Audit of the Sales and Collection Cycle Chapter 13

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

Accounts in the Sales and Collection Cycle 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

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

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

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

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

Sales Transaction Sales Accounts Accounts receivable Business Functions 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

Cash Receipts Transaction Accounts Cash in bank (debits from cash receipts) Accounts receivable Business Functions Processing and recording cash receipts Documents and Records Remittance advise, Prelisting of cash receipts, Cash receipts transaction file, Cash receipts journal or listing

Sales Returns and Allowances Transaction Accounts Sales returns and allowances Accounts receivable Business Functions Processing and recording sales returns and allowances Documents and Records Credit memo Sales returns and allowances journal

Charge-off of Uncollectible Accounts Transaction Accounts receivable Allowance for uncollectible accounts Business Functions Charging off uncollectible accounts receivable Documents and Records Uncollectible account authorization form General journal

Bad Debt Expense Transaction Accounts Bad debt expense Allowance for uncollectible accounts Business Functions Providing for bad debts Documents and Records General journal

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

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

Processing and Recording Cash Receipts Remittance advise Prelisting of cash receipts Cash receipts transaction file Cash receipts journal or listing

Lockbox Systems and Electronic Funds Transfer Bank Order/Payment Information Information Customer Company

Processing and Recording Sales Returns and Allowances Credit memo Sales returns and allowances journal

Charging Off Uncollectible Accounts Receivable Authorization Form This is a document used internally to indicate authority to write an account receivable off as uncollectible.

Providing for Bad Debts This provision represents a residual, resulting from management’s end-of-period adjustment of the allowance for uncollectible accounts.

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

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.

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.

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.

Understand internal control and design and perform tests Learning Objective 4 Understand internal control and design and perform tests of controls and substantive tests of transactions for sales.

Methodology for Designing Controls and Substantive Tests: Sales Design tests of controls and substantive tests of transactions for sales to meet transaction- related audit objectives. Understand internal control – sales Assess planned control risk – sales Audit procedures Sample size Evaluate cost-benefit of testing controls. Items to select Timing

Understanding Internal Control – Sales Study the client’s flowcharts, prepare an internal control questionnaire, and perform walk-through tests of sales.

Assess Planned Control Risk – Sales Adequate separation of duties Proper authorization Adequate documents and records Prenumbered documents Monthly statements Internal verification procedures

Internal Verification Procedures Evaluate cost-benefit of testing controls. Design tests of controls for sales.

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.

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.

Direction of Tests for Sales Customer order Shipping document Duplicate sales invoice Completeness Start Sales journal General ledger Accounts receivable master file = Existence Start

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

Apply the methodology for controls over sales transactions Learning Objective 5 Apply the methodology for controls over sales transactions to controls over sales returns and allowances.

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.

Sales Returns and Allowances There are, however, two important differences. Materiality Emphasis on objectives

Understand internal control and design and perform tests of Learning Objective 6 Understand internal control and design and perform tests of controls and substantive tests of transactions for cash receipts.

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

Apply the methodology for controls over the sales and collection cycle Learning Objective 7 Apply the methodology for controls over the sales and collection cycle to write-offs of uncollectible accounts receivable.

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

Additional Internal Controls Over Account Balances Realizable value Rights and obligations Presentation and disclosure

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 Bad debt expense Cash Allowance for doubtful accounts

Role of all Audit Tests in the Sales and Collection Cycle Accounts Receivable Cash in Bank Sales transactions Cash receipts transactions Audited by TOC, STOT, and AP Audited by TOC, STOT, and AP Ending balance Ending balance Audited by AP and TDP TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS

End of Chapter 13