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14 - 1©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Audit of the Sales and Audit of the Sales and Collection Cycle:Collection Cycle:Tests of Controls and Tests of Controls and Substantive Tests of Substantive Tests of TransactionsTransactions
Chapter 14Chapter 14
14 - 2©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 1Learning Objective 1
Identify the accounts and theIdentify the accounts and the
classes of transactions in theclasses of transactions in the
sales and collection cycle.sales and collection cycle.
14 - 3©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Accounts in the Sales and Accounts in the Sales and Collection CycleCollection Cycle
SalesSales
CashCashsalessales
Sales onSales onaccountaccount
Accounts ReceivableAccounts Receivable
Cash receiptsCash receipts
Sales returnsSales returnsand allowancesand allowances
Charge-off ofCharge-off ofuncollectibleuncollectibleaccountsaccounts
BeginningBeginningbalancebalance
Sales onSales onaccountaccount
EndingEndingbalancebalance
Cash in BankCash in Bank
Cash DiscountsCash DiscountsTakenTaken
Bad DebtBad DebtExpenseExpense
Sales ReturnsSales Returnsand Allowancesand Allowances
14 - 4©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Accounts in the Sales and Accounts in the Sales and Collection CycleCollection Cycle
Accounts ReceivableAccounts Receivable
Cash receiptsCash receipts
Sales returnsSales returnsand allowancesand allowances
Charge-off ofCharge-off ofuncollectibleuncollectibleaccountsaccounts
BeginningBeginningbalancebalance
Sales onSales onaccountaccount
EndingEndingbalancebalance
Allowance forAllowance forUncollectible AccountsUncollectible Accounts
Charge-off ofCharge-off ofuncollectibleuncollectibleaccountsaccounts
BeginningBeginningbalancebalance
Estimate ofEstimate ofbad debtbad debtexpenseexpense
EndingEndingbalancebalance
Bad DebtBad DebtExpenseExpense
14 - 5©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 2Learning Objective 2
Describe the business functionsDescribe the business functions
and the related documents andand the related documents and
records in the sales andrecords in the sales and
collection cycle.collection cycle.
14 - 6©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Sales TransactionSales Transaction
AccountsAccounts
SalesSales AccountsAccounts receivablereceivable
Business functionsBusiness functions
Processing customerProcessing customer ordersorders Granting creditGranting credit
Shipping goodsShipping goods Billing customersBilling customers and recording salesand recording sales
Documents and recordsDocuments and records
Customer orderCustomer order Sales orderSales order Customer order or salesCustomer order or sales orderorder Shipping documentShipping document Sales invoiceSales invoice Sales transaction fileSales transaction file Sales journal or listingSales journal or listing Accounts receivableAccounts receivable master filemaster file Accounts receivableAccounts receivable trial balancetrial balance Monthly statementsMonthly statements
14 - 7©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Cash Receipts TransactionCash Receipts Transaction
AccountsAccounts
Cash in bankCash in bank (debits from(debits from cash receipts)cash receipts) AccountsAccounts receivablereceivable
Business functionsBusiness functions
Processing andProcessing and recording cashrecording cash receiptsreceipts
Documents and recordsDocuments and records
Remittance adviceRemittance advice Prelisting of cashPrelisting of cash receiptsreceipts Cash receiptsCash receipts transaction filetransaction file Cash receipts journal orCash receipts journal or listinglisting
14 - 8©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Sales Returns and Allowances Sales Returns and Allowances TransactionTransaction
AccountsAccounts
Sales returnsSales returns andand allowancesallowances AccountsAccounts receivablereceivable
Business functionsBusiness functions
Processing andProcessing and recording salesrecording sales returns andreturns and allowancesallowances
Documents and recordsDocuments and records
Credit memoCredit memo Sales and returns andSales and returns and allowances journalallowances journal
14 - 9©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Charge-off of Uncollectible Charge-off of Uncollectible Accounts TransactionAccounts Transaction
AccountsAccounts
AccountsAccounts receivablereceivable Allowance forAllowance for uncollectibleuncollectible accountsaccounts
Business functionsBusiness functions
Charging offCharging off uncollectibleuncollectible accountsaccounts receivablereceivable
Documents and recordsDocuments and records
Uncollectible accountUncollectible account authorization formauthorization form General journalGeneral journal
14 - 10©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Bad Debt Expense TransactionBad Debt Expense Transaction
AccountsAccounts
Bad debtBad debt expenseexpense Allowance forAllowance for uncollectibleuncollectible accountsaccounts
Business functionsBusiness functions
Providing for badProviding for bad debtsdebts
Documents and recordsDocuments and records
General journalGeneral journal
14 - 11©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Processing Customer OrdersProcessing Customer Orders
Customer Order:Customer Order:A request for merchandise by a customerA request for merchandise by a customer
Sales Order: Sales Order: A document describing the goods orderedA document describing the goods orderedby a customerby a customer
14 - 12©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Granting CreditGranting Credit
Before goods are shipped, a properlyBefore goods are shipped, a properlyauthorized person must authorized person must approve creditapprove creditto the customer for sales on account.to the customer for sales on account.
14 - 13©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Shipping GoodsShipping Goods
This is the first point in the cycleThis is the first point in the cyclewhere company assets are given up.where company assets are given up.
14 - 14©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Billing Customers and Recording Billing Customers and Recording SalesSalesSales invoiceSales invoice
Sales transaction fileSales transaction file
Sales journal or listingSales journal or listing
Accounts receivable master fileAccounts receivable master file
Accounts receivable trial balanceAccounts receivable trial balance
Monthly statementMonthly statement
14 - 15©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Processing and Recording Cash Processing and Recording Cash ReceiptsReceipts
Remittance adviceRemittance advice
Prelisting of cash receiptsPrelisting of cash receipts
Cash receipts transaction fileCash receipts transaction file
Cash receipts journal or listingCash receipts journal or listing
14 - 16©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Processing and Recording Sales Processing and Recording Sales Returns and AllowancesReturns and Allowances
Credit memoCredit memo
Sales returns and allowances journalSales returns and allowances journal
14 - 17©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Charging Off UncollectibleCharging Off UncollectibleAccounts ReceivableAccounts Receivable
Uncollectible account authorization formUncollectible account authorization form
This is a document used internally toThis is a document used internally toindicate authority to write an accountindicate authority to write an accountreceivable off as uncollectiblereceivable off as uncollectible..
14 - 18©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Providing for Bad DebtsProviding for Bad Debts
This provision represents a residual,This provision represents a residual,resulting from management’sresulting from management’send-of-period adjustment of theend-of-period adjustment of theallowance for uncollectible accountsallowance for uncollectible accounts..
14 - 19©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 3Learning Objective 3
Understand how e-commerceUnderstand how e-commerce
activities affect the salesactivities affect the sales
and collection cycle.and collection cycle.
14 - 20©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Effect of E-Commerce on the Effect of E-Commerce on the Sales and Collection CycleSales and Collection Cycle
The Internet and other developingThe Internet and other developingtechnologies allow companies totechnologies allow companies todevelop new business models.develop new business models.
14 - 21©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Effect of E-Commerce on the Effect of E-Commerce on the Sales and Collection CycleSales and Collection Cycle
Business-to-business (B2B)Business-to-business (B2B)
Business-to-consumer (B2C)Business-to-consumer (B2C)
Management’s assertions for sales andManagement’s assertions for sales andcollection activities remain the same.collection activities remain the same.
14 - 22©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Effect of E-Commerce on the Effect of E-Commerce on the Sales and Collection CycleSales and Collection Cycle
Auditors should obtain an understandingAuditors should obtain an understandingof the design and operation of key internalof the design and operation of key internalcontrols over e-commerce revenues.controls over e-commerce revenues.
Evidence for e-commerce activities isEvidence for e-commerce activities islikely to be in electronic form.likely to be in electronic form.
14 - 23©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 4Learning Objective 4
Understand internal control,Understand internal control,
and design and perform testsand design and perform tests
of controls and substantiveof controls and substantive
tests of transactions for sales.tests of transactions for sales.
14 - 24©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Methodology for Designing Methodology for Designing Controls and Substantive TestsControls and Substantive Testsof Sales Transactions for Salesof Sales Transactions for Sales
Understand internalUnderstand internalcontrol – sales.control – sales.
Audit proceduresAudit procedures
Sample sizeSample size
Items to selectItems to select
TimingTiming
Assess plannedAssess plannedcontrol risk – sales.control risk – sales.
Determine extent ofDetermine extent oftesting controls.testing controls.
Design tests of controls andDesign tests of controls andsubstantive tests of transactionssubstantive tests of transactionsfor sales to meet transactionfor sales to meet transaction-related audit objectives.-related audit objectives.
14 - 25©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Understand Internal Control – Understand Internal Control – SalesSales
Study the client’s flowcharts, prepareStudy the client’s flowcharts, preparean internal control questionnaire, andan internal control questionnaire, andperform walk-through tests of sales.perform walk-through tests of sales.
Study the client’s flowcharts, prepareStudy the client’s flowcharts, preparean internal control questionnaire, andan internal control questionnaire, andperform walk-through tests of sales.perform walk-through tests of sales.
14 - 26©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Assess Planned Control Risk – Assess Planned Control Risk – SalesSales
1. Framework for assessing control risk1. Framework for assessing control risk
2. Identify key internal controls and deficiencies 2. Identify key internal controls and deficiencies
3. Associate controls and deficiencies with the3. Associate controls and deficiencies with the objectives objectives
4. Assess control risk for each objective4. Assess control risk for each objective
14 - 27©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Proper authorizationProper authorization
Assess Planned Control Risk – Assess Planned Control Risk – SalesSales
Internal verificationInternal verification proceduresprocedures
PrenumberedPrenumbereddocumentsdocuments
Monthly statementsMonthly statements
Adequate documentsAdequate documentsand recordsand records
Adequate separationAdequate separationof dutiesof duties
14 - 28©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Determine Extent of Testing Determine Extent of Testing ControlsControls
Audits of publicAudits of public companiescompanies
Audits of nonpublic Audits of nonpublic companiescompanies
14 - 29©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Transaction-Related AuditTransaction-Related AuditObjectives for SalesObjectives for Sales
Existence:Existence:Recorded sales are for shipments actually made.Recorded sales are for shipments actually made.
Accuracy:Accuracy:Recorded sales are for the amount shipped.Recorded sales are for the amount shipped.
Completeness:Completeness:Existing sales transactions are recorded.Existing sales transactions are recorded.
14 - 30©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Transaction-Related AuditTransaction-Related AuditObjectives for SalesObjectives for Sales
Classification:Classification:Sales transactions are properly classified.Sales transactions are properly classified.
Timing:Timing:Sales are recorded on the correct dates.Sales are recorded on the correct dates.
Posting and summarization:Posting and summarization:Sales transactions are properly includedSales transactions are properly includedin the accounts receivable master file.in the accounts receivable master file.
14 - 31©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Direction of Tests for SalesDirection of Tests for Sales
CompletenessCompletenessstartstart
ExistenceExistencestartstart
CustomerCustomerorderorder
ShippingShippingdocumentdocument
DuplicateDuplicatesalessales
invoiceinvoice
SalesSalesjournaljournal
GeneralGeneraljournaljournal
AccountsAccountsreceivablereceivablemaster filemaster file
==
14 - 32©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Summary of Methodology for Summary of Methodology for SalesSales
Transaction-related audit objectives (Column 1)Transaction-related audit objectives (Column 1)Key existing controls (Column 2)Key existing controls (Column 2)Tests of control (Column 3)Tests of control (Column 3)Deficiencies (Column 4)Deficiencies (Column 4)Substantive tests of transactions (Column 5)Substantive tests of transactions (Column 5)
14 - 33©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 5Learning Objective 5
Apply the methodology forApply the methodology for
controls over sales transactionscontrols over sales transactions
to controls over sales returnsto controls over sales returns
and allowances.and allowances.
14 - 34©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Sales Returns and AllowancesSales Returns and Allowances
The transaction-related audit objectives andThe transaction-related audit objectives andclient’s methods of controlling misstatementsclient’s methods of controlling misstatementsare essentially the same for processing creditare essentially the same for processing creditmemos as those described for sales.memos as those described for sales.
14 - 35©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Sales Returns and AllowancesSales Returns and Allowances
There are, however, two important differences.There are, however, two important differences.
MaterialityMateriality Emphasis onEmphasis onobjectivesobjectives
14 - 36©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 6Learning Objective 6
Understand internal control, andUnderstand internal control, and
design and perform tests ofdesign and perform tests of
controls and substantive testscontrols and substantive tests
of transactions for cash receipts.of transactions for cash receipts.
14 - 37©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Tests of Controls and Substantive Tests of Controls and Substantive Tests of Transactions for Cash Tests of Transactions for Cash ReceiptsReceipts
Determine whether cash received was recorded.Determine whether cash received was recorded. Prepare proof of cash receipts.Prepare proof of cash receipts. Test to discover lapping of accounts receivable.Test to discover lapping of accounts receivable.
14 - 38©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 7Learning Objective 7
Apply the methodology for Apply the methodology for
controls over the sales andcontrols over the sales and
collection cycle to write-offscollection cycle to write-offs
of uncollectible accountsof uncollectible accounts
receivable.receivable.
14 - 39©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Audit Tests for Uncollectible Audit Tests for Uncollectible AccountsAccounts
Existence of recorded write-offs is the mostExistence of recorded write-offs is the mostimportant transaction-related audit objective.important transaction-related audit objective.
What is a major concern in testing accountsWhat is a major concern in testing accountscharged off as uncollectible?charged off as uncollectible?
– – covering up a defalcation by charging offcovering up a defalcation by charging offaccounts receivable that have been collectedaccounts receivable that have been collected
14 - 40©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Additional Internal Controls Over Additional Internal Controls Over Account BalancesAccount Balances
Realizable valueRealizable value
Credit approvalCredit approval
Aged accounts receivable trial balanceAged accounts receivable trial balance
Charging off uncollectiblesCharging off uncollectibles
14 - 41©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Additional Internal Controls Over Additional Internal Controls Over Account BalancesAccount Balances
Rights and obligationsRights and obligations
Presentation and disclosurePresentation and disclosure
14 - 42©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Effect of Results of Controls andEffect of Results of Controls andSubstantive Tests of TransactionsSubstantive Tests of Transactions
The parts of the audit most affected by theThe parts of the audit most affected by thetests for the sales and collection cycle are:tests for the sales and collection cycle are:
Accounts receivableAccounts receivable
Bad debt expenseBad debt expense
CashCash
Allowance forAllowance fordoubtful accountsdoubtful accounts
14 - 43©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Types of Audit Tests for the Sales Types of Audit Tests for the Sales and Collection Cycleand Collection Cycle
SalesSalesAccountsAccounts
ReceivableReceivableCash inCash in
BankBankSalesSales
transactionstransactionsCash receiptsCash receiptstransactionstransactions
EndingEndingbalancebalance
EndingEndingbalancebalance
TOCTOC + + STOTSTOT + + APAP + + TDBTDB= Sufficient competent evidence per GAAS= Sufficient competent evidence per GAAS
Audited byAudited byTOCTOC, , STOTSTOT, and , and APAP
Audited by Audited by APAP and and TDBTDB
Audited byAudited byTOCTOC, , STOTSTOT, and , and APAP
14 - 44©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
End of Chapter 14End of Chapter 14