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Audit of the Sales andCollection Cycle

Chapter 13

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Learning Objective 1

Identify the accounts and the

classes of transactions in the

sales and collection cycle.

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Accounts in the Salesand Collection Cycle

SalesCashsales

Sales onaccount

Cash in Bank

Cash DiscountsTaken

Sales Returnsand Allowances

Bad DebtExpense

Accounts ReceivableBeginning Cash receiptsbalance

Sales returnsSales on and allowancesaccount

Charge-off ofEnding uncollectiblebalance accounts

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Accounts in the Salesand Collection Cycle

Accounts ReceivableBeginning Cash receiptsbalance

Sales returnsSales on and allowancesaccount

Charge-off ofEnding uncollectiblebalance accounts Bad Debt

Expense

Allowance for Uncollectible AccountsCharge-off of Beginninguncollectible balanceaccounts

Estimate of baddebt expense

Ending balance

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Learning Objective 2

Describe the business functions

and the related documents and

records in the sales and

collection cycle.

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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 properlyauthorized person must approve creditto the customer for sales on account.

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Sales Transaction

Accounts

BusinessFunctions

Documentsand Records

SalesAccounts receivable

Processing customer orders,Granting credit, Shipping goods,Billing customers and recording sales

Sales invoice, Sales journal or listing, Salestransaction file, Accounts receivable masterfile and trial balance, Monthly statements

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Cash Receipts Transaction

Accounts

BusinessFunctions

Documentsand Records

Cash in bank (debits from cash receipts)Accounts receivable

Processing and recording cash receipts

Remittance advise, Prelisting of cash receipts,Cash receipts transaction file,Cash receipts journal or listing

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 10

Sales Returns and Allowances Transaction

Accounts

BusinessFunctions

Documentsand Records

Sales returns and allowancesAccounts receivable

Processing and recordingsales returns and allowances

Credit memoSales returns and allowances journal

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Charge-off of Uncollectible Accounts Transaction

Accounts

BusinessFunctions

Documentsand Records

Accounts receivableAllowance for uncollectible accounts

Charging off uncollectibleaccounts receivable

Uncollectible account authorization formGeneral journal

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Bad Debt ExpenseTransaction

Accounts

BusinessFunctions

Documentsand Records

Bad debt expenseAllowance for uncollectible accounts

Providing for bad debts

General journal

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Shipping Goods

This is the first point in the cyclewhere company assets are given up.

Shippingdocument

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Billing Customersand 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 RecordingCash Receipts

Remittance advise

Prelisting of cash receipts

Cash receipts transaction file

Cash receipts journal or listing

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Lockbox Systems and Electronic Funds Transfer

CustomerCustomer

Bank

Order/PaymentInformation

CompanyCompany

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Processing and Recording Sales Returns and Allowances

Credit memo

Sales returns andallowances journal

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Charging Off UncollectibleAccounts Receivable

Uncollectible AccountAuthorization Form

This is a document used internally toindicate authority to write an account

receivable off as uncollectible.

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Providing for Bad Debts

This provision represents a residual,resulting from management’s

end-of-period adjustment of theallowance for uncollectible accounts.

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Learning Objective 3

Understand how e-commerce

activities affect the

sales and collection cycle.

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Effect of E-Commerce on the Sales and Collection Cycle

The Internet

The Internet andother developing

technologies allowcompanies to developnew business models.

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Effect of E-Commerce on the Sales and Collection Cycle

Business-to-business (B2B)

Business-to-consumer (B2C)

Management’s assertions for sales andcollection activities remain the same.

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Effect of E-Commerce on the Sales and Collection Cycle

Auditors should obtain an understandingof the design and operation of key internal

controls over e-commerce revenues.

Evidence for e-commerce activitiesis likely to be in electronic form.

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Learning Objective 4

Understand internal control

and design and perform tests

of controls and substantive

tests of transactions for sales.

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Methodology for Designing Controlsand Substantive Tests: Sales

Understand internalcontrol – sales

Assess plannedcontrol risk – sales

Evaluate cost-benefitof testing controls.

Design tests of controlsand substantive tests

of transactions for salesto meet transaction-

related audit objectives.

Audit proceduresSample size

Items to selectTiming

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Understanding InternalControl – Sales

Study the client’s flowcharts,prepare an internal controlquestionnaire, and performwalk-through tests of sales.

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Assess PlannedControl Risk – Sales

Adequate separationof duties

Proper authorizationAdequate documentsand records Prenumbered

documents Monthly statements Internal verification

procedures

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Internal Verification Procedures

Evaluate cost-benefitof testing controls.

Design tests ofcontrols for sales.

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Transaction-Related AuditObjectives for Sales

Existence:Recorded sales are for shipments actually made.

Accuracy:Recorded sales are for the amount shipped.

Completeness:Existing sales transactions are recorded.

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Design Substantive Testsof Transactions for Sales

Classification:Sales transactions are properly classified.

Timing:Sales are recorded on the correct dates.

Posting and summarization:Sales transactions are properly includedin the accounts receivable master file.

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Direction of Tests for Sales

Customerorder

Shippingdocument

Duplicatesales invoice

Salesjournal

Generalledger

Accountsreceivablemaster file

=

Completeness Start

Existence Start

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Summary of Methodologyfor Sales

Column 1: Transaction-related audit objectivesColumn 2: Key internal controlsColumn 3: Test of controlsColumn 4: WeaknessesColumn 5: Substantive tests of transactions

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Learning Objective 5

Apply the methodology for

controls over sales transactions

to controls over sales

returns and allowances.

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Sales Returnsand Allowances

The transaction-related audit objectivesand client’s methods of controlling

misstatements are essentially the samefor processing credit memos as those

described for sales.

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Sales Returnsand Allowances

There are, however, two important differences.

MaterialityEmphasis on

objectives

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Learning Objective 6

Understand internal control and

design and perform tests of

controls and substantive tests

of transactions for cash receipts.

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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

Determine whether cash received was recorded Prepare proof of cash receipts Test to discover lapping of accounts receivable

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 38

Learning Objective 7

Apply the methodology for controls

over the sales and collection cycle

to write-offs of uncollectible

accounts receivable.

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Audit Tests forUncollectible Accounts

Existence of recorded write-offs is the mostimportant transaction-related audit objective.

What is a major concern in testing accountscharged off as uncollectible?

– covering up a defalcation by charging offaccounts receivable that have been collected

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Additional Internal ControlsOver Account Balances

Realizable value

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 thetests for the sales and collection cycle are:

Accountsreceivable

Cash

Bad debtexpense

Allowance fordoubtful accounts

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Role of all Audit Tests in the Sales and Collection Cycle

SalesAccounts

ReceivableCash inBank

Salestransactions

Cash receiptstransactions

Endingbalance

Endingbalance

TOC + STOT + AP + TDP= Sufficient competent evidence per GAAS

Audited byTOC, STOT, and AP

Audited by AP and TDP

Audited byTOC, STOT, and AP

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End of Chapter 13