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AUDITING CHAPTER 10

AUDITING CHAPTER 10. Sales & Cash Receipts Transactions By David N. Ricchiute. TOPICS. Nature of revenue/receipt cycle Flow of information Auditor’s assessment of control risk Audit of internal 2 control for sales, cash receipts Computer auditing, sampling, tests of controls

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AUDITING CHAPTER 10

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  1. AUDITINGCHAPTER 10 Sales & Cash Receipts Transactions By David N. Ricchiute

  2. TOPICS • Nature of revenue/receipt cycle • Flow of information • Auditor’s assessment of control risk • Audit of internal2 control for sales, cash receipts • Computer auditing, sampling, tests of controls • Assurance, consulting services GBW 8th ed. Ch. 10

  3. NATURE OF REVENUE/RECEIPT CYCLE • Goods, services sold to customers in exchange for future promises to pay • Cash collected from customers GBW 8th ed. Ch. 10

  4. REVENUE/RECEIPT CYCLEFlow of Information • Customer order received • Sales order prepared • Price, quantity, goods, terms • Shipping document • Identifies goods shipped • Contract between seller, carrier • Sales invoice (bill) • Customer remittance advice • Returned with payment from customer GBW 8th ed. Ch. 10

  5. SELLER’S DOCUMENTS • Sales order • Identifies goods ordered, price, quantity, terms, etc. • Shipping document (bill of lading) • Identifies good shipped • Contract between seller & carrier • Sales invoice • Formal notice to customer of amount & payment terms • Customer remittance advice • Returned with payment GBW 8th ed. Ch. 10

  6. CONTROLS FOR CREDIT SALES • Multicopy, prenumbered sales order prepared • Customer credit reviewed, approved • Authorized copy sales order accompanies goods from Inventory Control to Shipping • Goods received in Shipping compared with sales order; shipping document prepared • Common carrier provides receipt for goods shipped • Shipping document, approved sales order sent to billing for preparation of invoice, daily sales summaries • Invoice copy sent to General Accounting for recording GBW 8th ed. Ch. 10

  7. CASH COLLECTION • Process • Checks by mail listed, endorsed • List copy to Accounts Receivable with remittance for posting • List copy with checks to Cash Receipts Dept. for daily deposit • Sales returns separate from cash collection • Uncollected accounts • Reviewed for credit limits, aged, written off as necessary GBW 8th ed. Ch. 10

  8. INTERNAL CONTROL & RISK ControlsRisks GBW 8th ed. Ch. 10

  9. ASSESSING CONTROL RISKObtain Understanding • Review Sarbanes-Oxley Section 404 documentation for sales process • Document the client’s system • Flowchart, questionnaire, narrative • Perform transaction walk-through • Identify control activities • Test controls to reduce control risk below maximum • Assess control risk GBW 8th ed. Ch. 10

  10. TESTS OF CONTROLSSales, Collection • Provide a reasonable degree assurance that employees comply with management’s procedures • Sales • Properly authorized, executed, recorded • Cash collections • Cash receipts recorded, deposited promptly • Returns, uncollectible accounts • Proper authorization, recording GBW 8th ed. Ch. 10

  11. CONTROL RISKShipping • Major risks • Unauthorized shipment • Fictitious or related parties • Goods properly shipped, not billed, recorded GBW 8th ed. Ch. 10

  12. TESTING CONTROLS: Shipping • Select random sample shipping documents • Examine sample for authorized sales order & agreement • Trace sample shipping documents to invoices (completeness) • Trace invoices to sales journal, A/R ledgers • Trace invoices to inventory records GBW 8th ed. Ch. 10

  13. CONTROL RISKBilling • Major risks • Bills sent but goods not shipped • Bills not properly prepared, recorded GBW 8th ed. Ch. 10

  14. TESTING CONTROLS: Billing • Select sample invoices from Billing dept. • Verify unit prices & mathematical accuracy • Trace invoices to shipping documents (existence/occurrence) • Trace invoices to sales journal, A/R ledgers • Trace invoices to inventory records GBW 8th ed. Ch. 10

  15. CONTROL RISKRecording • Periodic summaries not prepared or not prepared correctly GBW 8th ed. Ch. 10

  16. TESTING CONTROLS: Recording • Review evidence of procedures for • Reconciliation daily sales summaries with sales journal totals • Periodic reconciliation A/R trial balance with general ledger control • Scan sales journal for unusual transactions, large amounts • Verify mathematical accuracy sales journal for selected periods; trace postings to general ledger GBW 8th ed. Ch. 10

  17. CONTROL RISKCash Collection, Deposit • Risk of embezzlement, deposit into improper accounts GBW 8th ed. Ch. 10

  18. TESTING CONTROLS: Cash Collection & Deposit • Cash collection • Surprise basis: take control bank deposits • Compare total checks to total deposit slip • Compare check details to cash receipt records & A/R ledger • Determine timeliness • Deposits • Interim: compare deposits CRJ with bank statements • Trace CRJ to general ledger GBW 8th ed. Ch. 10

  19. CONTROL RISKSales Returns, Allowances • Risk that credit memoranda • Not approved • Not properly recorded GBW 8th ed. Ch. 10

  20. TESTING CONTROLS:Sales Returns & Allowances • Test details random sample credit memoranda • Receiving reports • Perpetual inventory records • Entries A/R ledger & general ledger • Review credit register for unusual items GBW 8th ed. Ch. 10

  21. CONTROL RISKUncollectible Accounts • Risk that account write-offs • Properly authorized • Properly recorded GBW 8th ed. Ch. 10

  22. TESTING CONTROLS:Uncollectible Accounts For written-off entries: • Select sample • Trace to authorization • Trace to posting • Review write-offs for unusual entries GBW 8th ed. Ch. 10

  23. ASSESSING CONTROL RISK • 2 Questions • Are controls effective? • Can controls be relied upon? • If answer is yes to both • Assess control risk below maximum • Assess detection risk above minimum • Restrict substantive tests of sales, receivables, cash GBW 8th ed. Ch. 10

  24. PRELIMINARY OPINION ON INTERNAL CONTROL • Required by Sarbanes-Oxley • Auditor must form opinion on management’s assessment of internal control over financial reporting based on • Reports of internal auditors • Auditor’s tests of controls • Substantive audit tests GBW 8th ed. Ch. 10

  25. TESTS OF CONTROLSDeduction Management • 3 Critical questions • Does Accounts Receivable monitor deductions? • Does Account Operations approve deduction inquiries • Does senior management review decisions made by Accounts Receivable, Account Operations? GBW 8th ed. Ch. 10

  26. COMPUTER AUDITING & SAMPLING • Understand the system • Tests of controls • Input controls • Code verification • Data entry controls • Processing controls • Control totals • Limit tests • Assess control risk GBW 8th ed. Ch. 10

  27. TESTS OF BILLING CONTROLSAn Example • Randomly select sample sales invoices • Verify unit prices, clerical accuracy • Trace details of invoices to shipping documents • Trace sales invoices to inventory records GBW 8th ed. Ch. 10

  28. ASSURANCE, CONSULTING SERVICES • Sarbanes-Oxley restricts • Information systems consulting to non-audit public clients, and any non-public clients GBW 8th ed. Ch. 10

  29. AUDITINGCHAPTER 11 Accounts Receivable & Cash Balances By David N. Ricchiute

  30. TOPICS INREVENUE/RECEIPT CYCLE • Relationship assertions & audit procedures • Relationship audit risk, client strategies, substantive tests • Substantive tests for assertions • Revenue recognition, earnings manipulation, & channel stuffing • Audit sampling & accounts receivable • Computer-assisted audit techniques GBW 8th ed. Ch. 10

  31. ASSERTIONS & OBJECTIVES Management assertions: Recorded receivables & cash balances • Exist • Include all transactions (completeness) • Represent rights of entity • Are valued appropriately • Are presented & disclosed properly GBW 8th ed. Ch. 10

  32. OBJECTIVES & PROCEDURES:Existence/Occurrence Objective: determine whether all recorded sales, receivables, cash balances Procedures • Existence • Physical observation • Confirmation • Transactions occurred • Cutoff testing for proper period GBW 8th ed. Ch. 10

  33. OBJECTIVES & PROCEDURES:Completeness Objective: determine whether all receivables, sales, cash of period are presented in financial statements Procedures • Examine documents • Apply analytical procedures • Cutoff bank statements, bank reconciliations, etc. GBW 8th ed. Ch. 10

  34. OBJECTIVES & PROCEDURES:Rights/Obligations Objective: determine whether entity has property rights to cash, accounts receivable Procedures • Examine documentation • Confirmations • Inquiries GBW 8th ed. Ch. 10

  35. OBJECTIVES & PROCEDURES:Valuation, Allocation Objective: determine whether entity has recorded items in correct amounts, accounts, & time periods Procedures • Confirm balances • Verify mathematical accuracy • Examine details of recording GBW 8th ed. Ch. 10

  36. OBJECTIVES & PROCEDURES:Presentation, Disclosure Objective: determine whether recorded transactions, balances properly classified, described, disclosed Procedures • Compare presentation to GAAP • Annual updates of AICPA guidelines GBW 8th ed. Ch. 10

  37. AUDIT RISK MODEL AR = CR x IR x DR • Detection risk (DR): likelihood that error could occur & not be detected • Based on • Control risk (CR) • Likelihood of material error • Inherent risk (IR) • Strategies & threats GBW 8th ed. Ch. 10

  38. DETECTION RISK DR = ____AR___ IR x CR • Nature, extent, timing substantive tests • Nature: more/less persuasive tests • Extent: larger/smaller samples • Timing: balance sheet date or interim GBW 8th ed. Ch. 10

  39. ASSERTIONS & PROCEDURESAccounts Receivable, Sales-1 Valuation • Verify mathematical accuracy AR • Obtain aged trial balance • Foot trial balance • Compare total AR per trial balance to general ledger GBW 8th ed. Ch. 10

  40. ASSERTIONS & PROCEDURESAccounts Receivable, Sales-2 Existence, rights, valuation • Confirm year-end accounts & notes receivable with debtors • Positive: tell auditor if balance correct • Large balances, inaccuracies • Negative: tell auditor only if balance incorrect • Control adequate, small balances GBW 8th ed. Ch. 10

  41. ASSERTIONS & PROCEDURESAccounts Receivable, Sales-3 Existence or occurrence, completeness • Test cutoff to determine whether sales, receivables recorded in proper period • FOB shipping point • FOB destination GBW 8th ed. Ch. 10

  42. ASSERTIONS & PROCEDURESAccounts Receivable, Sales-4 Valuation, rights • Review collectibility receivables • Determine adequacy allowance for doubtful accounts GBW 8th ed. Ch. 10

  43. ASSERTIONS & PROCEDURESAccounts Receivable, Sales-5 Existence or occurrence, completeness, valuation • Perform analytical procedures for reasonableness of sales, receivables balances • Collections problems • Overstated sales • Understated sales GBW 8th ed. Ch. 10

  44. ASSERTIONS & PROCEDURESAccounts Receivable, Sales-6 Presentation & disclosure • Review financial statements to determine • Accounts, notes receivable properly classified, described • Disclosures adequate GBW 8th ed. Ch. 10

  45. TESTING CUTOFFSales, Receivables At or around end each quarter, the former President directed his subordinates to hold IGI’s books open, to backdate invoices, shipping documents. This caused IGI to record out-of-period sales & to overstate revenue, net income end each quarter. • Procedures • Trace recorded sales to shipping documents before, after end of period GBW 8th ed. Ch. 10

  46. ASSERTIONS & PROCEDURES:Cash-1 Existence, rights, valuation • Confirm year end balances with all banks GBW 8th ed. Ch. 10

  47. ASSERTIONS & PROCEDURES:Cash-2 Valuation • Verify mathematical accuracy recorded cash balances • Foot cash journals • Trace totals to general ledger, year-end bank reconciliations • Test cash on hand GBW 8th ed. Ch. 10

  48. ASSERTIONS & PROCEDURES:Cash-3 Existence, completeness, valuation • Test cutoff • Obtain cutoff bank statement • Verify accuracy • Examine & trace to bank reconciliations & cash journals • Proof of cash • Reconcile recorded cash with bank confirmation • Examine interbank, intercompany transfers GBW 8th ed. Ch. 10

  49. ASSERTIONS & PROCEDURES:Cash-4 Presentation & disclosure • Review financial statements to determine • Cash balances properly classified, described • Disclosures adequate GBW 8th ed. Ch. 10

  50. TESTING CUTOFF FOR CASH • Reconcile internal documents • Cash journals • General ledger • Bank reconciliations • With external documents • Year-end bank statement • Cutoff bank statements • Bank confirmations GBW 8th ed. Ch. 10

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