Auditing

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Chapter 12 Auditing Sales and Receivables
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Overview

• Audit Objectives, audit plan audit procedures
• Sales, cash receipts and sales adjustment
  transactions

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Key Issues

• Sales are genuine and are neither overstated or
  understated.
• Receivables do actually exist and are
  collectable, and adequate allowances have been
  made for receivables that are doubtful in terms
  of their collectability.

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The Revenue Cycle

• Account Balances
• sales
• sales discounts
• a/cs receivable
• returns allowances
• cost of sales
• inventory
• bad-debts expense
• provision bad debts
• cash

• Transaction Classes
• credit sales
• cash receipts
• sales adjustments

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The Revenue Cycle

• Credit Sales Transactions
• Accepting customer orders
• Approving credit
• Filling dispatching orders
• Invoicing customers
• Recording the sales

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The Revenue Cycle

• Cash Receipts Transactions
• Receiving cash
• Over the counter
• Mail receipts
• Depositing cash in bank
• Recording receipts

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The Revenue Cycle

• Sales Adjustments
• cash discounts
• Sales returns allowances
• Bad debts

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Financial Assertions
Assertion category Transaction class audit objectives Account balance audit objectives
Existence or occurrence Recorded sales transactions represent goods shipped during the period Recorded cash receipts transactions represent cash received during the period Recorded sales adjustment transactions represent authorised discounts, returns and allowances, and bad debts applicable to the period Accounts receivable represent amounts owed by customers at balance date
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Financial Assertions
Assertion category Transaction class audit objectives Account balance audit objectives
Rights and obligations Not applicable Accounts receivable at balance date represent legal claims of the entity on customers for payment
Completeness All sales, cash receipts and sales adjustment transactions that occurred during the period have been recorded Accounts receivable include all claims on customers at balance date
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Financial Assertions
Assertion category Transaction class audit objectives Account balance audit objectives
Accuracy or valuation and allocation All sales, cash receipts and sales adjustment transactions are correctly journalised, summarised and posted Accounts receivable represent gross claims on customers at balance date and agree with the sum of the accounts receivable subsidiary ledger The allowance for bad debts represents a reasonable estimate of the difference between gross accounts receivable and their net realisable value
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Financial Assertions
Assertion category Transaction class audit objectives Account balance audit objectives
Presentation and Disclosure The details of sales, cash receipts and sales adjustment transactions support their presentation in the financial statements, including their classification and related disclosures Accounts receivable are properly identified and classified in the balance sheet Appropriate disclosures have been made concerning accounts receivable that have been factored or otherwise assigned
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The Audit Plan

• STRATEGY CONSIDERATIONS
• Mix of tests of control substantive tests to be
  applied depends on inherent control risk
  assessment materiality
• MATERIALITY
• Sales cash transactions are always material
• Accounts receivable balance is nearly always
  material

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Strategy Considerations

• INHERENT RISK
• Pressure on management to overstate revenue, cash
  receivables and understate bad debts
• High volume of transactions
• Contentious revenue recognition issues
• Cash is susceptible to misappropriation
• Sales adjustments used to conceal theft

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Strategy Considerations

• Variety magnitude of potential misstatements
  usually lead management to adopt extensive
  internal controls
• High transaction volume means lower assessed
  level of CR approach is more efficient for sales
  cash receipt transactions
• Where transaction volume is low /or controls
  ineffective, predominately substantive approach
  should be used

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Control Risk

• Control environment may reduce inherent risk
• Auditor must test the design effectiveness and
  operating effectiveness of the ICS over sales
• Based on results of tests, final assessment of CR
  is made and hence level of substantive testing
  planned
• See text Table 12.2

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Control Risk
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Control Risk
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Substantive Testing

• Main focus is gross amount due from customers on
  credit sales, and related allowance for doubtful
  debts
• Acceptable level of detection risk must first be
  determined
• Table 12.5 shows a standard substantive testing
  program for accounts receivable assertions

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Substantive Testing

• Initial Procedures
• Trace opening balances
• Review activity
• Agree accounts receivable trial balance
• Analytical Procedures
• Tests of Details of Transactions
• Vouch accounts receivables
• Test sales cash receipts cut-offs

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Substantive Testing

• Tests of Details of Balances
• Confirming accounts receivable
• ASA 505 External Confirmations
• Reliable external evidence on existence rights
  assertions
• Evaluate adequacy of bad debts provision
• 5. Presentation Disclosure

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Summary

• Sales and receipts from sales are the most
  important transaction classes for commercial
  entities
• A major focus of audit effort
• Major inherent risk for auditor is overstatement
  of revenues assets major risk for entity is
  misappropriation of cash

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• The accounts receivable clerk, Mary Herman, who
  receives a salary of P15,000 per month, has
  just purchased a new BMW. You, the internal
  auditor will be testing the accuracy of the
  accounts receivable balance of P117,000 as shown
  in the ledger.
• the following information is
  available for the first year of operation
• Collections from customers P 198,000
• Merchandise purchased 320,000
• Ending merchandise inventory
  70,000
• Goods are marked to sell at 40 above cost
• Instructions compute an estimate of the ending
  balance of accounts receivable from customers
  that should appear in the ledger and any apparent
  shortages. Assume all sales are made on account.

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