Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions

1. Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions Chapter 14

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

3. Accounts in the Sales and Collection Cycle

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

5. Sales Transaction 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

6. Cash Receipts Transaction Accounts Business Functions Documents and Records Cash in bank (debits from cash receipts) Accounts receivable Processing and recording cash receipts Remittance advice Prelisting of cash receipts Cash receipts transaction file Cash receipts journal or listing

7. Sales Returns and Allowances Transaction Accounts Business Functions Documents and Records Sales returns and allowances Accounts receivable Processing and recording sales returns and allowances Credit memo Sales and returns and allowances journal

8. Write-off of Uncollectible Accounts Transaction Accounts Business Functions Documents and Records Accounts receivable Allowance for uncollectible accounts Writing off uncollectible accounts receivable Uncollectible account authorization form General journal

9. Bad Debt Expense Transaction Accounts Business Functions Documents and Records Bad debt expense Allowance for uncollectible accounts Providing for bad debts General journal

10. Processing Customer Orders • Customer Order: • A request for merchandise by a customer • Sales Order: • A document describing the goods ordered • by a customer

11. Granting Credit Before goods are shipped, a properly authorized person must approve credit to the customer for sales on account

12. Shipping Goods • This is the first point in the cycle • at which the company gives up assets. • One type of shipping document is a • bill of lading. • Bills of lading are often transmitted once • goods have been shipping

13. Billing Customers and Recording Sales Sales transaction file Sales journal Accounts receivable file Accounts receivable trial balance

14. Processing and Recording Cash Receipts Prelisting of Cash receipts Remittance advice Cash receipts transaction file Cash receipts listing

15. Processing and Recording Sales Returns and Allowances • Credit memo • Sales returns and allowances journal

16. Writing Off UncollectibleAccounts Receivable Uncollectible account authorization form This is a document used internally to indicate authority to write an account receivable off as uncollectible

17. Providing for Bad Debts This provision represents a residual, resulting from management’s end-of-period adjustment of the allowance for uncollectible accounts

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

19. Audit procedures Sample size Items to select Timing Methodology for Designing Controls and Substantive Tests Understand internal control – sales Assess planned control risk – sales Determine extent of testing controls Design tests of controls and substantive tests of transactions for sales to meet transaction- related audit objectives

20. Understand Internal Control – Sales Study the client’s flowcharts, prepare an internal control questionnaire, and perform walk-through tests of sales.

21. 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

22. Assess Planned Control Risk – Sales • Adequate separation of duties • Proper authorization • Adequate documents and records • Pre-numbered documents • Monthly statements • Internal verification procedures

23. Determine Extent of Testing Controls Control effectiveness Control risk

24. Direction of Tests for Sales

25. Transaction-related AuditObjectives for Sales Occurrence: Recorded sales are for shipments actually made. Completeness: Existing sales transactions are recorded. Accuracy: Recorded sales are for the amount shipped.

26. Transaction-related AuditObjectives for Sales Posting and summarization: Sales transactions are correctly included in the accounts receivable master file. Classification: Sales transactions are correctly classified. Timing: Sales are recorded on the correct dates.

27. COSO Report Identifies Revenue Misstatement Techniques Improper sales cutoff Premature revenue recognition Sham sales Unauthorized shipments Fraudulent Techniques Improper % of completion Bill and hold Conditional sales Round-tripping loans as sales Consignment sales

28. Summary of Methodologyfor Sales • Identify key transaction-related audit objectives • Determine key existing controls • Design tests of controls to verify effectiveness • Evaluate any control deficiencies • Determine extent of substantive tests • of transactions

29. Learning Objective 4 Apply the methodology for controls over sales transactions to controls over sales returns and allowances.

30. 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.

31. Sales Returns and Allowances There are, however, two important differences: • Materiality • Emphasis • on • objectives

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

33. 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* * Only performed when fraud is suspected

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

35. Audit Tests for the Write-Offof Uncollectible Accounts • Occurrence transaction-related audit objective • Proper authorization of the write-off of • uncollectible accounts • Verification of accounts written off

36. Effect of Results of Controls and Substantive Tests of Transactions The parts of the audit most affected by the tests for the sales and collection cycle are: Allowance for doubtful accounts Accounts receivable Bad debt expense Cash

37. Types of Audit Tests for the Sales and Collection Cycle 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 AP and TDB TOC + STOT + AP + TDB = Sufficient appropriate evidence

38. End of Chapter 14