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Chapter 14: Audit of the Sales and Collection Cycle: Tests of Controls

Chapter 14: Audit of the Sales and Collection Cycle: Tests of Controls. Typical Transactions in the Sales and Collection Cycle. Five major classes of Transactions: Sales Cash receipts Sales returns and allowances The write-off of uncollectible accounts Bad-debt expense.

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Chapter 14: Audit of the Sales and Collection Cycle: Tests of Controls

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

  2. Typical Transactions in the Sales and Collection Cycle Five major classes of Transactions: • Sales • Cash receipts • Sales returns and allowances • The write-off of uncollectible accounts • Bad-debt expense

  3. An Overview of Functions, Documents, and Accounting Systems • Order Entry Department • The starting point Customer Order Sales order 1 Customer Prepare Sales Order 2 3 Credit Department A

  4. Okra Development Corp.Copy 8924 Bailey Road Purchase Order 6-3378 Salem, OR 92117 Date: August 5, 201X Ship By: September 12, 201X Terms: 2/10, n/30 FOB Shipping Point To: Ship to: Faragut Sales, Inc. Okra Development Corp. 3812 Briar Drive 8924 Bailey Road, Salem, OR 92115 Salem, OR 92117 Quantity 10 Number Model 317 Description Roller Bearing for Model 3118 Ripper Price 48.00 Amount 480.00 Purchase order number must appear on all shipments and invoices Ordered By Margaret Spangler

  5. 64412 Sales Order To: Okra Development Corp. 8924 Bailey Road Salem, OR 92117 Copy Faragut Sales, Inc. Ship to Okra Development 8924 Bailey Road, OR Ship by September 12, 201X Terms: 2/10, n/30 FOB Shipping Point Credit Approval Goods Counted Customer Order Number 6-3378 C.H. M.K. Quantity Number Description Amount 10 Model 317 480.00 Roller Bearing Date Shipped: 8/20/0X. Freight Bill #229-237441

  6. Shipping involves the Shipping Department Order Entry Approved Sales Order SO Billing and A/R BL BL BL Prepare Multi-Part Bill of Lading BL N Customer Common Carrier

  7. BILL OF LADING Faragut Sales, Inc. 3812 Briar Drive Salem, OR 92115 August 20, 201X Shipp to: Okra Development Corp. Destination: 8924 Bailey Road, Salem, OR 92117 Carrier: Yellow Express Car Initial: Car No. Copy 229-237441 Number of Packages 5 Description of Articles, Special Marks, and Exceptions Roller Bearings, 2 each Weight 28 lbs. Class or Rate 3 Faragut SalesShipper, PerJoe ChenAgentYellow ExpressPerSue Jones

  8. Prepare Sales Invoice & Sales Summary Sales Summary • Sales order & Bill of Lading goes to • Billing/Accounts Receivable Department Shipping Department SO BL SO BL INV INV N INV INV Cost Department for Perpetual Inventory General Accounting Customer

  9. D8-9912 Faragut Sales, Inc 3812 Briar Drive, Salem, OR 92115 Sales Invoice Copy Sold to: Okra Development Corp. 8924 Bailey Road Salem, OR 92117 Shipped to: 8924 Bailey Road Salem, OR 92117 Freight Bill No. 229-237441 FOB Shipping Point Invoice Date August 25, 201X Date Shipped August 20, 201X Terms 2/10, n/30 Your Order No. 6-3378 Quantity We are pleased to serve you Price Amount 10 Model 317 48.00 480.00 Pricing and Math J.D. Account Coding S.A.L.

  10. Page 327 SALES JOURNAL Date Sold to: Invoice No. Amount August 25 Okra Development Corp. D8-9912 480.00

  11. Customer Cheque Invoice Copy Invoice Cheque List Prepare List of Cash Received (2 copies) List Cashier Control Copy to General Accounting • Cash Collection • Receptionist/Mail Room Clerk

  12. Okra Development Corp. REMITTANCE ADVICE Salem, Or. Invoice No. Date Voucher Gross Amount Discount Net Amount D8-9912 8-25-1X 9-00018 480.00 9.60 470.40 Cheque No. Date Vendor No. Vendor Name Total Amount 867 9-04-1X 003270003 Faragut Sales, Inc. 470.40

  13. 15642 September 5, 201X Cash Receipts Listing Fountain City Warehouse x,400.00 Charlotte Sawyers, Inc. x,295.00 Brown, Inc. 1,200.00 Okra Development Corp. x,470.40 Toil Incorporated x,490.00 Harreleson Hardware 1,872.80 Barnaby Sales, Inc. x,982.00 Hartfords x,x92.00 5,802.20 Preparer Adding Machine Tape x,120.00 x,x98.32 x,x23.66 x,842.33 x,988.11 3,130.40 J.T.Lockett September 5, 201X Cash Summary Cash Receipts Listing 5,802.20 Over-the-counter cash receipts 3,130.40 8,932.60

  14. Mail Clerk Cheques List of Receipts Invoice Copies List of Receipts CR Summary CR Summary Prepare Deposit Slip & Cash Receipts Summary Cheques A/R to update A/R Sub-Ledger Deposit Slip General Accounting Bank • Cash must be deposited in the Bank • Cashier

  15. First National Bank Faragut Sales, Inc. Deposit Slip September 5, 201X Currency 3,130.40 400.00 295.00 1,200.00 470.00 490.00 1,872.80 982.00 92.00 $8,932.60 Cheques Teller 5

  16. Page 112 CASH RECEIPTS JOURNAL Date Customer Name Cash Sales Account Receivable Discount Credit August 25 Okra Development Corp. 470.40 9.60 480.00

  17. Cashier • The Accounts Receivable Sub-Ledger must be updated • A/R Department List of Receipts CR Summary Trial Balance Trial Balance Post to the Customer Account & Prepare Trial Balance D General Accounting for comparison to the G/L

  18. A/R Dept. Sales Summary List of Receipts CR Summary Post to the General Ledger Mail Clerk Cashier • The Role of General Accounting

  19. Typical Documents and Records • Sale is initiated with a • What documents accompany the sale? • Routine reports • include a sales journal • aged accounts receivable trial balance • Anything else?

  20. The Accounts of the Sales and Collection Cycle Gross sales Cash in bank Cash Sales Sales on Account Allowance for uncollectible accounts Accounts receivable Charge off of uncollectible accounts Cash receipts Sales returns and allowances Charge-off of uncollectible accounts Beginning balance Sales on account Ending balance Beginning balance Bad debts Ending balance Cash discounts taken Sales returns and allowances Bad debts

  21. Methods of Recording Transactions Manual recording Entered in batches Recorded one transaction at a time

  22. Control Differences Between Batch and Online Systems Batch systems: • Transactions readily traced • Groups of transactions are totaled Online systems: • Transactions recorded one at a time • Document sequencing is important

  23. Control Differences For Error Detection and Correction Online systems: • Focus is on preventing errors • Input edit check for valid customer data and reasonableness Batch systems: • one erroneous transaction • Error follow-up is required

  24. Batch and Online Systems: Segregation of Duties Batch systems: • Separate • Reconciliation and error follow-up Online systems: • In decentralized systems • Use passwords to separate

  25. Risk Assessment and the Sales Cycle Why do risk assessment? Remember that as risk increases

  26. Effect of General Controls • General controls • Are pervasive and affect multiple transaction cycles • Typical examples of general controls

  27. If general controls are good, If general controls are poor

  28. Methodology for Designing Tests of Controls for Sales Understand general controls - sales Understand internal control and evaluate design effectiveness - sales By assertion: Assess planned control risk; identify and assess risks of material misstatement - sales Evaluate cost-benefit of testing controls Design tests of controls for sales to meet transaction-related audit objectives Audit procedures Sample size Items to select Timing

  29. Documentation of Internal Controls Internal controls need to be documented The auditor focuses on What type of controls can these be?

  30. Key Controls for Sales Segregation of Duties Authorization Documents and Records

  31. Internal verification Prenumbered documents Monthly statements

  32. Application Controls • These are computer internal controls

  33. Tests of Internal Controls Once the key controls have been identified, the auditor can decide Tests of internal controls will be devised for

  34. Examples of Internal Control using the Occurrence Assertion • Manual Control • Key control: credit is approved before shipment takes place. • The manual control? • Possible test of control

  35. Automated Batch • Occurrence assertion • Key control: Orders causing balances to exceed credit limits are printed on an exception report • Possible test of control:

  36. Automated Online • Occurrence assertion • Key control: Orders causing balances to exceed credit limits are held in a separate transaction file • Possible test of control:

  37. Interdependent • Occurrence Assertion • Key control: Orders causing balances to exceed the credit limit are printed on an exception report and must be approved by a credit manager • Possible test of control:

  38. Manual, Automated and Interdependent Controls From the previous examples, it can be seen 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

  39. Direction of Testing Tracing Vouching

  40. Tracing • Goes from the start of the transaction to the posting • Is this a test for overstatement or understatement of sales? • Vouching • Goes from the general ledger or sales journal back to the original document

  41. Typical Concerns for Tests of Sales • Recorded sales occurred • Occurrence • Auditor is concerned with following possible misstatements • Recorded sale for which there was no shipment • Sale recorded more than once • Shipment made to non-existent customer

  42. Existing sales transactions are recorded • Completeness assertion • Want to test for unbilled shipments • Are shipping documents complete? • Recorded Sales are accurately recorded • Measurement assertion

  43. Recorded sales are properly classified • Ensure correct entry into the general ledger • Sales transactions are properly updated in the master file and correctly summarized • Accuracy of the master file is essential • Sales are recorded on the correct dates • Sales must be billed as soon as shipment takes place • Remember all the tests can be dome with the same sample of sales invoices and shipping documents

  44. Typical Controls and Tests for Cash Receipts

  45. Frequency of Testing of Internal Controls • Is an auditor allowed to use the results of prior testing in a current audit? • In this case, which type of controls must be tested annually? • Which type of controls could potentially be tested every three years?

  46. Testing of Interdependent Controls • The interdependent control has two parts: • A function performed • A function performed • It is only possible to rely upon the automated function if: • Both parts of the control must be tested to enable

  47. What if Control Testing Yielded Many Errors? • The first step is to determine whether the errors or exceptions • were due to a particular circumstance • or restricted to a particular time period

  48. If the errors are systemic • If this alternative control achieves the same purpose and is functioning correctly • If no compensating control?

  49. Material Error • If there is no compensating control • Want to quantify the extent of the error.

  50. Results of Quantifying the Error • If it turns out that the results of the weakness could result in immaterial error • If a material error could result

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