CHAPTER 8 Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions

Prepared by: Ahmad Fahmi b. Rosli Mohd Shahimi b. Halimi Atiah bt Jamalukhair Noor Suriani bt Musa Prepared for: Mdm Nor Effa Dalilati

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

Overview of Accounts in the Sales and Collection Cycle

Sales Cash sales Sales on account Accounts Receivable Beginning Cash receipts balance Sales on account Ending balance Sales returns and allowances Charge-off of uncollectible accounts Cash in Bank

Cash Discounts Taken

Sales Returns and Allowances

Bad Debt Expense

Accounts in the Sales and Collection Cycle

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

Ending balance

Write-off of uncollectible accounts

Analysis of the Sales and Collection Cycle

Excellent format for analysis:

Business Functions Accounts involved Documents and Records

Think Accounting Information Systems

Sales Transaction Objectives

1) Validity
Test of control Examine sales invoice for supporting bill of lading and customer order.
Substantive test Auditor is concerned with three types of misstatements: Recorded sale with no shipment Trace from sales journal entry to shipping document Sale recorded more than once Check cancellation of shipping documentation. Shipments made to nonexistent customers Person recording sales should not authorize shipments.

2) Completeness
Test of control Account for sequence of shipping documents. Substantive test Many audits ignore completeness on the grounds that overstatement of income are of greater concern. However, errors may still misstate financial statements. One effective procedure is to trace from shipping documents to the sales invoice and entry in the sales journal.

3) Accuracy
Test of control Account for sequence of shipping documents. Substantive test Many audits ignore completeness on the grounds that overstatement of income are of greater concern. However, errors may still misstate financial statements. One effective procedure is to trace from shipping documents to the sales invoice and entry in the sales journal.

4) Classification
Test of control Examine document package for duplicate verification.
Substantive test When there are cash and credit sales, it is important not to debit accounts receivable for a cash sale or to credit sales for collection of a receivable. It is also important not to classify sales of operating assets as sales. A common procedure is to examine duplicate sales invoice for proper account classification.

5) Timing
Test of control Account for sequence of shipping documents. Substantive test Sales should be billed when ownership is transferred to the customer. A common procedure is to compare the date of recording a sale in the sales journal with the date on the duplicate sales invoice and bill of lading.

6) Summarizing & posting

Test of control Examine evidence that accounts receivable master file is reconciled to the general ledger.
Substantive test Use audit software to foot and cross-foot the sales journal and trace totals to the general ledger.

Cash Receipts Transaction

Accounts Cash in bank (debits from cash receipts) Accounts receivable Business functions Processing and recording cash receipts Documents and records Remittance advice Prelisting of cash receipts Cash receipts transaction file Cash receipts journal or listing

Cash receipts Transaction Objectives

1) Validity
Test of control Observe whether accountant reconciles bank account.
Substantive test Trace cash receipts entries from the cash receipts journal entries to the bank statement.

2) Completeness
Test of control Observe prelisting of cash receipts. Substantive test Compare the prelisting with the duplicate deposit slip.

3) Accuracy
Test of control Observe whether accountant reconciles bank account. Substantive test Prepare a proof of cash receipts to reconcile cash receipts per books with cash receipts per bank.

4) Classification
Test of control Examine evidence of internal verification. Substantive test Examine prelisting for proper account classification.

5) Timing
Test of control Observe unrecorded cash at a point in time to see when it is recorded. Substantive test Compare date of deposit in bank statement to the dates in the cash receipts journal and prelisting of cash receipts.

6) Summarization & posting

Test of control Examine evidence that accounts receivable master file is reconciled to general ledger. Substantive test Use audit software to foot and cross-foot the cash receipts journal and trace to the general ledger.

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 and returns and allowances journal

Write-off of Uncollectible Accounts Transaction

Accounts Accounts receivable Allowance for uncollectible accounts Business functions write 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

Processing Customer Orders

Customer Order: 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.

Shipping Goods

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

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 advice

Prelisting of cash receipts

Cash receipts transaction file Cash receipts journal or listing

Processing and Recording Sales Returns and Allowances

Credit memo

Sales returns and allowances journal

Providing for Bad Debts

This provision represents a residual, resulting from managements end-of-period adjustment of the allowance for uncollectible accounts.

Methodology for Designing Controls and Substantive Tests of Sales Transactions for Sales
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

PROCESS FLOW OF SALES ACTIVITIES

1) Receives customer order

Receives Customers Purchases order

Purchases order

Approved customers list

Clerk prepares a prenumbered sales order & obtains approval from officer

Purchase order
SO SO SO 3 2 4

1 Sales Order (SO)

To credit department

TN

2) Approve customer order

SO
SO SO

From sales department

4
3 2

1 Sales Order (SO)

App. SO
App. SO App. SO 2 3

1 Approved sales order (App. SO)

Credit Approved by standing

Clerk checks the customers credit standing

To Sales department

3) Sends goods to customer

From sales department

1 Approved sales order (App. SO)

App. Sales order DN 3 DN 1 Delivery note (DN) 2

Clerk prepared prenumbered delivery note & obtain approval from officer

To Bin card

N
To Billing department To customer

4) Sends sales invoices to customer

To Billing department
From treasurers department Sales order
Sales invoices Gather data From sales order

Process the sales order

Preparation of Sales invoices

Sales invoices With total Amount to be paid

Clerk of account receivable checked the sale invoice Sales revenue account
Approval of monthly summary

Record sales invoices

Account receivable control

General Ledger

5) Received cash from customer

Received cash

Cash

Cash C/Sheet Cash C/Sheet Cash Cash register reading 1

Clerk prepares cash Count sheet & obtain Approval from cashier

Clerk agree cash Register reading With the actual Cash receipts

I
To Accounts department

Understand Internal Control Sales

Study the clients flowcharts, prepare an internal control questionnaire, and perform walk-through tests of sales.

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

Assess Planned Control Risk Sales

Adequate separation of duties Proper authorization Adequate documents and records Monthly statements Internal verification procedures Prenumbered documents

Determine Extent of Testing Controls

Audits of public companies

Audits of nonpublic companies

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.

Transaction-Related Audit Objectives 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

Sales journal

General journal

Accounts receivable master file

Completeness start

Existence start

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)

Sales Returns and Allowances

The transaction-related audit objectives and clients 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

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.

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

Credit approval Aged accounts receivable trial balance Charging off uncollectibles

Additional Internal Controls Over Account Balances

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 Cash Allowance for doubtful accounts

Bad debt expense

Types of Audit Tests for the Sales and Collection Cycle

Sales Sales transactions
Audited by TOC, STOT, and AP

Accounts Receivable Cash receipts transactions

Audited by TOC, STOT, and AP

Cash in Bank

Ending balance

Ending balance

Audited by AP and TDB

TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS