©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Audit of the Sales and Collection Cycle Chapter 14

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Learning Objective 1 Identify the accounts and the classes of transactions in the sales and collection cycle.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Accounts in the Sales and Collection Cycle SalesCashsales Sales on account Accounts Receivable Cash receipts Sales returns and allowances Charge-off of uncollectibleaccounts Beginningbalance Sales on account Endingbalance Cash in Bank Cash Discounts Taken Bad Debt Expense Sales Returns and Allowances

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Accounts in the Sales and Collection Cycle Accounts Receivable Cash receipts Sales returns and allowances Charge-off of uncollectibleaccounts Beginningbalance Sales on account Endingbalance Allowance for Uncollectible Accounts Charge-off of uncollectibleaccountsBeginningbalance Estimate of bad debt expense Endingbalance Bad Debt Expense

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Learning Objective 2 Describe the business functions and the related documents and records in the sales and collection cycle.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Sales Transaction AccountsSales Accounts Receivable Businessfunctions Processing customer orders, Granting credit, Shipping goods, Billing customers and recording sales Documents and records Sales invoice, Sales journal or listing, Sales transaction file, Accounts receivable master file and trial balance, Monthly statements

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Cash Receipts Transaction Accounts Cash in Bank (debits from cash receipts) Accounts Receivable Businessfunctions Processing and recording cash receipts Documents and records Remittance advice, Prelisting of cash receipts, Cash receipts transaction file, Cash receipts journal or listing

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Sales Returns and Allowances Transaction Accounts Sales returns and Allowances Accounts Receivable Businessfunctions Processing and recording sales returns and allowances Documents and records Credit memo Sales returns and allowances journal

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Charge-off of Uncollectible Accounts Transaction Accounts Accounts Receivable Allowance for Uncollectible Accounts Businessfunctions Charging off uncollectible accounts receivable Documents and records Uncollectible account authorization form General journal

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Bad Debt Expense Transaction Accounts Bad Debt Expense Allowance for Uncollectible Accounts Businessfunctions Providing for bad debts Documents and records General journal

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Processing Customer Orders Customer Order: Customer Order: A request for merchandise by a customer Sales Order: A document describing the goods ordered by a customer

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Granting Credit Before goods are shipped, a properly Before goods are shipped, a properly authorized person must approve credit to the customer for sales on account.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Shipping Goods This is the first point in the cycle where company assets are given up. Shippingdocument

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Billing Customers and Recording Sales Sales invoice Sales transaction file Sales journal or listing Accounts receivable master file Accounts receivable trial balance Monthly statement

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Processing and Recording Cash Receipts Remittance advice Prelisting of cash receipts Cash receipts transaction file Cash receipts journal or listing

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Processing and Recording Sales Returns and Allowances Credit memo Sales returns and allowances journal

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 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.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Providing for Bad Debts This provision represents a residual, resulting from management’s end-of-period adjustment of the allowance for uncollectible accounts.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Learning Objective 3 Understand how e-commerce activities affect the sales and collection cycle.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 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.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Effect of E-Commerce on the Sales and Collection Cycle Business-to-business (B2B) Business-to-consumer (B2C) Management’s assertions for sales and collection activities remain the same.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 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.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Learning Objective 4 Understand internal control and design and perform tests of controls and substantive tests of transactions for sales.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Audit procedures Sample size Items to select Timing Methodology for Designing Controls and Substantive Tests: Sales Understand internal control – sales. Assess planned control risk – sales. Evaluate cost-benefit of testing controls. Design tests of controls and substantive tests of transactions for sales to meet transaction- related audit objectives.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Understanding Internal Control – Sales Study the client’s flowcharts, prepare an internal control questionnaire, and perform walk-through tests of sales.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Assess Planned Control Risk – Sales Adequate separation of duties Proper authorization Adequate documents and records Prenumbereddocuments Monthly statements Monthly statements Internal verification Internal verification procedures procedures

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Internal Verification Procedures Evaluate cost-benefit of testing controls. Design tests of controls for sales.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Transaction-Related Audit Objectives for Sales Existence: Recorded sales are for shipments actually made. Accuracy: Recorded sales are for the amount shipped. Completeness: Existing sales transactions are recorded.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 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.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Direction of Tests for Sales CompletenessstartExistencestart CustomerorderShippingdocumentDuplicatesalesinvoiceSalesjournalGeneraljournalAccountsreceivable master file =

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Summary of Methodology for Sales Transaction-related audit objectives (column 1) Key internal controls (column 2) Tests of controls (column 3) Weaknesses (column 4) Substantive tests of transactions (column 5)

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Learning Objective 5 Apply the methodology for controls over sales transactions to controls over sales returns and allowances.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 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.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Sales Returns and Allowances There are, however, two important differences. Materiality Emphasis on objectives

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Learning Objective 6 Understand internal control and design and perform tests of controls and substantive tests of transactions for cash receipts.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 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

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Learning Objective 7 Apply the methodology for controls over the sales and collection cycle to write-offs of uncollectible accounts receivable.

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 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

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Additional Internal Controls Over Account Balances Realizable value Rights and obligations Presentation and disclosure

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 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: Accountsreceivable Bad debt expense Cash Allowance for doubtful accounts

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley Role of all Audit Tests in the Sales and Collection Cycle SalesAccountsReceivable Cash in BankSalestransactions Cash receipts transactions EndingbalanceEndingbalance TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS Audited by TOC, STOT, and AP Audited by AP and TDB Audited by TOC, STOT, and AP

©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley End of Chapter 14