Chapter 4- Audit of the Sales

and Collection Cycle:

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 14 - 1

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

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 Accounts in the Sales and Collection
Cycle
Sales Cash in Bank
Cash
sales
Accounts Receivable Cash Discounts
Sales on Taken
account Beginning Cash receipts
balance

Sales on Sales returns Sales Returns

account and allowances and Allowances

Ending Write-off of
balance uncollectible Bad Debt
accounts Expense

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

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 14 - 5

 Sales Transaction
Accounts Business Functions Documents and Records
Sales Processing Customer order
Accounts customer orders Sales order
Customer order or
receivable sales order
Granting credit Shipping document
Shipping goods Sales invoice
Billing customers Sales transaction file
and recording Sales journal or listing
sales Accounts receivable
master file
Accounts receivable
trial balance
Monthly statements
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 Cash Receipts Transaction
Accounts Business Functions Documents and Records
Cash in bank Processing and Remittance advice
(debits from recording cash Prelisting of cash
cash receipts) receipts receipts
Accounts Cash receipts
receivable transaction file
Cash receipts journal
or listing

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

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 Write-off of Uncollectible Accounts
Transaction
Accounts Business Functions Documents and Records
Accounts Writing off Uncollectible account
receivable uncollectible authorization from
Allowance for accounts general journal
uncollectible receivable
accounts

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 14 - 10

 Processing Customer Orders

Customer Order:
A request for merchandise by a customer

Sales Order:
A document describing the goods ordered
by a customer

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 Granting Credit

Before goods are shipped, a properly

authorized person must approve credit
to the customer for sales on account

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 Shipping Goods

This is the first point in the cycle

where company assets are given up

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 Billing Customers and Recording Sales

Sales invoice
Sales transaction file
Sales journal or listing
Accounts receivable master file
Accounts receivable trial balance
Monthly statement

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 14 - 14

 Processing and Recording Cash
Receipts
Remittance advice

Prelisting of cash receipts

Cash receipts transaction file

Cash receipts journal or listing

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 Processing and Recording Sales
Returns and Allowances
Credit memo

Sales returns and allowances journal

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 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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 14 - 17

 Providing for Bad Debts

This provision represents a residual,

resulting from managements
end-of-period adjustment of the
allowance for uncollectible accounts

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

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 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 Audit procedures

substantive tests of transactions Sample size
for sales to meet transaction- Items to select
related audit objectives Timing
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 Understand Internal Control Sales

Study the clients flowcharts, prepare

an internal control questionnaire, and
perform walk-through tests of sales.

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 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

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 Assess Planned Control Risk Sales

Adequate separation of duties

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

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 Determine Extent of Testing Controls

Audits of public companies

Audits of nonpublic companies

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 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.

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 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.

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 Direction of Tests for Sales

Duplicate
Customer Shipping
sales
order document
invoice

Accounts
Sales General
= receivable
journal journal
master file

Completeness Existence
start start
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 Learning Objective 4

Apply the methodology for controls

over sales transactions to controls
over sales returns and allowances.

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 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.

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 Sales Returns and Allowances

There are, however, two important differences.

Materiality

Emphasis on objectives

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 Learning Objective 5

Understand internal control, and

design and perform tests of
controls and substantive tests
of transactions for cash receipts.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 14 - 31

 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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 14 - 32

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

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 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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 14 - 34

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 14 - 35

 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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 14 - 36

 Types of Audit Tests for the Sales and
Collection Cycle
Accounts Cash in
Sales Receivable Bank
Sales Cash receipts
transactions transactions
Audited by Audited by
TOC, STOT, and AP TOC, STOT, and AP

Ending Ending
balance balance
Audited by AP and TDB

TOC + STOT + AP + TDB

= Sufficient appropriate evidence
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 End of Chapter-4

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