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Copyright © 2014 Pearson Education

Chapter 14

Audit of the Sales

and Collection

Cycle:

Tests of Control and

Substantive Tests of

Transactions

Copyright © 2014 Pearson Education 14-2

Identify the accounts and the classes of

transactions in the sales and collection

cycle.

Describe the business functions and the

related documents and records in the sales

and collection cycle.

Understand internal control, and design

and perform tests of controls and

substantive tests of transactions for sales.


Apply the methodology for controls over

sales transactions to controls over sales

returns and allowances.

Understand internal control, and design

and perform tests of controls and

substantive tests of transactions for cash

receipts.

Apply the methodology for controls over

the sales and collection cycle to write-offs

of uncollectible accounts receivable.


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

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1


Describe the business functions and the related documents and records in the sales and

collection cycle.

14-6

2


Accounts 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 Accounts receivable trial balance Monthly statements



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



Sales returns

and

allowances

Accounts

receivable

Processing and

recording sales

returns and

allowances

Credit memo

Sales and returns and

allowances journal



Accounts

receivable

Allowance for

uncollectible

accounts

Writing off

uncollectible

accounts

receivable

Uncollectible account

authorization form

General journal


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Bad debt

expense

Allowance for

uncollectible

accounts

Providing for bad

debts

General journal


Customer Order:

A request for merchandise by a customer

Sales Order:

A document describing the goods ordered

by a customer


Before goods are shipped, a properly

authorized person must approve credit

to the customer for sales on account


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 shipped


Sales transaction

file

Sales journal

Accounts receivable

file

Accounts receivable

trial balance


Prelisting of

Cash receipts

Cash receipts transaction

file


Credit memo

Sales returns and allowances journal


Uncollectible account authorization form

This is a document used internally to

indicate authority to write an account

receivable off as uncollectible


This provision represents a residual,

resulting from management’s

end-of-period adjustment of the

allowance for uncollectible accounts


Understand internal control, and design and perform tests of controls and substantive tests of

transactions for sales.

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3


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


Study the client’s flowcharts, prepare

an internal control questionnaire, and

perform walk-through tests of 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


Adequate separation of duties

Proper authorization

Adequate documents and records

Pre-numbered documents

Monthly statements

Internal verification procedures


Control

risk

Control

effectiveness


Occurrence:

Recorded sales are for shipments actually made.

Completeness:

Existing sales transactions are recorded.

Accuracy:

Recorded sales are for the

amount shipped.


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.


Improper

sales cutoff Sham sales

Improper

% of completion

Conditional sales

Round-tripping

loans as sales

Fraudulent

Techniques

Premature

revenue

recognition

Unauthorized

shipments

Bill and hold

Consignment

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


Apply the methodology for controls over sales transactions to controls over sales returns and

allowances.

14-31

4


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.


There are, however, two important differences:

Materiality

Emphasis

on

objectives


Understand internal control, and design and perform tests of controls and substantive tests

of transactions for cash receipts.

14-34

5


Determine whether cash received was recorded

Prepare proof of cash receipts*

Test to discover lapping of accounts receivable*


Apply the methodology for controls over the sales and collection cycle to write-offs of

uncollectible accounts receivable.

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6


Occurrence transaction-related audit objective

Proper authorization of the write-off of

uncollectible accounts

Verification of accounts written off


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


Audited by TOC, STOT, and AP

Audited by AP and TDB

Audited by TOC, STOT, and AP

Sales Accounts

Receivable Cash in Bank

Sales transactions

Cash receipts transactions

Ending balance

Ending balance

TOC + STOT + AP + TDB = Sufficient appropriate evidence


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14-41