Audit of the Sales and

Collection Cycle: Tests of

Controls and Substantive
Tests of Transactions
Chapter 14

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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
Beginning
uncollectible balance
accounts

Estimate of
bad debt
expense
Ending
balance
Bad Debt
Expense

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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

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Sales Transaction
Accounts

Business Functions Documents and Records

Sales
Accounts
receivable

Processing
customer orders

Granting credit
Shipping goods
Billing customers
and recording
sales

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Uncollectible account
authorization from
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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Processing and Recording

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Processing and Recording

Sales Returns and Allowances
Credit memo
Sales returns and allowances journal

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Providing for Bad Debts

This provision represents a residual,
resulting from managements
end-of-period adjustment of the
allowance for uncollectible accounts

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Understand Internal Control

Sales
Study the clients flowcharts, prepare
an internal control questionnaire, and
perform walk-through tests of sales.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Existence
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)

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Sales Returns and Allowances

The transaction-related audit objectives and
clients methods of controlling misstatements
are essentially the same for processing credit
memos as those described for sales.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Sales Returns and Allowances

There are, however, two important differences.
Materiality
Emphasis on objectives

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

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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

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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End of Chapter 14

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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