CHAPTER 12 Audit of the Sales and Collection Cycle: Tests of Controls

1. CHAPTER 12Audit of the Sales and Collection Cycle:Tests of Controls

2. What accounts are typically involved in the sales and collection cycle?

3. What accounts are typically involved in the sales and collection cycle? - sales - sales returns and allowances - bad debt expense - cash discounts taken - trade accounts receivable - allowance for uncollectible accounts - cash in the bank

4. What classes of transactions occur in the sales and collection cycle?

5. What classes of transactions occur in the sales and collection cycle? - sales (cash and credit) - cash receipts - sales returns and allowances - charge-off of uncollectible accounts - bad debt expense

6. What is the sequence of business functions that occurs in the sales and collection cycle?

7. Pace Company Customer Order To: Ace Company Please send us 45 gadgets on or before 10/25/04. Upon receipt, we will send payment of $3 each. What is the sequence ofbusiness functions that occursin the sales and collection cycle? 1. A customer order is processed.

8. What is the sequence ofbusiness functions that occursin the sales and collection cycle? 2. Customer credit is approved or declined. If credit is extended to a customer, will that customer pay their balance at some point in the future?

9. Ace Company Shipping Document (Bill of Lading) 45 gadgets were shipped to Pace Company on 10/22/04. What is the sequence ofbusiness functions that occursin the sales and collection cycle? 3. The goods are shipped.

10. What is the sequence ofbusiness functions that occursin the sales and collection cycle? 4. The customer is billed and the sale is recorded. Ace Company Sales Invoice To: Pace Company Date: 10/22/04 Thanks for purchasing 45 gadgets. Please remit $135 ($3 each) within 30 days.

11. Ace Company Sales Invoice To: Pace Company Date: 10/22/04 Thanks for purchasing 45 gadgets. Please remit $135 ($3 each) within 30 days. a/r master file customer _ $$ _ Pace Company 135 balance 135 sales journal description _ $$ _ Oct. 22, 2004 Pace Company 135

12. Summary Sales Report This report sum- marizes all sales for a period. sales journal description _ $$ _ Oct. 22, 2004 Pace Company 135 a/r master file customer _ $$ _ Pace Company 135 balance 135 Accounts Receivable Trial Balance This report lists the amount owed by each customer at a point in time.

13. Canada 48 a/r master file customer _ $$ _ Pace Company 135 balance 135 At month-end, customer state- ments are mailed indicating activity and amount owed. Accounts Receivable Trial Balance Ace Company This report lists the amount owed by each customer at a point in time. Pace Company statement enclosed

14. Remittance Advice Canada 48 What is the sequence ofbusiness functions that occursin the sales and collection cycle? 5. Cash receipts are processed and recorded. Ace Company Pace Company Pace Company Ace Company CANADIAN BANK

15. Canada 48 A remittance advice is sent to the cus- tomer with the sales invoice. It indicates the customer name, sales invoice num- ber, and amount owed. The advice is re- turned to the vendor with the customer payment. Ace Company Pace Company Ace Company Pace Company CANADIAN BANK

16. Remittance Advice Canada48 Ace Company Pace Company Ace Company Pace Company CANADIAN BANK A prelisting of cash receipts is prepared each day by some- one independent of accounting and cash custody. The prelisting indicates each cash receipt.

17. Remittance Advice Canada 48 Ace Company Pace Company Ace Company Pace Company CANADIAN BANK a/r master file customer _ $$ _ Pace Company 135 payment-11/2 (135) balance 0 cash receipts journal description _ $$ _ Nov. 2, 2004 Pace Company 135

18. CREDIT MEMO When a vendor grants credit to a customer for returned goods, a credit memo is prepared and the transac- tion is recorded in the sales returns and allowances journal.

19. AUTHORIZATION FOR UNCOLLECTIBLE ACCOUNT WRITE-OFF This form is used when a specific accounts receivable is judged uncollectible.

20. How does an auditor design tests of controls for sales?

21. Understand internal control as it relates to sales As discussed in chapter 9 How does an auditor design tests of controls and substantive tests for sales?

22. Understand internal control as it relates to sales How does an auditor design tests of controls and substantive tests for sales? Assess the planned control risk related to sales

23. Understand internal control as it relates to sales In assessing control risk, the auditor should consider: Assess the planned control risk related to sales ?

24. Understand internal control as it relates to sales In assessing control risk, the auditor should consider: - adequate segregation of duties - proper authorization - adequate documents and records - use of prenumbered documents - mailing of monthly statements - internal verification procedures Assess the planned control risk related to sales

25. Understand internal control as it relates to sales How does an auditor design tests of controls and substantive tests for sales? Assess the planned control risk related to sales Evaluate cost-benefit of testing controls

26. Understand internal control as it relates to sales Assess the planned control risk related to sales Will substantive tests be reduced sufficiently to justify the cost of performing tests of controls? Evaluate cost-benefit of testing controls

27. Design tests of controls for sales Understand internal control as it relates to sales How does an auditor design tests of controls for sales? Assess the planned control risk related to sales Evaluate cost-benefit of testing controls

28. Design tests of controls for sales Understand internal control as it relates to sales In designing other tests of controls for sales, the auditor should consider: Assess the planned control risk related to sales Evaluate cost-benefit of testing controls Do recorded sales actually exist?

29. Design tests of controls for sales Understand internal control as it relates to sales In designing other tests of controls for sales, the auditor should consider: Assess the planned control risk related to sales Evaluate cost-benefit of testing controls Are all existing sales transactions recorded?

30. Design tests of controls for sales Understand internal control as it relates to sales In designing other tests of controls for sales, the auditor should consider: Assess the planned control risk related to sales Evaluate cost-benefit of testing controls Are sales accurately recorded?

31. Design tests of controls for sales Understand internal control as it relates to sales In designing other tests of controls for sales, the auditor should consider: Assess the planned control risk related to sales Evaluate cost-benefit of testing controls Are recorded sales properly classified?

32. Design tests of controls for sales Understand internal control as it relates to sales In designing other tests of controls for sales, the auditor should consider: Assess the planned control risk related to sales Evaluate cost-benefit of testing controls Are sales recorded on the correct dates?

33. Design tests of controls for sales Understand internal control as it relates to sales In designing othe tests of controls for sales, the auditor should consider: Assess the planned control risk related to sales Evaluate cost-benefit of testing controls Are sales transactions properly included in the master file and correctly summarized?

34. The auditor should also perform procedures to detect fraud related to cash receipts.

35. The auditor should also perform procedures to detect fraud related to cash receipts: Determine whether cash received was recorded.

36. The auditor should also perform procedures to detect fraud related to cash receipts: Prepare a proof of cash receipts. ?

37. A proof of cash receipts reconciles cash receipts record- ed in the cash receipts journal with actual bank deposits. The auditor should also perform procedures to detect fraud related to cash receipts:

38. The auditor should also perform procedures to detect fraud related to cash receipts: Test to discover lapping of accounts receivable. ?

39. Lapping is a fraud scheme that occurs because of inadequate segregation of duties related to mail, cash receipts, and accounting.

40. A/R Able $1000 A/R Baker $1000 A/R Cain $1000 a lapping example CANADIAN BANK On Monday, a cheque is received from Able Co. in payment of their a/r. The cheque is stolen by the bookkeeper! No entry is made and all evidence of the payment receipt is destroyed.

41. a lapping example A/R Able $1000 -1000 0 A/R Baker $1000 A/R Cain $1000 CANADIAN BANK On Tuesday, a cheque is received from Baker Co. in payment of their a/r. The payment, however, is credited to Able’s account.

42. a lapping example A/R Able $1000 -1000 0 A/R Baker $1000 A/R Cain $1000 -1000 0 CANADIAN BANK On Wednesday, a cheque is received from Cain Co. in payment of their a/r. The payment, however, is credited to Baker’s account.

43. What audit procedures may detect lapping?

44. Canada 48 What audit procedures may detect lapping? - a/r confirmations (disputed balances, disputed timing of payments) client client’s a/r customer

45. What audit procedures may detect lapping? - a/r confirmations (disputed balances, disputed timing of payments) - comparison of deposit slips to cash receipts journal (different amounts, different timing)

46. Other than adequate segregation of duties, what client internal control may prevent or detect lapping?

47. required vacations (and rotation of duties during vacations) Other than adequate segregation of duties, what client internal control may prevent or detect lapping?

48. Attributes Sampling Sequence The attributes sampling sequence is similar to that of audit sampling. The same credit approval example will be used to illustrate attributes sampling.