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

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Audit of the Sales and Collection CycleTests of
Controls and Substantive Tests of Transactions

• Chapter 14

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Overview of Accounts in the Sales and Collection
Cycle
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Accounts in the Sales and Collection Cycle
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Analysis of the Sales and Collection Cycle

• Excellent format for analysis
• Business Functions
• Accounts involved
• Documents and Records
• Think Accounting Information Systems

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Sales Transaction
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Cash Receipts Transaction
Accounts

• Cash in bank
• (debits from
• cash receipts)
• Accounts
• receivable

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Sales Returns and Allowances Transaction
Accounts

• Sales returns
• and
• allowances
• Accounts
• receivable

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Charge-off of Uncollectible Accounts Transaction
Accounts

• Accounts
• receivable
• Allowance for
• uncollectible
• accounts

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Bad Debt Expense Transaction
Accounts

• Bad debt
• expense
• Allowance for
• uncollectible
• accounts

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Processing Customer Orders
Customer Order A request for merchandise by a
customer
Sales Order A document describing the goods
ordered by a customer
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Granting Credit
Before goods are shipped, a properly authorized
person must approve credit to the customer for
sales on account.
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Shipping Goods
This is the first point in the cycle where
company assets are given up.
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Billing Customers and Recording Sales
Sales invoice
Sales transaction file
Sales journal or listing
Accounts receivable master file
Accounts receivable trial balance
Monthly statement
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Processing and Recording Cash Receipts
Remittance advice
Prelisting of cash receipts
Cash receipts transaction file
Cash receipts journal or listing
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Processing and Recording Sales Returns and
Allowances
Credit memo
Sales returns and allowances journal
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Charging Off UncollectibleAccounts Receivable
Uncollectible account authorization form
This is a document used internally to indicate
authority to write an account receivable off as
uncollectible.
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Providing for Bad Debts
This provision represents a residual, resulting
from managements end-of-period adjustment of
the allowance for uncollectible accounts.
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Effect of E-Commerce on the Sales and Collection
Cycle
The Internet and other developing technologies
allow companies to develop new business models.
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Effect of E-Commerce on the Sales and Collection
Cycle
Business-to-business (B2B)
Business-to-consumer (B2C)
Managements assertions for sales and collection
activities remain the same.
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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.
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Methodology for Designing Controls and
Substantive Testsof Sales Transactions for Sales
Understand internal control sales.
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Understand Internal Control Sales
Study the clients flowcharts, prepare an
internal control questionnaire, and perform
walk-through tests of sales.
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Assess Planned Control Risk Sales
Four Steps
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
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Assess Planned Control Risk Sales
Adequate separation of duties
Proper authorization
Adequate documents and records
Prenumbered documents
Monthly statements
Internal verification procedures
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Determine Extent of Testing Controls
Audits of public companies
Audits of nonpublic companies
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Transaction-Related AuditObjectives for Sales
Existence Recorded sales are for shipments
actually made.
Completeness Existing sales transactions are
recorded.
Accuracy Recorded sales are for the amount
shipped.
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Transaction-Related AuditObjectives for Sales
Classification Sales transactions are properly
classified.
Timing Sales are recorded on the correct dates.
Posting and summarization Sales transactions are
properly included in the accounts receivable
master file.
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Direction of Tests for Sales
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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)
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Sales Returns and Allowances
The transaction-related audit objectives
and clients methods of controlling
misstatements are essentially the same for
processing credit memos as those described for
sales.
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Sales Returns and Allowances
There are, however, two important differences.
Materiality
Emphasis on objectives
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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.

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Audit Tests for Uncollectible Accounts
Existence of recorded write-offs is the
most important transaction-related audit
objective.
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
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Additional Internal Controls Over Account Balances
Realizable value
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Additional Internal Controls Over Account Balances
Rights and obligations
Presentation and disclosure
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Effect of Results of Controls andSubstantive
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
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Types of Audit Tests for the Sales and Collection
Cycle