Audit of the Sales and Collection

Cycle: Tests of Controls and

Substantive Tests of Transactions

Chapter 14

©2010
©2010 Prentice
Prentice Hall
Hall Business
Business Publishing,
Publishing, Auditing
Auditing 13/e,
13/e, Arens//Elder/Beasley
Arens/Elder/Beasley 14 - 1
 Learning Objective 1
• Identify the accounts and the
• classes of transactions in the
• sales and collection cycle.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 2

 Accounts in the Sales and Collection
Cycle
Sales Cash in Bank
Cash
sales
Accounts Receivable Cash Discounts
Sales on Taken
account Beginning Cash receipts
balance

Sales on Sales returns Sales Returns

account and allowances and Allowances

Ending Write-off of
balance uncollectible Bad Debt
accounts Expense

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 3

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

©2010 Prentice Hall Business Publishing, Auditing 13/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.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 5

 Sales Transaction
Accounts Business Functions Documents and Records
Sales Processing Customer order
Accounts customer orders Sales order
Customer order or
receivable sales order
Granting credit Shipping document
Shipping goods Sales invoice
Billing customers Sales transaction file
and recording Sales journal or listing
sales Accounts receivable
master file
Accounts receivable
trial balance
Monthly statements
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 6
 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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 7

 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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 8

 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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 9

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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 10

 Processing Customer Orders

Customer Order:
 A request for merchandise by a customer

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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 11

 Granting Credit

 Before goods are shipped, a properly

authorized person must approve credit
to the customer for sales on account

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 12

 Shipping Goods

 This is the first point in the cycle

where company assets are given up

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 13

 Billing Customers and Recording
Sales
 Sales invoice
 Sales transaction file
 Sales journal or listing
 Accounts receivable master file
 Accounts receivable trial balance
 Monthly statement

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 14

 Processing and Recording Cash
Receipts
 Remittance advice

 Prelisting of cash receipts

 Cash receipts transaction file

 Cash receipts journal or listing

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 15

 Processing and Recording Sales
Returns and Allowances
 Credit memo

 Sales returns and allowances journal

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 16

 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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 17

 Providing for Bad Debts

 This provision represents a residual,

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

©2010 Prentice Hall Business Publishing, Auditing 13/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.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 19

 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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 20
 Understand Internal Control –
Sales
Study the client’s flowcharts, prepare
an internal control questionnaire, and
perform walk-through tests of sales.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 21

 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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 22

 Assess Planned Control Risk – Sales

 Adequate separation of duties

 Proper authorization
 Adequate documents and records
 Prenumbered documents
 Monthly statements
 Internal verification procedures

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 23

 Determine Extent of Testing
Controls
 Audits of public companies

 Audits of nonpublic companies

©2010 Prentice Hall Business Publishing, Auditing 13/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.

©2010 Prentice Hall Business Publishing, Auditing 13/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.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 26

 Direction of Tests for Sales
Duplicate
Customer Shipping
sales
order document
invoice

Accounts
Sales General
= receivable
journal journal
master file

Completeness Occurrence
start start
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 27
 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)

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 28

 Learning Objective 4

• Apply the methodology for controls

• over sales transactions to controls
• over sales returns and allowances.

©2010 Prentice Hall Business Publishing, Auditing 13/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.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 30

 Sales Returns and Allowances

There are, however, two important differences.

 Materiality

 Emphasis on objectives

©2010 Prentice Hall Business Publishing, Auditing 13/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.

©2010 Prentice Hall Business Publishing, Auditing 13/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

©2010 Prentice Hall Business Publishing, Auditing 13/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.

©2010 Prentice Hall Business Publishing, Auditing 13/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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 35

 Additional Internal Controls Over
Account Balances
 Realizable value
 Credit approval
 Aged accounts receivable trial balance
 Writing off uncollectibles
 Rights and obligations
 Presentation and disclosure

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 36

 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
 Bad debt expense
 Allowance for doubtful accounts

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 37

 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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 38
 End of Chapter 14

©2010
©2010 Prentice
Prentice Hall
Hall Business
Business Publishing,
Publishing, Auditing
Auditing 13/e,
13/e, Arens//Elder/Beasley
Arens/Elder/Beasley 14 - 39