchandise by a customer

Sales Order: A document describing the goods ordered by a customer

Granting Credit

Before goods are shipped, a properly authorized person must approve credit to the customer for sales on account.

Shipping Goods

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

Billing Customers and Recording Sales

Sales invoice Sales transaction file Sales journal or listing Accounts receivable master file Accounts receivable trial balance Monthly statement

Processing and Recording Cash Receipts

Remittance advice

Prelisting of cash receipts

Cash receipts transaction file Cash receipts journal or listing

Processing and Recording Sales Returns and Allowances

Credit memo

Sales returns and allowances journal

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.

Providing for Bad Debts

This provision represents a residual, resulting from managements end-of-period adjustment of the allowance for uncollectible accounts.

Effect of E-Commerce on the Sales and Collection Cycle

The Internet and other developing technologies allow companies to develop new business models.

Effect of E-Commerce on the Sales and Collection Cycle

Business-to-business (B2B) Business-to-consumer (B2C)

Managements assertions for sales and collection activities remain the same.

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.

Methodology for Designing Controls and Substantive Tests of Sales Transactions for Sales
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. Audit procedures Sample size

Items to select Timing

Understand Internal Control Sales

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

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

Assess Planned Control Risk Sales

Adequate separation of duties Proper authorization Adequate documents and records Monthly statements Internal verification procedures Prenumbered documents

Determine Extent of Testing Controls

Audits of public companies

Audits of nonpublic companies

Transaction-Related Audit Objectives for Sales

Existence: Recorded sales are for shipments actually made. Completeness: Existing sales transactions are recorded. Accuracy: Recorded sales are for the amount shipped.

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.

Direction of Tests for Sales

Customer order

Shipping document

Duplicate sales invoice

Sales journal

General journal

Accounts receivable master file

Completeness start

Existence start

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)

Sales Returns and Allowances

The transaction-related audit objectives and clients methods of controlling misstatements are essentially the same for processing credit memos as those described for sales.

Sales Returns and Allowances

There are, however, two important differences.

Materiality

Emphasis on objectives

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.

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

Additional Internal Controls Over Account Balances

Realizable value

Credit approval Aged accounts receivable trial balance Charging off uncollectibles

Additional Internal Controls Over Account Balances

Rights and obligations

Presentation and disclosure

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 Allowance for doubtful accounts

Bad debt expense

Types of Audit Tests for the Sales and Collection Cycle

Sales Accounts Cash in Receivable Bank Sales Cash receipts transactions transactions
Audited by TOC, STOT, and AP Audited by TOC, STOT, and AP

Ending balance

Ending balance

Audited by AP and TDB

TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS