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

5 - 5
Audit of the Sales and
Collection Cycle: Tests of
Controls and Substantive
Tests of Transactions
Chapter 14
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 2
Learning Objective 1
Identify the accounts and the classes of
transactions in the sales and collection
cycle.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 3
Accounts in the Sales and
Collection Cycle
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 4
Learning Objective 2
Describe the business functions and the
related documents and records in the
sales and collection cycle.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 5
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
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 6
Cash Receipts Transaction
Cash in bank
(debits from
cash receipts)
Accounts
receivable
Processing and
recording cash
receipts
Remittance advice
Prelisting of cash
receipts
Cash receipts
transaction file
Cash receipts journal
or listing
Accounts Business Functions Documents and Records
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 7
Sales Returns and Allowances
Transaction
Sales returns
and
allowances
Accounts
receivable
Processing and
recording sales
returns and
allowances
Credit memo
Sales and returns and
allowances journal
Accounts Business Functions Documents and Records
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 8
Write-off of Uncollectible
Accounts Transaction
Accounts
receivable
Allowance for
uncollectible
accounts
Writing off
uncollectible
accounts
receivable
Uncollectible account
authorization form
General journal
Accounts Business Functions Documents and Records
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 9
Bad Debt Expense Transaction
Bad debt
expense
Allowance for
uncollectible
accounts
Providing for bad
debts
General journal
Accounts Business Functions Documents and Records
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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
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 12
Shipping Goods
This is the first point in the cycle
at which the company gives up assets.

One type of shipping document is a
bill of lading.

Bills of lading are often transmitted once
goods have been shipping
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Billing Customers and Recording
Sales
Sales
transaction
file
Sales
journal

Accounts
receivable
file
Accounts
receivable
trial balance
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 14
Processing and Recording Cash
Receipts
Remittance advice
Cash receipts
transaction
file
Cash receipts listing
Prelisting
of
Cash
receipts
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Processing and Recording Sales
Returns and Allowances
Credit memo

Sales returns and allowances journal
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Writing 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
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 17
Providing for Bad Debts
This provision represents a residual,
resulting from managements
end-of-period adjustment of the
allowance for uncollectible accounts
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 18
Learning Objective 3
Understand internal control, and design and
perform tests of controls and substantive
tests of transactions for sales.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 19
Methodology for Designing Controls
and 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 and
substantive tests of transactions
for sales to meet transaction-
related audit objectives
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Understand Internal Control
Sales
Study the clients 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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Assess Planned Control Risk
Sales
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 Testing
Controls
Control
risk
Control
effectiveness
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Direction of Tests for Sales
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Transaction-related Audit
Objectives for Sales
Occurrence:
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 correctly classified.
Timing:
Sales are recorded on the
correct dates.
Posting and summarization:
Sales transactions are correctly included
in the accounts receivable master file.
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COSO Report Identifies Revenue
Misstatement Techniques
Bill and hold
Improper
sales cutoff
Sham sales
Premature
revenue
recognition
Conditional sales
Round-tripping
loans as sales
Fraudulent
Techniques
Improper
% of completion
Unauthorized
shipments
Consignment
sales
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Summary of Methodology
for 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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Learning Objective 4
Apply the methodology for controls over
sales transactions to controls over sales
returns and allowances.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 30
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.
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Sales Returns and Allowances
There are, however, two important differences:

Emphasis
on
objectives
Materiality

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 32
Learning Objective 5
Understand internal control, and design
and perform tests of controls and
substantive tests of transactions for cash
receipts.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 33
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*
* Only performed when fraud is suspected
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Learning Objective 6
Apply the methodology for controls over the
sales and collection cycle to write-offs of
uncollectible accounts receivable.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 35
Audit Tests for the Write-Off
of Uncollectible Accounts
Occurrence transaction-related audit objective

Proper authorization of the write-off of
uncollectible accounts

Verification of accounts written off

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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
Cash
Allowance for
doubtful accounts
Bad debt expense
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 37
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 appropriate evidence
Audited by
TOC, STOT, and AP
Audited by AP and TDB
Audited by
TOC, STOT, and AP
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
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End of Chapter 14