Chapter 8 Audit of the Sales and Receipts Cycle

1. Objectives
1.1 To describe the documents and records that are usually found in the sales and receipts cycle. 1.2 To state the general audit procedures for the test of internal controls of this cycle. 1.3 To mention the substantive tests used for the trade debtors.

a l e s a n d R e c e i p C y c l e

t s

o c u m e n At s u d i t T a n d a n d R e c o r d s I n t e r n a l

e s t i n g D C o n t r o l

r a d e e b t o r s

r a n s a c t i o n - r I e n l ta e t re n d a l B a l a n c e - r e Sl a u t be ds t a n A u d i t C o n t r o l A u d i t T e s t s O b j e c t i v e s F u n c t i o n s O b j e c t i v e s

t i v e

S a l e s C a s h S i x r a n s a c tR i o e nc se i p tF s u n c t i o T r a n s a c t i o n s

n s

F T

i v e e s t s

2. Documents and Records

2.1 Customer order () a request for goods from an existing or a new customer received by sales representative or other personnel in the sales department.

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2.2 Sales order () a document recording the description, quantity and/or related information of the goods and services ordered to confirm the order received. It is also used internally for credit approval and authorization for delivery of goods or services. 2.3 Shipping document/goods delivery note () (a) a document prepared at the time when the goods are shipped or delivered, detailing the description, the quantity shipped and other relevant data. (b) bill of lading ( ) is an example of the shipping document that is prepared by the carrier to acknowledge the receipts of goods and also serves as a notice to customer for shipment by the seller.

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Basic Contact Details of Company

To: Date: 21 June 2007

Goods Delivery Note

No.: DN/02/6/104 Cat. No. 1. B201 2. R440 Product Name Japan-made Blue Ball Pen China-made Pencil and Eraser Quantity 15 dozens 20 dozens

Remarks: If there is any defect, please inform us immediately. Returns will not be accepted after 7 days.

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Representative Signature E&EO

Recipient Signature & Company Chop

2.4 Sales invoice a document indicating the details of goods sold, such as descriptions, quantity, terms of sales and the total price billed. 2.5 Sales journal (sales day book) a journal for recording sales and it serves as a posting summary to the general ledger. 2.6 Credit note () It is raised as a result of approval for customers returns or granting allowances to customers. (b) Its function is like an invoice but acts in the opposite way that it indicates the amount to be deducted from a customers account. 2.7 Sales returns and allowances journal similar to the sales journal mentioned above but it records the sales returns and allowances on the other hand (i.e., the credit notes) 2.8 Remittance advice ( ) a document prepared by the customer indicating his name, the numbers and the amounts of the individual invoices paid by him. That is, this document is received from the customer with his payment. 2.9 Cash receipt journal a journal for recording cash receipts from cash sales, collections and all other cash received. 2.10 Accounts receivable ledger a subsidiary ledger of customers accounts for recording individual sales, cash receipts, sales returns and allowances. 2.11 Monthly statement ( ) a document sent to each customer detailing the beginning balance of the month, the movement of transactions during the month like the amount and date of each sale, return and cash receipt, and the ending balance due. (a)

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3. Audit Testing and Internal Controls

3.1 The following description of the primary functions, internal controls to be identified and transaction-related audit objectives (control objectives) will clarify what an auditor is trying to accomplish in the audit of the cycle (Sample of the audit program for the test of controls, refer to Appendix I). 3.2 Transaction-related audit objectives for sales transactions. Objectives Descriptions Existence Recorded sales are for goods actually sent to customers which actually exist. Completeness Goods sent or services performed are correctly billed and properly recorded. Accuracy All sales are correctly billed and accurately recorded. Classification All sales transactions are properly classified into the appropriate account. Timing All invoices are raised shortly after the delivery of goods or services performed, and are recorded on a correct date in a timely manner. Posting and All sales are properly posted to the correct accounting summarization records. 3.3 Transaction-related audit objectives for cash receipts transactions. Objectives Descriptions Existence Cash receipts recorded in the accounting record have actually been received by the company and all cash discounts are properly authorized. Completeness Cash received by the company have all been recorded in the accounting records and promptly deposited. Accuracy All goods sold or services performed are only made to customers with good credit rating and have been properly authorized. Classification Cash receipts transactions are properly classified to the appropriate account (e.g. according to the companys chart of accounts). Timing All cash receipts are recorded on a timely basis. Posting and Cash receipts made are included in the debtors accounts of summarization accounts receivable ledger and properly summarized in the control accounts in general ledger. 3.4 This is a summary of the sales cycle, showing the possible problems and the related controls:

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3.5 The table shows the various assertions of the revenue cycle, together with control objectives, controls and tests of controls Assertion Control objectives
One person is not responsible for taking orders, recording sales and receiving payment Recorded transactions represent shipped. goods sales Sales recorded only with and approved shipping sales order form documentation.

Controls
Segregation duties of

Tests of controls
Observe and evaluate whether proper segregation of duties is operating.

Occurrence and existence

Test a sample of sales invoices for authorized order shipping documentation. Examine application controls authroisation. for form sales and

Accounting numerical sequences invoices of for

Review entitys

and

test

procedures

for accounting for numerical sequences of invoices.

Monthly customer statements sent out and queries independently. customer and

Review procedures statements dealing customer

entitys for and with queries

sending out monthly

complaints handled

and complaints.

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Assertion

Control objectives
Goods and services are only supplied to customers with good credit rating

Controls
Authorisation of credit terms to customers (senior staff authorization, references / credit checks for new customers, regular review of credit limits). Authorisation senior required by staff for

Tests of controls
Review entitys procedures for granting credit to customers.

Occurrence and existence

Examine a sample of sales orders for evidence of proper credit approval by the appropriate senior staff member.

changes in other customer data such as address, etc. Order not accepted unless credit limits reviewed first.

Examine application controls for credit limits.

Review customer ensure credit

all files

new to

satisfactory references

Authorised

price

have been obtained.

Goods services provided

and are at

lists and specified terms of trade in practice

Compare prices and terms on a sample of sales invoices to the authorized price list and terms of trade.

authorized prices and on authorized terms.

Examine application controls authorized and terms. for prices

Assertion

Control objectives

Controls

Tests of controls

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Completeness

All revenue relating to goods dispatched is recorded.

Accounting numerical sequences invoices.

for of

Review and test entitys procedures for accounting for numerical sequences of invoices. Trace a sample of shipping documents to the sales invoices and ledger.

All

goods

and

Shipping documentation invoices. is matched to sales

services sold are correctly invoiced.

Sales invoices are reconciled to the daily sales report.

Review a sample of reconciliations performed.

An open-order file is maintained and

Inspect order

the file

openfor

Accuracy

Cut-off

All sales and adjustments are correctly journalized, summarized and posted to the correct accounts. Transactions have been recorded in the correct period

reviewed regularly. Sales invoices and matching documents required for all entries.

unfilled orders. Vouch recorded sales to supporting documents.

All shipping documentation is forwarded to the invoicing section on a daily basis.

Compare dates on sales invoices with dates of corresponding shipping documentation. Compare dates on sales invoices with dates recorded in the sales ledger.

Daily invoicing of goods shipped.

Assertion

Control objectives
All transactions are properly classified in accounts.

Controls
Chart of accounts in place. Codes in place for different types of products services.
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Tests of controls
Review sales ledger for proper classification. Examine a sample of sales invoices for proper classification.

Classification

or

Test codes.

application

controls for proper

3.6 Control activities over sales and receipts six major functions in a typical sales and receipts cycle (a) Processing customer orders (b) Shipping/dispatching goods (c) Billing customers and recording sales (d) Processing and recording cash receipts (e) Processing sales returns and allowances (f) Writing off bad debts and providing for doubtful debts Control Activities 1. Processing customer orders All customer orders should be checked for credit limit and proper authorization. Special approval needed if credit limit exceeded Orders should be matched with invoices to follow up delivery and billing. Outstanding orders should be prepared periodically for management review and actions. Test of Controls Examine the orders for proper approval on granting credit to both existing and new customers. (existence) Scrutinize the sales order forms to identify if they are properly accounted for, e.g. sequentially prenumbered. (completeness) Ensure that outstanding orders are properly followed up by senior staff and sequence checks are done by senior staff. (completeness) Select a sample of shipping documents to ensure that shipments of goods are done after proper authorization. (existence) Ensure that deliveries of goods are recorded and properly accounted for by using pre-numbered dispatch notes. (completeness) Examine the duplicate of goods delivery note for customers

2. Shipping/dispatching goods Goods cannot be shipped without prior approval. Despatch notes should be prenumbered and a register kept of them to relate to sales invoices and orders.

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signature as evidence of receipt of goods. (existence) 3. Billing customers and recording sales Customers should be correctly and timely billed. Ensure that sales journal and the accounts receivable subsidiary ledger are updated frequently to provide latest information. Examine copies of sales invoices for supporting shipping documents, e.g. bills of lading and customers orders. (existence) Select a sample of sales invoices and examine for the numerical sequence. (completeness) Examine documents for unbilled shipments and unrecorded sales at any time. (completeness) Observe the mailing of monthly statements to customers by a properly designated person. (existence and accuracy) 4. Processing and recording cash receipts All cash/cheques receipts should be recorded in cash receipts journal and deposited in the bank on a timely basis. Accounts receivable subsidiary ledger should be updated promptly. Policy on granting cash discounts must exist. Observe the procedures of handling cash receipts to ensure that the persons are completely independent of the handling accounts receivable functions. (existence) Ensure that cash/cheques received are banked promptly and intact. (existence) Control account reconciliation is prepared promptly and having supervisors review. (accuracy) Discuss with management for policy established for granting of cash discounts. Examine credit notes to ensure that they are pre-numbered and sequentially accounted for. (completeness)

5. Processing sales returns and allowances Sales returns and allowances should be promptly investigated and then recorded with confirmation. Pre-numbered credit notes should be

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issued and recorded promptly.

Examine relevant documents, e.g. correspondence with customers, credit notes issued with approval, etc. (existence)

6. Writing off bad debts and for doubtful debts Credit managers approval should be obtained. Adequate allowance should be provided for outstanding debts.

Examine the policy for bad debts written-off and provision for bad debts. (existence) Examine documents, e.g. bad debts written off form, to obtain evidence of whether policy has been followed up and authorization has been granted. (existence) Examine managers approval for calculation of provision for doubtful debts. (accuracy)

3.7 Test your understanding 1 Internal control weaknesses The following narrative notes on the sales and cash receipts are found in the current year audit file: SALES Prenumbered Customer Order is raised by the Order Clerk upon receipt of written purchase order from the customers. The Customers Order is then passed to the Credit Control Clerk to check for outstanding balance. The Credit Control Clerk records the outstanding balance and initials on the Customer Order, thereafter the Customer Order will be returned to the Order Clerk for further ordering process. If it is a new customer, the Credit Control Clerk will simply mark nil on the Customer Order. As Milka Ltd. is a distributor, all sales are on credit terms. The Customer Order reaches the Shipping Department where the Shipping Clerk will prepare a prenumbered Delivery Note which consists of five copies. Copy 1 of the Delivery Note is passed to the Accounts Department, Copy 2 is filed in the Shipping Department, and Copy 3 is sent to the warehouse for packing. Copy 4 and 5 are taken by the Driver when delivering the goods. The customer is requested to sign and chop on Copy 4 as acknowledgement of

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receipt of goods ordered. Copy 5 will be retained by the customer. During the packing process, one Warehouse Clerk performs the packing, while the Driver is only responsible to deliver the goods to the customers. The Driver after delivery, returns Copy 4 to the Warehouse Clerk who will pass Copy 4 to the Accounts Department for the preparation of sales invoice. An Accounts Clerk will key in the necessary data except for the unit selling price into the computer for automatic generation of sales invoice. The automation involves the extract of unit selling price from the Unit Selling Price Master File for the calculation of sales value. Whenever there is a change in the price list, the Accounts Clerk will update the Unit Selling Price Master File according to the memo approved by both the Sales Manager and Sales Director, thereafter the memo will be filed by the Accounts Clerk. A sales invoice of 2 copies is generated by the computer with a sequential number assigned for each sales invoice. One copy of the sales invoice is kept by the Accounts Department for posting to accounting records, and another copy is mailed to the customer by the Mailing Clerk. CASH RECEIPT On a monthly basis, Accounts Department generates an ageing report of outstanding debtors for the review of the Financial Controller, who will inform the Sales Manager to take follow-up actions, but it is noted that the ageing reports for the last four months are still in the in-tray of the Financial Controller untouched. Cheques and cash collected are banked-in every Friday afternoon by the Accounts Clerk, who is responsible for the preparation of bank reconciliation statement and posting of entries to debtors ledger. Incoming mails are opened and recorded in an incoming mail log book by the Mailing Clerk. Required: Identify TEN internal control weaknesses of the sales and cash receipt cycles and make recommendations for improvement. (20 marks) (Adapted HKAAT June 1996)

4. Trade Debtors Substantive Tests

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4.1 The internal controls for establishing sales that give rise to debtors may have been tested in the audit of sales and receipts cycle, but the audit of trade debtors emphasizes on the tests of details of balances at balance sheet date. 4.2 Substantive tests Substantive tests 1. Tests of transactions Audit procedures The tests are procedures designed to discover whether the transactions recorded in the sales and receipts cycle have achieved all the transaction related audit objectives. of Existence Select balances from the debtors list and trace them to the sales invoices and monthly statements for correct aging and amount. Confirm outstanding balances by sending confirmation letters (positive or negative). Completeness Scrutinise shipping documents one month before and after year end to determine whether any goods delivered but not billed nor recorded. Select a sample of shipping documents and trace them to sales invoices. Perform cut-off tests. Accuracy Confirm the outstanding balance by sending positive confirmation. Perform cut-off tests. Classification Review the trade debtors list to see if there are any receivables from related parties which should be separately disclosed. Cut-off Perform cut-off tests. Detail tie-in Select balances from the debtors list and trace them to the sales invoices and monthly statements for correct aging and amount. Check that the aging report is correctly footed, and that the total balance agrees to the trial balance and
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2. Tests of balances

details

3. Cut-off tests

general ledger. Realisable value Review any disputes arose before and after year end, and also the trend of bad debts history. Rights of client Review minutes or discuss with client if there is any evidence of pledging accounts receivable as collateral. Send confirmation to bank. Presentation and disclosure Evaluate the adequacy of the notes in the financial statements. Sales cut-off - Sales happen when the title of goods passes and this can happen before shipment. - Observation of inventory count, the cut-off information for sales should be obtained. - Record in the working papers the last goods dispateched note number. - Trace these numbers to the sales journal and accounts receivable records to ensure they are recorded in the correct accounting period. Goods in transit Sales returns and allowances cut-off - Matched with related sales Cash receipts cut off - Check bank deposits with the bank statement after a few days of year end. - Can check the proper value of accounts receivable. Positive confirmation - Require debtor to confirm the balances. - Can discovered the overstatement, not understatement. - Used when the internal control system is not strong Negative confirmation - Require debtor to reply only when the
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4. Debtors circularization

5. Analytical procedures

balances do not agree. - Used when the internal control system is good and with a large number of small accounts. Objectives test for reasonableness Procedures: - Analyse the sales mix and compare GP margin with previous years. - Compare sales returns and allowances as a % of gross sales with previous years. - Other ratios, e.g. accounts receivable turnover days; aging categories as a % of accounts receivables; doubtful debts expense, etc.

4.3 Test your understanding 2 Irregularities QQ Ltd is a garment manufacturing company engaged in the export of garments to the US market. Over 2001 and 2002, the garment manufacturing industry suffered from weak demand from the US, but QQ Ltd still reported a much better return than its competitors in the industry. Its gross profit on sales was constant at 40% for 2001 and 2002. Due to cost restraints, the auditors have cut down the number of audit tests, especially cut-off tests. Furthermore, any discrepancy on debtors confirmation not exceeding 5% of the balance will not be investigated. Before the auditors signed the 2002 audit report, the finance director fired the companys accountant. The accountant was angry and told the auditors about improper accounting practices adopted by the finance director. Firstly, sales were invoiced on the date of receipt of customer orders. Secondly, customers were encouraged to settle their invoices early by giving 5% cash discount on invoice amount if the invoice was settled within 14 days from the delivery date. However, the booking of discounts allowed was delayed to the last day of the credit period, i.e. 75 days from the delivery date. The cash receipts records were correct and showed cash receipts amounting to 95% of the invoice amount. The auditors increased the sample size of a few audit procedures and carried out additional audit procedures aimed to detect fraud. They also studied the accounting records for 2001 and 2002 and quantified the actual sales and actual discounts allowed for 2001 and 2002 as below.
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Sales Discounted allowed Required: (a)

Reported data 2002 2001 $ million $ million 660 700 6.5 7.1

Actual data 2002 2001 $ million $ million 640 690 7.5 7.9

(b) (c)

(d)

Identify FOUR possible misstatements to those items on the balance sheet and profit and loss account of QQ Ltd for 2002. State clearly whether there may have been an overstatement or an understatement. (4 marks) Identify TWO irregularities and make recommendations thereon. (4 marks) Suggest audit procedures for detecting the inappropriate accounting treatment. State clearly the source of the sample (source data) and the records or documents to be traced to. (10 marks) Quantify the impact on the net profit for 2002. Your answer should also take into account the impact brought forward from 2001. [Ignore taxation] (2 marks) (Adapted HKIAAT Paper 8 Auditing June 2002)

4.4 Test your understanding 3 Cut-off tests In the audit of Belmont Manufacturing Co Ltds accounts for the year ended 31 December 2001, the following data are extracted from the accounting records.
Sales Invoice No. S0920 S0921 S0922 S0923 S0924 S0925 S0926 S0927 S0928 S0929 Date of Sales Invoice (Note I and II) 27 December 2001 29 December 2001 30 December 2001 30 December 2001 31 December 2001 2 January 2002 2 January 2002 3 January 2002 4 January 2002 5 January 2002 Goods Dispatched Note (GDN) No. D2193 D2198 D2195 D2196 D2200 D2201 D2192 D2194 D2199 D2197 Date of GDN Invoice Amount $30,000 $20,000 $40,000 $15,000 $14,000 $32,000 $50,000 $24,000 $18,000 $60,000

27 December 2001 3 January 2002 29 December 2001 31 December 2001 8 January 2002 8 January 2002 27 December 2001 28 December 2001 6 January 2002 31 December 2001

Note I: All the sales invoices are on FOB origin terms, i.e. the title passes to
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the buyer when the goods are shipped. Note II: The sales journal is updated according to the date of sales invoice. Belmont Manufacturing Co Ltd recorded all the sales with invoice issued on or before 31 December 2001 as sales for the year ended 31 December 2001. It is Belmonts pricing policy to fix its selling price at cost plus 25%.

Required: (a) (b) Briefly explain the term cut-off test. (2 marks) When and why do the auditors have to obtain (i) the number of last GDN on or before the year-end, and (ii) the number of the first GDN after the year-end? How would the auditors make use of these data? (4 marks) Classify each of the sales invoices from S0920 to S0929 into the correct accounting year. You are required to state the basis of your classification in general. (11 marks) Based on the cut-off error identified in (c), quantify the impact to the profit of Belmont for the year ended 31 December 2001. (3 marks) (Total 20 marks) (Adapted HKAAT December 2001)

(c)

(d)

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Appendix I AUDIT PROGRAM FOR REVENUES, CASH RECEIPTS, AND RECEIVABLES TEST OF CONTROLS CLIENT NAME: DATE OF FINANCIAL STATEMENTS: I. REVENUES, CASH RECEIPTS, AND RECEIVABLES Performed By Audit Objectives: To obtain an understanding of the design or operation of internal control relating to revenues, cash receipts, and receivables in order to assess their effectiveness in preventing or detecting material misstatements in financial statement assertions. 1. Select a sample of sales invoices from the sales journal for the period under audit and perform the following: a. Compare the amount per the sales invoice with the amount recorded in the sales journal. b. Trace the sales invoice amount to the accounts receivable subsidiary ledger. c. Trace the sales invoice amount to the cash receipts journal for evidence of subsequent payment. d. Compare data per the sales invoice (e.g., description, quantity, price) to the customers sales order, and check for appropriate credit authorization. e. Compare data per the sales invoice (e.g., customer name, product description, quantity) to data per the shipping document. f. Trace prices, discounts, and payment terms to price lists, contracts, and established policies. g. Test sales invoice extensions, footings, and
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Performed By discounts for mathematical accuracy. 2. Select a sample of daily sales journals for the period under audit and perform the following: a. Foot and crossfoot the sales journal. b. Trace totals from the sales journal to postings in the general ledger. c. Trace selected individual items from the sales journal to the accounts receivable subsidiary ledgers. 3. On a test basis, review the numerical sequence of shipping documents for the period under audit, and account for missing numbers or breaks in sequence. 4. Select a sample of shipping documents issued during the period under audit and perform the following: a. Compare data per the shipping document (e.g., customer name, product description, quantity) to data per the sales invoice. b. Compare the date of shipment per the shipping document to the date of billing per the sales invoice, and follow up on significant time lag. c. Trace amount and date per the sales invoice to entries in the sales journal. 5. Select a sample of daily cash receipts from the cash receipts journal for the period under audit and perform the following: a. Compare remittance advice amounts with entries in the daily cash receipts journal. b. Trace individual amounts of remittance advices to bank deposit tickets and trace total amount on deposit tickets to deposit amount on the bank statement. c. Determine the promptness of both deposits
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Performed By and book entries. d. Trace postings of cash receipts to the accounts receivable subsidiary ledger and determine if they are recorded in the proper period. e. Recalculate cash discounts and compare to company policy. 6. Select a sample of daily cash receipts journal for the period under audit and perform the following: a. Foot and crossfoot the cash receipts journal. b. Trace total amounts and account distributions from the cash receipts journal to postings in the general ledger. c. Obtain supporting deposit ticket and trace total amount from the cash receipts journal to deposit ticket amount and to the bank statement, noting agreement of date and amount. 7. Scan the cash receipts journals for a selected period and investigate any unusual entries. 8. Select a sample of credit memos issued during the period under audit and perform the following: a. Examine and test for proper authorization and approval in accordance with established policies and procedures. b. Trace data (e.g., name, date, amount) to sales or other appropriate journal and to the accounts receivable subsidiary ledger. c. Examine supporting documentation for propriety (e.g., evidence of returned goods). 9. Obtain and review the clients bank reconciliations on a test basis, and perform the
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Performed By following: a. Test the mathematical accuracy. b. Trace the bank balance to the bank statement. c. Trace the balance per books to the general ledger. d. Trace deposits per the bank statement to the cash receipts journal. e. Trace deposits in transit to the following months bank statement, and determine reasonableness of the time lag. f. Trace other reconciling items to supporting documentation, and determine reasonableness of their disposition. 10. If the accounting system is extremely ineffective, or there is high concern about risk of fraud, consider performing a proof of cash for a test period, including the following (see sample workpaper Proof of Cash at Section IV, Item AA-2): a. Trace the bank balance to the bank statement. b. Trace the balance per books to the general ledger. c. Trace the totals from the cash receipts and cash disbursements journals to the general ledger cash accounts. d. Check the mathematical accuracy of the cash receipts and cash disbursements journals. e. Account for all cash receipts per books as deposits per bank or deposits in transit. f. Trace deposits in transit to the following months bank statement, and determine reasonableness of the time lag.
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Performed By g. Review the numerical sequence of checks issued and account for all checks as paid, outstanding, or void. h. Test the list of outstanding checks and trace paid checks to the bank statement for the month subsequent to the period tested. i. Trace paid checks to the cash disbursements journal. j. Trace other reconciling items to supporting documentation, and determine reasonableness of their disposition.

Workpaper Reference

Based on the procedures performed and the results obtained, it is my opinion that the objectives listed in this audit program have been achieved. Performed by Reviewed and approved by Date Date

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Appendix II AUDIT PROGRAM FOR ACCOUNTS RECEIVABLE AND SALES SUBSTANTIVE TESTS CLIENT NAME: DATE OF FINANCIAL STATEMENTS: Audit Objectives A. Receivables reflected in the balance sheet exist, are for valid transactions, and include all authentic obligations of third parties to the entity. B. Billings are for the correct amount and uncollectible accounts are promptly identified and provided for. The allowance for uncollectible accounts is adequate. C. Receivables are properly classified in the balance sheet between current and noncurrent assets and disclosures are adequate with respect to assigned, pledged, unbilled, discounted and related-party receivables, and transfers of receivables. Financial Statement Assertions Existence or occurrence Completeness Rights and obligations Existence or occurrence Valuation or allocation

Presentation and disclosure

Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. b. Compare monthly sales by product line for the current year with monthly sales for the prior year and the first few months subsequent to year end. c. Compare monthly sales returns and allowances and credit memos for the
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Workpaper Reference

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Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. current year with those of the prior year and the first few months subsequent to year end. d. Compare the aging categories (e.g., 030 days; 31-60 days, etc.) of the current years accounts receivable with the prior years and/or industry data. e. Compute the following ratios for the current year and compare with the prior years ratios and/or industry data (see sample workpaper A/R Analytical Procedures at Section IV, Item AD-3): (1) Accounts receivable turnover. (2) Days sales in accounts receivable. (3) Ratio of allowance for uncollectible accounts to gross accounts receivable and credit sales. (4) Ratio of write-offs to credit sales. (5) Ratio of sales returns and allowances to credit sales. (6) Ratio of customer discounts to credit sales. (7) Ratio of gross profit to credit sales, in
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Workpaper Reference

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Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. total and by major product or division. 2. Prepare or obtain from the client an aged trial balance of trade accounts receivable and perform the following [A]: a. Test the arithmetical accuracy of the aged trial balance and the aging categories therein. b. Reconcile the total balance to the general ledger control account balance (see sample workpaper A/R Reconciliation to General Ledger at Section IV, Item AD-5). c. Note and investigate any unusual entries. d. Summarize the total of credit balances and make appropriate reclassification entry, if material. e. On a selective basis, trace individual account balances in the aged trial balance to individual subsidiary ledgers and vice versa. f. Determine which accounts receivable should be confirmed. The auditor may wish to use the form titled Audit Sampling Worksheet for Substantive Tests at Section III (FOR09), to determine which accounts receivable balances should be confirmed.

Workpaper Reference

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Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. 3. Select customer accounts from the aged trial balance for confirmation procedures and perform the following (see sample confirmation requests at Section II [COR07], [COR08], and [COR09]) [A]: a. Arrange for confirmation requests to be mailed directly by the auditor and maintain control over the confirmation process at all times. (See sample workpaper A/R Confirmation Control Summary at Section IV, Item AD-1.) b. Trace balances included in individual confirmation requests to subsidiary accounts. c. Mail confirmations using envelopes with the auditors return address. d. If the client requests exemption from confirmation for any accounts selected by the auditor, obtain and document satisfactory explanation, and determine necessity for alternative procedures. e. Obtain new addresses for confirmations returned by the post office as undeliverable, and remail. f. Send second requests for positive confirmations on which there is no reply and consider registered or certified mail for second requests.

Workpaper Reference

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Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. 4. Process the confirmation replies and summarize the results of confirmation procedures as follows (see sample workpaper A/R Confirmation Results Summary at Section IV, Item AD-2) [A, B]: a. For positive confirmation requests to which no reply was received and accounts exempted from confirmation at the clients request, perform alternative procedures for those customers by examining cash receipts subsequent to the confirmation date and, if no cash has been received, by examining sales invoices and corresponding shipping documents (see sample workpaper A/R Alternative Procedures and Review for Uncollectibles at Section IV, Item AD-6). b. Indicate the total accounts and balances confirmed without exceptions, confirmations reconciled, and nonreplies or exempted accounts with alternative procedures performed. 5. For accounts receivable confirmed on a date other than the balance-sheet date, prepare or obtain from the client an analysis of transactions (e.g., cash receipts, sales) between the confirmation date and the balance-sheet date, and perform the following (see sample workpaper A/R Rollforward from Confirmation Date to Balance-Sheet Date at Section IV, Item AD-4) [A]:

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Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. a. Trace the balance as of the confirmation date to the aged trial balance. b. Trace cash received per the analysis to the cash receipts journal and/or bank statements. c. Trace sales/revenue amounts per the analysis to the sales/revenue journal. d. Determine the reasonableness and propriety of any other reconciling items. e. Trace the ending balance per the analysis to the trial balance as of the balance-sheet date. f. Scan the accounts receivable and sales activity during the period from the interim date to the balance-sheet date and investigate any unusual activity.

Workpaper Reference

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N8-29

Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. 6. Prepare or obtain from the client an analysis of trade notes receivable, showing the following: (a) maker, (b) date note issued and due, (c) original terms of repayment, (d) collateral, (e) interest rate, (f) principal balance at the end of the prior period, (g) principal additions and repayments in the current period, (h) principal balance at the end of the current period, (i) accrued interest receivable at the end of the prior period, (j) interest earned and interest received in the current period, and (k) accrued interest receivable at the end of the current period, and perform the following (see sample workpaper Notes Receivable Analysis at Section IV, Item AE-1.) [A, B, C]: a. Test the arithmetical accuracy of the analysis. b. Trace totals to the general ledger. c. Examine copies of the notes. d. Determine whether positive confirmation requests are necessary and, if so, perform procedures as outlined in Steps 2 and 3 above. e. Determine the type of collateral for the notes. f. Recompute interest income and accrual. g. Trace interest collections to the cash receipts journal, if material.
N8-30

Workpaper Reference

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Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances.

Workpaper Reference

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7. Determine whether any accounts or notes receivable have been pledged, assigned, or discounted [A, C]. 8. Determine whether any accounts or notes receivable are owed by employees or related parties and, if so, perform the following [A, B, C]: a. Determine the nature and purpose of the transaction that resulted in the receivable balance. b. Determine whether transactions were properly executed and approved by an official of the company or the board of directors. c. Consider obtaining positive confirmation requests of such balances. d. Evaluate the collectibility of the balances outstanding. 9. For notes and accounts receivable with maturities greater than one year, perform the following [A, B, C]: a. Evaluate if the principal and interest payments will be collected in accordance with their contractual terms.

N8-31

Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. b. If either interest or principal payments will not be collected in accordance with their contractual terms, determine whether an allowance for credit loss has been computed. 10. Test the adequacy of the allowance for uncollectible accounts, as follows (see sample workpaper A/R Allowance for Uncollectible Accounts at Section IV, Item AD-7) [B]: a. Review subsequent cash collections of account balances. b. Review accounts written off during the period. c. Determine if write-offs have been properly authorized and examine related supporting documentation. d. Ask the client if there are any collection problems with accounts receivable currently classified as current assets. If so, consider whether such accounts should be reclassified to noncurrent assets. e. Perform and review ratio analyses for relationships such as (1) accounts receivable turnover, (2) allowance for uncollectible accounts to accounts receivable, (3) allowance for uncollectible accounts to sales, and (4) accounts written off to sales.

Workpaper Reference

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N8-32

Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. f. Review post-balance-sheet transactions related to receivables, particularly for discounts taken, credits allowed, and accounts written off, and determine whether any adjustments should be made as of the balance-sheet date. 11. Perform the following sales cutoff procedures and ascertain that receivables are recorded in the proper accounting period [A, B, C]: a. From the population of shipping documents, trace the last few shipments of the year to the sales journal and determine that they were properly included in accounts receivable as of the balance-sheet date.

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b. From the population of shipping documents, trace the first few shipments subsequent to year-end to the sales journal and determine that they were properly excluded from accounts receivable as of the balance-sheet date. ___________ c. Using the sales journal, trace the last few sales entries of the year from the sales journal to the shipping documents and determine that they were properly included in accounts receivable as of the balancesheet date. d. Using the sales journal, trace the first few

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N8-33

Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances.

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sales entries subsequent to year-end from the sales journal to the shipping documents and determine that they were properly excluded from accounts receivable as of the balance-sheet date. ___________ 12. If the auditor is highly concerned about the risk of fraud, audit procedures such as the following should be considered in addition to the ones listed above [A, B, C]: a. Perform a proof of cash (see sample workpaper Proof of Cash at Section IV, Item AA-2). b. Expand the number of accounts receivable confirmations and pursue all non-replies and discrepancies. c. Confirm amounts written off that appear unusual, such as write-offs of balances due from continuing customers. d. Compare sales price to list price. e. Ascertain that shipped merchandise actually arrived at the customers location and that the merchandise was not shipped to a warehouse or location controlled by the client. f. Ascertain that shipping documents and

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N8-34

Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. invoices are pre-numbered sequentially and accounted for. g. Examine original documents for sales invoices and shipping documents and be alert for possible alterations. h. Telephone customers directly and confirm items such as: unusual payment terms, sales returns, credit memos, side agreements, merchandise receipt date, or other concerns. i. Review customer complaints and look for unusual trends. j. Look for evidence of salespeople trying to meet or exceed sales goals in order to achieve quotas or increase their commissions or bonuses. k. Agree daily cash receipts detail to the bank statements and investigate unusual lags. 13. If disclosures about fair value are required, or the entity chooses to provide voluntary fair value information, perform the following [C]: a. Obtain information about the fair values of accounts receivable and notes receivable and determine that the valuation principles are being consistently applied under

Workpaper Reference

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N8-35

Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. GAAP. b. Determine that the fair value amounts are supported by the underlying documentation. c. Determine that the method of estimation and significant assumptions used are properly disclosed. 14. For transfers of accounts receivable to a third party, determine that the transaction has been accounted for in accordance with FAS-140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement 125), as follows [A,C]: a. If a transfer of accounts receivable has been accounted for as a sale by the client, determine that all of the following conditions have been met: (1) The transferred receivables have been isolated from the clientput presumptively beyond the reach of the client and its creditors, even in bankruptcy or other receivership.

Workpaper Reference

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N8-36

Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. (2) Each transferee has the right to pledge or exchange the receivables (or beneficial interests) it received, and no condition both constrains the transferee from taking advantage of its right to pledge or exchange and provides more than a trivial benefit to the client. (3) The client does not maintain effective control over the transferred receivables. b. Upon completion of a transfer of receivables by a client that satisfies the conditions to be accounted for as a sale as described in step a. above, determine that the client: (1) Has derecognized all receivables sold. (2) Has recognized all assets obtained and liabilities incurred in consideration as proceeds of the sale, including: cash; put or call options held or written (for example, guarantee or recourse obligations); forward commitments (for example, commitments to deliver additional receivables during the revolving periods of some securitizations); swaps (for example, provisions that convert interest rates from fixed to variable); and servicing liabilities, if applicable. ___________

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N8-37

Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. (3) Has initially measured at fair value assets obtained and liabilities incurred in a sale or, if it is not practicable to estimate the fair value of an asset or a liability, has applied alternative measures. (4) Has recognized in earnings any gain or loss on the sale. c. Upon completion of any transfer of accounts receivable in which the client is the transferor, determine that the client: (1) Has continued to carry in its statement of financial position any retained interest in the transferred receivables, including, if applicable: servicing assets, beneficial interests in assets transferred to a qualifying special-purpose entity in a ___________ securitization, and retained undivided interests. (2) Has allocated the previous carrying amount between the receivables sold, if any, and the retained interests, if any, based on their relative fair values at the date of transfer.

Workpaper Reference

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N8-38

Performed By 1. Perform the following analytical procedures for accounts receivable and investigate any significant fluctuations or deviations from the expected balances [A, B, C]: a. Compare the current years account balances with the prior years account balances for gross receivables; allowance for doubtful accounts; bad debts; and sales returns and allowances. d. If a transfer of accounts receivable in exchange for cash or other consideration (other than beneficial interests in the transferred assets) does not meet the criteria for a sale in step a. above, determine that the transfer has been accounted for as a secured borrowing with pledge of collateral. 15. Document the following items when an analytical procedure is used as the principal substantive test: a. The expectation, if not readily determinable from the documentation of the work performed, and the factors that were considered in developing the expectation. b. Results of the comparison of the expectation to the recorded amounts or ratios developed from recorded amounts. c. Any additional auditing procedures that were performed in response to significant unexpected differences arising from the analytical procedure, and the results of such additional procedures. 16. If detailed tests of transactions or controls are considered necessary, perform the applicable audit procedures contained in Audit Program Tests of Controls in Section I (AUD03).

Workpaper Reference

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N8-39

Based on the procedures performed and the results obtained, it is my opinion that the objectives listed in this audit program have been achieved. Performed by Reviewed and approved by Date Date

N8-40

Appendix III Sales and Receipts Cycle Flowchart

N8-41

Appendix IV Debtors Confirmation REQUEST FOR CONFIRMATION OF ACCOUNTS RECEIVABLE POSITIVE REQUEST (Prepared on clients letterhead) (Date) (Customers name and address) Dear__________: In connection with an audit of the financial statements of (insert name of client) as of (insert date) and for the (insert period [e.g., year, quarter]) then ended, please confirm directly to our auditors (insert name and address of auditors) the amount of your indebtedness to us as of (insert date), which according to our records amounted to $______.2 Please check the appropriate response below after determining whether this is in agreement with your records. If there are differences, please provide any information in sufficient detail to assist our auditors in reconciling the difference. After checking the appropriate response below, please sign and date your reply and mail it directly to our auditors in the enclosed return envelope. DO NOT SEND ANY PAYMENTS TO OUR AUDITORS. Thank you for your anticipated timely cooperation with this request. Respectfully, (Name of client) (Clients authorized signature and title) *********************************************** TO: (Insert auditors name)

N8-42

( ) The balance due (insert clients name) shown above as of (insert date) is correct. ( ) Our records show a balance of $_______ as of (insert date) and the difference may be due to the following:

Signature: Title: Date:

N8-43

REQUEST FOR CONFIRMATION OF ACCOUNTS RECEIVABLE NEGATIVE REQUEST (Prepared on clients letterhead) (Date) (Customers name and address) Dear__________: Our auditors (insert name and address of auditors) are conducting an audit of our financial statements as of (insert date) and for the (insert period [e.g., year, quarter]) then ended. Our records show the amount of your indebtedness to us as of (insert date) to be $_______. If this amount is not correct, please report details of any differences directly to our auditors in the space provided below and use the enclosed return envelope. IF YOU DO NOT WRITE TO OUR AUDITORS, THEY WILL CONSIDER THE BALANCE SHOWN ABOVE TO BE CORRECT. NO REPLY IS NECESSARY IF THE AMOUNT SHOWN ABOVE AGREES WITH YOUR RECORDS. DO NOT SEND ANY PAYMENTS TO OUR AUDITORS. Thank you for your anticipated timely cooperation with this request. Respectfully, (Name of client) (Clients authorized signature and title) *********************************************** TO: (Insert auditors name) The balance due (insert clients name) shown above as of (insert date) is not correct. Our records show a balance of $_______ and the difference may be due to the following:
N8-44

Signature: Title: Date:

N8-45