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

Chapter 14

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

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Accounts in the Sales and Collection Cycle

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

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Sales Transaction
Accounts Business Functions Documents and Records

Sales Accounts receivable

Processing customer orders Granting credit Shipping goods Billing customers and recording sales

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
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Cash Receipts Transaction

Accounts Business Functions Documents and Records

Cash in bank (debits from cash receipts) Accounts receivable

Processing and recording cash receipts

Remittance advice Prelisting of cash receipts Cash receipts transaction file Cash receipts journal or listing

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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

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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

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Bad Debt Expense Transaction

Accounts Business Functions Documents and Records

Bad debt expense Allowance for uncollectible accounts

Providing for bad debts

General journal

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Processing Customer Orders

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

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Granting Credit
Before goods are shipped, a properly authorized person must approve credit to the customer for sales on account

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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

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Billing Customers and Recording Sales

Sales transaction file Sales journal

Accounts receivable file

Accounts receivable trial balance

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Processing and Recording Cash Receipts

Prelisting of Cash receipts
Remittance advice

Cash receipts transaction file

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Cash receipts listing

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Processing and Recording Sales Returns and Allowances

Credit memo
Sales returns and allowances journal

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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

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Providing for Bad Debts

This provision represents a residual, resulting from managements end-of-period adjustment of the allowance for uncollectible accounts

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Learning Objective 3
Understand internal control, and design and perform tests of controls and substantive tests of transactions for sales.

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Methodology for Designing Controls and Substantive Tests

Understand internal control sales Assess planned control risk sales Determine extent of testing controls Audit procedures Design tests of controls and Sample size substantive tests of transactions for sales to meet transactionItems to select related audit objectives Timing
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Understand Internal Control Sales

Study the clients flowcharts, prepare an internal control questionnaire, and perform walk-through tests of sales.

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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
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Assess Planned Control Risk Sales

Adequate separation of duties

Proper authorization
Adequate documents and records Pre-numbered documents Monthly statements Internal verification procedures
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Determine Extent of Testing Controls

Control effectiveness Control risk

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Direction of Tests for Sales

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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.
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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.
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COSO Report Identifies Revenue Misstatement Techniques

Sham sales Improper sales cutoff Premature revenue recognition Unauthorized shipments

Improper % of completion

Fraudulent Techniques

Bill and hold Conditional sales Round-tripping loans as sales

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Consignment sales
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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

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Learning Objective 4
Apply the methodology for controls over sales transactions to controls over sales returns and allowances.

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Sales Returns and Allowances

The transaction-related audit objectives and clients methods of controlling misstatements are essentially the same for processing credit memos as those described for sales.

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Sales Returns and Allowances

There are, however, two important differences:

Materiality

Emphasis on objectives

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Learning Objective 5
Understand internal control, and design and perform tests of controls and substantive tests of transactions for cash receipts.

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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

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Learning Objective 6
Apply the methodology for controls over the sales and collection cycle to write-offs of uncollectible accounts receivable.

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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

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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

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Types of Audit Tests for the Sales and Collection Cycle

Sales Accounts Cash in Receivable Bank Sales Cash receipts transactions transactions
Audited by TOC, STOT, and AP Audited by TOC, STOT, and AP

Ending balance

Ending balance

Audited by AP and TDB

TOC + STOT + AP + TDB = Sufficient appropriate evidence

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End of Chapter 14

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

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