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11 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit of the Sales and Collection Cycle Chapter 11.

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Presentation on theme: "11 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit of the Sales and Collection Cycle Chapter 11."— Presentation transcript:

1 11 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit of the Sales and Collection Cycle Chapter 11

2 11 - 2 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 1 Identify the accounts and the classes of transactions in the sales and collection cycle.

3 11 - 3 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Accounts in the Sales and Collection Cycle Sales Cash sales Sales on account Cash in Bank Cash Discounts Taken Sales Returns and Allowances Bad Debt Expense Accounts Receivable BeginningCash receipts balance Sales returns Sales onand allowances account Charge-off of Endinguncollectible balanceaccounts

4 11 - 4 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Accounts in the Sales and Collection Cycle Accounts Receivable BeginningCash receipts balance Sales returns Sales onand allowances account Charge-off of Endinguncollectible balanceaccounts Bad Debt Expense Allowance for Uncollectible Accounts Charge-off ofBeginning uncollectiblebalance accounts Estimate of bad debt expense Ending balance

5 11 - 5 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 2 Identify the business functions and the related documents and records in the sales and collection cycle.

6 11 - 6 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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

7 11 - 7 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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 Sales invoice, Sales journal or listing, Sales transaction file, Accounts receivable master file and trial balance, Monthly statements

8 11 - 8 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley 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

9 11 - 9 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley 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

10 11 - 10 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Charge-off of Uncollectible Accounts Transaction Accounts Accounts receivable Allowance for uncollectible accounts Business Functions Charging off uncollectible accounts receivable Documents and Records Uncollectible account authorization form General journal

11 11 - 11 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Bad Debt Expense Transaction Accounts Bad debt expense Allowance for uncollectible accounts Business Functions Providing for bad debts Documents and Records General journal

12 11 - 12 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Shipping Goods This is the first point in the cycle where company assets are given up. Shipping document

13 11 - 13 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 3 Understand how e-commerce activities affect the sales and collection cycle.

14 11 - 14 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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.

15 11 - 15 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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.

16 11 - 16 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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.

17 11 - 17 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 4 Understand internal control and design and perform tests of controls and substantive tests of transactions for sales.

18 11 - 18 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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.

19 11 - 19 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Methodology for Designing Controls and Substantive Tests: Sales Understand internal control – sales Audit procedures Sample size Items to select Timing 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.

20 11 - 20 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Assess Planned Control Risk – Sales Adequate separation of duties Proper authorization Adequate documents and records Prenumbered documents Monthly statements Internal verification procedures

21 11 - 21 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Internal Verification Procedures Evaluate cost-benefit of testing controls. Design tests of controls for sales.

22 11 - 22 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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.

23 11 - 23 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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.

24 11 - 24 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Direction of Tests for Sales Sales journal General ledger Accounts receivable master file = Customer order Shipping document Duplicate sales invoice Completeness StartExistence Start

25 11 - 25 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley 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

26 11 - 26 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 5 Apply the methodology for controls over sales transactions to controls over sales returns and allowances.

27 11 - 27 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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.

28 11 - 28 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Sales Returns and Allowances There are, however, two important differences. Materiality Emphasis on objectives

29 11 - 29 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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.

30 11 - 30 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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

31 11 - 31 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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.

32 11 - 32 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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

33 11 - 33 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Additional Internal Controls Over Account Balances Realizable value Rights and obligations Presentation and disclosure

34 11 - 34 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/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 Bad debt expense Allowance for doubtful accounts

35 11 - 35 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Role of all Audit Tests in the Sales and Collection Cycle Sales transactions Cash receipts transactions Ending balance Ending balance TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS Audited by TOC, STOT, and AP Audited by AP and TDP Audited by TOC, STOT, and AP Sales Accounts Receivable Cash in Bank

36 11 - 36 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley End of Chapter 11

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