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©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 1 Audit of the Sales and Collection Cycle Chapter.

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Presentation on theme: "©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 13 - 1 Audit of the Sales and Collection Cycle Chapter."— Presentation transcript:

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2 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Audit of the Sales and Collection Cycle Chapter 13

3 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 1 Identify the accounts and the classes of transactions in the sales and collection cycle.

4 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Accounts in the Sales and Collection Cycle Sales Cash sales Sales on account Cash in Bank Cash Discounts Taken Sales Returns and Allowances Bad Debt Expense Accounts Receivable BeginningCash receipts balance Sales returns Sales onand allowances account Charge-off of Endinguncollectible balanceaccounts

5 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Accounts in the Sales and Collection Cycle Accounts Receivable BeginningCash receipts balance Sales returns Sales onand allowances account Charge-off of Endinguncollectible balanceaccounts Bad Debt Expense Allowance for Uncollectible Accounts Charge-off ofBeginning uncollectiblebalance accounts Estimate of bad debt expense Ending balance

6 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 2 Describe the business functions and the related documents and records in the sales and collection cycle.

7 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Processing Customer Orders Customer Order: A request for merchandise by a customer Sales Order: A document describing the goods ordered by a customer

8 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Granting Credit Before goods are shipped, a properly authorized person must approve credit to the customer for sales on account.

9 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Sales Transaction Accounts Business Functions Documents and Records Sales Accounts receivable Processing customer orders, Granting credit, Shipping goods, Billing customers and recording sales Sales invoice, Sales journal or listing, Sales transaction file, Accounts receivable master file and trial balance, Monthly statements

10 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Cash Receipts Transaction Accounts Business Functions Documents and Records Cash in bank (debits from cash receipts) Accounts receivable Processing and recording cash receipts Remittance advise, Prelisting of cash receipts, Cash receipts transaction file, Cash receipts journal or listing

11 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Sales Returns and Allowances Transaction Accounts Business Functions Documents and Records Sales returns and allowances Accounts receivable Processing and recording sales returns and allowances Credit memo Sales returns and allowances journal

12 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Charge-off of Uncollectible Accounts Transaction Accounts Business Functions Documents and Records Accounts receivable Allowance for uncollectible accounts Charging off uncollectible accounts receivable Uncollectible account authorization form General journal

13 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Bad Debt Expense Transaction Accounts Business Functions Documents and Records Bad debt expense Allowance for uncollectible accounts Providing for bad debts General journal

14 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Shipping Goods This is the first point in the cycle where company assets are given up. Shipping document

15 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Billing Customers and Recording Sales Sales invoice Sales transaction file Sales journal or listing Accounts receivable master file Accounts receivable trial balance Monthly statement

16 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Processing and Recording Cash Receipts Remittance advise Prelisting of cash receipts Cash receipts transaction file Cash receipts journal or listing

17 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Lockbox Systems and Electronic Funds Transfer Customer Bank Order/Payment Information Company

18 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Processing and Recording Sales Returns and Allowances Credit memo Sales returns and allowances journal

19 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 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.

20 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Providing for Bad Debts This provision represents a residual, resulting from management’s end-of-period adjustment of the allowance for uncollectible accounts.

21 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 3 Understand how e-commerce activities affect the sales and collection cycle.

22 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 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.

23 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Effect of E-Commerce on the Sales and Collection Cycle Business-to-business (B2B) Business-to-consumer (B2C) Management’s assertions for sales and collection activities remain the same.

24 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 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.

25 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 4 Understand internal control and design and perform tests of controls and substantive tests of transactions for sales.

26 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Methodology for Designing Controls and Substantive Tests: Sales Understand internal control – sales Assess planned control risk – sales Evaluate cost-benefit of testing controls. Design tests of controls and substantive tests of transactions for sales to meet transaction- related audit objectives. Audit procedures Sample size Items to select Timing

27 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Understanding Internal Control – Sales Study the client’s flowcharts, prepare an internal control questionnaire, and perform walk-through tests of sales.

28 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Assess Planned Control Risk – Sales Adequate separation of duties Proper authorization Adequate documents and records Prenumbered documents Monthly statements Internal verification procedures

29 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Internal Verification Procedures Evaluate cost-benefit of testing controls. Design tests of controls for sales.

30 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Transaction-Related Audit Objectives for Sales Existence: Recorded sales are for shipments actually made. Accuracy: Recorded sales are for the amount shipped. Completeness: Existing sales transactions are recorded.

31 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 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.

32 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Direction of Tests for Sales Customer order Shipping document Duplicate sales invoice Sales journal General ledger Accounts receivable master file = Completeness Start Existence Start

33 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Summary of Methodology for Sales Column 1:Transaction-related audit objectives Column 2:Key internal controls Column 3:Test of controls Column 4:Weaknesses Column 5:Substantive tests of transactions

34 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 5 Apply the methodology for controls over sales transactions to controls over sales returns and allowances.

35 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Sales Returns and Allowances The transaction-related audit objectives and client’s methods of controlling misstatements are essentially the same for processing credit memos as those described for sales.

36 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Sales Returns and Allowances There are, however, two important differences. Materiality Emphasis on objectives

37 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 6 Understand internal control and design and perform tests of controls and substantive tests of transactions for cash receipts.

38 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 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  Determine whether cash received was recorded  Prepare proof of cash receipts  Test to discover lapping of accounts receivable

39 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 7 Apply the methodology for controls over the sales and collection cycle to write-offs of uncollectible accounts receivable.

40 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 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

41 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Additional Internal Controls Over Account Balances Realizable value Rights and obligations Presentation and disclosure

42 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 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

43 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Role of all Audit Tests in the Sales and Collection Cycle Sales Accounts Receivable Cash in Bank Sales transactions Cash receipts transactions Ending balance Ending balance TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS Audited by TOC, STOT, and AP Audited by AP and TDP Audited by TOC, STOT, and AP

44 ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley End of Chapter 13


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