Chapter 14 | Bad Debt | Debits And Credits

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.

resulting from management’s end-of-period adjustment of the allowance for uncollectible accounts.Providing for Bad Debts This provision represents a residual. .

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) Management’s 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.

Design tests of controls and substantive tests of transactions for sales to meet transaction -related audit objectives.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. Audit procedures Sample size Items to select Timing .

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

Identify key internal controls and deficiencies 3. Framework for assessing control risk 2.Assess Planned Control Risk – Sales 1. 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 .

Completeness: Existing sales transactions are recorded.Transaction-Related Audit Objectives for Sales Existence: Recorded sales are for shipments actually made. . Accuracy: Recorded sales are for the amount shipped.

Posting and summarization: Sales transactions are properly included in the accounts receivable master file. Timing: Sales are recorded on the correct dates. .Transaction-Related Audit Objectives for Sales Classification: Sales transactions are properly classified.

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 client’s methods of controlling misstatements are essentially the same for processing credit memos as those described for sales. .

Materiality Emphasis on objectives . however. two important differences.Sales Returns and Allowances There are.

Prepare proof of cash receipts.Tests of Controls and Substantive Tests of Transactions for Cash Receipts    Determine whether cash received was recorded. . Test to discover lapping of accounts receivable.

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 .Audit Tests for Uncollectible Accounts Existence of recorded write-offs is the most important transaction-related audit objective.

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 .

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