Audit of the Sales and Collection Cycle

Chapter 13

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley

13 - 1

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

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley

13 - 2

Accounts in the Sales and Collection Cycle

Sales Cash sales Sales on account Cash in Bank Accounts Receivable Beginning Cash receipts balance Sales returns Sales on and allowances account Charge-off of Ending uncollectible balance accounts Cash Discounts Taken Sales Returns and Allowances

Bad Debt Expense

13 - 3

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley

Accounts in the Sales and Collection Cycle

Accounts Receivable Beginning Cash receipts balance Sales returns Sales on and allowances account Charge-off of Ending uncollectible balance accounts Allowance for Uncollectible Accounts Charge-off of Beginning uncollectible balance accounts Estimate of bad debt expense Ending balance Bad Debt Expense
13 - 4

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley

Learning Objective 2 Describe the business functions and the related documents and records in the sales and collection cycle.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 5

Processing Customer Orders

Customer Order: A request for merchandise by a customer
Sales Order: A document describing the goods ordered by a customer
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 6

Granting Credit

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

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley

13 - 7

Sales Transaction
Accounts
Sales Accounts receivable Processing customer orders, Granting credit, Shipping goods, Billing customers and recording sales

Business Functions

Sales invoice, Sales journal or listing, Sales Documents transaction file, Accounts receivable master and Records file and trial balance, Monthly statements
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 8

Cash Receipts Transaction

Accounts
Cash in bank (debits from cash receipts) Accounts receivable

Business Functions

Processing and recording cash receipts

Remittance advise, Prelisting of cash receipts, Documents Cash receipts transaction file, and Records Cash receipts journal or listing
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 9

Sales Returns and Allowances Transaction

Accounts
Sales returns and allowances Accounts receivable Processing and recording sales returns and allowances

Business Functions

Documents Credit memo and Records Sales returns and allowances journal
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 10

Charge-off of Uncollectible Accounts Transaction

Accounts
Accounts receivable Allowance for uncollectible accounts Charging off uncollectible accounts receivable

Business Functions

Documents Uncollectible account authorization form and Records General journal

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 11

Bad Debt Expense Transaction

Accounts
Bad debt expense Allowance for uncollectible accounts

Business Functions

Providing for bad debts

Documents General journal and Records

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 12

Shipping Goods
This is the first point in the cycle where company assets are given up.

Shipping document
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 13

Billing Customers and Recording Sales

Sales invoice
Sales transaction file

Sales journal or listing

Accounts receivable master file Accounts receivable trial balance

Monthly statement
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 14

Processing and Recording Cash Receipts

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

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 15

Lockbox Systems and Electronic Funds Transfer

Bank
Order/Payment Information Customer

Company

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 16

Processing and Recording Sales Returns and Allowances

Credit memo

Sales returns and allowances journal

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 17

Charging 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.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 18

Providing for Bad Debts

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

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 19

Learning Objective 3 Understand how e-commerce activities affect the sales and collection cycle.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 20

Effect of E-Commerce on the Sales and Collection Cycle

The Internet The Internet and other developing technologies allow companies to develop new business models.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 21

Effect of E-Commerce on the Sales and Collection Cycle

Business-to-business (B2B)

Business-to-consumer (B2C) Managements assertions for sales and collection activities remain the same.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 22

Effect of E-Commerce on the Sales and Collection Cycle

Auditors should obtain an understanding of the design and operation of key internal controls over e-commerce revenues.
Evidence for e-commerce activities is likely to be in electronic form.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 23

Learning Objective 4 Understand internal control and design and perform tests of controls and substantive tests of transactions for sales.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 24

Methodology for Designing Controls and Substantive Tests: Sales

Understand internal control sales Assess planned control risk sales Design tests of controls and substantive tests of transactions for sales to meet transactionrelated audit objectives. Audit procedures Sample size Items to select Timing

Evaluate cost-benefit of testing controls.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 25

Understanding Internal Control Sales

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

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 26

Assess Planned Control Risk Sales

Adequate separation of duties Adequate documents and records
Monthly statements

Proper authorization

Prenumbered documents Internal verification procedures

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 27

Internal Verification Procedures

Evaluate cost-benefit of testing controls.

Design tests of controls for sales.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 28

Transaction-Related Audit Objectives for Sales

Existence: Recorded sales are for shipments actually made. Completeness: Existing sales transactions are recorded. Accuracy: Recorded sales are for the amount shipped.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 29

Design Substantive Tests of Transactions for Sales

Classification: Sales transactions are properly classified. Timing: Sales are recorded on the correct dates. Posting and summarization: Sales transactions are properly included in the accounts receivable master file.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 30

Direction of Tests for Sales

Customer order Shipping document
Completeness Start

Duplicate sales invoice

Sales journal
Existence Start

General ledger

Accounts receivable master file

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 31

Summary of Methodology for Sales

Column 1: Transaction-related audit objectives Column 2: Key internal controls Column 3: Test of controls Column 4: Weaknesses Column 5: Substantive tests of transactions

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 32

Learning Objective 5 Apply the methodology for controls over sales transactions to controls over sales returns and allowances.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 33

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.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 34

Sales Returns and Allowances

There are, however, two important differences.

Materiality

Emphasis on objectives

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 35

Learning Objective 6 Understand internal control and design and perform tests of controls and substantive tests of transactions for cash receipts.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 36

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

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 37

Learning Objective 7 Apply the methodology for controls over the sales and collection cycle to write-offs of uncollectible accounts receivable.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 38

Audit Tests for Uncollectible Accounts

Existence of recorded write-offs is the most important transaction-related audit objective. What is a major concern in testing accounts charged off as uncollectible? covering up a defalcation by charging off accounts receivable that have been collected

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 39

Additional Internal Controls Over Account Balances

Realizable value

Rights and obligations

Presentation and disclosure

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 40

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 Cash Bad debt expense

Allowance for doubtful accounts

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 41

Role of all Audit Tests in the Sales and Collection Cycle

Sales
Sales transactions
Audited by TOC, STOT, and AP

Accounts Receivable
Cash receipts transactions

Cash in Bank

Audited by TOC, STOT, and AP

Ending balance

Ending balance

Audited by AP and TDP

TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 42

End of Chapter 13

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 43