audit of the sales and collection cycle

11 - 1©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley

Audit of the Sales andCollection Cycle

Chapter 11


Learning Objective 1

Identify the accounts and theclasses of transactions in the

sales and collection cycle.


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 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



Identify the business functionsand the related documents and

records in the sales andcollection cycle.


Processing Customer Orders

Customer Order:A request for merchandise

by a customer

Sales Order: A document describing the

goods ordered by a customer


Sales Transaction

Accounts SalesAccounts receivable

BusinessFunctions

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

Documentsand Records

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


Cash Receipts Transaction

Accounts Cash in bank (debits from cash receipts)Accounts receivable

BusinessFunctions Processing and recording cash receipts


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


Sales Returns andAllowances Transaction

Accounts Sales returns and allowancesAccounts receivable

BusinessFunctions

Processing and recordingsales returns and allowances


Credit memoSales returns and allowances journal


Charge-off of Uncollectible Accounts Transaction

Accounts Accounts receivableAllowance for uncollectible accounts

BusinessFunctions

Charging off uncollectibleaccounts receivable


Uncollectible account authorization formGeneral journal


Bad Debt ExpenseTransaction

Accounts Bad debt expenseAllowance for uncollectible accounts

BusinessFunctions Providing for bad debts

Documentsand Records General journal


Shipping Goods

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

Shippingdocument



Understand how e-commerceactivities affect the

sales and collection cycle.


Effect of E-Commerce on theSales and Collection Cycle

The Internet

The Internet andother developing

technologies allowcompanies to developnew business models.



Business-to-business (B2B)

Business-to-consumer (B2C)

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



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.



Understand internal controland design and perform testsof controls and substantive

tests of transactions for sales.


Understanding InternalControl – Sales

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


Methodology for Designing Controlsand Substantive Tests: Sales

Understand internalcontrol – sales

Audit proceduresSample size

Items to selectTiming

Assess plannedcontrol risk – sales

Evaluate cost-benefitof testing controls.

Design tests of controlsand substantive tests

of transactions for salesto meet transaction-

related audit objectives.


Assess PlannedControl Risk – Sales

Adequate separationof duties

Proper authorizationAdequate documentsand records Prenumbered

documents Monthly statements Internal verification

procedures


Internal Verification Procedures

Evaluate cost-benefitof testing controls.

Design tests ofcontrols for sales.


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.


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.


Direction of Tests for Sales

Salesjournal

Generalledger

Accountsreceivablemaster file

=

Customerorder

Shippingdocument

Duplicatesales invoice

Completeness Start

Existence Start


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



Apply the methodology forcontrols over sales transactions

to controls over salesreturns and allowances.



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

misstatements are essentially the samefor processing credit memos as those

described for sales.



There are, however, two important differences.

Materiality Emphasis onobjectives



Understand internal control, anddesign and perform tests of

controls and substantive testsof transactions for cash receipts.


Tests of Controls and Substantive Testsof Transactions for Cash Receipts

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



Apply the methodology for controlsover the sales and collection cycle

to write-offs of uncollectibleaccounts receivable.


Audit Tests forUncollectible Accounts

Existence of recorded write-offs is the mostimportant transaction-related audit objective.What is a major concern in testing accounts

charged off as uncollectible?– covering up a defalcation by charging offaccounts receivable that have been collected


Additional Internal ControlsOver Account Balances

Realizable value

Rights and obligations

Presentation and disclosure


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


Role of all Audit Tests in theSales and Collection Cycle

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

SalesAccounts

ReceivableCash inBank


End of Chapter 11