CHAPTER 9:

Slide 1
Obtaining and Recording the Customers Orders the sales process begins in the
sales department with the receipt of a customer order indicating the type and quantity of
merchandise being requested. The primary objective of this step is to ensure that relevant
data about the transaction are being transcribed into a standard format that can be
processed by the selling entitys system. The document prepared in this procedure is the
sales order that captures information about the customer and the products ordered. The
number of copies created will vary from system to system, depending on the operations to
be supported. The hypothetical system uses sales order copies for credit authorizations,
packing slips, stock release documents, and shipping notices. After preparing the sales
order, the sales order clerk files one copy of it in the customer open order file for future
reference.
Approving Credit the next step in the revenue cycle is transaction authorization, which
involves verifying the customers creditworthiness. In the hypothetical system, the credit
authorization copy of the sales order is sent to the credit department for approval. The
returned approval triggers the release of the other sales order copies simultaneously to
various departments.
Slide 2
Processing Shipping Orders the sales department sends the stock release (picking
ticket) copy of the sales order to the warehouse. This document identifies the items of
inventory that must be located and picked from the warehouse shelves. It also provides
formal authorization for the warehouse clerk to release custody of the specified assets.
The clerk then adjusts the stock records to reflect the reduction in inventory. The stock
records are not the formal accounting records for these assets. Before the arrival of the
goods and the stock release copy, the shipping department receives the packing slip and
shipping notice copies from the sales department. The packing slip travels with the goods
to the customer to describe the contents of the order. Upon receiving the goods from the
warehouse, the shipping clerk reconciles the physical items with the stock release
documents, the packing slip, and the shipping notice to verify the correctness of the order.
The shipping clerk packages the goods, attaches the packing slip to the container,
completes the shipping notice, and prepares a bill of lading, which is a formal contract
between the seller and the shipping company to transport the goods to the customer. The
shipping clerk transfer custody of the goods, the packing slip, and two copies of the bill of
lading to the carrier and then performs the following tasks:
Records the shipment in the shipping log.
Sends the shipping notice to the billing department as proof of shipment.
Files one copy each of the bill of lading, Stock Release, and file copy of the Sales
Order.
Slide 3
Automated Procedures a legacy system employs sequential file structures for its
accounting records. This approach is labor intensive and expensive. Most organizations
that still use sequential files store them on disks that are permanently connected (on-line)
to the computer system and require no human intervention.
Keystroke the process begins with the arrival of batches of shipping notices from the
shipping department. The keystroke clerks receive and convert batches of shipping
notices to magnetic media. The resulting transaction file will thus contain many separate
batches of sales orders. Batch control totals are calculated for each batch on the file.
Edit Run periodically, the batch sales order system is executed. The process may take
place only once or several times a day. The edit run is the 1 st run in the batch process.
This process validates transactions by testing each record for the existence of clerical or
logical errors. The edit program recalculates the batch control totals to reflect changes
due to the removal of error records.
Sort Run at this point, the sales order file is in no useful sequence. The sort run
program physically arranges the sales order transaction file sequentially.

AR Update and Billing Run the AR update program posts to accounts receivable by
sequentially matching the Account Number key in each sales order record with the
corresponding record in the AR-SUB master file. Some firms employ cycle billing of their
customers. The update program searches the billing date field in the AR-SUB master file
for those customers to be billed on that day of the month and prepare statements for the
selected accounts.

Slide 4
Sort and Inventory Update Runs the sort programs sorts the sales order file on the
secondary key. The inventory update program reduces the Quantity On Hand filed in the
affected inventory records. A new inventory master file is created in the process. The
program compares values of the Quantity On Hand and the Reorder Sales Point fields to
identify inventory items that need to be replenished. A journal voucher is prepared to
reflect the cost of goods sold and the reduction in inventory.
General Ledger Update Run under the sequential file approach, the general ledger
master file is not updated after each batch of transactions. Firms using sequential files
typically employ separate end-of-day procedures to update the general ledger accounts.
This program also generates a number of management reports.
Slide 9
Order Entry Procedures
Sales Procedures under real-time processing, sales clerks receiving orders from
customers process each transaction separately as it is received. The sales clerk also
performs the following tasks:
A credit check is performed on-line by accessing the customer credit file.
If credit is approved, the clerk then accesses the inventory master file and checks
the availability of the inventory.
The system automatically transmits an electronic stock release record to the
warehouse and a shipping notice to the shipping department, and records the sale
in the open sales order file.
Slide 10

Warehouse Procedures produces a hard copy printout of the electronically transmitted

stock release document. The clerk then picks the goods and sends them, along with a
copy of the stock release document, to the shipping department.
Shipping and Billing reconciles the goods, the stock release document, and the hard
copy packing slip produced on the terminal. The clerk then selects the carrier and
prepares the goods for shipment.

Slide 12
Features of Real-Time Processing a central feature of the system is the use of an
events database. Traditional accounting records may not exist per se. In theory, such a
system does not even need a general ledger since sales, sales returns, accounts
receivable-control, and cost of goods sold can all be derived from the invoices in the
events database. This system has the following advantages:
o Greatly shortens the cash cycle of the firm.
o Can give a firm a competitive advantage in the marketplace by maintaining current
inventory information, the sales staff can know immediately if inventories are in stock.
o Real-time editing permits the identification of many kinds of errors when they occur
and greatly improves the efficiency and the effectiveness of operations.
o Reduces the amount of paper documents in a system. Hard copy documents are
expensive to produce and clutter the system. Documents in electronic format are
efficient, effective, and adequate for most audit trails.
Slide 16

Relationship Between Management Assertions and Revenue Cycle Audit Objectives

[Table 9-1, p.393]
Existence or Occurrence verify that the accounts receivable balance represents
amounts actually owed to the organization at the balance sheet date. Establish that
revenue from sales transactions represent goods shipped and services rendered during the
period covered by the financial statements.
Completeness determine that all amounts owed to the organization at the balance
sheet date are reflected in accounts receivable. Verify that all sales for shipped goods, all
services rendered, and all returns and allowances for the period are reflected in the
financial statements.
Accuracy verify that revenue transactions are accurately computed and based on
current prices and correct quantities. Ensure that the accounts receivable subsidiary
ledger, the sales invoice file, and the remittance file are mathematically correct and agree
with general ledger accounts.
Rights and Obligations determine that the organization has a legal right to recorded
accounts receivable. Customer accounts that have been sold or factored have been
removed from the accounts receivable balance.
Valuation or Allocation determine that accounts receivable balance states its net
realizable value. Establish that the allocation for uncollectible accounts is appropriate.
Presentation and Disclosure verify that accounts receivable and revenues reported
for the period are properly described and classified in the financial statements.
Slide 17
Input Controls designed to ensure that transactions are valid, accurate, and complete.
Control techniques vary considerably between batch and real-time systems. The following input
controls relate to revenue cycle operations.
Credit Authorization Procedures purpose of the credit check is to establish the
creditworthiness of the customer. In batch systems with manual credit authorization
procedures, the credit department (or credit manager) is responsible for implementing the
firms credit policies.
Testing Credit Procedures the auditor needs to determine that effective procedures
exist to establish appropriate customer credit limits; communicate this information
adequately to the credit policy decision makers; review credit policy periodically and
revise it as necessary; and monitor adherence to current credit policy. The auditor can
verify the correctness of programmed decision rules by using either the test data or
integrated test facility (ITF) approaches to directly test their functionality. This can be
done by creating several dummy customer accounts and running test transactions and
then analyzing the rejected transactions to determine if the computer application correctly
applied the credit policy. The integrity of reference data is an important element in
testing credit policy controls. The auditor needs to verify that authority for making line-ofcredit changes is limited to authorized credit department personnel. Performing
substantive tests of detail to identify customers with excessive credit limits can do this.
Slide 18
Input Controls designed to ensure that transactions are valid, accurate, and complete.
Control techniques vary considerably between batch and real-time systems. The following input
controls relate to revenue cycle operations.
Data Validation Controls intended to detect transcription errors in transaction data
before they are processed. In the batch system data validation occurs only after the
goods have been shipped. Extensive error logs, error correction, and transaction
resubmission procedures characterize such systems. Validity tests performed in real-time
deal with most errors as they occur. The following are validity tests that pertain to the
revenue cycle:
o Missing Data Checks used to examine the contents of a filed for
the presence of blank spaces.

Numeric-Alphabetic Data Checks determine whether the correct

form of data is in a field.
o Limit Checks determine if the value in the field exceeds an
authorized limit.
o Range Checks assign upper and lower limits to acceptable data
values.
o Validity Checks compare actual values in a field against known
acceptable values.
o Check Digit controls identify keystroke errors in key fields by testing
their internal validity.
Testing Validation Controls the central audit issue is whether the validation programs
in the data editing system are functioning correctly and have continued to function as
intended throughout the period. Testing the logic of a validation program however
represents a significant undertaking. The auditor may decide to rely on the quality of
other controls to provide the assurance needed to reduce substantive testing. If controls
over systems development and maintenance are weak, the auditor may decide that
testing the data editing controls would be more efficient that performing extensive
substantive tests of details. ITF or the test data approach would enable the auditor to
perform explicit tests of logic. The auditor may achieve some degree of assurance by
reviewing error listings and error logs. Error listings and logs do not provide evidence of
undetected errors. An analysis of error conditions not present in the listing can be used to
guide the auditor in designing substantive tests to perform.
o

Slide 19
Input Controls designed to ensure that transactions are valid, accurate, and complete.
Control techniques vary considerably between batch and real-time systems. The following input
controls relate to revenue cycle operations.
Batch Controls used to manage high volumes of transaction data through a system.
The objective is to reconcile output produced by the system with the input originally
entered into the system. The controls continue through all phases of data processing. An
important element of batch control is the batch transmittal sheet, which captures relevant
information about the batch such as a unique batch number, batch date, transaction code,
record count, batch control total, and hash totals.
Testing Batch Controls the failure of batch controls to function properly can result in records
being lost or processed multiple times. Testing batch controls involves reviewing transmittal
records of batches processed throughout the period and reconciling them to the batch control
log. The auditor needs to investigate out-of-balance conditions to determine the cause. The
auditor should be able to obtain answers to these questions by reviewing and reconciling
transaction listings, error logs, and logs or resubmitted records.
Slide 20
Process Controls process controls include computerized procedures for file updating and
restricting access to data. The following are techniques related to file updating and access
controls;
File Update Controls run-to-run controls use batch control data to monitor the batch as
it moves from one run to another. These controls ensure that each run in the system
processes the batch correctly and completely.
o Transaction Code Controls revenue cycle systems are often designed to process
multiple record types. The actual tasks performed by the application are determined by a
transaction code assigned to each record.
o Sequence Check Control in systems that use sequential master files, the order of the
transaction records in the batch is critical to correct and complete processing. As the
batch moves through the process, it must be re-sorted in the order of the master file. A
sequence check control should be in place to compare the sequence of each record in the
batch with the previous record to ensure that proper sorting took place.

Testing File Update Controls the failure of a file update control to function properly can
result in records going unprocessed, being processed incorrectly, or being posted to the
wrong customers account. Tests of file update controls provide the auditor with evidence
relating to the assertions of existence, completeness, and accuracy. Testing run-to-run
controls is a logical extension of these procedures and needs no further explanation. Tests
of transaction codes and sequence checks can be performed using ITF or the test-data
approach. The auditor should create test data that contain records with incorrect
transaction codes and records that are out of sequence in the batch and verify that each
was handled correctly. The efficient use of logic-testing CAATTs like ITF requires careful
planning. By determining in advance the input and process controls to be tested, a single
audit procedure can be devised that performs all tests in one operation.

Slide 21
Access Controls prevent and detect unauthorized and illegal access to the firms assets.
Traditional techniques used to limit access to these assets include warehouse security,
depositing cash daily, using a safe or night deposit box, locking cash drawers and safes.
Controlling access to accounting records is no less important. The following are risks associated
with the revenue cycle
1.
Removal of ones account or someone elses from the books.
2.
Unauthorized individual can trigger shipment of a product.
3.
Removal of cash from the firm to cover the act by adjusting the cash account.
4.
Steal products and adjust the records to cover the theft.
Testing Access Controls - access control is at the heart of accounting information
integrity. In the absence of controls, invoices can be deleted, added, or falsified.
Computer access controls are both system-wide and application-specific. Access control
over revenue cycle applications depends upon effectively controlling access to the
operating systems, the networks, and the databases with which they interact.
Slide 22
Physical Controls
Segregation of Duties ensures that no single individual or department processes a
transaction in its entirety.
o Rule 1: Transaction authorization should be separate from transaction
processing.
o Rule 2: Asset custody should be separate from the record-keeping tasks.
o Rule 3: The organization should be so structured that the perpetration of a
fraud requires collusion between two or more individuals.
o Supervision by closely supervising employees who perform potentially incompatible
functions, a firm can compensate for the exposure inherent in a system. Supervision can
also provided control in systems that are properly segregated. Detecting crimes after the
fact accomplishes little. Prevention is the best solution. The deterrent effect of
supervision can provide an effective preventive control.
Slide 23
o Independent Verification the purpose is to review the work performed by others at
key junctures in the processes to identify and correct errors. Two examples:
o The shipping dept verifies that the goods sent from the warehouse are correct
in type and quantity.
o The billing dept reconciles the shipping notice with the sales notice to ensure
that customers are billed only for the items and quantities that were actually
shipped.
Testing Physical Controls the auditors review of organizational structure should disclose the
more gregarious examples of incompatible tasks. Covert relationships that lead to collusion may
not be apparent from an organizational chart. Many tasks that are normally segregated in
manual systems are consolidated in the data processing function of computer-bases systems.
Duties pertaining to the design, maintenance, and operation of computer programs need to be

separated. Programmers who write original computer programs should not be responsible for
making program changes.
Slide 24
Output Controls designed to ensure that information is not lost, misdirected, or corrupted and
that system processes function as intended. Output control can be designed to identify potential
problems.
The following are examples of audit trail output controls.
Reconciling the general ledger is an output control that can detect certain
types of transaction processing errors.
Maintenance of an audit trail. To resolve transaction processing errors,
each detected error needs to be traced to its source.
Details of transaction processing produced at intermediate points can
provide an audit trail that reflects activity through every stage of operations.
Accounts Receivable Change Report shows the overall change to
accounts receivable from sales orders and cash receipts. These numbers
should reconcile with total sales, total cash receipts (on account), and the
general ledger.
Transaction Logs every transaction successfully processed by the system
should be recorded on a transaction log, which serves as a journal. A
transaction log serves 2 purposes: Permanent record of valid transactions
and contains only successful transactions, none that were partially processed.
Transaction Listings system should produce a transaction listing of all
successful transactions.
Log of Automatic Transactions some transactions are triggered
internally by the system. To maintain an audit trail of these activities, all
internally generated transactions must be placed in a transaction log, and a
listing or these transactions should be sent to the appropriate managers.
Unique Transaction Identifiers each transaction processed by the
system must be uniquely identified with a transaction number. This is the
only practical means of tracing a particular transaction.
Error Listing a listing of all errors should go to the appropriate user to
support error correction and resubmission.
Testing Output Controls testing output controls involves reviewing summary reports for
accuracy, completeness, timeliness, and relevance to the decisions that they are intended to
support. The auditor should trace sample transactions through audit trail reports, including
transaction listings, error logs, and logs of resubmitted records. In modern systems, audit trails
are usually stored on-line in text files. Data extraction software such as ACL can be used to
search log files for specific records to verify the completeness and accuracy of output reports.
Slide 25
SUBSTANTIVE TESTS OF REVENUE CYCLE ACCOUNTS
The strategy used in determining the nature, timing, and extent of substantive tests derives from
the auditors assessment of inherent risk, unmitigated control risk, materiality considerations,
and the need to conduct the audit in an efficient manner.
Revenue Cycle Risks and Audit Concerns pertain to the potential for overstatement of
revenues and accounts rather than their understatement. The auditor should focus attention on
large and unusual transactions at or near period-end. The auditor will see evidence by
performing a combination of tests of internal controls and substantive tests. While positive
results from such a test may enable the auditor to reduce the degree of substantive testing
needed to gain assurance about the mathematical accuracy of account processing, they offer no
assurance about the collectibility of those accounts receivable. Similarly, ITF can be used to test
the credit-limit logic of the edit program to provide assurance that the organizations credit policy

is being properly implemented. This test, however, provides no evidence that proper cutoff
procedures were followed in calculating the total value of accounts receivable.
Slide 26
SUBSTANTIVE TESTS OF REVENUE CYCLE ACCOUNTS
Understanding Data the auditor needs to understand the systems and controls that produced
the data, as well as the physical characteristics of the files that contain them. The auditor must
verify that he or she is working with the correct version of the file to be analyzed. ACL can read
most sequential files and relational database tables directly, but esoteric and/or complex file
structures may require flattening before they can be analyzed. The auditor must verify that the
correct version of the original file was used and that all relevant records from the original were
transferred to the copy for analysis. The audit procedure described are based on the file
structure indicate the key data and logical linkages between files.
o
Customer File contains address and credit information about customers and is used to
validate sales transactions.
o
Sales Invoice File captures sales transaction data for the period. The sales invoice file
contains summary data for each invoice.
o
Line Item File contains a record for every product sold. These data also provide audit
evidence needed to corroborate the accuracy of price times quantity calculations that are
summarized in the sales invoices.
o
Inventory File contains quantity, price, supplier, and warehouse location data for each
item of inventory.
o
Shipping Log File a record of all sales orders shipped to customers. These data can
also be used to determine if customer orders are being shipped in a timely manner.
o
File Preparation Procedures each file needs to be defined in terms of its physical
location and its structure. When the file definition is completed, it is saved under a unique name
assigned by the auditor. Sometimes the contents of a data filed are different from what they are
supposed to be. Prior to performing any substantive tests on a new file, it is important to
validate its contents. ACLs verify command analyzes the data fields in the selected fields in the
selected file to ensure that their contents are consistent with the field type in the file definition.
Slide 27
The strategy used in determining the nature, timing, and extent of substantive tests derives from
the auditors assessment of inherent risk, unmitigated control risk, materiality considerations,
and the need to conduct the audit in an efficient manner.
Testing the Accuracy and Completeness Assertions auditors often precede substantive
tests of detail with an analytical review of account balances. This review will provide the auditor
with an overall perspective for trends in sales, cash receipts, sales returns, and accounts
receivable. Analytical procedures can provide assurance that transactions and accounts are
reasonably stated and complete and may thus permit the auditor to reduce substantive tests of
details on these accounts.
o
Review Sales Invoices for Unusual Trends and Exceptions a useful audit
procedure for identifying potential audit risks involves scanning data files for unusual
transactions and account balances. The auditor can use ACLs stratify feature to identify such
anomalies. This function groups data into predetermined intervals and counts the number of
records that fall into each interval. The auditor can use other ACL features to seek answers to
questions raised by the preceding analysis. Although the auditor cannot specifically identify from
the stratification which records are causing the anomalies, the potential problem has been
flagged. ACL provides a filter capability that can be used to select or ignore specific records
from an entire file.
Raises questions, points auditor in the direction of possible, or potential, anomalies.

Slide 28
Review Sales Invoice and Shipping Log Files for Missing and Duplicate Items
searching for missing and/or duplicate transactions is another important test that helps the
auditor corroborate or refute the completeness and accuracy assertions. ACL is capable of
testing a designated field for out-of-sequence records, gaps in sequence numbers, and duplicates
for the entire file. The auditor can scan the Invoice Number field of all records in the Sales
Invoice file. The auditor will need to interview management and employees involved in the
process and seek answers to the following types of questions:
o Are procedures in place to document and approve voided
invoices?
o How are gaps in sales invoices communicated to management?
o What physical controls exist over access to sales invoice source
documents?
o Are batch totals used to control total transactions during data
processing?
o Are transaction listings reconciled and reviewed by
management?
o
Review Line Item and Inventory Files for Sales Price Accuracy auditors
would verify pricing accuracy by comparing sales prices on the invoices with the published price
list. ACL allows the auditor to compare the prices charged on every invoice in the file for the
period under review. This procedure involves a few simple steps. First, notice that the actual
sales price charged is stored in the Sales Price field in the Line Item file. Both files need to be
ordered according to their common key. The next step is to combine the two files to create a
third. ACL accomplishes this with its Join feature. ACLs join feature permits the auditor to
specify the fields from the two input files that are passed to the new output file.
o
Testing for Unmatched Records - by selecting a different join option, the auditor
can produce a new file of only unmatched records.
Slide 29
The strategy used in determining the nature, timing, and extent of substantive tests derives from
the auditors assessment of inherent risk, unmitigated control risk, materiality considerations,
and the need to conduct the audit in an efficient manner.
Testing the Existence Assertion one of the most widely performed tests of existence is the
confirmation of accounts receivable. This test involves direct written contact between the
auditors and the clients customers to confirm account balances and transactions. Statement of
Auditing Standards No. 67, The Confirmation Process, states that auditors should request
confirmations of accounts receivable except in the following 3 situations:
1. Accounts receivable is immaterial.
2. Based on a review of internal controls, the auditor has assessed controls; the auditor has
assessed control risk to be low.
3. The confirmation process will be ineffective.
Open Invoice System records invoices individually rather than being summarized or grouped by
the creditor. The confirmation process involves 3 stages:
1. Selecting Accounts to Confirm obtaining a set of accounts for confirmation requires
three steps: consolidate the invoices by customer, join the data from the two files, and
select a sample of accounts from the joined file.
2. Consolidate Invoices consolidate all the open invoices for each customer. ACLs
classify command allows the auditor to set a filter to select only the open sales invoices
and to summarize the Invoice Amount field for each record based on thee Customer
Number.
3. Join the Files the next step in the confirmation process is to join the Classified Invoices
files and the Customer file to produce another new file called Accounts Receivable.

o
Preparing Confirmation Requests involves preparing confirmation requests that
contain the information captured in the AR-Sample file. The requests are drafted and
administered by the auditor but are written in the client entitys name.
o
Positive and Negative Confirmations in positive confirmations, the recipients are
asked to respond whether their records agree or disagree with the amount stated. This is useful
when the auditor suspects that a large number of accounts may be in dispute. A problem with
positive confirmations is poor response rates. Negative confirmations request the recipient to
respond only if they disagree with the amount shown in the letter. This technique is used
primarily when accounts receivable consist of a large number of low-value balances and the
control risk of misstatement is considered to be low. Once the creditor decides upon the nature
and the wording of the confirmation letter, it can be created using a word processor. ACLs
export feature greatly facilitates the physical task of inserting the relevant financial data for each
customer into the individual letters.
o
Evaluating and Controlling Responses maintaining control over the confirmation
process is critical to its integrity. The auditor should take all reasonable steps to ensure the
following procedures are observed.
o Retain custody of the confirmation letters until they are mailed.
o The letters should be addressed to the auditor, not the client organization.
o The confirmation letter replies should be mailed to the auditor, not the client organization.
o When the responses are returned to the auditor, discrepancies in the amount owed should
be investigated. Non-responses to positive confirmations also need to be investigated.
Slide 30
The strategy used in determining the nature, timing, and extent of substantive tests derives from
the auditors assessment of inherent risk, unmitigated control risk, materiality considerations,
and the need to conduct the audit in an efficient manner.
Testing the Valuation/Allocation Assertion the auditors objective regarding proper
valuation and allocation is to corroborate or refute that accounts receivable are stated at net
realizable value. The auditor needs to review the accounts receivable aging process to
determine that the allowance for doubtful accounts is adequate.
o Aging Accounts Receivable as accounts age, the probability that they will ultimately
be collected is decreased. The larger the number of older accounts that are included in an
organizations accounts receivable file, the larger the allowance for doubtful accounts
needs to be to reflect the risk. A key issue for auditors to resolve is whether the allowance
is calculated by the client is consistent with the composition of their organizations
accounts receivable portfolio and with prior years.
Review Past-Due Balances - The auditor should review past-due balances with the credit
manger to obtain information for basing an opinion on their collectibility. The auditors objective
is not to assess the collectibility of each account, but to determine that the methods used by the
credit manager to estimate the allowance for doubtful accounts is adequate and that the overall
allowance is reasonable.