Audit of the Sales and Collection Cycle:Tests of Controls and Substantive Tests of Transactions Chapter 14
Sales Cash in Bank Cash sales Accounts Receivable Cash Discounts Taken Sales on account Beginning balance Cash receipts Sales on account Sales returns and allowances Sales Returns and Allowances Ending balance Charge-off of uncollectible accounts Bad Debt Expense Overview of Accounts in the Sales and Collection Cycle
Allowance for Uncollectible Accounts Accounts Receivable Beginning balance Cash receipts Charge-off of uncollectible accounts Beginning balance Sales on account Sales returns and allowances Estimate of bad debt expense Ending balance Charge-off of uncollectible accounts Ending balance Bad Debt Expense Accounts in the Sales and Collection Cycle
Analysis of the Sales and Collection Cycle • Excellent format for analysis: • Business Functions • Accounts involved • Documents and Records • Think Accounting Information Systems
Accounts Business functions Documents and records • Sales • Accounts receivable • Processing customer • orders • Granting credit • Shipping goods • Billing customers and recording sales • Customer order • Sales order • Customer order or sales order • Shipping document • Sales invoice • Sales transaction file • Sales journal or listing • Accounts receivable master file • Accounts receivable trial balance • Monthly statements Sales Transaction
Business functions Documents and records • Processing and recording cash receipts • Remittance advice • Prelisting of cash receipts • Cash receipts transaction file • Cash receipts journal or listing Cash Receipts Transaction Accounts • Cash in bank (debits from cash receipts) • Accounts receivable
Business functions Documents and records • Processing and recording sales returns and allowances • Credit memo • Sales and returns and allowances journal Sales Returns and Allowances Transaction Accounts • Sales returns and allowances • Accounts receivable
Business functions Documents and records • Charging off uncollectible accounts receivable • Uncollectible account authorization form • General journal Charge-off of Uncollectible Accounts Transaction Accounts • Accounts receivable • Allowance for uncollectible accounts
Business functions Documents and records • Providing for bad debts • General journal Bad Debt Expense Transaction Accounts • Bad debt expense • Allowance for uncollectible accounts
Processing Customer Orders Customer Order: A request for merchandise by a customer Sales Order: A document describing the goods ordered by a customer
Granting Credit Before goods are shipped, a properly authorized person must approve credit to the customer for sales on account.
Shipping Goods This is the first point in the cycle where company assets are given up.
Billing Customers and Recording Sales Sales invoice Sales transaction file Sales journal or listing Accounts receivable master file Accounts receivable trial balance Monthly statement
Processing and Recording Cash Receipts Remittance advice Prelisting of cash receipts Cash receipts transaction file Cash receipts journal or listing
Processing and Recording Sales Returns and Allowances Credit memo Sales returns and allowances journal
Charging Off UncollectibleAccounts Receivable Uncollectible account authorization form This is a document used internally to indicate authority to write an account receivable off as uncollectible.
Providing for Bad Debts This provision represents a residual, resulting from management’s end-of-period adjustment of the allowance for uncollectible accounts.
Effect of E-Commerce on the Sales and Collection Cycle The Internet and other developing technologies allow companies to develop new business models.
Effect of E-Commerce on the Sales and Collection Cycle Business-to-business (B2B) Business-to-consumer (B2C) Management’s assertions for sales and collection activities remain the same.
Effect of E-Commerce on the Sales and Collection Cycle Auditors should obtain an understanding of the design and operation of key internal controls over e-commerce revenues. Evidence for e-commerce activities is likely to be in electronic form.
Design tests of controls and substantive tests of transactions for sales to meet transaction -related audit objectives. Assess planned control risk – sales. Audit procedures Sample size Determine extent of testing controls. Items to select Timing Methodology for Designing Controls and Substantive Testsof Sales Transactions for Sales Understand internal control – sales.
Understand Internal Control – Sales Study the client’s flowcharts, prepare an internal control questionnaire, and perform walk-through tests of sales.
Assess Planned Control Risk – Sales Four Steps: 1. Framework for assessing control risk 2. Identify key internal controls and deficiencies 3. Associate controls and deficiencies with the objectives 4. Assess control risk for each objective
Assess Planned Control Risk – Sales Adequate separation of duties Proper authorization Adequate documents and records Prenumbered documents Monthly statements Internal verification procedures
Determine Extent of Testing Controls Audits of public companies Audits of nonpublic companies
Transaction-Related AuditObjectives for Sales Existence: Recorded sales are for shipments actually made. Completeness: Existing sales transactions are recorded. Accuracy: Recorded sales are for the amount shipped.
Transaction-Related AuditObjectives 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.
Customer order Shipping document Duplicate sales invoice Sales journal General journal = Accounts receivable master file Completeness start Existence start Direction of Tests for Sales
Summary of Methodology for Sales Transaction-related audit objectives (Column 1) Key existing controls (Column 2) Tests of control (Column 3) Deficiencies (Column 4) Substantive tests of transactions (Column 5)
Sales Returns and Allowances The transaction-related audit objectives and client’s methods of controlling misstatements are essentially the same for processing credit memos as those described for sales.
Sales Returns and Allowances There are, however, two important differences. Materiality Emphasis on objectives
Tests of Controls and Substantive Tests of Transactions for Cash Receipts • Determine whether cash received was recorded. • Prepare proof of cash receipts. • Test to discover lapping of accounts receivable.
Audit Tests for Uncollectible Accounts Existence of recorded write-offs is the most important transaction-related audit objective. What is a major concern in testing accounts charged off as uncollectible? – covering up a defalcation by charging off accounts receivable that have been collected
Credit approval Aged accounts receivable trial balance Charging off uncollectibles Additional Internal Controls Over Account Balances Realizable value
Additional Internal Controls Over Account Balances Rights and obligations Presentation and disclosure
Effect of Results of Controls andSubstantive Tests of Transactions The parts of the audit most affected by the tests for the sales and collection cycle are: Accounts receivable Cash Bad debt expense Allowance for doubtful accounts
Sales Accounts Receivable Cash in Bank Sales transactions Cash receipts transactions Audited by TOC, STOT, and AP Audited by TOC, STOT, and AP Ending balance Ending balance Audited by APand TDB TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS Types of Audit Tests for the Sales and Collection Cycle