2Major Processes in the Sales & Collections Cycle Sale of goods and services (Revenue)Payments received for goods and services (Collection)Goods returned by and claims received from customers (Returns)
3Steps in the Revenue Process Receiving customer ordersAuthorizing credit terms and shipmentConfirming ordersExecuting ordersRecording the shipments or services performed
4Steps in the Revenue Process (Cont.) Receiving customer ordersComputer controls:Customer checksValid customer numberSelf-check algorithmField checksKey characteristicsCompleteness of required fieldsReasonableness checksOrder quantitiesProduct combinationsClear procedures for resolving computer red flagsPeriodic reports on Open Orders
5Steps in the Revenue Process (Cont.) Authorizing credit terms and shipmentComputer controlsCredit check for repeat customersInventory availabilityCredit review for new customersCredit worthinessExistenceSeparation of Credit & Sales DepartmentsWhen approved a Sales Order is producedPrenumbered and controlled
6Steps in the Revenue Process (Cont.) Confirming ordersCustomer verification of sales order accuracyItemsQuantitiesPriceConfirm shipping date
7Steps in the Revenue Process (Cont.) Executing ordersAssembling goods for shipmentPicking list (sales order)Verify items picked and update inventoryMove items to shipping dockShip ordered goodsPacking slip (sales order)Verify items packed (agree picking & sales order)Shipping report and bill of ladingPrenumbered and controlledPeriodic reports on Open ShipmentsSeparation of Warehousing & Shipping
8Steps in the Revenue Process (Cont.) Bill the customer and record the saleAgree information on and existence of customer order, sales order, and shipping report.Prepare a Sales InvoicePrenumbered and controlledComputer controlsSend sales invoice to customerInvestigation of missing or repeated document numbers
9Understanding the Entity & Its Environment Develop an expectation concerning total revenues and gross margin based on general economy, competitive environment, and market position.Identify and understand difficult revenue recognition issues:Long-term construction/contractsBundled services/revenuesPotential for unearned revenue and collection difficulties
10Inherent Risks General incentive to overstate revenues and receivables High volume of transactionsEfforts to increase customer value, may increase accounting complexity:Bundled servicesRights of returnFinancing options
11Entity-Level Controls Control Environment:Integrity & Ethical ValuesManagement AggressionRevenue and profit centered incentivesRevenue recognition policiesCompetence and CommitmentVarious control responsibilitiesAccounting personnelAudit committee/BODRisk Assessment:What has been identified and what actions have been taken?Changes to the environment (Competition, Regulation, Reporting Req.)?Additional monitoring, training, incentives, or reports?Monitoring:Verify that monitoring activities are operating effectively.Consider any problems uncovered that could impact the audit of revenues:Billing errorsRegulatory inquiryActions to address previous auditor concerns
12Auditor Objectives Transaction Objectives Occurrence: Recorded sales represent goods shipped during the period.Completeness: All sales made during the period were recorded.Accuracy: All sales are accurately valued using GAAP and correctly journalized, summarized, and posted.Cutoff: All sales have been recorded in the correct accounting period.Classification: All sales have been recorded in the proper accounts.Balance Objectives:Existence: Accounts receivable represents amounts owed by customers on the balance sheet date.Completeness: Accounts receivable includes all claims on customers at the balance sheet date.Rights & Obligations: Accounts receivable at the balance sheet date represents legal claims of the entity on customers for payment.Valuation & Allocation: Accounts receivable represent gross claims on customers at the balance sheet date, and agrees with the sum of the accounts receivable subsidiary ledger.
13Potential Misstatements Transaction ObjectivesOccurrence: (Overstatement)A single sales invoice recorded twice or a cancelled sales invoice recorded.Fictitious customer and sale recorded.Shipments without the consent and agreement of the customer.The earnings process is not complete:Recording a sale before shipment or other prerequisites of being earned.Unearned revenue recorded as earned.The amount may not be realizable:Substantial uncertainty exists about collectibility.Customer obligations are contingent on other actions (financing, resale, etc.).Completeness: (Understatement)Shipped orders have not been billed and recorded.Accuracy:Transactions are recorded for incorrect amounts (Over- and Understatements).Cutoff:Books left open too long (Overstatement) or closed too early (Understatement).Classification:Transactions are recorded in incorrect accounts (Over- and Understatements).
14Objectives & Controls Activities Transaction ObjectivesOccurrence:Sales invoice sequencing (double entry)Customer validity check (not fictitious)Authorized customer order and shipping document (not fictitious & earning process complete)Credit check (collectibility)Completeness:Prenumbered and controlled documentsAccuracy:Computer input controlsAuthorized customer order and shipping document (independent agreement)Posting and updating of accounts done automatically through computer technologyCutoff:Periodic review of Open filesClassification:Are there any special financing arrangements or rights of return?What are the control procedures for cancelled orders?How likely are unearned revenues, and what are the client’s control procedures for these liabilities?What did we miss?
15Tests of Controls & Tests of Transactions Transaction ObjectiveTest of ControlSubstantive TestsOccurrenceComputer-assisted auditing techniques (CAATs)Examine Sales Invoice packets for supporting documentationReview sequence of sales invoicesReview journal for unusual transactionsVouch from the sales journal to the supporting documentsCompletenessAccount for sequence of shipping documentsObserve and review evidence for document controlTrace from the shipping documents to the sales journalAccuracyCAATsConfirm agreement between supporting documentation sourcesRecalculate prices and extensions on sales invoiceTrace a few transactions from inception to completionCutoffAccount for sequence of supporting documents.Confirm period reviews of open filesAnalyze Sales Invoices and Shipping Documents close to year end to confirm appropriate recordingClassificationTrace transactions from Sales Invoice to the Sales Journal, verifying appropriate classification
16Analytical Procedures & Tests of Balances Transaction ObjectiveAnalytical ProceduresSubstantive TestsExistenceCompare gross margins w/ prior yearsConsider monthly sales over timeCompare A/R turnover w/prior yearsReview subsidiary ledger for unusual amountsConfirm receivablesAlternative proceduresCompletenessTrace from the A/R master to the aging scheduleRights & ObligationsN/AReview BOD minutes for A/R pledging or factoringReview material sales contracts for terms and conditionsInquire of managementValuation & AllocationCompare bad debts to prior yearsCompare allowance account to prior yearsCompare A/R turnover w/ prior yearsCompare amounts in aging categories w/ prior yearsInquire as to likelihood of collection for older accountsAssess appropriateness based on independent estimates and other knowledge obtained regarding collection