Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions
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Transcript of Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions
Audit of the Sales and Audit of the Sales and Collection Cycle:Collection Cycle:Tests of Controls and Tests of Controls and Substantive Tests of Substantive Tests of TransactionsTransactions
Chapter 14Chapter 14
Overview of Accounts in the Sales and Overview of Accounts in the Sales and Collection CycleCollection Cycle
SalesSales
CashCashsalessales
Sales onSales onaccountaccount
Accounts ReceivableAccounts Receivable
Cash receiptsCash receipts
Sales returnsSales returnsand allowancesand allowances
Charge-off ofCharge-off ofuncollectibleuncollectibleaccountsaccounts
BeginningBeginningbalancebalance
Sales onSales onaccountaccount
EndingEndingbalancebalance
Cash in BankCash in Bank
Cash DiscountsCash DiscountsTakenTaken
Bad DebtBad DebtExpenseExpense
Sales ReturnsSales Returnsand Allowancesand Allowances
Accounts in the Sales and Collection CycleAccounts in the Sales and Collection Cycle
Accounts ReceivableAccounts Receivable
Cash receiptsCash receipts
Sales returnsSales returnsand allowancesand allowances
Charge-off ofCharge-off ofuncollectibleuncollectibleaccountsaccounts
BeginningBeginningbalancebalance
Sales onSales onaccountaccount
EndingEndingbalancebalance
Allowance forAllowance forUncollectible AccountsUncollectible Accounts
Charge-off ofCharge-off ofuncollectibleuncollectibleaccountsaccounts
BeginningBeginningbalancebalance
Estimate ofEstimate ofbad debtbad debtexpenseexpense
EndingEndingbalancebalance
Bad DebtBad DebtExpenseExpense
Analysis of the Sales and Collection CycleAnalysis of the Sales and Collection Cycle
• Excellent format for analysis:Excellent format for analysis:• Business FunctionsBusiness Functions• Accounts involvedAccounts involved• Documents and RecordsDocuments and Records
• Think Accounting Information SystemsThink Accounting Information Systems
Sales TransactionSales Transaction
AccountsAccounts
SalesSales AccountsAccounts receivablereceivable
Business functionsBusiness functions
Processing customerProcessing customer ordersorders Granting creditGranting credit
Shipping goodsShipping goods Billing customersBilling customers and recording salesand recording sales
Documents and recordsDocuments and records
Customer orderCustomer order Sales orderSales order Customer order or salesCustomer order or sales orderorder Shipping documentShipping document Sales invoiceSales invoice Sales transaction fileSales transaction file Sales journal or listingSales journal or listing Accounts receivableAccounts receivable master filemaster file Accounts receivableAccounts receivable trial balancetrial balance Monthly statementsMonthly statements
Cash Receipts TransactionCash Receipts Transaction
AccountsAccounts
Cash in bankCash in bank (debits from(debits from cash receipts)cash receipts) AccountsAccounts receivablereceivable
Business functionsBusiness functions
Processing andProcessing and recording cashrecording cash receiptsreceipts
Documents and recordsDocuments and records
Remittance adviceRemittance advice Prelisting of cashPrelisting of cash receiptsreceipts Cash receiptsCash receipts transaction filetransaction file Cash receipts journal orCash receipts journal or listinglisting
Sales Returns and Allowances TransactionSales Returns and Allowances Transaction
AccountsAccounts
Sales returnsSales returns andand allowancesallowances AccountsAccounts receivablereceivable
Business functionsBusiness functions
Processing andProcessing and recording salesrecording sales returns andreturns and allowancesallowances
Documents and recordsDocuments and records
Credit memoCredit memo Sales and returns andSales and returns and allowances journalallowances journal
Charge-off of Uncollectible Accounts Charge-off of Uncollectible Accounts TransactionTransaction
AccountsAccounts
AccountsAccounts receivablereceivable Allowance forAllowance for uncollectibleuncollectible accountsaccounts
Business functionsBusiness functions
Charging offCharging off uncollectibleuncollectible accountsaccounts receivablereceivable
Documents and recordsDocuments and records
Uncollectible accountUncollectible account authorization formauthorization form General journalGeneral journal
Bad Debt Expense TransactionBad Debt Expense Transaction
AccountsAccounts
Bad debtBad debt expenseexpense Allowance forAllowance for uncollectibleuncollectible accountsaccounts
Business functionsBusiness functions
Providing for badProviding for bad debtsdebts
Documents and recordsDocuments and records
General journalGeneral journal
Processing Customer OrdersProcessing Customer Orders
Customer Order:Customer Order:A request for merchandise by a customerA request for merchandise by a customer
Sales Order: Sales Order: A document describing the goods orderedA document describing the goods orderedby a customerby a customer
Granting CreditGranting Credit
Before goods are shipped, a properlyBefore goods are shipped, a properlyauthorized person must authorized person must approve creditapprove creditto the customer for sales on account.to the customer for sales on account.
Shipping GoodsShipping Goods
This is the first point in the cycleThis is the first point in the cyclewhere company assets are given up.where company assets are given up.
Billing Customers and Recording SalesBilling Customers and Recording Sales
Sales invoiceSales invoice
Sales transaction fileSales transaction file
Sales journal or listingSales journal or listing
Accounts receivable master fileAccounts receivable master file
Accounts receivable trial balanceAccounts receivable trial balance
Monthly statementMonthly statement
Processing and Recording Cash ReceiptsProcessing and Recording Cash Receipts
Remittance adviceRemittance advice
Prelisting of cash receiptsPrelisting of cash receipts
Cash receipts transaction fileCash receipts transaction file
Cash receipts journal or listingCash receipts journal or listing
Processing and Recording Sales Returns Processing and Recording Sales Returns and Allowancesand Allowances
Credit memoCredit memo
Sales returns and allowances journalSales returns and allowances journal
Charging Off UncollectibleCharging Off UncollectibleAccounts ReceivableAccounts Receivable
Uncollectible account authorization formUncollectible account authorization form
This is a document used internally toThis is a document used internally toindicate authority to write an accountindicate authority to write an accountreceivable off as uncollectiblereceivable off as uncollectible..
Providing for Bad DebtsProviding for Bad Debts
This provision represents a residual,This provision represents a residual,resulting from management’sresulting from management’send-of-period adjustment of theend-of-period adjustment of theallowance for uncollectible accountsallowance for uncollectible accounts..
Effect of E-Commerce on the Sales and Effect of E-Commerce on the Sales and Collection CycleCollection Cycle
The Internet and other developingThe Internet and other developingtechnologies allow companies totechnologies allow companies todevelop new business models.develop new business models.
Effect of E-Commerce on the Sales and Effect of E-Commerce on the Sales and Collection CycleCollection Cycle
Business-to-business (B2B)Business-to-business (B2B)
Business-to-consumer (B2C)Business-to-consumer (B2C)
Management’s assertions for sales andManagement’s assertions for sales andcollection activities remain the same.collection activities remain the same.
Effect of E-Commerce on the Sales and Effect of E-Commerce on the Sales and Collection CycleCollection Cycle
Auditors should obtain an understandingAuditors should obtain an understandingof the design and operation of key internalof the design and operation of key internalcontrols over e-commerce revenues.controls over e-commerce revenues.
Evidence for e-commerce activities isEvidence for e-commerce activities islikely to be in electronic form.likely to be in electronic form.
Methodology for Designing Controls and Methodology for Designing Controls and Substantive TestsSubstantive Testsof Sales Transactions for Salesof Sales Transactions for Sales
Understand internalUnderstand internalcontrol – sales.control – sales.
Audit proceduresAudit procedures
Sample sizeSample size
Items to selectItems to select
TimingTiming
Assess plannedAssess plannedcontrol risk – sales.control risk – sales.
Determine extent ofDetermine extent oftesting controls.testing controls.
Design tests of controls andDesign tests of controls andsubstantive tests of transactionssubstantive tests of transactionsfor sales to meet transactionfor sales to meet transaction-related audit objectives.-related audit objectives.
Understand Internal Control – SalesUnderstand Internal Control – Sales
Study the client’s flowcharts, prepareStudy the client’s flowcharts, preparean internal control questionnaire, andan internal control questionnaire, andperform walk-through tests of sales.perform walk-through tests of sales.
Study the client’s flowcharts, prepareStudy the client’s flowcharts, preparean internal control questionnaire, andan internal control questionnaire, andperform walk-through tests of sales.perform walk-through tests of sales.
Assess Planned Control Risk – SalesAssess Planned Control Risk – Sales
1. Framework for assessing control risk1. Framework for assessing control risk
2. Identify key internal controls and deficiencies 2. Identify key internal controls and deficiencies
3. Associate controls and deficiencies with the3. Associate controls and deficiencies with the objectives objectives
4. Assess control risk for each objective4. Assess control risk for each objective
Proper authorizationProper authorization
Assess Planned Control Risk – SalesAssess Planned Control Risk – Sales
Internal verificationInternal verification proceduresprocedures
PrenumberedPrenumbereddocumentsdocuments
Monthly statementsMonthly statements
Adequate documentsAdequate documentsand recordsand records
Adequate separationAdequate separationof dutiesof duties
Determine Extent of Testing ControlsDetermine Extent of Testing Controls
Audits of publicAudits of public companiescompanies
Audits of nonpublic Audits of nonpublic companiescompanies
Transaction-Related AuditTransaction-Related AuditObjectives for SalesObjectives for Sales
Existence:Existence:Recorded sales are for shipments actually made.Recorded sales are for shipments actually made.
Accuracy:Accuracy:Recorded sales are for the amount shipped.Recorded sales are for the amount shipped.
Completeness:Completeness:Existing sales transactions are recorded.Existing sales transactions are recorded.
Transaction-Related AuditTransaction-Related AuditObjectives for SalesObjectives for Sales
Classification:Classification:Sales transactions are properly classified.Sales transactions are properly classified.
Timing:Timing:Sales are recorded on the correct dates.Sales are recorded on the correct dates.
Posting and summarization:Posting and summarization:Sales transactions are properly includedSales transactions are properly includedin the accounts receivable master file.in the accounts receivable master file.
Direction of Tests for SalesDirection of Tests for Sales
CompletenessCompletenessstartstart
ExistenceExistencestartstart
CustomerCustomerorderorder
ShippingShippingdocumentdocument
DuplicateDuplicatesalessales
invoiceinvoice
SalesSalesjournaljournal
GeneralGeneraljournaljournal
AccountsAccountsreceivablereceivablemaster filemaster file
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Summary of Methodology for SalesSummary of Methodology for Sales
Transaction-related audit objectives (Column 1)Transaction-related audit objectives (Column 1)Key existing controls (Column 2)Key existing controls (Column 2)Tests of control (Column 3)Tests of control (Column 3)Deficiencies (Column 4)Deficiencies (Column 4)Substantive tests of transactions (Column 5)Substantive tests of transactions (Column 5)
Sales Returns and AllowancesSales Returns and Allowances
The transaction-related audit objectives andThe transaction-related audit objectives andclient’s methods of controlling misstatementsclient’s methods of controlling misstatementsare essentially the same for processing creditare essentially the same for processing creditmemos as those described for sales.memos as those described for sales.
Sales Returns and AllowancesSales Returns and Allowances
There are, however, two important differences.There are, however, two important differences.
MaterialityMateriality Emphasis onEmphasis onobjectivesobjectives
Tests of Controls and Substantive Tests of Tests of Controls and Substantive Tests of Transactions for Cash ReceiptsTransactions for Cash Receipts
Determine whether cash received was recorded.Determine whether cash received was recorded. Prepare proof of cash receipts.Prepare proof of cash receipts. Test to discover lapping of accounts receivable.Test to discover lapping of accounts receivable.
Audit Tests for Uncollectible AccountsAudit Tests for Uncollectible Accounts
Existence of recorded write-offs is the mostExistence of recorded write-offs is the mostimportant transaction-related audit objective.important transaction-related audit objective.
What is a major concern in testing accountsWhat is a major concern in testing accountscharged off as uncollectible?charged off as uncollectible?
– – covering up a defalcation by charging offcovering up a defalcation by charging offaccounts receivable that have been collectedaccounts receivable that have been collected
Additional Internal Controls Over Account Additional Internal Controls Over Account BalancesBalances
Realizable valueRealizable value
Credit approvalCredit approval
Aged accounts receivable trial balanceAged accounts receivable trial balance
Charging off uncollectiblesCharging off uncollectibles
Additional Internal Controls Over Account Additional Internal Controls Over Account BalancesBalances
Rights and obligationsRights and obligations
Presentation and disclosurePresentation and disclosure
Effect of Results of Controls andEffect of Results of Controls andSubstantive Tests of TransactionsSubstantive Tests of Transactions
The parts of the audit most affected by theThe parts of the audit most affected by thetests for the sales and collection cycle are:tests for the sales and collection cycle are:
Accounts receivableAccounts receivable
Bad debt expenseBad debt expense
CashCash
Allowance forAllowance fordoubtful accountsdoubtful accounts
Types of Audit Tests for the Sales and Types of Audit Tests for the Sales and Collection CycleCollection Cycle
SalesSalesAccountsAccounts
ReceivableReceivableCash inCash in
BankBankSalesSales
transactionstransactionsCash receiptsCash receiptstransactionstransactions
EndingEndingbalancebalance
EndingEndingbalancebalance
TOCTOC + + STOTSTOT + + APAP + + TDBTDB= Sufficient competent evidence per GAAS= Sufficient competent evidence per GAAS
Audited byAudited byTOCTOC, , STOTSTOT, and , and APAP
Audited by Audited by APAP and and TDBTDB
Audited byAudited byTOCTOC, , STOTSTOT, and , and APAP