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Chapter 14Audit of the Sales and Collection
Cycle
Statement
Presentation Outline
I. Accounts and Documents in the Sales and Collection Cycle
II. Segregation of Duties
III. Sales Transaction Audit Objectives
IV. Sales Return and Allowance Audit Objectives
V. Cash Collection Transaction Audit Objectives
VI. Other Sales and Collection Cycle Considerations
I. Accounts and Documents in the Sales and Collection Cycle
A. Accounts in the Sales and Collection Cycle
B. Documents in the Sales and Collection Cycle
A. Accounts in the Salesand Collection Cycle
SalesCashsales
Sales onaccount
Cash in Bank
Cash DiscountsTaken
Sales Returnsand Allowances
Bad DebtExpense
Accounts ReceivableBeginning Cash receiptsbalance
Sales returnsSales on and allowancesaccount
Charge-off ofEnding uncollectiblebalance accounts
Accounts ReceivableBeginning Cash receiptsbalance
Sales returnsSales on and allowancesaccount
Charge-off ofEnding uncollectiblebalance accounts Bad Debt
Expense
Allowance for Uncollectible AccountsCharge-off of Beginninguncollectible balanceaccounts
Estimate of baddebt expense
Ending balance
A. Accounts in the Salesand Collection Cycle (continued)
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.
II. Segregation of Duties in the Revenue Cycle
A. Authorizing sales transactions
B. Approving credit
C. Recording sales
D. Maintaining custody of goods
E. Suggested List of Duties to be Segregated
A. Authorizing Sales Transactions
Sales transactions are initiated by a customer order. The customer
order provides the basis for preparing a
sales order.
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
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.
D. Maintaining Custody of Goods
Custody of goods in warehouse or awaiting
shipment.
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
III. Sales Transaction Audit Objectives
A. Existence
B. Completeness
C. Accuracy
D. Classification
E. Timing
F. Posting and Summarization
Note: See Table 13-2 on pages 382-383 for a full description of Transaction-related objectives for sales
A. 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.
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.
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.
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.
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.
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.
IV. Sales Return and Allowance Audit Objectives
A. An Internal Control for Existence
B. An Internal Control for Completeness
C. 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.
A. Sales AdjustmentExistence
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.
Ensure that all sales returns and allowances and charge-
offs are approved by appropriate personnel.
B. Sales AdjustmentCompleteness
Unrecorded sales returns and allowances can be
material and can be used by a company’s
management to overstate net income.
Sales Adjustment FormDiscount for Damaged merchandise
Approval$5RS
General Journal
Sales Allowance 5 Acc. Rec. 5
Ensure that prenumbered salesadjustment forms are used,
and that all forms are accounted for.
Form #36
Record Adjustment #36
C. Major Types of Sales Adjustment Transactions
1. Customers may receive discounts for paying early.
2. Customers may return goods or request selling price reductions.
3. Incorrect billing.
4. Bad debt write-offs.
V. Cash Collection Transaction Audit Objectives
A. Existence
B. Completeness
C. Accuracy
D. Classification
E. Timing
F. Posting and Summarization
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.
B. Cash Collections Completeness
Test of control – Observe prelisting of cash receipts.
Substantive test – Compare the prelisting with the duplicate deposit slip.
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.
D. Cash Collections Classification
Test of control – Examine evidence of internal verification.
Substantive test – Examine prelisting for proper account classification.
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.
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.
VI. Other Sales and Collection Cycle Considerations
A. Lapping of Accounts ReceivableB. Audit Tests for Uncollectible Accounts
A. Lapping of Accounts Receivable
CustomerA’s
Account
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.
Customer A Customer B
CustomerB’s
Account
Dishonest Employee
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.
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