COURSE : AUDIT I

TOGDHER UNIVERSITY

COURSE: AUDIT I

CHAPTER Five: Audit of Revenue and Collection Cycle

SEMESTER SEVEN: ACCOUNTING

INSTRUCTOR: ABDIHAKIM TIYARI ( BA, MBA).

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Chapter 5

Audit of Revenue and

Collection Cycle

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 INTERNAL CONTROL OVER SALES AND
COLLECTION CYCLE
 The numerous documents and records used
by large companies in processing credit sales
transactions often include the following:
Customer order: a request for goods or service
by a customer
Sales order: A document describing the goods
ordered by a customer
Shipping documents: This is the first point in
the cycle where company assets are given up
Sales invoice: detail information of the goods
and basic document for recording the goods.3
 Cont’d
• Sales Journal: a journal for recording sales
• Credit Memo: document that shows the returned goods or
an allowance granted to customer
• Remittance advice: like cash receipt voucher, used for the
record of customer name, sales invoice no. and the amount
received.
• Cash receipt Journal: used to record cash received from
customer
• Accounts Receivable subsidiary ledger(master file): for
recording individual sales, cash receipt and sales return and
allowance
• Customer monthly statement: document sent to customer
that shows detail information of subsidiary ledger
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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 Audit procedures

substantive tests of transactions Sample size
for sales to meet transaction- Items to select
related audit objectives Timing
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 Substantive Tests of Sales Transactions

A. Recorded sales are valid

For this objective, the auditor is concerned
with two types of misstatements: sales
being included in the journals for which
no shipment was made and shipments
being made to fictitious customers.
Appropriate substantive tests of
transactions for invalid transactions
depends on where the auditor believes
misstatements are likely to occur.
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 B. Sales are properly authorized

• It is necessary to test by substantive

procedures whether the firm’s
general credit, shipping, and
pricing policies are being followed.
This is especially true of pricing
sales.

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 C. Recorded sales are properly valued

• This deals with shipping the amount of goods

ordered, correctly billing for the amount of
goods shipped, and correctly recording the
amount billed. A typical substantive test is to
start with entries in the sales journal and
compare the total of selected transactions
with A/R master file entries and duplicate
sales invoices. If a control is effective, the
sample size for substantive tests of
transactions can be reduced.
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 D. Recorded sales are properly
classified
• Here the auditor examines supporting
documents to determine the proper
classification of a transaction and
compares this to the actual account to
which it is charged.

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 E. Sales are recorded on a
timely basis
• Transactions could be omitted from the
accounting records or sales could be
recorded in the wrong period if they
are not recorded on a timely basis.
Significant differences between the
dates on shipping invoices and
duplicate sales invoices could indicate a
cutoff problem. 10
F. Sales transactions are properly included in the master file and correctly
summarized.

• It is necessary to perform some clerical accuracy

tests by footing the journals and tracing the totals
and details to the general ledger and the master
file to check whether there are misstatements.
The distinction between the summarization and
other objectives is that summarization includes
footing journals, master file records, and ledgers
and tracing from one to the other among the
three.

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Exhibit 7.4 Assertions about Classes of Transactions
7-12
and Events for the Period

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 Part two

11/26/2021 13
 AUDITING ACCOUNTS RECEIVABLE

• Test Aged Listing of Accounts

Receivable
• Confirm balances.
• Perform analytical procedures
• Test sales cut-off
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 7-15
Exhibit 7.6Assertions and Substantive
Procedures in the Revenue and Collection Cycle

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 Audit of Cash

NATURE OF CASH
• Cash and bank balances are liquid assets and
include:
• Notes and units.
• Bank current accounts.
• Bank deposit accounts.
 Because of their liquidity, these assets represent
the most vulnerable of all the company’s assets.
On the other hand, they are the most easily
verified, because they can be confirmed directly
by third parties or by physical counts. 16
 THE AUDITORS’ OBJECTIVES IN
EXAMINATION OF CASH
• The auditors have five objectives in the audit of cash:
– Consider internal control over cash transactions.
– Determine the existence of recorded cash and the
client’s ownership of this asset.
– Establish the completeness of recorded cash.
– Establish the clerical accuracy of cash schedules.
– Determine that the statement presentation of cash is
appropriate.
• The overall objective of the audit of cash is to
determine that cash is fairly presented in conformity
with International Financial Reporting Standard
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 Special five evidential procedures for cash
The following five procedures merit additional discussion
because of their importance and complexity: receipt of a
bank confirmation, receipt of a cutoff bank statement, tests
of the bank reconciliation, test of lapping and test of kitting.
1. Receipt of a Bank Confirmation: all other information
on the reconciliation should be traced to the relevant
audit schedules. If the bank confirmation does not agree
with the audit schedules, auditors must investigate the
difference.
2. Receipt of a Cut-off Bank Statement: A cut-off bank
statement is a partial-period bank statement and the
related copies of cancelled checks, duplicate deposit slips,
and other documents included in bank statements,
mailed by the bank directly to the audit firm’s office. 18
3. Tests of the Bank Reconciliation
Well-prepared independent bank reconciliation
is an essential internal control over cash.
Auditors test the bank reconciliation to
determine whether client personnel have
carefully prepared the bank reconciliation and to
verify whether the client’s recorded bank balance
is the same amount as the actual cash in the bank
except for deposits in transit, outstanding
checks, and other reconciling items.

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 4. Test to Discover Lapping
Lapping: is the postponement of entries for the
collection of receivables to conceal an existing cash
shortage.
• Recording of receipt from one customer is deferred and
the shortage covered from with receipts from another
customer
• This fraud is perpetrated by a person who records cash
both in the cash receipts journal and the subsidiary
ledger
• The fraud can be detected comparing the name,
amount, and date on remittance advice with cash
journal entries and related deposit slips
• This test is performed where there is weakness in control
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 5. Tests for kitting
Kitting: is transferring money from one bank to
another and improperly recording the transaction.
Near the balance sheet date a check is immediately
drawn on bank account and immediately deposited in
a second account before end of the period at a late
enough date so that it does not clear the first bank
before the end of the period. The amount of the
transfer is recorded as asset in both banks.
 A useful approach is to list all bank transfers made
a few days before and after the balance sheet date
and to trace each to the accounting records.
Performed regardless of the system of internal
control 21
 Audit of Petty Cash
• Petty cash is a unique account. Although it is often
immaterial in amount, many auditors verify petty
cash primarily because of the potential for
embezzlement and the client’s expectation that
auditors will examine the account, even when the
amount is immaterial.
• The most important internal control for petty cash
is the use of an imprest fund that is the
responsibility of one individual. In addition, petty
cash funds should not be mixed with other receipts,
and the fund should be kept separate from all other
activities. 22