Audit of the Sales and Collection Cycle Tests

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Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of

Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions Chapter 14 © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 14 - 1

Learning Objective 1 Identify the accounts and the classes of transactions in the sales

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 sales Sales on account Cash

Accounts in the Sales and Collection Cycle Sales Cash sales Sales on account Cash in Bank Accounts Receivable Beginning Cash receipts balance Cash Discounts Taken Sales on account Sales returns and allowances Sales Returns and Allowances Ending balance Write-off of uncollectible accounts © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Bad Debt Expense 14 - 3

Accounts in the Sales and Collection Cycle Accounts Receivable Beginning Cash receipts balance Sales

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

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 Sales Accounts receivable Business Functions Documents and Records Processing customer orders

Sales Transaction Accounts Sales Accounts receivable Business Functions Documents and Records Processing customer orders Granting credit Shipping goods Billing customers and recording sales © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 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 14 - 6

Cash Receipts Transaction Accounts Business Functions Documents and Records Cash in bank Processing and

Cash Receipts Transaction Accounts Business Functions Documents and Records Cash in bank Processing and (debits from recording cash receipts) receipts Accounts receivable © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Remittance advice Prelisting of cash receipts Cash receipts transaction file Cash receipts journal or listing 14 - 7

Sales Returns and Allowances Transaction Accounts Business Functions Documents and Records Sales returns and

Sales Returns and Allowances Transaction Accounts Business Functions Documents and Records Sales returns and allowances Accounts receivable Processing and recording sales returns and allowances © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Credit memo Sales and returns and allowances journal 14 - 8

Write-off of Uncollectible Accounts Transaction Accounts Business Functions Documents and Records Accounts Writing off

Write-off of Uncollectible Accounts Transaction Accounts Business Functions Documents and Records Accounts Writing off receivable uncollectible Allowance for accounts uncollectible receivable accounts © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Uncollectible account authorization form General journal 14 - 9

Bad Debt Expense Transaction Accounts Business Functions Documents and Records Bad debt Providing for

Bad Debt Expense Transaction Accounts Business Functions Documents and Records Bad debt Providing for bad expense debts Allowance for uncollectible accounts © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley General journal 14 - 10

Processing Customer Orders Customer Order: Ø A request for merchandise by a customer Sales

Processing Customer Orders Customer Order: Ø A request for merchandise by a customer Sales Order: Ø A document describing the goods ordered by a customer © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 11

Granting Credit Ø Before goods are shipped, a properly authorized person must approve credit

Granting Credit Ø 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 Ø This is the first point in the cycle where company assets

Shipping Goods Ø 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 Ø Sales invoice Ø Sales transaction file Ø Sales

Billing Customers and Recording Sales Ø Sales invoice Ø Sales transaction file Ø Sales journal or listing Ø Accounts receivable master file Ø Accounts receivable trial balance Ø Monthly statement © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 14

Processing and Recording Cash Receipts Ø Remittance advice Ø Prelisting of cash receipts Ø

Processing and Recording Cash Receipts Ø Remittance advice Ø Prelisting of cash receipts Ø Cash receipts transaction file Ø 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 Ø Credit memo Ø Sales returns and

Processing and Recording Sales Returns and Allowances Ø Credit memo Ø Sales returns and allowances journal © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 16

Writing Off Uncollectible Accounts Receivable Ø Uncollectible account authorization form Ø This is a

Writing Off Uncollectible Accounts Receivable Ø Uncollectible account authorization form Ø 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 Ø This provision represents a residual, resulting from management’s end-of-period

Providing for Bad Debts Ø 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

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

Methodology for Designing Controls and Substantive Tests Understand internal control – sales Assess planned control risk – sales Determine extent of testing controls Audit procedures Design tests of controls and Sample size substantive tests of transactions 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,

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

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 Ø Adequate separation of duties Ø Proper authorization

Assess Planned Control Risk – Sales Ø Adequate separation of duties Ø Proper authorization Ø Adequate documents and records Ø Prenumbered documents Ø Monthly statements Ø Internal verification procedures © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 23

Determine Extent of Testing Controls Ø Audits of public companies Ø Audits of nonpublic

Determine Extent of Testing Controls Ø Audits of public companies Ø 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:

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

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 Customer order Sales journal Shipping document Duplicate sales invoice

Direction of Tests for Sales Customer order Sales journal Shipping document Duplicate sales invoice General journal Accounts receivable master file Completeness start © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley = Occurrence start 14 - 27

Summary of Methodology for Sales Ø Transaction-related audit objectives (Column 1) Ø Key existing

Summary of Methodology for Sales Ø Transaction-related audit objectives (Column 1) Ø Key existing controls (Column 2) Ø Tests of control (Column 3) Ø Deficiencies (Column 4) Ø 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

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

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. Ø Materiality Ø Emphasis

Sales Returns and Allowances There are, however, two important differences. Ø Materiality Ø 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

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 Ø Determine whether

Tests of Controls and Substantive Tests of Transactions for Cash Receipts Ø Determine whether cash received was recorded Ø Prepare proof of cash receipts* ØTest 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

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 Ø Occurrence transaction-related audit objective Ø

Audit Tests for the Write-Off of Uncollectible Accounts Ø Occurrence transaction-related audit objective Ø Proper authorization of the write-off of uncollectible accounts Ø Verification of accounts written off © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 14 - 35

Additional Internal Controls Over Account Balances Ø Realizable value Ø Credit approval Ø Aged

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

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: Ø Accounts receivable Ø Cash Ø Bad debt expense Ø 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 Sales Accounts Cash in

Types of Audit Tests for the Sales and Collection Cycle Sales Accounts Cash in Receivable Bank Sales Cash receipts transactions Audited by TOC, STOT, and AP Ending 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 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 14

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