Chapter 8 Audit of the Sales and Receipts Cycle

1. Objectives

1.1 To describe the documents and records that are usually found in the sales and
receipts cycle.
1.2 To state the general audit procedures for the test of internal controls of this
cycle.
1.3 To mention the substantive tests used for the trade debtors.

S a les
and
R e c e i p ts
C y c le

D o c u m e n ts A u d it T estin g T ra de
and and D e b to rs
R eco rd s In te rn a l C o n tro l

T r a n s a c tio n - r e la te d In tern al B a la n c e-re la ted S u b s ta n t i v e

A u d it C o n trol A u d it T e s ts
O b jec tiv es F u n c tio n s O b jec tiv es

S a les C ash S ix F ive

T ra n s ac tio n s R e c e ip ts F u n c tio n s T e s ts
T ra n s ac tio n s

2. Documents and Records

2.1 Customer order (客戶訂單) – a request for goods from an existing or a new
customer received by sales representative or other personnel in the sales
department.

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2.2 Sales order ( 銷 售 訂 單 ) – a document recording the description, quantity
and/or related information of the goods and services ordered to confirm the
order received. It is also used internally for credit approval and
authorization for delivery of goods or services.

2.3 Shipping document/goods delivery note (送貨單) –

(a) a document prepared at the time when the goods are shipped or
delivered, detailing the description, the quantity shipped and other
relevant data.
(b) bill of lading ( 提 單 ) is an example of the shipping document that is
prepared by the carrier to acknowledge the receipts of goods and also
serves as a notice to customer for shipment by the seller.

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 Basic Contact Details of Company
To: Date: 21 June 2007
Goods Delivery Note
No.: DN/02/6/104

Cat. No. Product Name Quantity

1. B201 Japan-made Blue Ball Pen 15 dozens
2. R440 China-made Pencil and Eraser 20 dozens

Remarks:
If there is any defect, please inform us immediately. Returns will not be accepted
after 7 days.

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Representative Signature Recipient Signature
& Company Chop
E&EO

2.4 Sales invoice – a document indicating the details of goods sold, such as
descriptions, quantity, terms of sales and the total price billed.
2.5 Sales journal (sales day book) – a journal for recording sales and it serves as
a posting summary to the general ledger.
2.6 Credit note (貸記單)
(a) It is raised as a result of approval for customers’ returns or granting
allowances to customers.
(b) Its function is like an invoice but acts in the opposite way that it
indicates the amount to be deducted from a customer’s account.
2.7 Sales returns and allowances journal – similar to the sales journal
mentioned above but it records the sales returns and allowances on the other
hand (i.e., the credit notes)
2.8 Remittance advice ( 付 款 通 知 書 ) – a document prepared by the customer
indicating his name, the numbers and the amounts of the individual invoices
paid by him. That is, this document is received from the customer with his
payment.
2.9 Cash receipt journal – a journal for recording cash receipts from cash sales,
collections and all other cash received.
2.10 Accounts receivable ledger – a subsidiary ledger of customers accounts for
recording individual sales, cash receipts, sales returns and allowances.
2.11 Monthly statement (月 結 單 ) – a document sent to each customer detailing
the beginning balance of the month, the movement of transactions during the
month like the amount and date of each sale, return and cash receipt, and the
ending balance due.

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3. Audit Testing and Internal Controls

3.1 The following description of the primary functions, internal controls to be

identified and transaction-related audit objectives (control objectives) will
clarify what an auditor is trying to accomplish in the audit of the cycle
(Sample of the audit program for the test of controls, refer to Appendix I).
3.2 Transaction-related audit objectives for sales transactions.
Objectives Descriptions
Existence Recorded sales are for goods actually sent to customers
which actually exist.
Completeness Goods sent or services performed are correctly billed and
properly recorded.
Accuracy All sales are correctly billed and accurately recorded.
Classification All sales transactions are properly classified into the
appropriate account.
Timing All invoices are raised shortly after the delivery of goods
or services performed, and are recorded on a correct date in
a timely manner.
Posting and All sales are properly posted to the correct accounting
summarization records.

3.3 Transaction-related audit objectives for cash receipts transactions.

Objectives Descriptions
Existence Cash receipts recorded in the accounting record have
actually been received by the company and all cash
discounts are properly authorized.
Completeness Cash received by the company have all been recorded in
the accounting records and promptly deposited.
Accuracy All goods sold or services performed are only made to
customers with good credit rating and have been properly
authorized.
Classification Cash receipts transactions are properly classified to the
appropriate account (e.g. according to the company’s chart
of accounts).
Timing All cash receipts are recorded on a timely basis.
Posting and Cash receipts made are included in the debtor’s accounts of
summarization accounts receivable ledger and properly summarized in the

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 control accounts in general ledger.

3.4 This is a summary of the sales cycle, showing the possible problems and the
related controls:

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3.5 The table shows the various assertions of the revenue cycle, together with
control objectives, controls and tests of controls

Assertion Control objectives Controls Tests of controls

Occurrence  One person is not  Segregation of  Observe and
and existence responsible for duties evaluate whether
taking orders, proper segregation
recording sales of duties is
and receiving operating.
payment

 Recorded sales  Sales recorded only  Test a sample of

transactions with approved sales invoices for
represent goods sales order form authorized sales
shipped. and shipping order form and
documentation. shipping
documentation.
 Examine application
controls for
authroisation.

 Accounting for  Review and test

numerical entity’s procedures
sequences of for accounting for
invoices numerical sequences
of invoices.

 Monthly customer  Review entity’s

statements sent out procedures for
and customer sending out monthly
queries and statements and
complaints handled dealing with
independently. customer queries
and complaints.

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 Assertion Control objectives Controls Tests of controls
Occurrence  Goods and  Authorisation of  Review entity’s
and existence services are only credit terms to procedures for
supplied to customers (senior granting credit to
customers with staff authorization, customers.
good credit rating references / credit
checks for new
customers, regular
review of credit
limits).

 Authorisation by  Examine a sample of

senior staff sales orders for
required for evidence of proper
changes in other credit approval by
customer data such the appropriate
as address, etc. senior staff member.

 Order not accepted  Examine application

unless credit limits controls for credit
reviewed first. limits.
 Review all new
customer files to
ensure satisfactory
credit references
have been obtained.

 Goods and  Authorised price  Compare prices and

services are lists and specified terms on a sample of
provided at terms of trade in sales invoices to the
authorized prices practice authorized price list
and on authorized and terms of trade.
terms.  Examine application
controls for
authorized prices
and terms.

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 Assertion Control objectives Controls Tests of controls
Completeness  All revenue  Accounting for  Review and test
relating to goods numerical entity’s procedures
dispatched is sequences of for accounting for
recorded. invoices. numerical sequences
of invoices.

 All goods and  Shipping  Trace a sample of

services sold are documentation is shipping documents
correctly matched to sales to the sales invoices
invoiced. invoices. and ledger.
 Sales invoices are  Review a sample of
reconciled to the reconciliations
daily sales report. performed.
 An open-order file  Inspect the open-
is maintained and order file for
reviewed regularly. unfilled orders.
Accuracy  All sales and  Sales invoices and  Vouch recorded
adjustments are matching sales to supporting
correctly documents required documents.
journalized, for all entries.
summarized and
posted to the
correct accounts.
Cut-off  Transactions have  All shipping  Compare dates on
been recorded in documentation is sales invoices with
the correct period forwarded to the dates of
invoicing section corresponding
on a daily basis. shipping
documentation.

 Daily invoicing of  Compare dates on

goods shipped. sales invoices with
dates recorded in the
sales ledger.

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 Assertion Control objectives Controls Tests of controls
Classification  All transactions  Chart of accounts  Review sales ledger
are properly in place. for proper
classified in  Codes in place for classification.
accounts. different types of  Examine a sample of
products or sales invoices for
services. proper classification.
 Test application
controls for proper
codes.

3.6 Control activities over sales and receipts – six major functions in a typical
sales and receipts cycle
(a) Processing customer orders
(b) Shipping/dispatching goods
(c) Billing customers and recording sales
(d) Processing and recording cash receipts
(e) Processing sales returns and allowances
(f) Writing off bad debts and providing for doubtful debts

Control Activities Test of Controls

1. Processing customer orders
 All customer orders should be checked 
for credit limit and proper
authorization. Special approval needed
if credit limit exceeded
 Orders should be matched with 
invoices to follow up delivery and
billing. Outstanding orders should be
prepared periodically for management
review and actions.
2. Shipping/dispatching goods
 Goods cannot be shipped without prior 
Examine the orders for proper
approval on granting credit to both
existing and new customers.
(existence)
Scrutinize the sales order forms to
identify if they are properly
accounted for, e.g. sequentially
prenumbered. (completeness)
 Ensure that outstanding orders are
properly followed up by senior
staff and sequence checks are done
by senior staff. (completeness)
Select a sample of shipping

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 approval. documents to ensure that shipments
 Despatch notes should be pre- of goods are done after proper
numbered and a register kept of them authorization. (existence)
to relate to sales invoices and orders.  Ensure that deliveries of goods are
recorded and properly accounted
for by using pre-numbered dispatch
notes. (completeness)
 Examine the duplicate of goods
delivery note for customer’s
signature as evidence of receipt of
goods. (existence)
3. Billing customers and recording sales
 Customers should be correctly and  Examine copies of sales invoices
timely billed. for supporting shipping documents,
 Ensure that sales journal and the e.g. bills of lading and customers’
accounts receivable subsidiary ledger orders. (existence)
are updated frequently to provide latest  Select a sample of sales invoices
information. and examine for the numerical
sequence. (completeness)
 Examine documents for unbilled
shipments and unrecorded sales at
any time. (completeness)
 Observe the mailing of monthly
statements to customers by a
properly designated person.
(existence and accuracy)
4. Processing and recording cash receipts
 All cash/cheques receipts should be  Observe the procedures of handling
recorded in cash receipts journal and cash receipts to ensure that the
deposited in the bank on a timely persons are completely
basis. independent of the handling
 Accounts receivable subsidiary ledger accounts receivable functions.
should be updated promptly. (existence)
 Policy on granting cash discounts must  Ensure that cash/cheques received
exist. are banked promptly and intact.
(existence)
 Control account reconciliation is
prepared promptly and having

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5. Processing sales returns and allowances
 Sales returns and allowances should be 
promptly investigated and then
recorded with confirmation.
 Pre-numbered credit notes should be
issued and recorded promptly.
6. Writing off bad debts and for doubtful
debts
 Credit manager’s approval should be 
obtained.
 Adequate allowance should be
provided for outstanding debts.  Examine documents, e.g. bad debts
supervisor’s review. (accuracy)
 Discuss with management for
policy established for granting of
cash discounts.
Examine credit notes to ensure that
they are pre-numbered and
sequentially accounted for.
(completeness)
 Examine relevant documents, e.g.
correspondence with customers,
credit notes issued with approval,
etc. (existence)
Examine the policy for bad debts
written-off and provision for bad
debts. (existence)
written off form, to obtain evidence
of whether policy has been
followed up and authorization has
been granted. (existence)
 Examine manager’s approval for
calculation of provision for
doubtful debts. (accuracy)

3.7 Test your understanding 1 – Internal control weaknesses

The following narrative notes on the sales and cash receipts are found in the
current year audit file:

SALES
Prenumbered Customer Order is raised by the Order Clerk upon receipt of
written purchase order from the customers. The Customers Order is then
passed to the Credit Control Clerk to check for outstanding balance. The
Credit Control Clerk records the outstanding balance and initials on the
Customer Order, thereafter the Customer Order will be returned to the Order
Clerk for further ordering process. If it is a new customer, the Credit Control

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Clerk will simply mark nil on the Customer Order. As Milka Ltd. is a
distributor, all sales are on credit terms.

The Customer Order reaches the Shipping Department where the Shipping
Clerk will prepare a prenumbered Delivery Note which consists of five copies.
Copy 1 of the Delivery Note is passed to the Accounts Department, Copy 2 is
filed in the Shipping Department, and Copy 3 is sent to the warehouse for
packing. Copy 4 and 5 are taken by the Driver when delivering the goods. The
customer is requested to sign and chop on Copy 4 as acknowledgement of
receipt of goods ordered. Copy 5 will be retained by the customer. During the
packing process, one Warehouse Clerk performs the packing, while the Driver
is only responsible to deliver the goods to the customers.

The Driver after delivery, returns Copy 4 to the Warehouse Clerk who will
pass Copy 4 to the Accounts Department for the preparation of sales invoice.
An Accounts Clerk will key in the necessary data except for the unit selling
price into the computer for automatic generation of sales invoice. The
automation involves the extract of unit selling price from the Unit Selling
Price Master File for the calculation of sales value. Whenever there is a change
in the price list, the Accounts Clerk will update the Unit Selling Price Master
File according to the memo approved by both the Sales Manager and Sales
Director, thereafter the memo will be filed by the Accounts Clerk. A sales
invoice of 2 copies is generated by the computer with a sequential number
assigned for each sales invoice. One copy of the sales invoice is kept by the
Accounts Department for posting to accounting records, and another copy is
mailed to the customer by the Mailing Clerk.

CASH RECEIPT
On a monthly basis, Accounts Department generates an ageing report of
outstanding debtors for the review of the Financial Controller, who will inform
the Sales Manager to take follow-up actions, but it is noted that the ageing
reports for the last four months are still in the in-tray of the Financial
Controller untouched. Cheques and cash collected are banked-in every Friday
afternoon by the Accounts Clerk, who is responsible for the preparation of
bank reconciliation statement and posting of entries to debtors ledger.
Incoming mails are opened and recorded in an incoming mail log book by the
Mailing Clerk.

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 Required:

Identify TEN internal control weaknesses of the sales and cash receipt cycles
and make recommendations for improvement. (20 marks)
(Adapted HKAAT June 1996)

4. Trade Debtors – Substantive Tests

4.1 The internal controls for establishing sales that give rise to debtors may have
been tested in the audit of sales and receipts cycle, but the audit of trade
debtors emphasizes on the tests of details of balances at balance sheet date.
4.2 Substantive tests

Substantive tests Audit procedures

1. Tests of transactions  The tests are procedures designed to discover
whether the transactions recorded in the sales and
receipts cycle have achieved all the transaction
related audit objectives.
2. Tests of details of Existence
balances  Select balances from the debtors’ list and trace them
to the sales invoices and monthly statements for
correct aging and amount.
 Confirm outstanding balances by sending
confirmation letters (positive or negative).
Completeness
 Scrutinise shipping documents one month before
and after year end to determine whether any goods
delivered but not billed nor recorded.
 Select a sample of shipping documents and trace
them to sales invoices.
 Perform cut-off tests.
Accuracy
 Confirm the outstanding balance by sending positive
confirmation.
 Perform cut-off tests.
Classification

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  Review the trade debtors list to see if there are any
receivables from related parties which should be
separately disclosed.
Cut-off
 Perform cut-off tests.
Detail tie-in
 Select balances from the debtors’ list and trace them
to the sales invoices and monthly statements for
correct aging and amount.
 Check that the aging report is correctly footed, and
that the total balance agrees to the trial balance and
general ledger.
Realisable value
 Review any disputes arose before and after year end,
and also the trend of bad debts history.
Rights of client
 Review minutes or discuss with client if there is any
evidence of pledging accounts receivable as
collateral.
 Send confirmation to bank.
Presentation and disclosure
 Evaluate the adequacy of the notes in the financial
statements.
3. Cut-off tests  Sales cut-off
- Sales happen when the title of goods passes and
this can happen before shipment.
- Observation of inventory count, the cut-off
information for sales should be obtained.
- Record in the working papers the last goods
dispateched note number.
- Trace these numbers to the sales journal and
accounts receivable records to ensure they are
recorded in the correct accounting period.
 Goods in transit
 Sales returns and allowances cut-off
- Matched with related sales
 Cash receipts cut off

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 - Check bank deposits with the bank statement
after a few days of year end.
- Can check the proper value of accounts
receivable.
4. Debtors’  Positive confirmation
circularization - Require debtor to confirm the balances.
- Can discovered the overstatement, not
understatement.
- Used when the internal control system is not
strong
 Negative confirmation
- Require debtor to reply only when the
balances do not agree.
- Used when the internal control system is good
and with a large number of small accounts.
5. Analytical procedures  Objectives – test for reasonableness
 Procedures:
- Analyse the sales mix and compare GP margin
with previous years.
- Compare sales returns and allowances as a % of
gross sales with previous years.
- Other ratios, e.g. accounts receivable turnover
days; aging categories as a % of accounts
receivables; doubtful debts expense, etc.

4.3 Test your understanding 2 – Irregularities

QQ Ltd is a garment manufacturing company engaged in the export of
garments to the US market. Over 2001 and 2002, the garment manufacturing
industry suffered from weak demand from the US, but QQ Ltd still reported a
much better return than its competitors in the industry. Its gross profit on sales
was constant at 40% for 2001 and 2002. Due to cost restraints, the auditors
have cut down the number of audit tests, especially cut-off tests. Furthermore,
any discrepancy on debtors’ confirmation not exceeding 5% of the balance
will not be investigated.

Before the auditors signed the 2002 audit report, the finance director fired the
company’s accountant. The accountant was angry and told the auditors about

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 improper accounting practices adopted by the finance director. Firstly, sales
were invoiced on the date of receipt of customer orders. Secondly, customers
were encouraged to settle their invoices early by giving 5% cash discount on
invoice amount if the invoice was settled within 14 days from the delivery
date. However, the booking of discounts allowed was delayed to the last day of
the credit period, i.e. 75 days from the delivery date. The cash receipts records
were correct and showed cash receipts amounting to 95% of the invoice
amount.

The auditors increased the sample size of a few audit procedures and carried
out additional audit procedures aimed to detect fraud. They also studied the
accounting records for 2001 and 2002 and quantified the actual sales and
actual discounts allowed for 2001 and 2002 as below.

Reported data Actual data

2002 2001 2002 2001
$ million $ million $ million $ million
Sales 660 700 640 690
Discounted allowed 6.5 7.1 7.5 7.9

Required:

(a) Identify FOUR possible misstatements to those items on the balance

sheet and profit and loss account of QQ Ltd for 2002. State clearly
whether there may have been an overstatement or an understatement.
(4 marks)
(b) Identify TWO irregularities and make recommendations thereon.
(4 marks)
(c) Suggest audit procedures for detecting the inappropriate accounting
treatment. State clearly the source of the sample (source data) and the
records or documents to be traced to. (10 marks)
(d) Quantify the impact on the net profit for 2002. Your answer should also
take into account the impact brought forward from 2001. [Ignore
taxation] (2 marks)
(Adapted HKIAAT Paper 8 Auditing June 2002)

4.4 Test your understanding 3 – Cut-off tests

In the audit of Belmont Manufacturing Co Ltd’s accounts for the year ended

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31 December 2001, the following data are extracted from the accounting
records.
Sales Date of Sales Goods Date of GDN Invoice
Invoice Invoice Dispatched Amount
No. (Note I and II) Note (GDN)
No.
S0920 27 December 2001 D2193 27 December 2001 $30,000
S0921 29 December 2001 D2198 3 January 2002 $20,000
S0922 30 December 2001 D2195 29 December 2001 $40,000
S0923 30 December 2001 D2196 31 December 2001 $15,000
S0924 31 December 2001 D2200 8 January 2002 $14,000
S0925 2 January 2002 D2201 8 January 2002 $32,000
S0926 2 January 2002 D2192 27 December 2001 $50,000
S0927 3 January 2002 D2194 28 December 2001 $24,000
S0928 4 January 2002 D2199 6 January 2002 $18,000
S0929 5 January 2002 D2197 31 December 2001 $60,000

Note I: All the sales invoices are on FOB origin terms, i.e. the title passes to
the buyer when the goods are shipped.
Note II: The sales journal is updated according to the date of sales invoice.

Belmont Manufacturing Co Ltd recorded all the sales with invoice issued on
or before 31 December 2001 as sales for the year ended 31 December 2001. It
is Belmont’s pricing policy to fix its selling price at cost plus 25%.

Required:

(a) Briefly explain the term “cut-off test”. (2 marks)

(b) When and why do the auditors have to obtain
(i) the number of last GDN on or before the year-end, and
(ii) the number of the first GDN after the year-end?
How would the auditors make use of these data? (4 marks)
(c) Classify each of the sales invoices from S0920 to S0929 into the
correct accounting year. You are required to state the basis of your
classification in general. (11 marks)
(d) Based on the cut-off error identified in (c), quantify the impact to the

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profit of Belmont for the year ended 31 December 2001. (3 marks)
(Total 20 marks)
(Adapted HKAAT December 2001)

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Appendix I – AUDIT PROGRAM FOR REVENUES, CASH RECEIPTS, AND
RECEIVABLES – TEST OF CONTROLS

CLIENT NAME:

DATE OF FINANCIAL STATEMENTS:

I. REVENUES, CASH RECEIPTS, AND RECEIVABLES

Performed Workpaper
By Reference
Audit Objectives: To obtain an understanding of
the design or operation of internal control relating
to revenues, cash receipts, and receivables in order
to assess their effectiveness in preventing or
detecting material misstatements in financial
statement assertions.

1. Select a sample of sales invoices from the sales

journal for the period under audit and perform
the following:

a. Compare the amount per the sales invoice

with the amount recorded in the sales
journal.

b. Trace the sales invoice amount to the

accounts receivable subsidiary ledger.

c. Trace the sales invoice amount to the cash

receipts journal for evidence of subsequent
payment.

d. Compare data per the sales invoice (e.g.,

description, quantity, price) to the
customer’s sales order, and check for
appropriate credit authorization.

e. Compare data per the sales invoice (e.g.,

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 Performed Workpaper
By Reference
customer name, product description,
quantity) to data per the shipping
document.

f. Trace prices, discounts, and payment terms

to price lists, contracts, and established
policies.

g. Test sales invoice extensions, footings, and

discounts for mathematical accuracy.

2. Select a sample of daily sales journals for the

period under audit and perform the following:

a. Foot and crossfoot the sales journal.

b. Trace totals from the sales journal to

postings in the general ledger.

c. Trace selected individual items from the

sales journal to the accounts receivable
subsidiary ledgers.

3. On a test basis, review the numerical sequence

of shipping documents for the period under
audit, and account for missing numbers or
breaks in sequence.

4. Select a sample of shipping documents issued

during the period under audit and perform the
following:

a. Compare data per the shipping document

(e.g., customer name, product description,
quantity) to data per the sales invoice.

b. Compare the date of shipment per the

shipping document to the date of billing per

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 Performed Workpaper
By Reference
the sales invoice, and follow up on
significant time lag.

c. Trace amount and date per the sales invoice

to entries in the sales journal.

5. Select a sample of daily cash receipts from the

cash receipts journal for the period under audit
and perform the following:

a. Compare remittance advice amounts with

entries in the daily cash receipts journal.

b. Trace individual amounts of remittance

advices to bank deposit tickets and trace
total amount on deposit tickets to deposit
amount on the bank statement.

c. Determine the promptness of both deposits

and book entries.

d. Trace postings of cash receipts to the

accounts receivable subsidiary ledger and
determine if they are recorded in the proper
period.

e. Recalculate cash discounts and compare to

company policy.

6. Select a sample of daily cash receipts journal

for the period under audit and perform the
following:

a. Foot and crossfoot the cash receipts

journal.

b. Trace total amounts and account

distributions from the cash receipts journal

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 Performed Workpaper
By Reference
to postings in the general ledger.

c. Obtain supporting deposit ticket and trace

total amount from the cash receipts journal
to deposit ticket amount and to the bank
statement, noting agreement of date and
amount.

7. Scan the cash receipts journals for a selected

period and investigate any unusual entries.

8. Select a sample of credit memos issued during

the period under audit and perform the
following:

a. Examine and test for proper authorization

and approval in accordance with
established policies and procedures.

b. Trace data (e.g., name, date, amount) to

sales or other appropriate journal and to the
accounts receivable subsidiary ledger.

c. Examine supporting documentation for

propriety (e.g., evidence of returned
goods).

9. Obtain and review the client’s bank

reconciliations on a test basis, and perform the
following:

a. Test the mathematical accuracy.

b. Trace the bank balance to the bank

statement.

c. Trace the balance per books to the general

ledger.

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 Performed Workpaper
By Reference

d. Trace deposits per the bank statement to the

cash receipts journal.

e. Trace deposits in transit to the following

month’s bank statement, and determine
reasonableness of the time lag.

f. Trace other reconciling items to supporting

documentation, and determine
reasonableness of their disposition.

10. If the accounting system is extremely

ineffective, or there is high concern about risk
of fraud, consider performing a proof of cash
for a test period, including the following (see
sample workpaper “Proof of Cash” at Section
IV, Item AA-2):

a. Trace the bank balance to the bank

statement.

b. Trace the balance per books to the general

ledger.

c. Trace the totals from the cash receipts and

cash disbursements journals to the general
ledger cash accounts.

d. Check the mathematical accuracy of the

cash receipts and cash disbursements
journals.

e. Account for all cash receipts per books as

deposits per bank or deposits in transit.

f. Trace deposits in transit to the following

month’s bank statement, and determine

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 Performed Workpaper
By Reference
reasonableness of the time lag.

g. Review the numerical sequence of checks

issued and account for all checks as paid,
outstanding, or void.

h. Test the list of outstanding checks and trace

paid checks to the bank statement for the
month subsequent to the period tested.

i. Trace paid checks to the cash

disbursements journal.

j. Trace other reconciling items to supporting

documentation, and determine
reasonableness of their disposition.

Based on the procedures performed and the results obtained, it is my opinion that the
objectives listed in this audit program have been achieved.

Performed by Date

Reviewed and approved by Date

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Appendix II – AUDIT PROGRAM FOR ACCOUNTS RECEIVABLE AND
SALES – SUBSTANTIVE TESTS

CLIENT NAME:

DATE OF FINANCIAL STATEMENTS:

Audit Objectives Financial Statement Assertions

A. Receivables reflected in the balance sheet Existence or occurrence
exist, are for valid transactions, and include Completeness
all authentic obligations of third parties to Rights and obligations
the entity.

B. Billings are for the correct amount and Existence or occurrence

uncollectible accounts are promptly Valuation or allocation
identified and provided for. The allowance
for uncollectible accounts is adequate.

C. Receivables are properly classified in the Presentation and disclosure

balance sheet between current and
noncurrent assets and disclosures are
adequate with respect to assigned, pledged,
unbilled, discounted and related-party
receivables, and transfers of receivables.

N8-26
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

b. Compare monthly sales by product line for

the current year with monthly sales for the
prior year and the first few months ___________ __________
subsequent to year end.

c. Compare monthly sales returns and

allowances and credit memos for the
current year with those of the prior year
and the first few months subsequent to year ___________ __________
end.

d. Compare the aging categories (e.g., 0-30

days; 31-60 days, etc.) of the current year’s
accounts receivable with the prior year’s ___________ __________
and/or industry data.

e. Compute the following ratios for the

current year and compare with the prior
year’s ratios and/or industry data (see
sample workpaper “A/R Analytical ___________ __________
Procedures” at Section IV, Item AD-3):

(1) Accounts receivable turnover. ___________ __________

N8-27
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

(2) Days sales in accounts receivable. ___________ __________

(3) Ratio of allowance for uncollectible

accounts to gross accounts receivable ___________ __________
and credit sales.

(4) Ratio of write-offs to credit sales. ___________ __________

(5) Ratio of sales returns and allowances to

credit sales. ___________ __________

(6) Ratio of customer discounts to credit ___________ __________

sales.

(7) Ratio of gross profit to credit sales, in

total and by major product or division. ___________ __________

2. Prepare or obtain from the client an aged trial

balance of trade accounts receivable and
perform the following [A]:

a. Test the arithmetical accuracy of the aged

trial balance and the aging categories
therein.

N8-28
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

b. Reconcile the total balance to the general

ledger control account balance (see sample
workpaper “A/R Reconciliation to General
Ledger” at Section IV, Item AD-5).

c. Note and investigate any unusual entries.

d. Summarize the total of credit balances and

make appropriate reclassification entry, if
material.

e. On a selective basis, trace individual

account balances in the aged trial balance
to individual subsidiary ledgers and vice
versa.

f. Determine which accounts receivable

should be confirmed. The auditor may wish
to use the form titled “Audit Sampling
Worksheet for Substantive Tests” at Section
III (FOR09), to determine which accounts
receivable balances should be confirmed.

N8-29
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

3. Select customer accounts from the aged trial

balance for confirmation procedures and
perform the following (see sample
confirmation requests at Section II [COR07],
[COR08], and [COR09]) [A]:

a. Arrange for confirmation requests to be

mailed directly by the auditor and maintain
control over the confirmation process at all
times. (See sample workpaper “A/R
Confirmation Control Summary” at Section
IV, Item AD-1.)

b. Trace balances included in individual

confirmation requests to subsidiary
accounts.

c. Mail confirmations using envelopes with

the auditor’s return address.

d. If the client requests exemption from

confirmation for any accounts selected by
the auditor, obtain and document
satisfactory explanation, and determine
necessity for alternative procedures.

N8-30
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

e. Obtain new addresses for confirmations

returned by the post office as
undeliverable, and remail.

f. Send second requests for positive

confirmations on which there is no reply
and consider registered or certified mail for
second requests.

4. Process the confirmation replies and

summarize the results of confirmation
procedures as follows (see sample workpaper
“A/R Confirmation Results Summary” at
Section IV, Item AD-2) [A, B]:

N8-31
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

a. For positive confirmation requests to which

no reply was received and accounts
exempted from confirmation at the client’s
request, perform alternative procedures for
those customers by examining cash receipts
subsequent to the confirmation date and, if
no cash has been received, by examining
sales invoices and corresponding shipping
documents (see sample workpaper “A/R
Alternative Procedures and Review for
Uncollectibles” at Section IV, Item AD-6).

b. Indicate the total accounts and balances

confirmed without exceptions,
confirmations reconciled, and nonreplies or
exempted accounts with alternative
procedures performed.

N8-32
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

5. For accounts receivable confirmed on a date

other than the balance-sheet date, prepare or
obtain from the client an analysis of
transactions (e.g., cash receipts, sales) between
the confirmation date and the balance-sheet
date, and perform the following (see sample
workpaper “A/R Rollforward from
Confirmation Date to Balance-Sheet Date” at
Section IV, Item AD-4) [A]:

a. Trace the balance as of the confirmation

date to the aged trial balance.

b. Trace cash received per the analysis to the

cash receipts journal and/or bank
statements.

c. Trace sales/revenue amounts per the

analysis to the sales/revenue journal.

d. Determine the reasonableness and propriety

of any other reconciling items.

e. Trace the ending balance per the analysis to

the trial balance as of the balance-sheet
date.

N8-33
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

f. Scan the accounts receivable and sales

activity during the period from the interim
date to the balance-sheet date and
investigate any unusual activity.

6. Prepare or obtain from the client an analysis of

trade notes receivable, showing the following:
(a) maker, (b) date note issued and due, (c)
original terms of repayment, (d) collateral, (e)
interest rate, (f) principal balance at the end of
the prior period, (g) principal additions and
repayments in the current period, (h) principal
balance at the end of the current period, (i)
accrued interest receivable at the end of the
prior period, (j) interest earned and interest
received in the current period, and (k) accrued
interest receivable at the end of the current
period, and perform the following (see sample
workpaper “Notes Receivable Analysis” at
Section IV, Item AE-1.) [A, B, C]:

a. Test the arithmetical accuracy of the

analysis.

N8-34
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

b. Trace totals to the general ledger.

c. Examine copies of the notes.

d. Determine whether positive confirmation

requests are necessary and, if so, perform
procedures as outlined in Steps 2 and 3
above.

e. Determine the type of collateral for the

notes.

f. Recompute interest income and accrual.

g. Trace interest collections to the cash

receipts journal, if material.

7. Determine whether any accounts or notes

receivable have been pledged, assigned, or
discounted [A, C].

8. Determine whether any accounts or notes

receivable are owed by employees or related
parties and, if so, perform the following [A, B,
C]:

N8-35
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

a. Determine the nature and purpose of the

transaction that resulted in the receivable
balance.

b. Determine whether transactions were

properly executed and approved by an
official of the company or the board of
directors.

c. Consider obtaining positive confirmation

requests of such balances.

d. Evaluate the collectibility of the balances

outstanding.

9. For notes and accounts receivable with

maturities greater than one year, perform the
following [A, B, C]:

a. Evaluate if the principal and interest

payments will be collected in accordance
with their contractual terms.

N8-36
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

b. If either interest or principal payments will

not be collected in accordance with their
contractual terms, determine whether an
allowance for credit loss has been
computed.

10. Test the adequacy of the allowance for

uncollectible accounts, as follows (see sample
workpaper “A/R Allowance for Uncollectible
Accounts” at Section IV, Item AD-7) [B]:

a. Review subsequent cash collections of

account balances.

b. Review accounts written off during the

period.

c. Determine if write-offs have been properly

authorized and examine related supporting
documentation.

d. Ask the client if there are any collection

problems with accounts receivable
currently classified as current assets. If so,
consider whether such accounts should be
reclassified to noncurrent assets.

N8-37
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

e. Perform and review ratio analyses for

relationships such as (1) accounts
receivable turnover, (2) allowance for
uncollectible accounts to accounts
receivable, (3) allowance for uncollectible
accounts to sales, and (4) accounts written
off to sales.

f. Review post-balance-sheet transactions

related to receivables, particularly for
discounts taken, credits allowed, and
accounts written off, and determine
whether any adjustments should be made as
of the balance-sheet date.

11. Perform the following sales cutoff procedures

and ascertain that receivables are recorded in
the proper accounting period [A, B, C]:

a. From the population of shipping

documents, trace the last few shipments of
the year to the sales journal and determine
that they were properly included in ___________ __________
accounts receivable as of the balance-sheet

N8-38
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

date.

b. From the population of shipping

documents, trace the first few shipments
subsequent to year-end to the sales journal
and determine that they were properly
excluded from accounts receivable as of the ___________ __________
balance-sheet date.

c. Using the sales journal, trace the last few

sales entries of the year from the sales
journal to the shipping documents and
determine that they were properly included
in accounts receivable as of the balance- ___________ __________
sheet date.

d. Using the sales journal, trace the first few

sales entries subsequent to year-end from
the sales journal to the shipping documents
and determine that they were properly
excluded from accounts receivable as of the ___________ __________
balance-sheet date.

12. If the auditor is highly concerned about the risk

of fraud, audit procedures such as the

N8-39
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

following should be considered in addition to

the ones listed above [A, B, C]:

a. Perform a proof of cash (see sample

workpaper “Proof of Cash” at Section IV, ___________ __________
Item AA-2).

b. Expand the number of accounts receivable

confirmations and pursue all non-replies
and discrepancies. ___________ __________

c. Confirm amounts written off that appear

unusual, such as write-offs of balances due
from continuing customers. ___________ __________

d. Compare sales price to list price. ___________ __________

e. Ascertain that shipped merchandise

actually arrived at the customer’s location
and that the merchandise was not shipped
to a warehouse or location controlled by ___________ __________
the client.

f. Ascertain that shipping documents and

invoices are pre-numbered sequentially and ___________ __________

N8-40
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

accounted for.

g. Examine original documents for sales

invoices and shipping documents and be
alert for possible alterations. ___________ __________

h. Telephone customers directly and confirm

items such as: unusual payment terms,
sales returns, credit memos, side
agreements, merchandise receipt date, or ___________ __________
other concerns.

i. Review customer complaints and look for

unusual trends. ___________ __________

j. Look for evidence of salespeople trying to

meet or exceed sales goals in order to
achieve quotas or increase their ___________ __________
commissions or bonuses.

k. Agree daily cash receipts detail to the bank

statements and investigate unusual lags. ___________ __________

13. If disclosures about fair value are required, or

the entity chooses to provide voluntary fair

N8-41
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

value information, perform the following [C]:

a. Obtain information about the fair values of

accounts receivable and notes receivable
and determine that the valuation principles
are being consistently applied under ___________ __________
GAAP.

b. Determine that the fair value amounts are

supported by the underlying ___________ __________
documentation.

c. Determine that the method of estimation

and significant assumptions used are ___________ __________
properly disclosed.

14. For transfers of accounts receivable to a third

party, determine that the transaction has been
accounted for in accordance with FAS-140,
Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of
Liabilities (a replacement of FASB Statement
125), as follows [A,C]:

N8-42
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

a. If a transfer of accounts receivable has

been accounted for as a sale by the client,
determine that all of the following ___________ __________
conditions have been met:

(1) The transferred receivables have been

isolated from the client—put
presumptively beyond the reach of the
client and its creditors, even in ___________ __________
bankruptcy or other receivership.

(2) Each transferee has the right to pledge

or exchange the receivables (or
beneficial interests) it received, and no
condition both constrains the transferee
from taking advantage of its right to
pledge or exchange and provides more ___________ __________
than a trivial benefit to the client.

(3) The client does not maintain effective

control over the transferred receivables. ___________ __________

N8-43
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

b. Upon completion of a transfer of

receivables by a client that satisfies the
conditions to be accounted for as a sale as
described in step a. above, determine that
the client:

(1) Has derecognized all receivables sold. ___________ __________

(2) Has recognized all assets obtained and

liabilities incurred in consideration as
proceeds of the sale, including: cash;
put or call options held or written (for
example, guarantee or recourse
obligations); forward commitments (for
example, commitments to deliver
additional receivables during the
revolving periods of some
securitizations); swaps (for example, ___________ __________
provisions that convert interest rates
from fixed to variable); and servicing
liabilities, if applicable.

N8-44
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

(3) Has initially measured at fair value

assets obtained and liabilities incurred
in a sale or, if it is not practicable to
estimate the fair value of an asset or a ___________ __________
liability, has applied alternative
measures.

(4) Has recognized in earnings any gain or

loss on the sale. ___________ __________

c. Upon completion of any transfer of

accounts receivable in which the client is
the transferor, determine that the client:

(1) Has continued to carry in its

statement of financial position any
retained interest in the transferred
receivables, including, if applicable:
servicing assets, beneficial interests
in assets transferred to a qualifying ___________ __________
special-purpose entity in a
securitization, and retained
undivided interests.

N8-45
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

(2) Has allocated the previous carrying

amount between the receivables
sold, if any, and the retained
interests, if any, based on their ___________ __________
relative fair values at the date of
transfer.

d. If a transfer of accounts receivable in

exchange for cash or other consideration
(other than beneficial interests in the
transferred assets) does not meet the
criteria for a sale in step a. above,
determine that the transfer has been ___________ __________
accounted for as a secured borrowing with
pledge of collateral.

15. Document the following items when an

analytical procedure is used as the
principal substantive test:

a. The expectation, if not readily determinable

from the documentation of the work
performed, and the factors that were
considered in developing the expectation.

N8-46
 Performed Workpaper
By Reference
1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:

a. Compare the current year’s account

balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales ___________ __________
returns and allowances.

b. Results of the comparison of the

expectation to the recorded amounts or
ratios developed from recorded amounts.

c. Any additional auditing procedures that

were performed in response to significant
unexpected differences arising from the
analytical procedure, and the results of
such additional procedures.

16. If detailed tests of transactions or controls are

considered necessary, perform the applicable
audit procedures contained in “Audit Program
—Tests of Controls” in Section I (AUD03).

Based on the procedures performed and the results obtained, it is my opinion that the
objectives listed in this audit program have been achieved.

Performed by Date

Reviewed and approved by Date

N8-47
Appendix III – Sales and Receipts Cycle Flowchart

N8-48
Appendix IV – Debtor’s Confirmation

REQUEST FOR CONFIRMATION OF ACCOUNTS RECEIVABLE—

POSITIVE REQUEST

(Prepared on client’s letterhead)

(Date)
(Customer’s name and address)

Dear__________:

In connection with an audit of the financial statements of (insert name of client) as of

(insert date) and for the (insert period [e.g., year, quarter]) then ended, please confirm
directly to our auditors (insert name and address of auditors) the amount of your
indebtedness to us as of (insert date), which according to our records amounted to
$______.2

Please check the appropriate response below after determining whether this is in
agreement with your records. If there are differences, please provide any information
in sufficient detail to assist our auditors in reconciling the difference.

After checking the appropriate response below, please sign and date your reply and
mail it directly to our auditors in the enclosed return envelope. DO NOT SEND ANY
PAYMENTS TO OUR AUDITORS.

Thank you for your anticipated timely cooperation with this request.

Respectfully,

(Name of client)

(Client’s authorized signature and title)

***********************************************

TO: (Insert auditor’s name)

N8-49
( ) The balance due (insert client’s name) shown above as of (insert date) is correct.

( ) Our records show a balance of $_______ as of (insert date) and the difference may
be due to the following:

Signature:

Title:

Date:

N8-50
 REQUEST FOR CONFIRMATION OF ACCOUNTS RECEIVABLE—
NEGATIVE REQUEST

(Prepared on client’s letterhead)

(Date)
(Customer’s name and address)

Dear__________:

Our auditors (insert name and address of auditors) are conducting an audit of our
financial statements as of (insert date) and for the (insert period [e.g., year, quarter])
then ended. Our records show the amount of your indebtedness to us as of (insert
date) to be $_______. If this amount is not correct, please report details of any
differences directly to our auditors in the space provided below and use the enclosed
return envelope.

IF YOU DO NOT WRITE TO OUR AUDITORS, THEY WILL CONSIDER THE

BALANCE SHOWN ABOVE TO BE CORRECT. NO REPLY IS NECESSARY IF
THE AMOUNT SHOWN ABOVE AGREES WITH YOUR RECORDS.

DO NOT SEND ANY PAYMENTS TO OUR AUDITORS.

Thank you for your anticipated timely cooperation with this request.

Respectfully,

(Name of client)

(Client’s authorized signature and title)

***********************************************

TO: (Insert auditor’s name)

The balance due (insert client’s name) shown above as of (insert date) is not correct.
Our records show a balance of $_______ and the difference may be due to the
following:

N8-51
Signature:

Title:

Date:

N8-52