Chapter 14 Audit of the Sales and Collection Cycle

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Chapter 14Audit of the Sales and Collection Cycle
Statement
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Presentation Outline

1. Accounts and Documents in the Sales and
   Collection Cycle
2. Segregation of Duties
3. Sales Transaction Audit Objectives
4. Sales Return and Allowance Audit Objectives
5. Cash Collection Transaction Audit Objectives
6. Other Sales and Collection Cycle Considerations

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I. Accounts and Documents in the Sales and
Collection Cycle

1. Accounts in the Sales and Collection Cycle
2. Documents in the Sales and Collection Cycle

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A. Accounts in the Salesand Collection Cycle
Sales Cash sales Sales on account
Cash in Bank
Cash Discounts Taken
Accounts Receivable Beginning Cash
receipts balance Sales returns Sales on and
allowances account Charge-off
of Ending uncollectible balance accounts
Sales Returns and Allowances
Bad Debt Expense
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A. Accounts in the Salesand Collection Cycle
(continued)
Accounts Receivable Beginning Cash
receipts balance Sales returns Sales on and
allowances account Charge-off
of Ending uncollectible balance accounts
Allowance for Uncollectible Accounts Charge-off
of Beginning uncollectible balance accounts
Estimate of bad debt
expense Ending balance
Bad Debt Expense
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B. Documents in the Sales and Collection Cycle

• Bill of lading a written contract between a
  carrier and seller for the receipt and shipment
  of goods.
• Sales invoice a document indicating the
  description and quantity of goods sold, the
  price, freight charges, insurance, terms, and
  other relevant data.
• Credit memo a document indicating a reduction
  in the amount due from a customer because of
  returned goods or an allowance granted
• Remittance advice a document that accompanies
  the sales invoice mailed to the customer that can
  be returned to the seller with the cash payment
• Customer statement A document summarizing
  customer balance and account activity, that is
  sent to the customer for billing purposes.

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II. Segregation of Duties in the Revenue Cycle

1. Authorizing sales transactions
2. Approving credit
3. Recording sales
4. Maintaining custody of goods
5. Suggested List of Duties to be Segregated

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A. Authorizing Sales Transactions

• Sales transactions are initiated by a customer
  order. The customer order provides the basis for
  preparing a sales order.

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B. Approving Credit

• A copy of the sales order is sent to the credit
  department for approval. A computer may simply
  compare preestablished credit limits to see if
  the customer has credit available

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C. Recording Sales

• Accounts receivable maintains the accounts
  receivable subsidiary ledger. May be a
  computerized accounts receivable master file.
• General accounting maintains control accounts in
  the general ledger.

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D. Maintaining Custody of Goods

• Custody of goods in warehouse or awaiting
  shipment.

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E. Suggested List of Duties to be Segregated

• Authorization Functions
• Receiving orders for sales
• Granting credit and pursuing unpaid accounts
• Recordkeeping Functions
• Billing customers and recording sales
• Maintaining inventory records
• Maintaining general ledger accounting records
• Maintaining detailed accounts receivable records
• Custody of Asset Functions
• Shipping goods
• Processing cash receipts

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III. Sales Transaction Audit Objectives

1. Existence
2. Completeness
3. Accuracy
4. Classification
5. Timing
6. Posting and Summarization

Note See Table 13-2 on pages 382-383 for a full
description of Transaction-related objectives
for sales
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Sales Transactions Existence

• Test of control Examine sales invoice for
  supporting bill of lading and customer order.
• Substantive test Auditor is concerned with
  three types of misstatements
• Recorded sale with no shipment Trace from sales
  journal entry to shipping document
• Sale recorded more than once Check cancellation
  of shipping documentation.
• Shipments made to nonexistent customers Person
  recording sales should not authorize shipments.

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B. Sales Transactions Completeness

• Test of control Account for sequence of
  shipping documents.
• Substantive test Many audits ignore
  completeness on the grounds that overstatement of
  income are of greater concern. However, errors
  may still misstate financial statements. One
  effective procedure is to trace from shipping
  documents to the sales invoice and entry in the
  sales journal.

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C. Sales Transactions Accuracy

• Test of control Examine the approved price list
  for accuracy and proper authorization.
• Substantive test Start with entries in the
  sales journal and compare the total of selected
  transactions with accounts receivable master file
  entries and duplicate sales invoices.

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D. Sales Transactions Classification

• Test of control Examine document package for
  duplicate verification.
• Substantive test When there are cash and credit
  sales, it is important not to debit accounts
  receivable for a cash sale or to credit sales for
  collection of a receivable. It is also important
  not to classify sales of operating assets as
  sales. A common procedure is to examine
  duplicate sales invoice for proper account
  classification.

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E. Sales Transactions Timing

• Test of control Account for sequence of shipping
  documents.
• Substantive test Sales should be billed when
  ownership is transferred to the customer. A
  common procedure is to compare the date of
  recording a sale in the sales journal with the
  date on the duplicate sales invoice and bill of
  lading.

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F. Sales Transactions Posting and Summarization

• Test of control Examine evidence that accounts
  receivable master file is reconciled to the
  general ledger.
• Substantive test Use audit software to foot and
  cross-foot the sales journal and trace totals to
  the general ledger.

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IV. Sales Return and Allowance Audit Objectives

1. An Internal Control for Existence
2. An Internal Control for Completeness
3. Common Types of Transactions

The objectives and methodology for auditing sales
returns and allowances is the same as for sales.
The same procedure can be used to develop
suitable controls, tests of controls, and
substantive tests of transactions to verify the
amounts.
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Sales AdjustmentExistence
Ensure that all sales returns and allowances and
charge- offs are approved by appropriate
personnel.

• Ensuring that recorded sales adjustments actually
  occurred is important because a diversion of cash
  from an account receivable collection could be
  covered up by a fictitious sales return or
  allowance.

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B. Sales AdjustmentCompleteness
Sales Adjustment Form Discount for Damaged
merchandise
Form 36

• Unrecorded sales returns and allowances can be
  material and can be used by a companys
  management to overstate net income.

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Approval
RS
General Journal
Ensure that prenumbered sales adjustment forms
are used, and that all forms are accounted for.
Sales Allowance 5
Acc. Rec. 5
Record Adjustment 36
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C. Major Types of Sales Adjustment Transactions

• Customers may receive discounts for paying early.
• Customers may return goods or request selling
  price reductions.
• Incorrect billing.
• Bad debt write-offs.

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V. Cash Collection Transaction Audit Objectives

1. Existence
2. Completeness
3. Accuracy
4. Classification
5. Timing
6. Posting and Summarization

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A. Cash Collections Existence

• Test of control Observe whether accountant
  reconciles bank account.
• Substantive test Trace cash receipts entries
  from the cash receipts journal entries to the
  bank statement.

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B. Cash Collections Completeness

• Test of control Observe prelisting of cash
  receipts.
• Substantive test Compare the prelisting with
  the duplicate deposit slip.

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C. Cash Collections Accuracy

• Test of control Observe whether accountant
  reconciles bank account.
• Substantive test Prepare a proof of cash
  receipts to reconcile cash receipts per books
  with cash receipts per bank.

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D. Cash Collections Classification

• Test of control Examine evidence of internal
  verification.
• Substantive test Examine prelisting for proper
  account classification.

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E. Cash Collections Timing

• Test of control Observe unrecorded cash at a
  point in time to see when it is recorded.
• Substantive test Compare date of deposit in
  bank statement to the dates in the cash receipts
  journal and prelisting of cash receipts.

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E. Cash Collections Posting and Summarization

• Test of control Examine evidence that accounts
  receivable master file is reconciled to general
  ledger.
• Substantive test Use audit software to foot and
  cross-foot the cash receipts journal and trace to
  the general ledger.

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VI. Other Sales and Collection Cycle
Considerations

1. Lapping of Accounts Receivable
2. Audit Tests for Uncollectible Accounts

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A. Lapping of Accounts Receivable
Lapping is when, to cover a cash theft, an
employee defers recording cash receipts from one
customer and covers the shortage with receipts
from another customer. It can be detected by
comparing the name, amount, and dates shown on
remittance advices with cash receipts journal
entries and related duplicate deposit slips.
Dishonest Employee
Customer Bs Account
Customer As Account
Customer A
Customer B
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B. Audit Tests for Uncollectible Accounts

• Major concern is that client covers up a theft by
  charging off accounts receivable that have
  actually been collected.
• Audit tests for proper authorization of
  write-off. This often involves an aged analysis
  of receivables. It is also usually necessary to
  examine correspondence in client files to
  establish uncollectibility.
• After the auditor has concluded that the accounts
  should be charged off, the auditor should verify
  the corresponding journal entries and postings
  into the general and subsidiary ledgers.

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Summary

• Accounts and Documents in the Sales and
  Collection Cycle
• Segregation of Duties
• Sales Transaction Audit Objectives
• Sales Return and Allowance Transaction Audit
  Objectives
• Cash Collection Transaction Audit Objectives
• Lapping of Accounts Receivable
• Uncollectible Accounts