Addthis Arens Chapter14

Audit of the Sales and
Collection Cycle: Tests of
Controls and Substantive
Tests of Transactions
Chapter 14

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley

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Learning Objective 1
Identify the accounts and the
classes of transactions in the
sales and collection cycle.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Accounts in the Sales and
Collection Cycle

Sales
Cash
sales
Sales on
account

Cash in Bank

Accounts Receivable
Beginning Cash receipts
balance

Cash Discounts
Taken

Sales on
account

Sales returns
and allowances

Sales Returns
and Allowances

Ending
balance

Write-off of
uncollectible
accounts

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

Bad Debt
Expense
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Accounts in the Sales and
Collection Cycle
Accounts Receivable

Beginning Cash receipts
balance
Sales on
account

Sales returns
and allowances

Ending
balance

Write-off of
uncollectible
accounts

Allowance for
Uncollectible Accounts
Write-off of
uncollectible
accounts

Beginning
balance
Estimate of
bad debt
expense
Ending
balance

Bad Debt
Expense

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 2
Describe the business functions
and the related documents and
records in the sales and

collection cycle.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Sales Transaction
Accounts

Sales
Accounts
receivable

Business Functions Documents and Records

Processing
customer orders
Granting credit
Shipping goods
Billing customers

and recording
sales

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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
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Cash Receipts Transaction
Accounts

Business Functions Documents and Records

Cash in bank
Processing and
(debits from
recording cash
cash receipts) receipts
Accounts
receivable

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

Remittance advice
Prelisting of cash
receipts
Cash receipts
transaction file

Cash receipts journal
or listing

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Sales Returns and Allowances
Transaction
Accounts

Business Functions Documents and Records

Sales returns
and
allowances
Accounts
receivable

Processing and
recording sales
returns and

allowances

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

Credit memo
Sales and returns and
allowances journal

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Write-off of Uncollectible
Accounts Transaction
Accounts

Business Functions Documents and Records

Accounts
Writing off
receivable
uncollectible

Allowance for
accounts
uncollectible receivable
accounts

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

Uncollectible account
authorization form
General journal

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Bad Debt Expense Transaction
Accounts

Business Functions Documents and Records

Bad debt
Providing for bad

expense
debts
Allowance for
uncollectible
accounts

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

General journal

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Processing Customer Orders
Customer Order:
 A request for merchandise by a customer
Sales Order:
 A document describing the goods ordered
by a customer

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Granting Credit
 Before goods are shipped, a properly
authorized person must approve credit
to the customer for sales on account

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Shipping Goods
 This is the first point in the cycle
where company assets are given up

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Billing Customers and
Recording Sales
 Sales invoice
 Sales transaction file
 Sales journal or listing
 Accounts receivable master file
 Accounts receivable trial balance
 Monthly statement

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Processing and Recording Cash
Receipts
 Remittance advice
 Prelisting of cash receipts
 Cash receipts transaction file
 Cash receipts journal or listing

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Processing and Recording
Sales Returns and Allowances
 Credit memo
 Sales returns and allowances journal

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Providing for Bad Debts
 This provision represents a residual,
resulting from management’s
end-of-period adjustment of the
allowance for uncollectible accounts

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 3
Understand internal control, and
design and perform tests of
controls and substantive tests
of transactions for sales.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Methodology for Designing Controls
and Substantive Tests
Understand internal control – sales
Assess planned control risk – sales
Determine extent of testing controls
Audit procedures
Design tests of controls and
Sample size
substantive tests of transactions
for sales to meet transactionItems to select
related audit objectives
Timing
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Understand Internal Control –
Sales
Study the client’s flowcharts, prepare
an internal control questionnaire, and
perform walk-through tests of sales.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Assess Planned Control Risk –
Sales
 Adequate separation of duties
 Proper authorization
 Adequate documents and records
 Prenumbered documents
 Monthly statements
 Internal verification procedures

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Determine Extent of Testing
Controls
 Audits of public companies
 Audits of nonpublic companies

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Transaction-related Audit
Objectives for Sales
Occurrence:
Recorded sales are for shipments actually made.
Completeness:
Existing sales transactions are recorded.
Accuracy:
Recorded sales are for the amount shipped.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Transaction-related Audit
Objectives 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.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Direction of Tests for Sales
Customer
order

Sales
journal

Shipping
document

Duplicate
sales
invoice

General
journal

Accounts
receivable
master file

Completeness
start
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

=

Occurrence
start
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Summary of Methodology
for 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)

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 4
Apply the methodology for controls
over sales transactions to controls
over sales returns and allowances.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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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.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Sales Returns and Allowances
There are, however, two important differences.
 Materiality
 Emphasis on objectives

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 5
Understand internal control, and
design and perform tests of
controls and substantive tests
of transactions for cash receipts.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 6
Apply the methodology for
controls over the sales and
collection cycle to write-offs
of uncollectible accounts
receivable.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Additional Internal Controls
Over Account Balances
 Realizable value
 Credit approval
 Aged accounts receivable trial balance
 Writing off uncollectibles
 Rights and obligations
 Presentation and disclosure

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Types of Audit Tests for the
Sales and Collection Cycle
Sales

Accounts
Cash in
Receivable
Bank
Sales
Cash receipts
transactions
transactions
Audited by
TOC, STOT, and AP

Ending
balance

Audited by
TOC, STOT, and AP

Ending
balance

Audited by AP and TDB

TOC + STOT + AP + TDB
= Sufficient appropriate evidence
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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End of Chapter 14

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley

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