©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions Chapter 14

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Learning Objective 1 Identify the accounts and the classes of transactions in the sales and collection cycle.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Accounts in the Sales and Collection Cycle

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Learning Objective 2 Describe the business functions and the related documents and records in the sales and collection cycle.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Sales Transaction Accounts Sales Accounts receivable Business Functions Processing customer orders Granting credit Shipping goods Billing customers and recording sales Documents and Records 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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Cash Receipts Transaction 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 AccountsBusiness FunctionsDocuments and Records

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Sales Returns and Allowances Transaction Sales returns and allowances Accounts receivable Processing and recording sales returns and allowances Credit memo Sales and returns and allowances journal AccountsBusiness FunctionsDocuments and Records

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Write-off of Uncollectible Accounts Transaction Accounts receivable Allowance for uncollectible accounts Writing off uncollectible accounts receivable Uncollectible account authorization form General journal AccountsBusiness FunctionsDocuments and Records

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Bad Debt Expense Transaction Bad debt expense Allowance for uncollectible accounts Providing for bad debts General journal AccountsBusiness FunctionsDocuments and Records

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Processing Customer Orders Customer Order:  A request for merchandise by a customer Sales Order:  A document describing the goods ordered by a customer

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Granting Credit Before goods are shipped, a properly authorized person must approve credit to the customer for sales on account

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Shipping Goods  This is the first point in the cycle at which the company gives up assets.  One type of shipping document is a bill of lading.  Bills of lading are often transmitted once goods have been shipping

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Billing Customers and Recording Sales Sales transaction file Sales journal Accounts receivable file Accounts receivable trial balance

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Processing and Recording Cash Receipts Remittance advice Cash receipts transaction file Cash receipts listing Prelisting of Cash receipts

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Processing and Recording Sales Returns and Allowances  Credit memo  Sales returns and allowances journal

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Writing 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

©2012 Prentice Hall Business Publishing, Auditing 14/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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Learning Objective 3 Understand internal control, and design and perform tests of controls and substantive tests of transactions for sales.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Methodology for Designing Controls and Substantive Tests Understand internal control – sales Audit procedures Sample size Items to select Timing 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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Understand Internal Control – Sales Study the client’s flowcharts, prepare an internal control questionnaire, and perform walk-through tests of sales.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Assess Planned Control Risk – Sales  Adequate separation of duties  Proper authorization  Adequate documents and records  Pre-numbered documents  Monthly statements  Internal verification procedures

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Determine Extent of Testing Controls Control risk Control effectiveness

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Direction of Tests for Sales

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Transaction-related Audit Objectives for Sales Occurrence: Recorded sales are for shipments actually made. Accuracy: Recorded sales are for the amount shipped. Completeness: Existing sales transactions are recorded.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Transaction-related Audit Objectives for Sales Classification: Sales transactions are correctly classified. Timing: Sales are recorded on the correct dates. Posting and summarization: Sales transactions are correctly included in the accounts receivable master file.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley COSO Report Identifies Revenue Misstatement Techniques Bill and hold Improper sales cutoff Sham sales Premature revenue recognition Conditional sales Round-tripping loans as sales Fraudulent Techniques Improper % of completion Unauthorized shipments Consignment sales

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Summary of Methodology for Sales  Identify key transaction-related audit objectives  Determine key existing controls  Design tests of controls to verify effectiveness  Evaluate any control deficiencies  Determine extent of substantive tests of transactions

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Learning Objective 4 Apply the methodology for controls over sales transactions to controls over sales returns and allowances.

©2012 Prentice Hall Business Publishing, Auditing 14/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.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Sales Returns and Allowances There are, however, two important differences: Emphasis on objectives Materiality

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Learning Objective 5 Understand internal control, and design and perform tests of controls and substantive tests of transactions for cash receipts.

©2012 Prentice Hall Business Publishing, Auditing 14/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* * Only performed when fraud is suspected

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Learning Objective 6 Apply the methodology for controls over the sales and collection cycle to write-offs of uncollectible accounts receivable.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Audit Tests for the Write-Off of Uncollectible Accounts  Occurrence transaction-related audit objective  Proper authorization of the write-off of uncollectible accounts  Verification of accounts written off

©2012 Prentice Hall Business Publishing, Auditing 14/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: Accounts receivable Cash Allowance for doubtful accounts Bad debt expense

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Types of Audit Tests for the Sales and Collection Cycle Sales Accounts Receivable Cash in Bank Sales transactions Cash receipts transactions Ending balance Ending balance TOC + STOT + AP + TDB = Sufficient appropriate evidence Audited by TOC, STOT, and AP Audited by AP and TDB Audited by TOC, STOT, and AP

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley End of Chapter 14