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Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions. Chapter 14. Learning Objective 1. Identify the accounts and the classes of transactions in the sales and collection cycle. Accounts in the Sales and Collection Cycle. Sales. Cash in Bank.

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Audit of the sales and collection cycle tests of controls and substantive tests of transactions

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

Chapter 14


Learning objective 1
Learning Objective 1 and Substantive Tests of Transactions

  • Identify the accounts and the

  • classes of transactions in the

  • sales and collection cycle.


Accounts in the sales and collection cycle
Accounts in the Sales and Collection Cycle and Substantive Tests of Transactions

Sales

Cash in Bank

Cash

sales

Accounts Receivable

Cash Discounts

Taken

Sales on

account

Beginning

balance

Cash receipts

Sales on

account

Sales returns

and allowances

Sales Returns

and Allowances

Ending

balance

Write-off of

uncollectible

accounts

Bad Debt

Expense


Accounts in the sales and collection cycle1
Accounts in the Sales and Collection Cycle and Substantive Tests of Transactions

Allowance for

Uncollectible Accounts

Accounts Receivable

Beginning

balance

Cash receipts

Write-off of

uncollectible

accounts

Beginning

balance

Sales on

account

Sales returns

and allowances

Estimate of

bad debt

expense

Ending

balance

Write-off of

uncollectible

accounts

Ending

balance

Bad Debt

Expense


Learning objective 2
Learning Objective 2 and Substantive Tests of Transactions

  • Describe the business functions

  • and the related documents and

  • records in the sales and

  • collection cycle.


Sales transaction
Sales Transaction and Substantive Tests of Transactions

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 receipts transaction
Cash Receipts Transaction and Substantive Tests of Transactions

Accounts

Business Functions

Documents and Records

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 transaction
Sales Returns and Allowances Transaction and Substantive Tests of Transactions

Accounts

Business Functions

Documents and Records

Sales returns

and

allowances

Accounts

receivable

Processing and

recording sales

returns and

allowances

Credit memo

Sales and returns and

allowances journal


Write off of uncollectible accounts transaction
Write-off of Uncollectible Accounts Transaction and Substantive Tests of Transactions

Accounts

Business Functions

Documents and Records

Accounts

receivable

Allowance for

uncollectible

accounts

Writing off

uncollectible

accounts

receivable

Uncollectible account

authorization form

General journal


Bad debt expense transaction
Bad Debt Expense Transaction and Substantive Tests of Transactions

Accounts

Business Functions

Documents and Records

Bad debt

expense

Allowance for

uncollectible

accounts

Providing for bad

debts

General journal


Processing customer orders
Processing Customer Orders and Substantive Tests of Transactions

  • Customer Order:

  • A request for merchandise by a customer

  • Sales Order:

  • A document describing the goods ordered

  • by a customer


Granting credit
Granting Credit and Substantive Tests of Transactions

  • Before goods are shipped, a properly

  • authorized person must approve credit

  • to the customer for sales on account


Shipping goods
Shipping Goods and Substantive Tests of Transactions

  • This is the first point in the cycle

  • where company assets are given up


Billing customers and recording sales
Billing Customers and Recording Sales and Substantive Tests of Transactions

  • Sales invoice

  • Sales transaction file

  • Sales journal or listing

  • Accounts receivable master file

  • Accounts receivable trial balance

  • Monthly statement


Processing and recording cash receipts
Processing and Recording Cash Receipts and Substantive Tests of Transactions

  • Remittance advice

  • Prelisting of cash receipts

  • Cash receipts transaction file

  • Cash receipts journal or listing


Processing and recording sales returns and allowances
Processing and Recording Sales Returns and Allowances and Substantive Tests of Transactions

  • Credit memo

  • Sales returns and allowances journal


Writing off uncollectible accounts receivable
Writing Off Uncollectible and Substantive Tests of TransactionsAccounts Receivable

  • Uncollectible account authorization form

  • This is a document used internally to

  • indicate authority to write an account

  • receivable off as uncollectible


Providing for bad debts
Providing for Bad Debts and Substantive Tests of Transactions

  • This provision represents a residual,

  • resulting from management’s

  • end-of-period adjustment of the

  • allowance for uncollectible accounts


Learning objective 3
Learning Objective 3 and Substantive Tests of Transactions

  • Understand internal control, and

  • design and perform tests of

  • controls and substantive tests

  • of transactions for sales.


Methodology for designing controls and substantive tests

Audit procedures and Substantive Tests of Transactions

Sample size

Items to select

Timing

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

substantive tests of transactions

for sales to meet transaction-

related audit objectives


Understand internal control sales
Understand Internal Control – Sales and Substantive Tests of Transactions

Study the client’s flowcharts, prepare

an internal control questionnaire, and

perform walk-through tests of sales.


Assess planned control risk sales
Assess Planned Control Risk – Sales and Substantive Tests of Transactions

Four Steps:

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 sales1
Assess Planned Control Risk – Sales and Substantive Tests of Transactions

  • Adequate separation of duties

  • Proper authorization

  • Adequate documents and records

  • Prenumbered documents

  • Monthly statements

  • Internal verification procedures


Determine extent of testing controls
Determine Extent of Testing Controls and Substantive Tests of Transactions

  • Audits of public companies

  • Audits of nonpublic companies


Transaction related audit objectives for sales
Transaction-related Audit and Substantive Tests of TransactionsObjectives for Sales

Occurrence:

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 sales1
Transaction-related Audit and Substantive Tests of TransactionsObjectives 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.


Direction of tests for sales
Direction of Tests for Sales and Substantive Tests of Transactions

Customer

order

Shipping

document

Duplicate

sales

invoice

Sales

journal

General

journal

=

Accounts

receivable

master file

Occurrence

start

Completeness

start


Summary of methodology for sales
Summary of Methodology and Substantive Tests of Transactionsfor 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)


Learning objective 4
Learning Objective 4 and Substantive Tests of Transactions

  • Apply the methodology for controls

  • over sales transactions to controls

  • over sales returns and allowances.


Sales returns and allowances
Sales Returns and Allowances and Substantive Tests of Transactions

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.


Sales returns and allowances1
Sales Returns and Allowances and Substantive Tests of Transactions

There are, however, two important differences.

  • Materiality

  • Emphasis on objectives


Learning objective 5
Learning Objective 5 and Substantive Tests of Transactions

  • Understand internal control, and

  • design and perform tests of

  • controls and substantive tests

  • of transactions for cash receipts.


Tests of controls and substantive tests of transactions for cash receipts
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*

* Only performed when fraud is suspected


Learning objective 6
Learning Objective 6 Cash Receipts

  • Apply the methodology for

  • controls over the sales and

  • collection cycle to write-offs

  • of uncollectible accounts

  • receivable.


Audit tests for the write off of uncollectible accounts
Audit Tests for the Write-Off Cash Receiptsof Uncollectible Accounts

  • Occurrence transaction-related audit objective

  • Proper authorization of the write-off of

  • uncollectible accounts

  • Verification of accounts written off


Additional internal controls over account balances
Additional Internal Controls Over Account Balances Cash Receipts

  • Realizable value

  • Credit approval

  • Aged accounts receivable trial balance

  • Writing off uncollectibles

  • Rights and obligations

  • Presentation and disclosure


Effect of results of controls and substantive tests of transactions
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


Types of audit tests for the sales and collection cycle
Types of Audit Tests for the Sales and Collection Cycle Transactions

Sales

Accounts

Receivable

Cash in

Bank

Sales

transactions

Cash receipts

transactions

Audited by

TOC, STOT, and AP

Audited by

TOC, STOT, and AP

Ending

balance

Ending

balance

Audited by AP and TDB

TOC + STOT + AP + TDB

= Sufficient appropriate evidence


End of chapter 14

End of Chapter 14 Transactions


Completing the tests in the sales and collection cycle accounts receivable

Completing the Tests Transactionsin the Sales and Collection Cycle:Accounts Receivable

Chapter 16


Learning objective 11
Learning Objective 1 Transactions

  • Describe the methodology for

  • designing tests of details of

  • balances using the audit

  • risk model.


Accounts receivable balance related audit objectives
Accounts Receivable Balance-related Audit Objectives Transactions

1. Detail tie-in

5. Classification

2. Existence

6. Cutoff

3. Completeness

7. Realizable value

4. Accuracy

8. Rights


Methodology for designing tests of details of balances for a r
Methodology for Designing Tests Transactionsof Details of Balances for A/R

Identify client business

risks affecting

accounts receivable

Phase I

Set tolerable misstatement

and assess inherent risk

for accounts receivable

Phase I

Assess control risk for

sales and collection cycle

Phase I


Methodology for designing tests of details of balances for a r1
Methodology for Designing Tests Transactionsof Details of Balances for A/R

Design and perform

tests of controls and

substantive tests

of transactions

for the sales and

collection cycle

Phase II


Methodology for designing tests of details of balances for a r2
Methodology for Designing Tests Transactionsof Details of Balances for A/R

Design and perform

analytical procedures

for accounts

receivable balance

Phase III

Phase III

Design tests of

details of accounts

receivable balance

to satisfy

balance-related

audit objectives

Audit procedures

Sample size

Items to select

Timing


Relationship between sales and accounts receivable
Relationship Between Sales and Accounts Receivable Transactions

ACCOUNTS RECEIVABLE

BALANCE-RELATED

AUDIT OBJECTIVES

Detail tie-in

Completeness

Classification

Realizable

value

Rights

Existence

Accuracy

Cutoff

Translation-related

audit objectives

Sales

Occurrence

×

Completeness

×

Accuracy

×

Posting and

summarization

×

Classification

×

Timing

×


Relationship between sales and accounts receivable1
Relationship Between Sales and Accounts Receivable Transactions

ACCOUNTS RECEIVABLE

BALANCE-RELATED

AUDIT OBJECTIVES

Detail tie-in

Completeness

Classification

Realizable

value

Rights

Existence

Accuracy

Cutoff

Translation-related

audit objectives

Cash receipts

Occurrence

×

Completeness

×

Accuracy

×

Posting and

summarization

×

Classification

×

Timing

×


Learning objective 21
Learning Objective 2 Transactions

  • Design and perform analytical

  • procedures for accounts in the

  • sales and collection cycle.


Analytical procedures for the sales and collection cycle
Analytical Procedures for the Sales and Collection Cycle Transactions

Compare by product line:

  • Gross margin percentage with

    previous years

  • Sales by month over time

  • Sales returns and allowances

    as a percentage of gross sales

    with previous years


Analytical procedures for the sales and collection cycle1
Analytical Procedures for the Sales and Collection Cycle Transactions

Compare with previous years:

  • Individual customer balances over

    a stated amount

  • Bad debt expense as a percentage

    of gross sales

  • Days that accounts receivable

    are outstanding


Analytical procedures for the sales and collection cycle2
Analytical Procedures for the Sales and Collection Cycle Transactions

Compare with previous years:

  • Aging category as a percentage

    of receivables

  • Allowance for uncollectible accounts as

  • a percentage of accounts receivable

  • Write-off of uncollectible accounts as a

  • percentage of total accounts receivable


Selected comparative information
Selected Comparative Information Transactions

12/31/09

($000)

Percent

change

2008-

2009

12/31/08

($000)

Percent

change

2007-

2008

12/31/07

($000)

Sales

Gross margin

Accounts receivable

Bad debt expense

Total current assets

Total assets

Net earnings

Number of accounts

receivable

Number of accts. rec. with

balances over $100,000

144,328

39,845

20,197

3,323

51,027

61,367

5,681

258

37

9.0

9.6

7.3

(2.1)

14.0

(7.0)

21.9

16.7

15.6

132,421

36,350

18,827

3,394

44,779

66,021

4,659

221

32

7.0

7.0

14.1

7.3

6.6

8.0

39.0

5.7

6.7

123,737

33,961

16,505

3,162

41,989

61,147

3,351

209

30


Analytical procedures sales and collection cycle
Analytical Procedures: Sales and Collection Cycle Transactions

12/31/09

12/31/08

12/31/07

Gross margin/net sales

Sales returns and allowances/

gross sales

Bad debt expense/net sales

Allowance for uncollectible

accounts/accounts receivable

Number of days receivables

outstanding

Net accounts receivable/

current assets

27.85%

0.90%

2.30%

6.10%

48.09

37.20%

27.70%

0.90%

2.60%

7.50%

47.96

32.50%

27.68%

0.90%

2.60%

6.40%

49.32

32.30%


Design and perform tests of details of a r balance phase iii
Design and Perform Tests of Details of A/R Balance (Phase III)

  • Planned detection risk for each

    objective is an auditor decision

  • Combining the factors that determine

  • planned detection risk is complex


Learning objective 31
Learning Objective 3 III)

  • Design and perform tests of

  • details of balances for accounts

  • receivable.


Designing tests of detail of balances
Designing Tests of Detail III)of Balances

Accounts receivable are correctly added and

agree with the Master File and the General

Ledger (aged trial balance).

  • Recorded accounts receivable exist

  • Existing accounts receivable are included


Designing tests of detail of balances1
Designing Tests of Detail III)of Balances

  • Accounts receivable are accurate

  • Accounts receivable are properly classified

  • Cutoff for accounts receivable is correct


Designing tests of detail of balances2
Designing Tests of Detail III)of Balances

  • Accounts receivable is stated at

  • realizable value

  • The client has rights to accounts receivable

  • Accounts receivable presentation and

  • disclosure


Learning objective 41
Learning Objective 4 III)

  • Obtain and evaluate accounts

  • receivable confirmations.


Confirmations are required except when
Confirmations Are Required, Except When: III)

1. Accounts receivable are immaterial.

2. The auditor considers confirmations

ineffective evidence because response

rates will likely be inadequate or unreliable.

3. The combined level of inherent risk and

control risk is low and other substantive

evidence can be accumulated to provide

sufficient evidence.


Type of confirmation
Type of Confirmation III)

  • Positive confirmation

  • Blank confirmation form

  • Invoice confirmation

  • Negative confirmation


Timing
Timing III)

The most reliable evidence from confirmations

is obtained when they are sent as close to the

balance sheet date as possible.


Sample size
Sample Size III)

  • Tolerable misstatement

  • Inherent risk

  • Control risk

  • Achieved detection risk from

  • other substantive tests

  • Type of confirmation


Maintaining control
Maintaining Control III)

After the items for confirmation have been

selected, the auditor must maintain control

of the confirmations until they are returned

from the customer.


Follow up on nonresponses
Follow-up on Nonresponses III)

When positive confirmations are used,

AU 330 requires follow-up procedures

for confirmations not returned by

the customer.


Subsequent cash receipts
Subsequent Cash Receipts III)

Evidence of the receipt of cash subsequent

to the confirmation date includes examining

remittance advices, entries in the cash

receipts records, or perhaps even

subsequent credits in the accounts

receivable master file.


Duplicate sales invoices
Duplicate Sales Invoices III)

These are useful in verifying the actual

issuance of a sales invoice and the

actual date of the billing.


Shipping documents
Shipping Documents III)

These are important in establishing

whether the shipment was actually

made and as a test of cutoff.


Analysis of difference
Analysis of Difference III)

  • Payment has already been made

  • Goods have not been received

  • The goods have been returned

  • Clerical errors and disputed accounts


Drawing conclusions
Drawing Conclusions III)

  • Reevaluate internal control

  • Evaluate the qualitative nature of

  • misstatements

  • Determine whether sufficient evidence

  • was obtained


Learning objective 51
Learning Objective 5 III)

  • Design audit procedures for the

  • audit of accounts receivable,

  • using an evidence planning

  • worksheet as a guide.


Source of each row in the evidence planning worksheet
Source of Each Row in the Evidence Planning Worksheet III)

  • Tolerable misstatement

  • Acceptable audit risk

  • Inherent risk

  • Control risk

  • Substantive tests of

    transactions results

  • Analytical procedures

  • Planned detection risk and

    planned audit evidence



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