AUDITING CHAPTER 10

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