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Audit of the Sales and

Collection Cycle

Chapter 13

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 1
Learning Objective 1

Identify the accounts and the


classes of transactions in the
sales and collection cycle.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 2
Accounts in the Sales
and Collection Cycle
Sales Cash in Bank
Cash
sales
Accounts Receivable Cash Discounts
Sales on Beginning Cash receipts Taken
account balance
Sales returns Sales Returns
Sales on and allowances and Allowances
account
Charge-off of
Ending uncollectible Bad Debt
balance accounts Expense

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 3
Accounts in the Sales
and Collection Cycle

Accounts Receivable Allowance for Uncollectible Accounts


Beginning Cash receipts Charge-off of Beginning
balance uncollectible balance
Sales returns accounts
Sales on and allowances Estimate of bad
account debt expense
Charge-off of
Ending uncollectible Ending balance
balance accounts Bad Debt
Expense

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 4
Learning Objective 2

Describe the business functions


and the related documents and
records in the sales and
collection cycle.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 5
Processing Customer Orders

Customer Order:
A request for merchandise
by a customer

Sales Order:
A document describing the
goods ordered by a customer

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 6
Granting Credit

Before goods are shipped, a properly


authorized person must approve credit
to the customer for sales on account.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 7
Sales Transaction
Sales
Accounts
Accounts receivable

Processing customer orders,


Business
Granting credit, Shipping goods,
Functions
Billing customers and recording sales

Sales invoice, Sales journal or listing, Sales


Documents
transaction file, Accounts receivable master
and Records
file and trial balance, Monthly statements
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 8
Cash Receipts Transaction
Cash in bank (debits from cash receipts)
Accounts
Accounts receivable

Business
Processing and recording cash receipts
Functions

Remittance advise, Prelisting of cash receipts,


Documents
Cash receipts transaction file,
and Records
Cash receipts journal or listing
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 9
Sales Returns and Allowances
Transaction
Sales returns and allowances
Accounts
Accounts receivable

Business Processing and recording


Functions sales returns and allowances

Documents Credit memo


and Records Sales returns and allowances journal
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 10
Charge-off of Uncollectible
Accounts Transaction
Accounts receivable
Accounts
Allowance for uncollectible accounts

Business Charging off uncollectible


Functions accounts receivable

Documents Uncollectible account authorization form


and Records General journal
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 11
Bad Debt Expense
Transaction
Bad debt expense
Accounts
Allowance for uncollectible accounts

Business
Providing for bad debts
Functions

Documents
General journal
and Records
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 12
Shipping Goods

This is the first point in the cycle


where company assets are given up.

Shipping
document

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 13
Billing Customers
and Recording Sales

Sales invoice
Sales transaction file
Sales journal or listing
Accounts receivable master file
Accounts receivable trial balance
Monthly statement

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 14
Processing and Recording
Cash Receipts

Remittance advise
Prelisting of cash receipts
Cash receipts transaction file
Cash receipts journal or listing

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 15
Lockbox Systems and
Electronic Funds Transfer
Bank

Order/Payment
Information

Customer
Customer
Company
Company

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 16
Processing and Recording
Sales Returns and Allowances

Credit memo

Sales returns and


allowances journal

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 17
Charging Off Uncollectible
Accounts Receivable

Uncollectible Account
Authorization Form

This is a document used internally to


indicate authority to write an account
receivable off as uncollectible.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 18
Providing for Bad Debts

This provision represents a residual,


resulting from managements
end-of-period adjustment of the
allowance for uncollectible accounts.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 19
Learning Objective 3

Understand how e-commerce


activities affect the
sales and collection cycle.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 20
Effect of E-Commerce on the
Sales and Collection Cycle

The Internet
The Internet and
other developing
technologies allow
companies to develop
new business models.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 21
Effect of E-Commerce on the
Sales and Collection Cycle

Business-to-business (B2B)

Business-to-consumer (B2C)

Managements assertions for sales and


collection activities remain the same.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 22
Effect of E-Commerce on the
Sales and Collection Cycle

Auditors should obtain an understanding


of the design and operation of key internal
controls over e-commerce revenues.

Evidence for e-commerce activities


is likely to be in electronic form.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 23
Learning Objective 4

Understand internal control


and design and perform tests
of controls and substantive
tests of transactions for sales.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 24
Methodology for Designing Controls
and Substantive Tests: Sales
Design tests of controls
Understand internal
and substantive tests
control sales
of transactions for sales
to meet transaction-
Assess planned related audit objectives.
control risk sales Audit procedures
Sample size
Evaluate cost-benefit Items to select
of testing controls. Timing
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 25
Understanding Internal
Control Sales

Study the clients flowcharts,


prepare an internal control
questionnaire, and perform
walk-through tests of sales.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 26
Assess Planned
Control Risk Sales

Adequate separation
of duties
Proper authorization
Adequate documents
and records Prenumbered
documents
Monthly statements
Internal verification
procedures

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 27
Internal Verification
Procedures

Evaluate cost-benefit
of testing controls.

Design tests of
controls for sales.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 28
Transaction-Related Audit
Objectives for Sales

Existence:
Recorded sales are for shipments actually made.
Completeness:
Existing sales transactions are recorded.
Accuracy:
Recorded sales are for the amount shipped.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 29
Design Substantive Tests
of Transactions for Sales

Classification:
Sales transactions are properly classified.
Timing:
Sales are recorded on the correct dates.
Posting and summarization:
Sales transactions are properly included
in the accounts receivable master file.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 30
Direction of Tests for Sales

Customer Shipping Duplicate


order document sales invoice
Completeness Start

Sales General Accounts


journal ledger = receivable
master file
Existence Start
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 31
Summary of Methodology
for Sales

Column 1: Transaction-related audit objectives


Column 2: Key internal controls
Column 3: Test of controls
Column 4: Weaknesses
Column 5: Substantive tests of transactions

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 32
Learning Objective 5

Apply the methodology for


controls over sales transactions
to controls over sales
returns and allowances.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 33
Sales Returns
and Allowances

The transaction-related audit objectives


and clients methods of controlling
misstatements are essentially the same
for processing credit memos as those
described for sales.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 34
Sales Returns
and Allowances

There are, however, two important differences.

Emphasis on
Materiality
objectives

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 35
Learning Objective 6

Understand internal control and


design and perform tests of
controls and substantive tests
of transactions for cash receipts.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 36
Tests of Controls and Substantive
Tests
of Transactions for Cash Receipts

Determine
Determine whether
whether cash
cash received
received was
was recorded
recorded
Prepare
Prepare proof
proof of
of cash
cash receipts
receipts
Test
Test to
to discover
discover lapping
lapping of
of accounts
accounts receivable
receivable

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 37
Learning Objective 7

Apply the methodology for controls


over the sales and collection cycle
to write-offs of uncollectible
accounts receivable.

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 38
Audit Tests for
Uncollectible Accounts

Existence of recorded write-offs is the most


important transaction-related audit objective.
What is a major concern in testing accounts
charged off as uncollectible?
covering up a defalcation by charging off
accounts receivable that have been collected

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 39
Additional Internal Controls
Over Account Balances

Realizable value

Rights and obligations

Presentation and disclosure

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 40
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 Bad debt


receivable expense

Allowance for
Cash
doubtful accounts
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 41
Role of all Audit Tests in the
Sales and Collection Cycle
Accounts Cash in
Sales Receivable Bank
Sales Cash receipts
transactions transactions
Audited by Audited by
TOC, STOT, and AP TOC, STOT, and AP
Ending Ending
balance balance
Audited by AP and TDP

TOC + STOT + AP + TDP


= Sufficient competent evidence per GAAS
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 42
End of Chapter 13

2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 43