Chapter 14Audit of the Sales and Collection

Cycle

Statement

Presentation Outline

I. Accounts and Documents in the Sales and Collection Cycle

II. Segregation of Duties

III. Sales Transaction Audit Objectives

IV. Sales Return and Allowance Audit Objectives

V. Cash Collection Transaction Audit Objectives

VI. Other Sales and Collection Cycle Considerations

I. Accounts and Documents in the Sales and Collection Cycle

A. Accounts in the Sales and Collection Cycle

B. Documents in the Sales and Collection Cycle

A. 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

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

A. Accounts in the Salesand Collection Cycle (continued)

B. Documents in the Sales and Collection Cycle

Bill of lading – a written contract between a carrier and seller for the receipt and shipment of goods.

Sales invoice – a document indicating the description and quantity of goods sold, the price, freight charges,

insurance, terms, and other relevant data. Credit memo – a document indicating a reduction in the

amount due from a customer because of returned goods or an allowance granted

Remittance advice – a document that accompanies the sales invoice mailed to the customer that can be returned

to the seller with the cash payment Customer statement – A document summarizing

customer balance and account activity, that is sent to the customer for billing purposes.

II. Segregation of Duties in the Revenue Cycle

A. Authorizing sales transactions

B. Approving credit

C. Recording sales

D. Maintaining custody of goods

E. Suggested List of Duties to be Segregated

A. Authorizing Sales Transactions

Sales transactions are initiated by a customer order. The customer

order provides the basis for preparing a

sales order.

B. Approving Credit

A copy of the sales order is sent to the credit

department for approval. A computer may simply compare preestablished credit

limits to see if the customer has credit

available

C. Recording Sales

Accounts receivable maintains the accounts receivable subsidiary

ledger. May be a computerized

accounts receivable master file.

General accounting maintains control accounts in the general ledger.

D. Maintaining Custody of Goods

Custody of goods in warehouse or awaiting

shipment.

E. Suggested List of Duties to be Segregated

Authorization Functions: Receiving orders for sales

Granting credit and pursuing unpaid accounts

Recordkeeping Functions: Billing customers and recording sales

Maintaining inventory records Maintaining general ledger accounting records

Maintaining detailed accounts receivable records

Custody of Asset Functions: Shipping goods

Processing cash receipts

III. Sales Transaction Audit Objectives

A. Existence

B. Completeness

C. Accuracy

D. Classification

E. Timing

F. Posting and Summarization

Note: See Table 13-2 on pages 382-383 for a full description of Transaction-related objectives for sales

A. Sales Transactions Existence

Test of control – Examine sales invoice for supporting bill of lading and customer order.

Substantive test – Auditor is concerned with three types of misstatements:

Recorded sale with no shipment – Trace from sales journal entry to shipping document

Sale recorded more than once – Check cancellation of shipping documentation.

Shipments made to nonexistent customers – Person recording sales should not authorize shipments.

B. Sales Transactions Completeness

Test of control – Account for sequence of shipping documents.

Substantive test – Many audits ignore completeness on the grounds that overstatement

of income are of greater concern. However, errors may still misstate financial statements. One effective procedure is to trace from shipping

documents to the sales invoice and entry in the sales journal.

C. Sales Transactions Accuracy

Test of control – Examine the approved price list for accuracy and proper authorization.

Substantive test – Start with entries in the sales journal and compare the total of selected

transactions with accounts receivable master file entries and duplicate sales invoices.

D. Sales Transactions Classification

Test of control – Examine document package for duplicate verification.

Substantive test – When there are cash and credit sales, it is important not to debit accounts

receivable for a cash sale or to credit sales for collection of a receivable. It is also important not to classify sales of operating assets as sales. A common procedure is to examine duplicate sales

invoice for proper account classification.

E. Sales Transactions Timing

Test of control –Account for sequence of shipping documents.

Substantive test – Sales should be billed when ownership is transferred to the customer. A common procedure is to compare the date of

recording a sale in the sales journal with the date on the duplicate sales invoice and bill of lading.

F. Sales Transactions Posting and Summarization

Test of control – Examine evidence that accounts receivable master file is reconciled to the general

ledger.

Substantive test – Use audit software to foot and cross-foot the sales journal and trace totals to the

general ledger.

IV. Sales Return and Allowance Audit Objectives

A. An Internal Control for Existence

B. An Internal Control for Completeness

C. Common Types of Transactions

The objectives and methodology for auditing sales returns

and allowances is the same as for sales. The same procedure

can be used to develop suitable controls, tests of controls, and

substantive tests of transactions to verify the amounts.

A. Sales AdjustmentExistence

Ensuring that recorded sales adjustments

actually occurred is important because a

diversion of cash from an account

receivable collection could be covered up by a fictitious sales return or allowance.

Ensure that all sales returns and allowances and charge-

offs are approved by appropriate personnel.

B. Sales AdjustmentCompleteness

Unrecorded sales returns and allowances can be

material and can be used by a company’s

management to overstate net income.

Sales Adjustment FormDiscount for Damaged merchandise

Approval$5RS

General Journal

Sales Allowance 5 Acc. Rec. 5

Ensure that prenumbered salesadjustment forms are used,

and that all forms are accounted for.

Form #36

Record Adjustment #36

C. Major Types of Sales Adjustment Transactions

1. Customers may receive discounts for paying early.

2. Customers may return goods or request selling price reductions.

3. Incorrect billing.

4. Bad debt write-offs.

V. Cash Collection Transaction Audit Objectives

A. Existence

B. Completeness

C. Accuracy

D. Classification

E. Timing

F. Posting and Summarization

A. Cash Collections Existence

Test of control – Observe whether accountant reconciles bank account.

Substantive test – Trace cash receipts entries from the cash receipts journal entries to the bank

statement.

B. Cash Collections Completeness

Test of control – Observe prelisting of cash receipts.

Substantive test – Compare the prelisting with the duplicate deposit slip.

C. Cash Collections Accuracy

Test of control – Observe whether accountant reconciles bank account.

Substantive test – Prepare a proof of cash receipts to reconcile cash receipts per books with cash

receipts per bank.

D. Cash Collections Classification

Test of control – Examine evidence of internal verification.

Substantive test – Examine prelisting for proper account classification.

E. Cash Collections Timing

Test of control – Observe unrecorded cash at a point in time to see when it is recorded.

Substantive test – Compare date of deposit in bank statement to the dates in the cash receipts

journal and prelisting of cash receipts.

E. Cash Collections Posting and Summarization

Test of control – Examine evidence that accounts receivable master file is reconciled to general

ledger.

Substantive test – Use audit software to foot and cross-foot the cash receipts journal and trace to

the general ledger.

VI. Other Sales and Collection Cycle Considerations

A. Lapping of Accounts ReceivableB. Audit Tests for Uncollectible Accounts

A. Lapping of Accounts Receivable

CustomerA’s

Account

Lapping is when, to cover a cash theft, an employee defers recording cash receipts from one customer and covers the shortage with receipts from another customer. It can be

detected by comparing the name, amount, and dates shown on remittance advices with cash receipts journal entries and

related duplicate deposit slips.

Customer A Customer B

CustomerB’s

Account

Dishonest Employee

B. Audit Tests for Uncollectible Accounts

Major concern is that client covers up a theft by charging off accounts receivable that have actually

been collected. Audit tests for proper authorization of write-off.

This often involves an aged analysis of receivables. It is also usually necessary to

examine correspondence in client files to establish uncollectibility.

After the auditor has concluded that the accounts should be charged off, the auditor should verify the

corresponding journal entries and postings into the general and subsidiary ledgers.

Summary

Accounts and Documents in the Sales and Collection Cycle

Segregation of Duties Sales Transaction Audit Objectives

Sales Return and Allowance Transaction Audit Objectives

Cash Collection Transaction Audit Objectives Lapping of Accounts Receivable

Uncollectible Accounts