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Audit of the Sales andCollection Cycle

Chapter 14

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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

Endingbalance

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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/Purchase Order:A request for merchandise

by a customer

Sales Order: A document describing the

goods ordered by a customerCredit check and

Authorization to ship

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Granting Credit

Before goods are shipped, a properlyauthorized person (system) must approve credit

to the customer for sales on account.Access controls

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Sales Transaction

Accounts

BusinessFunctions

Documentsand Records

Sales (credit)Accounts receivable (debit) esp. B2B/Big Ticket

Processing customer orders,Granting credit, Shipping goods,Billing customers and recording sales (j/e)

PO,SO, Shipping Document, Sales invoice (bill), Sales journal or listing, Accounts receivableMaster file/sub ledger (confirmation), Monthly statements sent to customers

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Cash Receipts Transaction

Accounts

BusinessFunctions

Documentsand Records

Cash in bank (debit: form = check, EFT, credit card, etc.); Accounts receivable (credit)OR B2C: dr. cash, cr. sales

Processing and recording cash receiptsSeparation of duties key!

Remittance advise, Prelisting of cash receiptsSeparateCash receipts journal or listing, Bank rec,and A/R records

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Sales Returns and Allowances Transaction

Accounts

BusinessFunctions

Documentsand Records

Sales returns and allowances (debit–contra sales)Accounts receivable (credit)

Processing and recordingsales returns and allowances

Credit memo – put inv. back and credit customerSeparateSales returns and allowances journal, A/R files

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Bad Debt ExpenseTransaction

Accounts

BusinessFunctions

Documentsand Records

Bad debt expense (debit-contra sales)Allowance for uncollectible accounts(cr. contra A/R) – Estimate! Matching Princ.Providing for bad debts – Authorization andreview,Separate from handling of cash!

General journal - Adjustment

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Charge-off of Uncollectible Accounts Transaction

Accounts

BusinessFunctions

Documentsand Records

Accounts receivable (credit)Allowance for uncollectible accounts (debit)No I/S effect – for known uncollectibles

Charging off uncollectibleaccounts receivable – Authorization, Doc., Separation from cash handling

Uncollectible account authorization formA/R master files and G/L

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Learning Objective 3

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 procedures/StaffingSample size/Budget

Items to selectTiming

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Understanding InternalControl – Sales

Study the client’s flowcharts,prepare an internal control

questionnaire/matrix, and performwalk-through of sales.

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Preliminarily Assess Control Risk – Sales

Adequate separationof duties

Proper authorization (C1)Adequate documents

and records (C2) PrenumberedDocuments (C5)

Monthly statements (C9) Internal verification

procedures (C6)See p. 452 (col 2) for

listing of controls!

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Control Risk below MAX?

Evaluate cost-benefitof testing controls.

Design tests ofcontrols for sales.See p. 452 (col 3)!

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Transaction-Related AuditObjectives for Sales

Why are we going over Occurrence and Accuracy?Is there a method to my madness?????????

Accuracy (let’s go over I/C and ToT): :Recorded sales are for the amount shipped.

Completeness:Existing sales transactions are recorded.

Occurrence (let’s go over I/C and ToT):Recorded sales are for shipments actually made.

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Direction of Tests for Sales

Customerorder

Shippingdocument

Duplicatesales invoice

Salesjournal

Generalledger

Accountsreceivablemaster file

=

Completeness Start

Occurrence Start

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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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Summary of Methodologyfor Sales

Table 14-2 p. 452:Column 1: Transaction-related audit objectivesColumn 2: Key internal controls (quest. and matrix)Preliminary CR – test controls or CR at max?Column 3: Test of controls – Final CR assessmentColumn 4: Weaknesses – Material? Inc. CR? SOX report? Remediate? Compensating control?Column 5: Have DR, Substantive tests of transactionsIf Prel. CR adjusted upwards for final CR– more ToT!!

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Learning Objective 5

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 Testsof Transactions for Cash Receipts

Table 14-3 p. 461– same process as Sales! Most important:

Determine whether cash received was recorded(completeness) Sep. duties, send mthly statements,

Test to discover lapping of accounts receivable:Pocket cash and cover A/R with next cash receipt, and so on – separation, vacation, compare name, timing,

and amount on remittance to cash receipts and A/R j/e• Prepare proof of cash receipts: trace from cash

receipts journal to bank deposits, bank rec (occurrence)

Table 14-3 p. 461– same process as Sales! Most important:

Determine whether cash received was recorded(completeness) Sep. duties, send mthly statements,

Test to discover lapping of accounts receivable:Pocket cash and cover A/R with next cash receipt, and so on – separation, vacation, compare name, timing,

and amount on remittance to cash receipts and A/R j/e• Prepare proof of cash receipts: trace from cash

receipts journal to bank deposits, bank rec (occurrence)

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Learning Objective 6

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-I/C and ToT

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

Covering up cash pocketed by writing off accounts receivable that have been collected. I/Cs: Separation of duties, proper documentation and authorization. ToTs: compare write-offs to independent credit reports, look at past payment history.

Occurrence – writing off A/R accounts that have been “collected.” We will hammer completeness

and real. value in A/R testing (analysis of aging).

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Effect of Results of Controls andSubstantive Tests of

TransactionsIn summary, the parts of the audit most affected by the tests (I/C and ToT) for the sales and collection cycle are:

AccountsReceivable – less confirms?

Cash – smaller sampleFor Dep. In-transit?

Bad debtExpense – bigger AP

Threshold?

Allowance fordoubtful accounts – bigger AP threshold?

Sales – only AP?

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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 + TDB= Sufficient competent evidence per GAAS

Audited byTOC, STOT

Audited by AP and TDB

Audited byTOC, STOT

Audited by AP and TDB

Endingbalance

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End of Chapter 14