Audit of the Sales and

Collection Cycle: Tests of

Controls and Substantive
Tests of Transactions

Chapter 14
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©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5-5

 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 - 2

 Accounts in the Sales and
Collection Cycle

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 3

 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 - 4

 Sales Transaction
Accounts Business Functions Documents and Records
Sales Processing Customer order
Accounts customer orders Sales order
Customer order or
receivable Granting credit sales order
Shipping goods Shipping document
Billing customers Sales invoice
and recording Sales transaction file
sales 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 - 5
 Cash Receipts Transaction
Accounts Business Functions Documents and Records
Cash in bank Processing and Remittance advice
(debits from recording cash Prelisting of cash
cash receipts) receipts receipts
Accounts Cash receipts
receivable transaction file
Cash receipts journal
or listing

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 6

 Sales Returns and Allowances
Transaction
Accounts Business Functions Documents and Records
Sales returns Processing and Credit memo
and recording sales Sales and returns and
allowances returns and allowances journal
Accounts allowances
receivable

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 7

 Write-off of Uncollectible
Accounts Transaction
Accounts Business Functions Documents and Records
Accounts Writing off Uncollectible account
receivable uncollectible authorization form
Allowance for accounts General journal
uncollectible receivable
accounts

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 8

 Bad Debt Expense Transaction
Accounts Business Functions Documents and Records
Bad debt Providing for bad General journal
expense debts
Allowance for
uncollectible
accounts

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 9

 Processing Customer Orders

Customer Order:
 A request for merchandise by a customer

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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 10

 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 - 11

 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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 12

 Billing Customers and Recording
Sales

Sales Sales
transaction journal
file

Accounts Accounts
receivable receivable
file trial balance
©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 13
 Processing and Recording Cash
Receipts

Prelisting
of
Cash
receipts
Remittance advice

Cash receipts
transaction
file
Cash receipts listing
©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 14
 Processing and Recording Sales
Returns and Allowances

 Credit memo

Sales returns and allowances journal

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 15

 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 - 16

 Providing for Bad Debts

This provision represents a residual,

resulting from management’s
end-of-period adjustment of the
allowance for uncollectible accounts

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 17

 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 - 18

 Methodology for Designing Controls
and Substantive Tests
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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 19

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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 20

 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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 21

 Assess Planned Control Risk –
Sales
Adequate separation of duties

Proper authorization

Adequate documents and records

Pre-numbered documents

Monthly statements

Internal verification procedures

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 22
 Determine Extent of Testing
Controls

Control
effectiveness
Control
risk

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 23

 Direction of Tests for Sales

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 24

 Transaction-related Audit
Objectives for Sales
Occurrence:
Recorded sales are for shipments actually made.

Completeness:
Existing sales transactions are recorded.

Accuracy:
Recorded sales are for the
amount shipped.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 25

 Transaction-related Audit
Objectives for Sales
Posting and summarization:
Sales transactions are correctly included
in the accounts receivable master file.

Classification:
Sales transactions are correctly classified.

Timing:
Sales are recorded on the
correct dates.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 26

 COSO Report Identifies Revenue
Misstatement Techniques
Improper Premature
sales cutoff revenue
Sham sales
recognition

Unauthorized
Improper shipments
% of completion
Fraudulent
Techniques
Bill and hold
Conditional sales

Round-tripping
Consignment
loans as sales
sales
©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 27
 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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 28

 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 - 29

 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.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 30

 Sales Returns and Allowances

There are, however, two important differences:

Emphasis
Materiality
on
objectives

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 31

 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 - 32

 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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 33

 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 - 34

 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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 35

 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:

Allowance for
Accounts doubtful accounts
receivable
Bad debt expense

Cash

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 36

 Types of Audit Tests for the
Sales and Collection Cycle
Accounts Cash in
Sales Receivable Bank
Sales Cash receipts
transactions transactions
Audited by Audited by
TOC, STOT, and AP TOC, STOT, and AP

Ending Ending
balance balance
Audited by AP and TDB

TOC + STOT + AP + TDB

= Sufficient appropriate evidence
©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 37
 End of Chapter 14

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5-5