copyright © 2007 pearson education canada 1 chapter 13: audit of the sales and collection cycle:...

Copyright © 2007 Pearson Education Canada1

Chapter 13: Audit of the Sales and Collection Cycle:

Tests of Controls

Copyright © 2007 Pearson Education Canada

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Chapter 13 objectives

Identify typical records and transactions in the sales cycle

Explain how general controls affect the audit of the sales and collection cycle

Describe the methodology for designing tests of controls for sales

Discuss the effect of the results of tests of controls on the audit

Explain how the tests of control audit program organized


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Classes of transactions in the sales and collection cycle

Sales (cash and on account) Cash receipts Sales returns and allowances Charge-off (or write-off) of uncollectible

accounts Bad-debt expense


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Typical records and transactions in the sales cycle

Sale is initiated with a customer order; shipping documents and invoice accompany the sale, which is recorded both in a transaction file (sales) and summarized in a customer master file (or in a database)

Routine reports include a sales journal and an aged accounts receivable trial balance


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Method of recording the transaction

Can be recorded manually (rare now) Alternatively, could be entered in batches

in the computer system (groups of transactions)

If recorded one transaction at a time, is online transaction processing


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Control differences between batch and online systems: audit trails

Batch systems: Transactions readily

traced from source transaction to general ledger posting

Totals from groups of transactions are totaled, and these totals traced

Online systems: Transactions may be

initiated and recorded without source documents (e.g. phone orders)

Document sequencing is important to track documents.


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Control differences between batch and online systems: error detection and correction

Batch systems: If one transaction is in

error, the whole batch is rejected

Error followup is required to ensure timely processing and avoid cutoff errors

Online systems: Focus is on

preventing errors Input edit processes

check for valid customer data and reasonableness


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Control differences between batch and online systems: segregation of duties

Batch systems: Can be achieved by

separating totaling and counting from data entry

Reconciliation and error followup should be independent of data entry

Online systems: Decentralization may

result in inadequate segregation of duties

Use passwords to separate transaction entry from master file entry (e.g. update of credit limits)


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Effect of general controls

Prior to assessing the individual transaction cycles, the auditor documents general controls that are pervasive and that affect multiple transaction cycles

If general controls are good, the auditor may be able to rely upon and test interdependent or fully automated controls

If general controls are poor, the auditor may be able to rely upon only manual controls, or may need to conduct a substantive-oriented audit


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Methodology for designing tests of controls for sales


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Documentation of internal controls

Internal controls need to be documented for every audit assertion for every class of transactions

The auditor focuses on key controls, or those controls that have the greatest effect for that audit assertion

These controls could be manual, automated, or interdependent


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Tests of internal controls

Once the key controls have been identified, the auditor can decide whether the control(s) will be tested or whether tests of details will be conducted instead

Tests of internal controls will be devised for each key control that will be tested


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Example of internal control: occurrence assertion (manual)

Key control: credit is approved before shipment takes place: The sales manager initials all sales orders over $25 to indicate approval.

Possible test of control: Examine a sample of sales orders to ensure that the sales manager’s initial is present.


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Example of internal control: occurrence assertion (automated

batch) Key control: Orders causing balances to exceed

credit limits are printed on an exception report and are not processed for shipment.

Possible test of control: Examine a selection of exception reports and ensure that: these orders exceed the credit limit and that the orders were not processed for shipment.


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Example of internal control: occurrence assertion (automated

online) Key control: Orders causing balances to exceed

credit limits are held in a separate transaction file and are not processed for shipment.

Possible test of control: Request the client to print off the day’s on-hold transaction file. View the file to ensure that all orders in the file exceed the customer’s credit limits.


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Example of internal control: occurrence assertion

(interdependent) Key control: Orders causing balances to exceed

the credit limit are printed on an exception report and must be approved by a credit manager prior to shipment by means of entering a password.

Possible test of control: Review an exception report and ensure that all sales orders there caused the customers’ credit limit to be exceeded. Discuss with the sales manager processes followed to release such held orders.


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Practice problem 13-22 (p. 412)

Practice identifying the audit assertion that goes with a particular control

How would you test the control?


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Manual, automated and interdependent controls

From the previous examples, you can see that:– Manual controls are controls performed

entirely by people– Automated controls (batch or online) are

performed only by computerized systems– Interdependent controls rely upon computer

processes (automation) but a person must also be involved to fully perform the control


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Frequency of testing of internal controls

Which type of controls must be tested annually?

Which type of controls could potentially be tested every three years? Under what circumstances?


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Full testing of interdependent controls

The interdependent control has two parts:– A function performed by an automated systems– A function performed by an individual

It is only possible to rely upon the automated function if: general controls have been assessed as good

Then, both parts of the control must be tested to enable reliance upon the control


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What if control testing yielded many errors?

The first step is to determine whether the errors (exceptions) were due to a particular circumstance or restricted to a particular time period

For example, the credit manager was on holidays, and so no one approved credit, or the person who approved credit in his/her absence made many errors


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Practice differentiating between what is likely an error or fraud

How would you prevent the error or fraud?


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What if control testing yielded many errors? (cont’d)

If it turns out that the errors are systemic (i.e. throughout the period and cannot be isolated to a particular cause), then

The auditor first looks for a compensating (alternative control)

If this alternative control achieves the same purpose and is functioning correctly, then the auditor can still rely upon internal controls


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How do we decide whether there could be a material error?

If there is no compensating control, then the auditor needs to investigate to determine whether there is potential for this weakness to result in a material error

Conduct dual-purpose or weakness investigation (detail) tests

These tests help to quantify the extent of the error


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Results of quantifying the error

If it turns out that the results of the weakness could result in immaterial error, the weakness will be reported in a management letter, and extended tests of detail may not be required

If a material error could result, the matter needs to be reported both to management and the audit committee and the tests need to be sufficient to provide a reasonable range for the extent of the error


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Design versus performance format of audit program

The initial audit program is organized by audit assertion, to ensure that controls are assessed (and possibly tested) for each assertion

It is then organized into a performance format to maximum efficiency (e.g. all tests for the shipping document would be grouped)

The use of automated working paper software facilitates this process


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Computer-assisted audit tests

Where there are a large number of transactions, it is effective for auditors to use computer-assisted audit tests

For example, in internal controls testing, the auditor could use automated sampling routines to access the client sales transaction file and select an attribute sample of sales transactions, printing details of the transactions


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Look at the sampling process for sales

How are results evaluated?


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Suitability of test data

Batch systems: Test data may be inappropriate, as the transactions would be processed by the accounting system. Only transactions that will be rejected could be used.

Online systems: Test data is useful to verify the accurate functioning of online input edit controls (e.g. rejection of invalid customer numbers)


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Suitability of generalized audit software

Best suited for analytical review, tests of detail, or dual-purpose tests, for example:– Adding up the sales transactions to sum to the

sales for the day, month or year– Reperformance of tax calculations– Examination of customer master file to

determine if any balances exceed their credit limit

copyright © 2007 pearson education canada 1 chapter 13: audit of the sales and collection cycle:...

Documents

key controls

manual controls

audit assertionthese

transaction file sales

audit trailsbatch systems

correctionbatch systems

source transaction

sales journal