Audit of the Sales and

Collection Cycle

Chapter 14

2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 14 - 1
 Learning Objective 1

Identify the accounts and the

classes of transactions in the
sales and collection cycle.

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 Accounts in the Sales
and Collection Cycle
Sales Cash in Bank
Cash
sales
Accounts Receivable Cash Discounts
Sales on Taken
account Beginning Cash receipts
balance
Sales on Sales returns Sales Returns
account and allowances and Allowances

Ending Charge-off of
balance uncollectible Bad Debt
accounts Expense

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 Accounts in the Sales
and Collection Cycle
Allowance for
Accounts Receivable Uncollectible Accounts
Beginning Cash receipts Charge-off of Beginning
balance uncollectible balance
accounts
Sales on Sales returns Estimate of
account and allowances bad debt
expense
Ending Charge-off of
balance uncollectible Ending
accounts balance
Bad Debt
Expense

2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 14 - 4
 Learning Objective 2

Describe the business functions

and the related documents
and records in the sales
and collection cycle.

2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 14 - 5
 Sales Transaction

Sales
Accounts
Accounts Receivable

Processing customer orders,

Business
Granting credit, Shipping goods,
functions
Billing customers and recording sales

Sales invoice, Sales journal or listing, Sales

Documents
transaction file, Accounts receivable master
and records
file and trial balance, Monthly statements
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 Cash Receipts Transaction

Cash in Bank (debits from cash receipts)

Accounts
Accounts Receivable

Business
Processing and recording cash receipts
functions

Remittance advice, Prelisting of cash receipts,

Documents
Cash receipts transaction file,
and records
Cash receipts journal or listing
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 Sales Returns and
Allowances Transaction

Sales returns and Allowances

Accounts
Accounts Receivable

Business Processing and recording

functions sales returns and allowances

Documents Credit memo

and records Sales returns and allowances journal

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 Charge-off of Uncollectible
Accounts Transaction

Accounts Receivable
Accounts
Allowance for Uncollectible Accounts

Business Charging off uncollectible

functions accounts receivable

Documents Uncollectible account authorization form

and records General journal

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 Bad Debt Expense
Transaction

Bad Debt Expense

Accounts
Allowance for Uncollectible Accounts

Business
Providing for bad debts
functions

Documents
General journal
and records

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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

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 Granting Credit

Before goods are shipped, a properly

authorized person must approve credit
to the customer for sales on account.

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 Shipping Goods

This is the first point in the cycle

where company assets are given up.

Shipping
document

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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
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 Processing and Recording
Cash Receipts

Remittance advice

Prelisting of cash receipts

Cash receipts transaction file

Cash receipts journal or listing

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 Processing and Recording
Sales Returns and Allowances

Credit memo

Sales returns and

allowances journal

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 Charging 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 for Bad Debts

This provision represents a residual,

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

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 Learning Objective 3

Understand how e-commerce

activities affect the sales
and collection cycle.

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 Effect of E-Commerce on the
Sales and Collection Cycle

The Internet
The Internet and
other developing
technologies allow
companies to develop
new business models.

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 Effect of E-Commerce on the
Sales and Collection Cycle

Business-to-business (B2B)

Business-to-consumer (B2C)

Managements assertions for sales and

collection activities remain the same.

2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 14 - 21
 Effect of E-Commerce on the
Sales and Collection Cycle

Auditors should obtain an understanding

of the design and operation of key internal
controls over e-commerce revenues.

Evidence for e-commerce activities

is likely to be in electronic form.

2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 14 - 22
 Learning Objective 4

Understand internal control

and design and perform tests
of controls and substantive
tests of transactions for sales.

2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 14 - 23
 Methodology for Designing Controls
and Substantive Tests: Sales

Understand internal Design tests of controls

control sales. and substantive tests
of transactions for sales
to meet transaction-
Assess planned related audit objectives.
control risk sales.
Audit procedures
Sample size
Evaluate cost-benefit Items to select
of testing controls. Timing
2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 14 - 24
 Understanding 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 Prenumbered
documents
Monthly statements
Internal verification
procedures

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 Internal Verification Procedures

Evaluate cost-benefit
of testing controls.

Design tests of
controls for sales.

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 Transaction-Related Audit
Objectives for Sales

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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 Design Substantive Tests
of Transactions for Sales

Classification:
Sales transactions are properly classified.
Timing:
Sales are recorded on the correct dates.

Posting and summarization:

Sales transactions are properly included
in the accounts receivable master file.
2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 14 - 29
 Direction of Tests for Sales

Duplicate Accounts
Customer Shipping Sales General
order document
sales
journal journal
= receivable
invoice master file

Completeness Existence
start start

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 Summary of Methodology
for Sales

Transaction-related audit objectives (column 1)

Key internal controls (column 2)
Tests of controls (column 3)
Weaknesses (column 4)
Substantive tests of transactions (column 5)

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 Learning Objective 5

Apply the methodology for

controls over sales transactions
to controls over sales
returns and allowances.

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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.

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 Sales Returns
and Allowances

There are, however, two important differences.

Emphasis on
Materiality
objectives

2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 14 - 34
 Learning Objective 6

Understand internal control and

design and perform tests of
controls and substantive tests
of transactions for cash receipts.

2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 14 - 35
 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

2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 14 - 36
 Learning Objective 7

Apply the methodology for controls

over the sales and collection cycle
to write-offs of uncollectible
accounts receivable.

2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 14 - 37
 Audit Tests for
Uncollectible Accounts

Existence of recorded write-offs is the most

important transaction-related audit objective.

What is a major concern in testing accounts

charged off as uncollectible?

covering up a defalcation by charging off

accounts receivable that have been collected
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 Additional Internal Controls
Over Account Balances

Realizable value

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
Cash
receivable

Bad debt Allowance for

expense doubtful accounts
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 Role of all Audit Tests in the
Sales and Collection Cycle
Accounts Cash in
Sales Receivable Bank
Sales Cash receipts
transactions transactions
Audited by Audited by
TOC, STOT, and AP TOC, STOT, and AP
Ending Ending
balance balance
Audited by AP and TDB

TOC + STOT + AP + TDB

= Sufficient competent evidence per GAAS
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 End of Chapter 14

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