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12 - 1 Copyright 2003 Pearson Education Canada Inc. CHAPTER 12 Audit of the Sales and Collection Cycle: Tests of Controls
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12 - 1Copyright 2003 Pearson Education Canada Inc.
CHAPTER 12Audit of the Sales and
Collection Cycle:Tests of Controls
12 - 2Copyright 2003 Pearson Education Canada Inc.
What accounts are typically involved in the sales and What accounts are typically involved in the sales and collection cycle?collection cycle?
12 - 3Copyright 2003 Pearson Education Canada Inc.
What accounts are typically involved in the sales and What accounts are typically involved in the sales and collection cycle?collection cycle?
- sales- sales returns and allowances- bad debt expense- cash discounts taken- trade accounts receivable- allowance for uncollectible accounts- cash in the bank
12 - 4Copyright 2003 Pearson Education Canada Inc.
What What classes of transactionsclasses of transactions occur in the sales occur in the sales and collection cycle?and collection cycle?
12 - 5Copyright 2003 Pearson Education Canada Inc.
- sales (cash and credit)- cash receipts- sales returns and allowances- charge-off of uncollectible accounts- bad debt expense
What What classes of transactionsclasses of transactions occur in the sales occur in the sales and collection cycle?and collection cycle?
12 - 6Copyright 2003 Pearson Education Canada Inc.
What is the What is the sequence of business functionssequence of business functions that occurs in the sales and collection that occurs in the sales and collection
cycle?cycle?
12 - 7Copyright 2003 Pearson Education Canada Inc.
What is the What is the sequence ofsequence ofbusiness functionsbusiness functions that occurs that occurs
in the sales and collection cycle?in the sales and collection cycle?
1. A customer order is processed.
Pace CompanyCustomer Order
To: Ace CompanyPlease send us 45 gadgets on orbefore 10/25/04. Upon receipt, wewill send payment of $3 each.
12 - 8Copyright 2003 Pearson Education Canada Inc.
2. Customer credit is approved or declined.
If credit is extended to acustomer, will that customer
pay their balance at somepoint in the future?
What is the What is the sequence ofsequence ofbusiness functionsbusiness functions that occurs that occurs
in the sales and collection cycle?in the sales and collection cycle?
12 - 9Copyright 2003 Pearson Education Canada Inc.
3. The goods are shipped.
Ace CompanyShipping Document
(Bill of Lading)45 gadgets were shipped to Pace Company on 10/22/04.
What is the What is the sequence ofsequence ofbusiness functionsbusiness functions that occurs that occurs
in the sales and collection cycle?in the sales and collection cycle?
12 - 10Copyright 2003 Pearson Education Canada Inc.
4. The customer is billed and the sale is recorded.
Ace CompanySales Invoice
To: Pace CompanyDate: 10/22/04Thanks for purchasing 45 gadgets.Please remit $135 ($3 each) within 30 days.
What is the What is the sequence ofsequence ofbusiness functionsbusiness functions that occurs that occurs
in the sales and collection cycle?in the sales and collection cycle?
12 - 11Copyright 2003 Pearson Education Canada Inc.
sales journal description _ $$ _Oct. 22, 2004Pace Company 135
a/r master file customer _ $$ _Pace Company 135 balance 135
Ace CompanySales Invoice
To: Pace CompanyDate: 10/22/04Thanks for purchasing 45 gadgets.Please remit $135 ($3 each) within 30 days.
12 - 12Copyright 2003 Pearson Education Canada Inc.
sales journal description _ $$ _Oct. 22, 2004Pace Company 135
a/r master file customer _ $$ _Pace Company 135 balance 135
SummarySales
Report
This report sum-marizes all salesfor a period.
AccountsReceivable
Trial Balance
This report liststhe amount owedby each customerat a point in time.
12 - 13Copyright 2003 Pearson Education Canada Inc.
a/r master file customer _ $$ _Pace Company 135 balance 135
AccountsReceivable
Trial Balance
This report liststhe amount owedby each customerat a point in time.
Ace Company
Pace Company
stat
emen
t
encl
osed
At month-end,customer state-
ments are mailedindicating activityand amount owed.
Canada 48
12 - 14Copyright 2003 Pearson Education Canada Inc.
5. Cash receipts are processed and recorded.
Ace Company
Pace Company
Remittance Advice
Ace Company
Pace Company
What is the What is the sequence ofsequence ofbusiness functionsbusiness functions that occurs that occurs
in the sales and collection cycle?in the sales and collection cycle?
CANADIAN BANK
Canada 48
12 - 15Copyright 2003 Pearson Education Canada Inc.
Ace Company
Pace CompanyAce Company
Pace Company
A remittance advice is sent to the cus-tomer with the sales invoice. It indicatesthe customer name, sales invoice num-ber, and amount owed. The advice is re-turned to the vendor with the customer
payment.CANADIAN BANK
Canada 48
12 - 16Copyright 2003 Pearson Education Canada Inc.
Ace Company
Pace Company
Remittance Advice
Ace Company
Pace Company
A prelisting of cash receipts is prepared each day by some- one independent of accounting and cash custody. The prelisting indicates each cash receipt.
CANADIAN BANK
Canada48
12 - 17Copyright 2003 Pearson Education Canada Inc.
Ace Company
Pace Company
Remittance Advice
Ace Company
Pace Company
a/r master file customer _ $$ _Pace Company 135payment-11/2 (135) balance 0
CANADIAN BANK
Canada 48
cash receipts journaldescription _ $$ _Nov. 2, 2004Pace Company 135
12 - 18Copyright 2003 Pearson Education Canada Inc.
CREDIT MEMO When a vendor grants credit to a customer for returned goods, a credit memo is prepared and the transac- tion is recorded in the sales returns and allowances journal.
12 - 19Copyright 2003 Pearson Education Canada Inc.
AUTHORIZATION FORUNCOLLECTIBLE
ACCOUNT WRITE-OFF
This form is used when a specific accounts receivable is judged uncollectible.
12 - 20Copyright 2003 Pearson Education Canada Inc.
How does an auditor How does an auditor design tests of design tests of
controls for sales?controls for sales?
12 - 21Copyright 2003 Pearson Education Canada Inc.
How does an auditor How does an auditor design tests of design tests of controls and controls and
substantive tests for substantive tests for sales?sales?
Understand internal control as it relates
to sales
As discussedin chapter 9
12 - 22Copyright 2003 Pearson Education Canada Inc.
How does an auditor How does an auditor design tests of design tests of controls and controls and
substantive tests for substantive tests for sales?sales?
Assess the plannedcontrol risk related
to sales
Understand internal control as it relates
to sales
12 - 23Copyright 2003 Pearson Education Canada Inc.
Assess the plannedcontrol risk related
to sales
In assessing control risk, the In assessing control risk, the auditor should consider:auditor should consider:
Understand internal control as it relates
to sales
?
12 - 24Copyright 2003 Pearson Education Canada Inc.
Assess the plannedcontrol risk related
to sales
In assessing control risk, the In assessing control risk, the auditor should consider:auditor should consider:
- adequate segregation of duties- proper authorization- adequate documents and records- use of prenumbered documents- mailing of monthly statements- internal verification procedures
Understand internal control as it relates
to sales
12 - 25Copyright 2003 Pearson Education Canada Inc.
How does an auditor How does an auditor design tests of design tests of controls and controls and
substantive tests for substantive tests for sales?sales?
Assess the plannedcontrol risk related
to sales
Evaluatecost-benefit
of testingcontrols
Understand internal control as it relates
to sales
12 - 26Copyright 2003 Pearson Education Canada Inc.
Assess the plannedcontrol risk related
to sales
Evaluatecost-benefit
of testingcontrols
Will substantivetests be reduced
sufficiently to justify the cost ofperforming tests
of controls?
Understand internal control as it relates
to sales
12 - 27Copyright 2003 Pearson Education Canada Inc.
Evaluatecost-benefit
of testingcontrols
How does an auditor How does an auditor design tests of design tests of
controls for sales?controls for sales?
Assess the plannedcontrol risk related
to sales
Design tests of controls for sales
Understand internal control as it relates
to sales
12 - 28Copyright 2003 Pearson Education Canada Inc.
Evaluatecost-benefit
of testingcontrols
Assess the plannedcontrol risk related
to sales
In designing other tests In designing other tests of controls for sales, the of controls for sales, the auditor should consider:auditor should consider:
Do recordedsales actually
exist?
Understand internal control as it relates
to sales
Design tests of controls for sales
12 - 29Copyright 2003 Pearson Education Canada Inc.
Evaluatecost-benefit
of testingcontrols
Assess the plannedcontrol risk related
to sales
In designing other tests In designing other tests of controls for sales, the of controls for sales, the auditor should consider:auditor should consider:
Are allexisting salestransactionsrecorded?
Understand internal control as it relates
to sales
Design tests of controls for sales
12 - 30Copyright 2003 Pearson Education Canada Inc.
Evaluatecost-benefit
of testingcontrols
Assess the plannedcontrol risk related
to sales
In designing other tests In designing other tests of controls for sales, the of controls for sales, the auditor should consider:auditor should consider:
Are salesaccuratelyrecorded?
Understand internal control as it relates
to sales
Design tests of controls for sales
12 - 31Copyright 2003 Pearson Education Canada Inc.
Evaluatecost-benefit
of testingcontrols
Assess the plannedcontrol risk related
to sales
In designing other tests In designing other tests of controls for sales, the of controls for sales, the auditor should consider:auditor should consider:
Are recordedsales properly
classified?
Understand internal control as it relates
to sales
Design tests of controls for sales
12 - 32Copyright 2003 Pearson Education Canada Inc.
Evaluatecost-benefit
of testingcontrols
Assess the plannedcontrol risk related
to sales
In designing other tests In designing other tests of controls for sales, the of controls for sales, the auditor should consider:auditor should consider:
Are salesrecorded onthe correct
dates?
Understand internal control as it relates
to sales
Design tests of controls for sales
12 - 33Copyright 2003 Pearson Education Canada Inc.
Evaluatecost-benefit
of testingcontrols
Assess the plannedcontrol risk related
to sales
In designing othe tests of In designing othe tests of controls for sales, the controls for sales, the
auditor should consider:auditor should consider:
Are salestransactions
properly includedin the master file
and correctlysummarized?
Understand internal control as it relates
to sales
Design tests of controls for sales
12 - 34Copyright 2003 Pearson Education Canada Inc.
The auditor should also perform procedures The auditor should also perform procedures to detect to detect fraudfraud related to cash receipts. related to cash receipts.
12 - 35Copyright 2003 Pearson Education Canada Inc.
The auditor should also perform procedures The auditor should also perform procedures to detect to detect fraudfraud related to cash receipts: related to cash receipts:
Determine whethercash received was
recorded.
12 - 36Copyright 2003 Pearson Education Canada Inc.
?
The auditor should also perform procedures The auditor should also perform procedures to detect to detect fraudfraud related to cash receipts: related to cash receipts:
Prepare a proofof cash receipts.
12 - 37Copyright 2003 Pearson Education Canada Inc.
The auditor should also perform procedures The auditor should also perform procedures to detect to detect fraudfraud related to cash receipts: related to cash receipts:
A proof ofcash receipts
reconciles cashreceipts record-ed in the cash
receipts journalwith actual bank
deposits.
12 - 38Copyright 2003 Pearson Education Canada Inc.?
The auditor should also perform procedures The auditor should also perform procedures to detect to detect fraudfraud related to cash receipts: related to cash receipts:
Test to discoverlapping of accounts
receivable.
12 - 39Copyright 2003 Pearson Education Canada Inc.
LappingLapping is a fraud is a fraudscheme that occurs scheme that occurs
because of because of inadequateinadequatesegregation of dutiessegregation of duties related to mail, cash related to mail, cash
receipts, andreceipts, andaccounting.accounting.
12 - 40Copyright 2003 Pearson Education Canada Inc.
a lapping examplea lapping example
On Monday, a cheque is received from Able Co. in payment of their a/r. Thecheque is stolen by the bookkeeper! Noentry is made and all evidence of thepayment receipt is destroyed.
A/R Able $1000
A/R Baker $1000
A/R Cain $1000
CANADIAN BANK
12 - 41Copyright 2003 Pearson Education Canada Inc.
On Tuesday, a cheque is received from Baker Co. in payment of their a/r. Thepayment, however, is credited to Able’saccount.
A/R Able $1000 -1000 0
A/R Baker $1000
A/R Cain $1000
a lapping examplea lapping example
CANADIAN BANK
12 - 42Copyright 2003 Pearson Education Canada Inc.
On Wednesday, a cheque is receivedfrom Cain Co. in payment of their a/r.The payment, however, is credited toBaker’s account.
A/R Able $1000 -1000 0
A/R Baker $1000
A/R Cain $1000
-1000 0
a lapping examplea lapping example
CANADIAN BANK
12 - 43Copyright 2003 Pearson Education Canada Inc.
What audit procedures may What audit procedures may detect lapping?detect lapping?
12 - 44Copyright 2003 Pearson Education Canada Inc.
What audit procedures may What audit procedures may detect lapping?detect lapping?
- a/r confirmations (disputed balances, disputed timing of payments)
client’s a/r customer
clientCanada 48
12 - 45Copyright 2003 Pearson Education Canada Inc.
What audit procedures may What audit procedures may detect lapping?detect lapping?
- a/r confirmations (disputed balances, disputed timing of payments)
- comparison of deposit slips to cash receipts journal (different amounts, different timing)
12 - 46Copyright 2003 Pearson Education Canada Inc.
Other than adequate segregation of duties, what Other than adequate segregation of duties, what client internal control client internal control may prevent or detect may prevent or detect
lapping?lapping?
12 - 47Copyright 2003 Pearson Education Canada Inc.
Other than adequate segregation of duties, what Other than adequate segregation of duties, what client internal control client internal control may prevent or detect may prevent or detect
lapping?lapping?
requiredvacations
(and rotation ofduties during
vacations)
12 - 48Copyright 2003 Pearson Education Canada Inc.
Attributes Sampling Sequence Attributes Sampling Sequence
The attributessampling sequence issimilar to that of audit sampling. The same
credit approval examplewill be used to illustrate
attributes sampling.
