Audit of the Revenue and Collection Cycle:

Tests of controls and Substantive Tests of Transactions

Nature of the Revenue and Collection Cycle

 Consists of the activities relating to the exchange
of goods and services with customers and the
collection of the revenue in cash
For a trading concern, the classes of transactions in the
revenue and collection cycle involve:
a. Sales (cash and credit);
b. Sales adjustments (discounts, returns and
allowances, and uncollectible accounts provisions
and write-offs); and
c. Cash receipts (collections on accounts and cash
sales).
Accounts affected by the revenue and collection cycle
1. Sales
2. Accounts receivable and notes receivable
3. Sales returns and allowances
4. Cash in bank (debits from cash receipts)
5. Sales discount
6. Allowance for uncollectible accounts
7. Uncollectible accounts expense
8. Inventories (merchandise, finished goods)

Documents used in the Revenue and Collection Cycle and their Audit Significance
Documents Purpose Audit Significance
Customer’s Purchase A request for merchandise by a customer. Provides evidence that a customer
Order actually ordered the goods.

Purchase order numbers are generally

Sales Order A pre-numbered document for recording the
related information for goods ordered by a
customer (description, quantity, etc.)
Used to show credit approval and authorization
for shipment
Shipping documents or A pre-numbered document prepared to initiate
Bill of Lading shipment of the goods, indicating the
description of the merchandise, the quantity
shipped, and other relevant data.
recorded on sales invoices so that an
auditor can determine the purchase order
to which an invoice relates.
Contains the seller’s understanding of the
sales terms.
Seller should account for the numerical
sequence to help ensure that shipments are
made for sales orders and that all sales are
billed.
Signature of the carrier or customer on the
shipping document provides externally
created evidence that goods have been
shipped.

Seller should account for the numerical

Sales Invoice A pre-numbered document indicating the
description and quantity of goods sold, the
price including freight, insurance, terms, and
other relevant data
Credit Memo A pre-numbered document indicating a
reduction in the amount due from a customer
because of returned goods or an allowance
granted
Takes the same general form as sales invoice,
but supports reductions in accounts receivable
Remittance Advice Document that a customer attaches to a check
in payment of an invoice
sequence to ensure that all shipments are
recorded as sales
Indicates credit terms, shipping terms, and
price charged for merchandise.
Sellers should account for the numerical
sequence to help ensure that all sales are
recorded.
Provides evidence that a seller has
reduced that amount previously billed to a
customer.
Seller should account for the numerical
sequence to ensure that all credit memos
are recorded.
Indicates the date and amount of payment
and the invoices paid

May be a turnaround document, a part of a Seller generally file remittance advices by

check or a statement identifying the invoices date.
being paid. Facilitate recording cash receipts.
 Uncollectible account
authorization form
Monthly statement
A pre-numbered document used internally,
indicating authority to write an account
receivable off as uncollectible
A document sent to each customer indicating
the beginning balance of accounts receivable,
the amount and date of each sale, cash
payments received, credit memos issued, and
ending balance due
Seller should account for the numerical
sequence to ensure that all write-offs are
recorded
A statement mailed to a customer
reporting a beginning balance and
transactions that occurred during the
period
If inaccurate, many customers would
contact the seller

Accounting Records in the Revenue and Collection Cycle

Record Purpose
Sales Journal A journal for recording sales transactions.
A detailed sales journal includes each transactions.
Sales Returns and A journal similar to the sales journal except the merchandisers use it to record returns of
Allowances Journal merchandise or adjustments to invoice prices.
Cash Receipts Journal A journal for recording cash receipts from collections, cash sales, and all other cash receipts.
General Journal A journal in which are recorded all transactions for which a special journal has not been
created
Frequently include entries to estimate uncollectible accounts expense and entries to write off
accounts identified as uncollectible
Accounts Receivable A file for recording individual sales, cash receipts, and sales returns allowances for each
Master File or Subsidiary customer and maintaining customer account balances
Ledger
Accounts Receivable A listing of the amount owed by each customer at a point in time.
Trial Balance Prepared directly from the accounts receivable master file

Audit of Sales Transactions

 Business Activities for Sales Transactions  In addition to answers to questionnaires, the

a. Accepting sales order information gathered by the auditor may be
b. Approving credit documented in flowcharts and narrative
c. Filling sales order memoranda
d. Shipping sales order
e. Billing customers Tests of Controls over Sales and Receivables
 Controls are important because of their effect on
Evaluation of Internal Control over Sales Transactions the assertions embodied in the financial
 Information concerning specific controls over statements.
sales transactions is obtained through inquiry,  Auditors identify specific assertions for each
observation and review of documentation. general assertion to be tested.

General and Controls Tests of Controls

Specific Assertions
Existence or Occurrence
Recorded sales are for
shipments actually made to
customers
Completeness
All sales transactions that
occurred are recorded
Recording of sales is supported by
customer orders, sales orders;
Approved by the credit department; and
Approved and executed shipping
documents
Clerk independent of accounts receivable
prepares and mails monthly statements to
customers for all trade accounts receivable
and follows up on any complaints
Pre-numbered shipping documents are
accounted for to determine that a sales
invoice is prepared for all shipments
Examination of approved customer order, sales
order, shipping document, and copy of sales
invoice for a sample of entries in the sales
journal;
Documents should bear the required approval;
Details regarding the transaction should be
consistent.
Observation whether clerk independent of
accounts receivable does so;
Examination of files on complaints received
from selected months
Observation of the client performing the
procedure;
Select a sample of shipping orders and
examination of the invoice that bills the sale;
Presence of a sales invoice copy indicates that
the shipment was billed

Rights and Obligations
Sales recorded represent only
sales transactions
Valuation or Allocation
Sales are correctly billed and
recorded
Presentation and
Disclosure
Sales and accounts receivable
are recorded to result in
presentation and disclosure in
accordance with PAS/PFRS.
Pre-numbered sales invoices are accounted
for to determine that all sales are recorded
Procedures to ensure timely recording of
sales and proper cut-off are established
Check sales orders and sales invoices for
terms to determine that transaction is a sale
rather than a consignment
For all goods shipped, goods are counted
and descriptions and quantities are
compared to those on sales orders and
shipping documents prior to shipping
Customer credit is approved by a
responsible official prior to merchandise
shipment (reduces the likelihood of the
account being uncollectible)
Sales invoices are checked for:
a. Proper pricing
b. Mathematical accuracy
c. Terms
Accounts receivable subsidiary ledger is
balanced to the general ledger control
account regularly (absence of this =
careless recordkeeping and omission of
postings of sales or payments
Sales must be properly classified to
generate accurate segment reporting.
Entities may require a second person to
independently review or check the account
coding on invoices
Observation if clerk recording sales is
accounting for the numerical sequence of
invoices and determines why any missing
invoices have not been processed;
Tracing of a selected sample of sales invoice
into the sales journal
Inquiry of how procedures are followed;
Observation of procedures being followed;
Inspections of report on the last shipments that
the shipping clerk sends to the billing clerk;
Proper cut-off also provides evidence about the
existence of transactions
Observation that the control is being performed
Observation that the control is being performed;
Examination of a sample of shipping orders for
the signature on the shipping documents that
indicates that the counting and comparison
occurred
Examination of a sample of sales order for
credit approval prior to shipment
Perform the following:
a. Inquiry about the updating and use of
price lists
b. Examination of a sample of invoice
copies to determine that they contain
a signature indicating that the price,
mathematical accuracy and terms
have been checked
Observation that the control is being performed;
Footing of accounts receivable subsidiary and
ledger accounts
Determination if the invoice copy contains the
signature that indicates approval of account
classifications used

Audit Program for Tests of Controls: Sales

 To test for existence or occurrence, the auditor  The auditor can also observe the presence of
tests from accounting records back to underlying some controls, rather than examine a sample of
documents that indicate that the transaction documents to obtain evidence about a control.
occurred.
 To test whether all transactions are recorded, an
auditor compares pre-numbered documents to
entries in the accounting records.

Audit Procedures
1. For a sample of entries in the sales journal,
a. Compare data in the sales journal to approved customer order, sales order, shipping document and copy of sales
invoice for:
i. Customer order number
ii. Invoice number
iii. Customer name
iv. Date
v. Description of goods
 vi. Quantity
vii. Price
viii. Invoice amount
ix. Terms
b. Determine credit approval
c. Determine that signature are on invoices indicating independent checking for
i. Proper pricing
ii. Mathematical accuracy
iii. Terms
d. Examine signature evidencing recheck if accounting coding
2. For a sample of shipping documents, examine signatures indicating that for goods shipped, goods are counted,
quantities and descriptions of the goods shipped are compared to quantities and descriptions on sales orders and
shipping documents prior to shipping, and the transactions are recorded in the sales journal
3. Discuss the procedures followed with the person (independent of the bookkeeper) who mails to customers monthly
statements for all trade accounts receivable and follows up on any complaints. Review the client’s correspondence
files reflecting resolution of above items
4. Observe the procedures followed to ensure a proper cut-off sales at year-end
5. Observe that the accounts receivable subsidiary ledger is balanced to the general ledger control account regularly
6. Examine evidence of accounting for the sequence of sales orders, shipping documents, and sales invoices

The foregoing tests of controls over sales transactions may reveal the following weaknesses, possible errors and misstatements
Internal Control Weaknesses or
Factors that Increase the Risk of the
Misstatement
Ineffective board of directors, audit
committee, or internal audit function;
undue pressure to meet sales targets;
top management action not conducive
to ethical conduct
Ineffective billing process in which
billing is not tied to shipping
information
Examples of Fraud/Error Description of Possible Errors or
Misstatement
Recording fictitious sales without Recording unearned revenue
receiving a customer order or shipping
the goods;
Intentional over-shipment of goods
Recording sales based on the receipt of Recording unearned revenue
orders from customers rather than the
shipment of goods

Ineffective controls for testing invoices, Inaccurate billing and recording of sales
or ineffective input validation checks
and computer reconciliations to ensure
the accuracy of databases

Inadequate accounting manual; Recording cash that represents a

incompetent accounting personnel
Ineffective board of directors, audit
committee, or internal audit function;
top management action not conductive
to ethical conduct; undue pressure to
meet sales targets
Ineffective cutoff procedures in the
shipping department
Ineffective board of directors, audit
committee, or internal audit function;
top management action not conductive
to ethical conduct; undue pressure to
meet sales targets
Aggressive attitude of management
toward financial reporting; incompetent
chief accounting officer
Ineffective board of directors, audit
committee, or internal audit function;
top management action not conductive
liability (e.g. receipt of customer’s
deposit) as revenue
Holding the sales journal open to record
next year’s sales as having occurred in
the current year
Recording sales in the wrong period
based on incorrect shipping information
Recording sales when the customer is
likely to return the goods
Recording sales when the customer’s
payment is contingent upon the
customer receiving financing or selling
the goods to another party (e.g.
consignment sales)
Recording franchise revenue when he
franchises are sold even though
obligation to perform significant
services still exist
Early (late) recognition of revenue –
“cut off error”
Early (late) recognition of revenue –
“cut off error”
Recording revenue when significant
uncertainties exist
Recording revenue when significant
uncertainties exist
Recording revenue when significant
services still must be performed by
seller
to ethical conduct; undue pressure to
meet sales targets
Ineffective board of directors, audit
committee, or internal audit function;
top management action not conducive
to ethical conduct; incompetent
individuals involved in the estimation
process
Aggressive attitude of management
toward financial reporting; incompetent
personnel involved in the
estimation/accounting process
Misstating the percentage of completion Overestimation of the amount of
of several projects by a construction revenue earned
company using the percentage-of-
completion method of revenue
recognition
Overestimating the percentage of Overestimation of the amount of
completion on projects by a revenue earned
construction company using the POC
method