Auditing and assurance services 14e by arens chapter 14

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 5Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions Chapter

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 5

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

Tests of Transactions

Chapter 14

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Learning Objective 1

Identify the accounts and the classes of

transactions in the sales and collection

cycle.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 3

Accounts in the Sales and

Collection Cycle

Learning Objective 2

Describe the business functions and the

related documents and records in the

sales and collection cycle.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 5

Documents and Records

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

Remittance advice Prelisting of cash receipts

Cash receipts transaction file Cash receipts journal

or listing

Accounts Business Functions Documents and Records

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 7

Sales Returns and Allowances

allowances

Credit memo Sales and returns and allowances journal

Accounts Business Functions Documents and Records

receivable

Uncollectible account authorization form General journal

Accounts Business Functions Documents and Records

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 9

Bad Debt Expense Transaction

Processing Customer Orders

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 11

Granting Credit

Before goods are shipped, a properly

to the customer for sales on account

Shipping Goods

 This is the first point in the cycle

at which the company gives up assets.

bill of lading.

 Bills of lading are often transmitted once goods have been shipping

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 13

Billing Customers and Recording

Sales

Sales transaction

file

Sales journal

Accounts

receivable

file

Accounts receivable trial balance

Processing and Recording Cash

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 15

Processing and Recording Sales

Returns and Allowances

Writing 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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 17

Providing for Bad Debts

This provision represents a residual, resulting from management’s

end-of-period adjustment of the allowance for uncollectible accounts

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 19

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

Study the client’s flowcharts, prepare

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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 21

Assess Planned Control Risk –

Sales

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 –

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 23

Determine Extent of Testing

Controls

Control risk

Control effectiveness

Direction of Tests for Sales

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 25

Sales are recorded on the

Posting and summarization:

Sales transactions are correctly included

in the accounts receivable master file.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 27

COSO Report Identifies Revenue

Misstatement Techniques

Bill and hold

Improper sales cutoff Sham sales

Premature revenue recognition

Conditional sales

Round-tripping loans as sales

Fraudulent Techniques

Improper

% of completion

Unauthorized shipments

Consignment

sales

Summary of Methodology

for Sales

 Identify key transaction-related audit objectives

 Determine key existing controls

 Design tests of controls to verify effectiveness

 Evaluate any control deficiencies

 Determine extent of substantive tests

of transactions

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 29

Learning Objective 4

Apply the methodology for controls over

sales transactions to controls over sales returns and allowances.

Sales Returns and Allowances

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.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 31

Sales Returns and Allowances

There are, however, two important differences:

Emphasis

on objectives Materiality

Learning Objective 5

Understand internal control, and design

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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 33

Tests of Controls and Substantive Tests of Transactions for Cash

Receipts

 Prepare proof of cash receipts*

* Only performed when fraud is suspected

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 35

Audit Tests for the Write-Off

of Uncollectible Accounts

 Occurrence transaction-related audit objective

 Proper authorization of the write-off of

uncollectible accounts

 Verification of accounts written off

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

Allowance for doubtful accounts

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 14 - 37

Types of Audit Tests for the Sales and Collection Cycle

Sales transactions Cash receipts transactions

Audited by AP and TDB

Audited by TOC, STOT, and AP

End of Chapter 14