Audit of the Sales and Collection Cycle

1. Audit of the Sales andCollection Cycle Chapter 14

2. Learning Objective 1 Identify the accounts and the classes of transactions in the sales and collection cycle.

3. Accounts in the Salesand Collection Cycle Sales Cash sales Sales on account Cash in Bank Cash Discounts Taken Accounts Receivable Beginning Cash receipts balance Sales returns Sales on and allowances account Ending balance Sales Returns and Allowances Bad Debt Expense

4. Accounts in the Salesand Collection Cycle Accounts Receivable Beginning Cash receipts balance Sales returns Sales on and allowances account Charge-off of Ending uncollectible balance accounts Allowance for Uncollectible Accounts Charge-off of Beginning uncollectible balance accounts Estimate of bad debt expense Ending balance Bad Debt Expense

5. Learning Objective 2 Describe the business functions and the related documents and records in the sales and collection cycle.

6. Processing Customer Orders Customer/Purchase Order: A request for merchandise by a customer Sales Order: A document describing the goods ordered by a customer Credit check and Authorization to ship

7. Granting Credit Before goods are shipped, a properly authorized person (system) must approve credit to the customer for sales on account. Access controls (Sales Dept)

8. Sales Transaction Accounts receivable (debit) esp. B2B/Big Ticket Sales (credit) Accounts Business Functions 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 receivable Master file/sub ledger (confirmation), Monthly statements sent to customers (control) Documents and Records

9. Cash Receipts Transaction Cash in bank (debit: form = check, EFT, etc.); Accounts receivable (credit) OR B2C (McDonalds): dr. cash, cr. sales Accounts Business Functions Processing and recording cash receipts Separation of duties key! Lapping AR Remittance advise, Prelisting of cash receipts Separate Cash receipts journal or listing, Bank rec, and A/R records Documents and Records

10. Sales Returns and Allowances Transaction Accounts Sales returns and allowances (debit–contra sales) Accounts receivable (credit) Business Functions Processing and recording sales returns and allowances Credit memo – put inv. back and credit customer Separate Sales returns and allowances journal, A/R files Documents and Records

11. Bad Debt ExpenseTransaction Accounts Bad debt expense (debit-contra sales) Allowance for uncollectible accounts (cr. contra A/R) – Estimate! Matching Princ. Business Functions Providing for bad debts – Authorization and review, Separate from handling of cash! Documents and Records General journal - Adjustment

12. Charge-off of Uncollectible Accounts Transaction Accounts receivable (credit) Allowance for uncollectible accounts (debit) No I/S effect – for known uncollectibles Accounts Business Functions Charging off uncollectible accounts receivable – Authorization, Doc., Separation from cash handling – WHY? Documents and Records Uncollectible account authorization form A/R master files and G/L

13. Learning Objective 3 Understand internal control, and design and perform tests of controls and substantive tests of transactions for sales.

14. Methodology for Designing Controlsand Substantive Tests: Sales Design tests of controls and substantive tests of transactions for sales to meet transaction- related audit objectives. Understand internal control – sales Assess planned control risk – sales Audit procedures/Staffing Sample size/Budget Evaluate cost-benefit of testing controls. Items to select Timing

15. Understanding InternalControl – Sales Study the client’s flowcharts, prepare an internal control questionnaire/matrix, and perform walk-through of sales.

16. Preliminarily Assess Control Risk – Sales Adequate separation of duties Proper authorization (C1) Adequate documents and records (C2) Prenumbered Documents (C5) Monthly statements (C9) Internal verification procedures (C6) See p. 452 (col 2) for listing of controls!

17. Control Risk below MAX? Evaluate cost-benefit of testing controls. Design tests of controls for sales. See p. 452 (col 3)!

18. Transaction-Related AuditObjectives for Sales Occurrence (let’s go over I/C and ToT): Recorded sales are for shipments actually made. Completeness: Existing sales transactions are recorded. Accuracy (let’s go over I/C and ToT): : Recorded sales are for the amount shipped. Why are we going over Occurrence and Accuracy? Is there a method to my madness?????????

19. Direction of Tests for Sales Customer order Shipping document Duplicate sales invoice Completeness Start Sales journal General ledger Accounts receivable master file = Occurrence Start

20. 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 included in the accounts receivable master file.

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

22. Learning Objective 5 Understand internal control and design and perform tests of controls and substantive tests of transactions for cash receipts.

23. 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)

24. Learning Objective 6 Apply the methodology for controls over the sales and collection cycle to write-offs of uncollectible accounts receivable.

25. Audit Tests forUncollectible Accounts-I/C and ToT What is a major concern in testing accounts charged off as uncollectible? Occurrence – writing off A/R accounts that have been “collected.” We will hammer completeness and real. value in A/R testing (analysis of aging). 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.

26. Effect of Results of Controls andSubstantive Tests of Transactions In summary, the parts of the audit most affected by the tests (I/C and ToT) for the sales and collection cycle are: Bad debt Expense – bigger AP Threshold? Sales – only AP? Accounts Receivable – less confirms? Allowance for doubtful accounts – bigger AP threshold? Cash – smaller sample For Dep. In-transit?

27. Role of all Audit Tests in the Sales and Collection Cycle Sales Accounts Receivable Cash in Bank Sales transactions Cash receipts transactions Audited by TOC,STOT Audited by TOC, STOT Ending balance Ending balance Ending balance Audited by AP and TDB Audited by AP and TDB TOC+STOT+AP+TDB = Sufficient competent evidence per GAAS

28. End of Chapter 14