AUDIT 2

EAB31103
AUDIT OF THE SALES &
COLLECTION CYCLE : TESTS OF
CONTROLS AND SUBSTANTIVE
TESTS OF TRANSACTIONS
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TOPIC OUTLINES
1) Accounts and classes of transactions in the sales and

2)
3)
4)
5)
6)
7)
8)

collection cycle
Business functions in the cycle and related documents
and records
Methodology for designing tests of controls and
substantive tests of transactions for sales
Sales returns and allowances
Methodology for designing tests of controls and
substantive tests of transactions for cash receipts
Audit tests for uncollectible accounts
Additional internal controls over account balances
Effects of results of tests of controls and substantive test of
transactions
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(1) ACCOUNTS AND CLASSES OF

TRANSACTIONS IN THE SALES AND
COLLECTION CYCLE

Sales
Cash receipts
Sales return and allowances
Charge-off of uncollectible accounts
(bad debts)
Estimate of bad debt expenses
(provision/allowance for uncollectible
debts)
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ACCOUNTS IN THE SALES AND COLLECTION CYCLE

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(2) BUSINESS FUNCTIONS IN THE CYCLE

AND RELATED DOCUMENTS AND RECORDS

Processing customer orders

Granting credit
Shipping goods
Billing customers & recording sales
Processing and recording cash receipts
Processing and recording sales returns and
allowance
Writing off uncollectible accounts receivables
Providing for bad debts
** Table 14-1; pg 403/417
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SALES TRANSACTIONS
Accounts

Sales
Accounts
receivable

Business Functions Documents and Records

Processing
customer orders
Granting credit
Shipping goods
Billing customers
and recording
sales

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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

Cash in bank
(debits from
cash receipts)
Accounts
receivable

Business Functions Documents and Records

Processing and
recording cash
receipts

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Remittance advice
Prelisting of cash
receipts
Cash receipts
transaction file
Cash receipts journal
or listing

SALES RETURNS AND ALLOWANCES

TRANSACTION
Accounts

Sales returns
and
allowances
Accounts
receivable

Business Functions Documents and Records

Processing and
recording sales
returns and
allowances

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Credit memo
Sales and returns and
allowances journal

WRITE-OFF OF UNCOLLECTIBLE
ACCOUNTS TRANSACTION
Accounts

Accounts
receivable
Allowance for
uncollectible
accounts

Business Functions Documents and Records

Writing off
uncollectible
accounts
receivable

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Uncollectible account
authorization form
General journal

BAD DEBT EXPENSE

TRANSACTION
Accounts

Bad debt
expense
Allowance for
uncollectible
accounts

Business Functions Documents and Records

Providing for bad

debts

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General journal

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PROCESSING CUSTOMER
ORDERS
Customer Order:
A request for merchandise/goods/services
by a customer
Sales Order:
A document describing the goods ordered
by a customer
often used to indicate credit approval and
authorisation for shipment
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GRANTING CREDIT
Before goods are shipped, a properly
authorized person must approve credit
to the customer for sales on account
weak practices often results in excessive
bad debts

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SHIPPING GOODS
This is the first point in the cycle
at which the company gives up assets.
One type of shipping document is
bill of lading.
Bills of lading are often transmitted once
goods have been shipping

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BILLING CUSTOMERS AND

RECORDING SALES

Sales
transaction
file

Accounts
receivable
file

Accounts
receivable
trial
balance

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Sales
journal

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PROCESSING AND
RECORDING CASH
RECEIPTS
Prelisting
of
Cash
receipts
Remittance advice

Cash receipts
transaction
file
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Cash receipts listing

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PROCESSING AND RECORDING

SALES RETURNS AND ALLOWANCES

Credit memo
Sales returns and allowances journal

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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

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PROVIDING BAD DEBTS

This provision/allowance represents a

residual, resulting from managements
end-of-period adjustment of the
allowance for uncollectible accounts

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(3) METHODOLOGY FOR DESIGNING

CONTROLS AND SUBSTANTIVE TESTS
Understand internal control sales
Assess planned control risk sales
Determine extent of testing controls
Design tests of controls and
substantive tests of transactions
for sales to meet transactionrelated audit objectives
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UNDERSTAND INTERNAL
CONTROL SALES
Study the clients flowcharts, prepare
an internal control questionnaire, and
perform walk-through tests of sales.

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ASSESS PLANNED CONTROL

RISK SALES
Adequate separation of duties
Proper authorization
Adequate documents and records
Pre-numbered documents
Monthly statements
Internal verification procedures
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1) Adequate separation of duties

Anyone responsible for recording sales &
cash receipts be denied access to cash.
Separate the credit-granting from sales
function
2) Proper authorisation
Credit must be properly authorised
before a sale take place
Good shipped after proper authorization

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3) Adequate documents and records

- e.g. Multi-copy pre-numbered sales invoice;
approve credit, authorize shipment, billing
Pre-numbered documents
- prevent the failure to bill or record sales
- avoid duplicate billing & recording
4) Monthly statements
- disagreement about the balance in the
account
5) Internal verification procedures
- use of computer programmes or independent
persons
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DIRECTION OF TESTS FOR SALES

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TRANSACTION-RELATED AUDIT
OBJECTIVES FOR SALES

Occurrence/existence:
Recorded sales are for shipments actually made.
Completeness:
Existing sales transactions are recorded.
Accuracy:
Recorded sales are for the
amount shipped.
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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.
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COSO REPORT IDENTIFIES REVENUE

MISSTATEMENT TECHNIQUES
Improper
sales cutoff

Sham sales

Improper
% of completion

Fraudulent
Techniques

Round-tripping
loans as sales

Premature
revenue
recognition

Consignment
sales
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(4) SALES RETURNS AND

ALLOWANCES
Apply the methodology for control over sales
transactions
Sales return & allowances are immaterial
Emphasise on occurrence/existence
objective; uncover any theft of cash from the
collection of account receivables. (fictitious
SRA)
Completeness; understated SRA (why??)

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TEST OF CONTROLS SALES RETURNS AND

ALLOWANCES
Less voluminous.
Two controls that are important:
1. Credit memo approved by a different person from the initiator.
Segregation of duties between access to customers records and
authorization of credit memo.
2. Credit for returned goods supported by receiving document to
prove that the goods have been returned physically.
Auditors can examine a sample of credit memo for proper
authorisation and support of goods returned.
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(5) METHODOLOGY FOR DESIGNING TESTS OF

CONTROLS AND SUBSTANTIVE TESTS OF
TRANSACTIONS FOR CASH RECEIPTS

Determine whether cash received was

recorded
Prepare proof of cash receipts/prelisting of
cash receipts
Test to discover lapping of accounts
receivable (cash lapping)

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(6) AUDIT TESTS FOR UNCOLLECTIBLE

ACCOUNTS

Apply the methodology for control over

sales transactions
Possibility of the client covering up a
defalcation by charging off account
receivables that have already been
collected.
IC proper authorisation

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(7) ADDITIONAL INTERNAL CONTROLS

OVER ACCOUNT BALANCES

Realisable Value High Inherent Risk

- collectability of receivables
Credit approval
Periodic aged account receivables
trial balance review & Follow-up by
management personnel
Charging off uncollectible accounts
when they are no longer likely to be
collected
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(8) EFFECTS OF RESULTS OF TESTS OF

CONTROLS AND SUBSTANTIVE TEST
OF TRANSACTIONS

The most significant effect of the result

of the test of control and substantive
test of transaction = confirmation of
AR
Type of confirmation
Size of sample
Timing of test

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SPECIAL TUTORIAL
Instructions :
1.Write an essay of more than 100 words. Please indicate the
number of words at the end of essay.
2.Use handwriting only
3.Please submit on your 1st class
Question
Your essay should contain the following :
1.Why I like to learn accounting
2.What should I do to get an A for Audit
3.Do you want to become an auditor? (Yes/no and give reason
for your answer)
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TUTORIAL WEEK 1
Questions:
1.Please explain all terms in slides #27
2.Exercise14.25 pg: 428/443

It does not matter how slowly you go as long as

you do not stop

Confucius

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