Plant Assets & Intangibles

Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of TransactionsChapter 1414-1

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.111111Learning Objectives14-2Identify 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.

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.2Learning Objectives14-3Apply 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.

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.3Identify the accounts and the classes of transactions in the sales and collection cycle.

14-41Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.4Accounts in the Sales and Collection Cycle14-5

The overall objective in the audit of the sales and collection cycle is to evaluate whether the account balances affected by the cycle are fairly presented in accordance with accounting standards.Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.The overall objective in the audit of the sales and collection cycle is to evaluate whether the account balances affected by the cycle are fairly presented in accordance with accounting standards.

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

14-62Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.6Sales Transaction14-7AccountsBusiness FunctionsDocuments 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 statementsThe sales and collection cycle involves the decisions and processes necessary for the transfer of the ownership of goods and services to customers after they are made available for sale.Before auditors can assess control risk and design tests of controls and substantive tests of transactions, they need to understand the business functions and documents and records in a business. Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.The sales and collection cycle involves the decisions and processes necessary for the transfer of the ownership of goods and services to customers after they are made available for sale.

Before auditors can assess control risk and design tests of controls and substantive tests of transactions, they need to understand the business functions and documents and records in a business.

7Cash Receipts Transaction14-8AccountsBusiness FunctionsDocuments and Records Cash in bank (debits from cash receipts) Accounts receivable Processing and recording cash receiptsRemittance advice Prelisting of cash receipts Cash receipts transaction file Cash receipts journal or listingCopyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.8Sales Returns and Allowances Transaction14-9AccountsBusiness FunctionsDocuments and Records Sales returns and allowances Accounts receivable Processing and recording sales returns and allowances Credit memo Sales and returns and allowances journalCopyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.9Write-off of Uncollectible Accounts Transaction14-10AccountsBusiness FunctionsDocuments and Records Accounts receivable Allowance for uncollectible accounts Writing off uncollectible accounts receivable Uncollectible account authorization form General journalCopyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.10Bad Debt Expense Transaction14-11AccountsBusiness FunctionsDocuments and Records Bad debt expense Allowance for uncollectible accounts Providing for bad debts General journalCopyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.11Processing Customer Orders14-12Customer Order: A request for merchandise by a customerSales Order: A document describing the goods orderedby a customerCopyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.12Granting Credit14-13Before goods are shipped, a properlyauthorized person must approve creditto the customer for sales on accountCopyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.Weak practices in credit approval often result in excessive bad debts and accounts receivable that may be uncollectible.

13Shipping Goods14-14 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 shippedThe shipping document is essential to the proper billing of shipments to customers.Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.The shipping document is essential to the proper billing of shipments to customers.

14Billing Customers and Recording Sales14-15

Sales transaction fileSales journal

Accounts receivable fileAccounts receivable trial balance

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.The most important aspects of billing are:All shipments made have been billed (completeness)No shipment has been billed more than once (occurrence)Each one is billed for the proper amount (accuracy).

Billing the proper amount is dependent on charging the customer for the quantity shipped at the authorized price, including consideration fro freight insurance and terms of payment.

15The most important aspects of billing are:

All shipments made have been billed (completeness)No shipment has been billed more than once (occurrence)Each one is billed for the proper amount (accuracy).

Billing the proper amount is dependent on charging the customer for the quantity shipped at the authorized price, including consideration for freight insurance and terms of payment.

16Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.Processing and Recording Cash Receipts14-17

Prelisting of Cash receipts Cash receiptstransaction file

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.A remittance advice is a document mailed to the customer and typically returned to the seller with the cash payment.

The prelisting of cash receipts is a list prepared when cash is received by someone who has no responsibility for recording sales, accounts receivable, or cash and who has no access to accounting records.

The transaction file is a computer generated file that includes all cash receipts transactions processed by the accounting system for a period.

The cash receipts listing is generated from the cash receipts transaction file and includes all transactions for a time period.

17A remittance advice is a document mailed to the customer and typically returned to the seller with the cash payment.

The prelisting of cash receipts is a list prepared when cash is received by someone who has no responsibility for recording sales, accounts receivable, or cash and who has no access to accounting records.

The transaction file is a computer generated file that includes all cash receipts transactions processed by the accounting system for a period.

The cash receipts listing is generated from the cash receipts transaction file and includes all transactions for a time period.

18Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.Processing and Recording Sales Returns and Allowances14-19 Credit memo

Sales returns and allowances journalA credit memo indicates a reduction in the amount due from a customer because of returned goods or an allowance.

The sales returns journal is used to record sales returns and allowances and performs the same function as the sales journal.Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.A credit memo indicates a reduction in the amount due from a customer because of returned goods or an allowance.

The sales returns journal is used to record sales returns and allowances and performs the same function as the sales journal.

19Writing Off UncollectibleAccounts Receivable14-20Uncollectible account authorization formThis is a document used internally toindicate authority to write an accountreceivable off as uncollectibleCopyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.20Providing for Bad Debts14-21This provision represents a residual,resulting from managementsend-of-period adjustment of theallowance for uncollectible accountsCompanies cannot expect to collect 100% of the sales, therefore, accounting principles require them to record bad debt expense for the amount they do not expect to collect. Most companies record this entry at the end of the month or quarter.

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.Companies cannot expect to collect 100% of the sales, therefore, accounting principles require them to record bad debt expense for the amount they do not expect to collect. Most companies record this entry at the end of the month or quarter.

21Understand internal control, and design and perform tests of controls and substantive tests of transactions for sales.

14-223Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.22Methodology for Designing Controls and Substantive Tests14-23Understand internal control salesAssess planned control risk salesDetermine extent of testing controlsDesign tests of controls andsubstantive tests of transactionsfor sales to meet transaction-related audit objectivesAudit proceduresSample sizeItems to selectTimingCopyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.23Understand Internal Control Sales14-24Study the clients flowcharts, preparean internal control questionnaire, andperform walk-through tests of sales.Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.Auditors study the clients flowcharts, make inquiries of the client using an internal control questionnaire, and perform walk-through tests of sales.

24Assess Planned Control Risk Sales14-251. Framework for assessing control risk2. Identify key internal controls and deficiencies 3. Associate controls and deficiencies with the objectives 4. Assess control risk for each objectiveThe six transaction related audit objectives provide this framework.Key internal controls and deficiencies for sales will differ for every audit because every client has different internal controls.The auditor assesses control risk for each objective. This step affects the auditors decision about controls and substantive tests.Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.The six transaction related audit objectives provide this framework.

Key internal controls and deficiencies for sales will differ for every audit because every client has different internal controls.

The auditor then associates the controls and deficiencies for each objective.

The auditor assesses control risk for each objective. This step affects the auditors decision about controls and substantive tests.

25Assess Planned Control Risk Sales14-26Adequate separation of duties

Proper authorization

Adequate documents and records

Pre-numbered documents

Monthly statements

Internal verification proceduresCopyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.Proper separation of duties prevents various types of misstatements due to both errors and fraud.

Proper authorization has three key points:credit must be properly authorized before a sale takes place.goods should be shipped only after proper authorizationprices including basic terms, freight and discounts must be authorized.

Adequate record keeping procedures must exist before most of the transaction related audit objectives can be met.

Pre-numbering is meant to prevent both the failure to bill or record sales and the occurrence of duplicate billings and recordings.

Sending monthly statements is a useful control because it encourages customers to respond if the balance is incorrectly stated.

Computer programs or independent personnel should check that the processing and recording of sales transactions fulfill each of the six transaction-related audit objectives.

26Proper separation of duties prevents various types of misstatements due to both errors and fraud.

Proper authorization has three key points:credit must be properly authorized before a sale takes place.goods should be shipped only after proper authorizationprices including basic terms, freight and discounts must be authorized.

Adequate record keeping procedures must exist before most of the transaction related audit objectives can be met.

Pre-numbering is meant to prevent both the failure to bill or record sales and the occurrence of duplicate billings and recordings.

Sending monthly statements is a useful control because it encourages customers to respond if the balance is incorrectly stated.

Computer programs or independent personnel should check that the processing and recording of sales transactions fulfill each of the six transaction-related audit objectives.

27Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.Determine Extent of Testing Controls14-28Control risk

Control effectiveness In audits of public companies, the auditor must perform extensive tests of key controls and evaluate the impact of the deficiencies on the auditors report on internal controls over financial reporting.

The extent of testing of controls in audits of nonpublic companies depends on the effectiveness of the controls and the extent to which the auditor believes they can be relied on to reduce control risk The Higher the Control Effectiveness,,, the Lower would be the Control RiskCopyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.In audits of public companies, the auditor must perform extensive tests of key controls and evaluate the impact of the deficiencies on the auditors report on internal controls over financial reporting.

The extent of testing of controls in audits of nonpublic companies depends on the effectiveness of the controls and the extent to which the auditor believes they can be relied on to reduce control risk.

28Direction of Tests for Sales14-29

Auditors need to understand the difference between tracing from source documents to the journals and vouching from the journals back to source documents.

The tracing tests for omitted transactions and the vouching tests for nonexistent transactions.Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.Auditors need to understand the difference between tracing from source documents to the journals and vouching from the journals back to source documents. The former tests for omitted transactions and the latter tests for nonexistent transactions.

29Transaction-related AuditObjectives for Sales14-30Occurrence:Recorded sales are for shipments actually made.Completeness:Existing sales transactions are recorded.Accuracy:Recorded sales are for the amount shipped.

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.The accurate recording of sales transactions concerns:Shipping the amount of goods orderedAccurately billing for the amount of goods shippedAccurately recording the amount billed in the accounting records

30Transaction-related AuditObjectives for Sales14-31Posting and summarization:Sales transactions are correctly includedin the accounts receivable master file.Classification:Sales transactions are correctly classified.Timing:Sales are recorded on the correct dates.

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.The proper inclusion of all sales transactions in the accounts receivable master file is essential because the accuracy of these records affects the client's ability to collect outstanding receivables.

Auditors must still be concerned that transactions are charged to the correct general ledger account.

Sales should be billed and recorded as soon after shipment takes place as possible to prevent the unintentional omission of transactions from the records and to make sure that sales are recorded in the proper period.

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Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.COSO Report Identifies Revenue Misstatement Techniques14-34Improper sales cutoffSham salesImproper % of completionConditional salesRound-tripping loans as salesFraudulent TechniquesPremature revenue recognitionUnauthorized shipmentsBill and holdConsignment sales

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.14-35

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.Are there any questions?35Summary of Methodology for Sales14-36 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

See table 14-2 page 470Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.Apply the methodology for controls over sales transactions to controls over sales returns and allowances.

14-374Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.37Sales Returns and Allowances14-38The transaction-related audit objectives andclients methods of controlling misstatementsare essentially the same for processing creditmemos as those described for sales.Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.38Sales Returns and Allowances14-39There are, however, two important differences:Materiality

Emphasis on objectives In many instances, sales returns and allowances are so immaterial the auditor can ignore them.

For sales returns and allowances, auditors usually emphasize testing recorded transactions to uncover any theft of cash from the collection of accounts receivable that was covered up by a fictitious sales return or allowance.Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.In many instances, sales returns and allowances are so immaterial the auditor can ignore them.

For sales returns and allowances, auditors usually emphasize testing recorded transactions to uncover any theft of cash from the collection of accounts receivable that was covered up by a fictitious sales return or allowance.

39Understand internal control, and design and perform tests of controls and substantive tests of transactions for cash receipts.

14-405Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.40Tests of Controls and Substantive Tests of Transactions for Cash Receipts14-41 Determine whether cash received was recorded Prepare proof of cash receipts*Test to discover lapping of accounts receivable*Auditors use the same methodology for designing tests of controls and substantive tests of transactions for cash receipts as they use for sales.Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.Auditors use the same methodology for designing tests of controls and substantive tests of transactions for cash receipts as they use for sales.

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Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

14-44Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.Are there any questions?44Copyright All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.

14-45Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.