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

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1 Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions Chapter Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5-5

2 Learning Objective 1 Identify the accounts and the classes of transactions in the sales and collection cycle Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-2

3 Accounts in the Sales and Collection Cycle 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-3

4 Learning Objective 2 Describe the business functions and the related documents and records in the sales and collection cycle Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-4

5 Sales Transaction Accounts Sales Accounts receivable Business Functions Processing customer orders Granting credit Shipping goods Billing customers and recording sales Documents and Records 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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-5

6 Cash Receipts Transaction Accounts Cash in bank (debits from cash receipts) Accounts receivable Business Functions Documents and Records Processing and recording cash receipts Remittance advice Prelisting of cash receipts Cash receipts transaction file Cash receipts journal or listing 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-6

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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-7

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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-8

9 Bad Debt Expense Transaction Accounts Bad debt expense Allowance for uncollectible accounts Business Functions Documents and Records Providing for bad debts General journal 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-9

10 Processing Customer Orders Customer Order: A request for merchandise by a customer Sales Order: A document describing the goods ordered by a customer 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-10

11 Granting Credit Before goods are shipped, a properly authorized person must approve credit to the customer for sales on account 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-11

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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-12

13 Billing Customers and Recording Sales Sales transaction file Sales journal Accounts receivable file Accounts receivable trial balance 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-13

14 Processing and Recording Cash Receipts Remittance advice Prelisting of Cash receipts Cash receipts transaction file Cash receipts listing 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-14

15 Processing and Recording Sales Returns and Allowances Credit memo Sales returns and allowances journal 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-15

16 Writing Off Uncollectible Accounts Receivable Uncollectible account authorization form This is a document used internally to indicate authority to write an account receivable off as uncollectible 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-16

17 Providing for Bad Debts This provision represents a residual, resulting from management s end-of-period adjustment of the allowance for uncollectible accounts 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-17

18 Learning Objective 3 Understand internal control, and design and perform tests of controls and substantive tests of transactions for sales Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-18

19 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 transactionrelated audit objectives Audit procedures Sample size Items to select Timing 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-19

20 Understand Internal Control Sales Study the client s flowcharts, prepare an internal control questionnaire, and perform walk-through tests of sales Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-20

21 Assess Planned Control Risk Sales 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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-21

22 Assess Planned Control Risk Sales Adequate separation of duties Proper authorization Adequate documents and records Pre-numbered documents Monthly statements Internal verification procedures 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-22

23 Determine Extent of Testing Controls Control risk Control effectiveness 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-23

24 Direction of Tests for Sales 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-24

25 Transaction-related Audit Objectives for Sales Occurrence: Recorded sales are for shipments actually made. Completeness: Existing sales transactions are recorded. Accuracy: Recorded sales are for the amount shipped Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-25

26 Transaction-related Audit Objectives 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 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-26

27 COSO Report Identifies Revenue Misstatement Techniques Sham sales Improper sales cutoff Premature revenue recognition Improper % of completion Fraudulent Techniques Unauthorized shipments Conditional sales Round-tripping loans as sales Consignment sales Bill and hold 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-27

28 Summary of Methodology for 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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-28

29 Learning Objective 4 Apply the methodology for controls over sales transactions to controls over sales returns and allowances Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-29

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 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-30

31 Sales Returns and Allowances There are, however, two important differences: Materiality Emphasis on objectives 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-31

32 Learning Objective 5 Understand internal control, and design and perform tests of controls and substantive tests of transactions for cash receipts Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-32

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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-33

34 Learning Objective 6 Apply the methodology for controls over the sales and collection cycle to write-offs of uncollectible accounts receivable Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-34

35 Audit Tests for the Write-Off of Uncollectible Accounts Occurrence transaction-related audit objective Proper authorization of the write-off of uncollectible accounts Verification of accounts written off 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-35

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: Accounts receivable Allowance for doubtful accounts Bad debt expense Cash 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-36

37 Sales Types of Audit Tests for the Sales and Collection Cycle Accounts Receivable Sales Cash receipts transactions transactions Audited by TOC, STOT, and AP Ending balance Ending balance Audited by AP and TDB Audited by TOC, STOT, and AP TOC + STOT + AP + TDB = Sufficient appropriate evidence Cash in Bank 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14-37

38 End of Chapter Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5-5

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