Audit of the Sales and

Collection Cycle:
Tests of Controls and
Substantive Tests of
Transactions

Chapter 14
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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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
Sales
Cash
sales
Sales on
account

Cash in Bank

Accounts Receivable
Beginning Cash receipts
balance

Cash Discounts
Taken

Sales on
account

Sales returns
and allowances

Sales Returns
and Allowances

Ending
balance

Charge-off of
uncollectible
accounts

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

Bad Debt
Expense
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Accounts in the Sales and

Collection Cycle
Accounts Receivable
Beginning Cash receipts
balance
Sales on
account

Sales returns
and allowances

Ending
balance

Charge-off of
uncollectible
accounts

Allowance for
Uncollectible Accounts
Charge-off of Beginning
uncollectible balance
accounts
Estimate of
bad debt
expense

Bad Debt
Expense

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

Ending
balance

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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

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

Shipping goods
Billing customers
and recording sales

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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

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Charge-off of Uncollectible
Accounts Transaction
Accounts

Business functions

Documents and records

Accounts
receivable
Allowance for
uncollectible
accounts

Charging 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
where company assets are given up.

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Billing Customers and Recording

Sales
Sales invoice
Sales transaction file
Sales journal or listing
Accounts receivable master file
Accounts receivable trial balance
Monthly statement
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Processing and Recording Cash

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

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Processing and Recording Sales

Returns and Allowances
Credit memo

Sales returns and allowances journal

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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.

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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 how e-commerce

activities affect the sales
and collection cycle.

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Effect of E-Commerce on the

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

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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.

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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.

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Learning Objective 4
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
of Sales Transactions for Sales
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 transaction
-related audit objectives.
Audit procedures
Sample size
Items to select
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
Adequate documents
and records

Proper authorization

Monthly statements

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

Prenumbered
documents
Internal verification
procedures
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Determine Extent of Testing

Controls
Audits of public
companies

Audits of nonpublic
companies

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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.
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Transaction-Related Audit
Objectives 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.
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Direction of Tests for Sales

Customer
order

Shipping
document

Completeness
start

Duplicate
sales
invoice

Sales
journal

General
journal

Accounts
receivable
master file

Existence
start

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Summary of Methodology for

Sales
Transaction-related audit objectives (Column 1)
Key existing controls (Column 2)
Tests of control (Column 3)
Deficiencies (Column 4)
Substantive tests of transactions (Column 5)

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Learning Objective 5
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

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

Emphasis on
objectives

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Learning Objective 6
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.

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Learning Objective 7
Apply the methodology for
controls over the sales and
collection cycle to write-offs
of uncollectible accounts
receivable.
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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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
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Additional Internal Controls Over

Account Balances
Realizable value
Credit approval
Aged accounts receivable trial balance
Charging off uncollectibles

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Additional Internal Controls Over

Account Balances
Rights and obligations

Presentation and disclosure

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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

Cash

Bad debt expense

Allowance for
doubtful accounts

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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

Ending
balance

Audited by
TOC, STOT, and AP

Ending
balance

Audited by AP and TDB

TOC + STOT + AP + TDB

= Sufficient competent evidence per GAAS
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End of Chapter 14

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