Audit of the Sales and Collection Cycle

1. Audit of the Sales andCollection Cycle Chapter 11

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

3. 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 Charge-off of Ending uncollectible balance accounts Sales Returns and Allowances Bad Debt Expense Accounts in the Salesand Collection Cycle

4. 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 Accounts in the Salesand Collection Cycle

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

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

7. Accounts Sales Accounts receivable Business Functions Processing customer orders, Granting credit, Shipping goods, Billing customers and recording sales Documents and Records Sales invoice, Sales journal or listing, Sales transaction file, Accounts receivable master file and trial balance, Monthly statements Sales Transaction

8. Business Functions Processing and recording cash receipts Documents and Records Remittance advise, 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

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

10. Business Functions Charging off uncollectible accounts receivable Documents and Records Uncollectible account authorization form General journal Charge-off of Uncollectible Accounts Transaction Accounts Accounts receivable Allowance for uncollectible accounts

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

12. Shipping Goods This is the first point in the cycle where company assets are given up. Shipping document

13. Learning Objective 3 Understand how e-commerce activities affect the sales and collection cycle.

14. The Internet Effect of E-Commerce on theSales and Collection Cycle The Internet and other developing technologies allow companies to develop new business models.

15. Effect of E-Commerce on theSales and Collection Cycle Business-to-business (B2B) Business-to-consumer (B2C) Management’s assertions for sales and collection activities remain the same.

16. Effect of E-Commerce on theSales 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.

17. Learning Objective 4 Understand internal control and design and perform tests of controls and substantive tests of transactions for sales.

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

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

20. Assess PlannedControl Risk – Sales Adequate separation of duties Proper authorization Adequate documents and records Prenumbered documents Monthly statements Internal verification procedures

21. Internal Verification Procedures Evaluate cost-benefit of testing controls. Design tests of controls for sales.

22. 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.

23. 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.

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

25. Summary of Methodologyfor Sales Column 1: Transaction-related audit objectives Column 2: Key internal controls Column 3: Test of controls Column 4: Weaknesses Column 5: Substantive tests of transactions

26. Learning Objective 5 Apply the methodology for controls over sales transactions to controls over sales returns and allowances.

27. Sales Returnsand 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.

28. Sales Returnsand Allowances There are, however, two important differences. Materiality Emphasis on objectives

29. Learning Objective 6 Understand internal control, and design and perform tests of controls and substantive tests of transactions for cash receipts.

30. Tests of Controls and Substantive Testsof Transactions for Cash Receipts • Determine whether cash received was recorded • Prepare proof of cash receipts • Test to discover lapping of accounts receivable

31. Learning Objective 7 Apply the methodology for controls over the sales and collection cycle to write-offs of uncollectible accounts receivable.

32. Audit Tests forUncollectible 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

33. Additional Internal ControlsOver Account Balances Realizable value Rights and obligations Presentation and disclosure

34. 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 Bad debt expense Cash Allowance for doubtful accounts

35. 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 TDP TOC+STOT+AP+TDP = Sufficient competent evidence per GAAS Role of all Audit Tests in theSales and Collection Cycle

36. End of Chapter 11