1. Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions
Chapter 14
Arens et.al.,

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

3. Accounts in the Sales and Collection Cycle
Cash in Bank
Cash
sales
Accounts Receivable
Cash Discounts
Taken
Sales on
account
Beginning
balance
Cash receipts
Sales on
account
Sales returns
and allowances
Sales Returns
and Allowances
Ending
balance
Write-off of
uncollectible
accounts
Bad Debt
Expense

4. Accounts in the Sales and Collection Cycle
Allowance for
Uncollectible Accounts
Accounts Receivable
Beginning
balance
Cash receipts
Write-off of
uncollectible
accounts
Beginning
balance
Sales on
account
Sales returns
and allowances
Estimate of
bad debt
expense
Ending
balance
Write-off of
uncollectible
accounts
Ending
balance
Bad Debt
Expense

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

6. Sales Transaction Sales Accounts receivable Processing customer orders
Business Functions
Documents and Records
Sales
Accounts
receivable
Processing
customer orders
Granting credit
Shipping goods
Billing customers
and recording
sales
Customer order
Sales order
Customer order or
sales order
Shipping document
Sales invoice
Sales transaction file
Sales journal or listing
Accounts receivable
master file
trial balance
Monthly statements

7. 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

8. 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

9. Write-off of Uncollectible Accounts Transaction
Business Functions
Documents and Records
Accounts
receivable
Allowance for
uncollectible
accounts
Uncollectible account
authorization form
General journal
Writing off
uncollectible
accounts
receivable

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

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

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

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

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

15. Processing and Recording Cash Receipts
Remittance advice
Prelisting of cash receipts
Cash receipts transaction file
Cash receipts journal or listing

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

17. 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

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

19. Learning Objective 3 Understand internal control, and
design and perform tests of
controls and substantive tests
of transactions for sales.

20. Methodology for Designing Controls and Substantive Tests
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

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

22. Assess Planned Control Risk – Sales
Four Steps:
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

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

24. Determine Extent of Testing Controls
Audits of public companies
Audits of nonpublic companies

25. Transaction-related Audit Objectives for Sales
Occurrence:
Recorded sales are for shipments actually made.
Completeness:
Existing sales transactions are recorded.
Accuracy:
Recorded sales are for the amount shipped.

26. Transaction-related Audit Objectives for Sales
Posting and summarization:
Sales transactions are correctly included
in the accounts receivable master file.
Classification:
Sales transactions are correctly classified.
Timing:
Sales are recorded on the correct dates.

27. Direction of Tests for Sales
Customer
order
Shipping
document
Duplicate
sales
invoice
Sales
journal
General
journal =
Accounts
receivable
master file
Completeness
start
Occurrence
start

28. 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)

29. Learning Objective 4 Apply the methodology for controls
over sales transactions to controls
over sales returns and allowances.

30. 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.

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

32. Learning Objective 5 Understand internal control, and
design and perform tests of
controls and substantive tests
of transactions for cash receipts.

33. 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

34. Learning Objective 6 Apply the methodology for
controls over the sales and
collection cycle to write-offs
of uncollectible accounts
receivable.

35. 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

36. Additional Internal Controls Over Account Balances
Realizable value
Credit approval
Aged accounts receivable trial balance
Writing off uncollectibles
Rights and obligations
Presentation and disclosure

37. 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

38. Types of Audit Tests for 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 TDB
TOC + STOT + AP + TDB
= Sufficient appropriate evidence

39. End of Chapter 14