Chapter 14 Audit of the Sales and Collection Cycle Statement

Presentation Outline Accounts and Documents in the Sales and Collection Cycle Segregation of Duties Sales Transaction Audit Objectives Sales Return and Allowance Audit Objectives Cash Collection Transaction Audit Objectives Other Sales and Collection Cycle Considerations

I. Accounts and Documents in the Sales and Collection Cycle Accounts in the Sales and Collection Cycle Documents in the Sales and Collection Cycle

A. Accounts in the Sales and Collection Cycle Cash sales Sales on account Cash in Bank Accounts Receivable Beginning Cash receipts balance Sales returns Sales on and allowances account Charge-off of Ending uncollectible balance accounts Cash Discounts Taken Sales Returns and Allowances Bad Debt Expense

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

B. Documents in the Sales and Collection Cycle Bill of lading – a written contract between a carrier and seller for the receipt and shipment of goods. Sales invoice – a document indicating the description and quantity of goods sold, the price, freight charges, insurance, terms, and other relevant data. Credit memo – a document indicating a reduction in the amount due from a customer because of returned goods or an allowance granted Remittance advice – a document that accompanies the sales invoice mailed to the customer that can be returned to the seller with the cash payment Customer statement – A document summarizing customer balance and account activity, that is sent to the customer for billing purposes.

II. Segregation of Duties in the Revenue Cycle Authorizing sales transactions Approving credit Recording sales Maintaining custody of goods Suggested List of Duties to be Segregated

A. Authorizing Sales Transactions Sales transactions are initiated by a customer order. The customer order provides the basis for preparing a sales order.

B. Approving Credit A copy of the sales order is sent to the credit department for approval. A computer may simply compare preestablished credit limits to see if the customer has credit available

General accounting maintains control accounts in the general ledger. C. Recording Sales Accounts receivable maintains the accounts receivable subsidiary ledger. May be a computerized accounts receivable master file. General accounting maintains control accounts in the general ledger.

D. Maintaining Custody of Goods Custody of goods in warehouse or awaiting shipment.

E. Suggested List of Duties to be Segregated Authorization Functions: Receiving orders for sales Granting credit and pursuing unpaid accounts Recordkeeping Functions: Billing customers and recording sales Maintaining inventory records Maintaining general ledger accounting records Maintaining detailed accounts receivable records Custody of Asset Functions: Shipping goods Processing cash receipts

III. Sales Transaction Audit Objectives Existence Completeness Accuracy Classification Timing Posting and Summarization Note: See Table 13-2 on pages 382-383 for a full description of Transaction-related objectives for sales

Sales Transactions Existence Test of control – Examine sales invoice for supporting bill of lading and customer order. Substantive test – Auditor is concerned with three types of misstatements: Recorded sale with no shipment – Trace from sales journal entry to shipping document Sale recorded more than once – Check cancellation of shipping documentation. Shipments made to nonexistent customers – Person recording sales should not authorize shipments.

B. Sales Transactions Completeness Test of control – Account for sequence of shipping documents. Substantive test – Many audits ignore completeness on the grounds that overstatement of income are of greater concern. However, errors may still misstate financial statements. One effective procedure is to trace from shipping documents to the sales invoice and entry in the sales journal.

C. Sales Transactions Accuracy Test of control – Examine the approved price list for accuracy and proper authorization. Substantive test – Start with entries in the sales journal and compare the total of selected transactions with accounts receivable master file entries and duplicate sales invoices.

D. Sales Transactions Classification Test of control – Examine document package for duplicate verification. Substantive test – When there are cash and credit sales, it is important not to debit accounts receivable for a cash sale or to credit sales for collection of a receivable. It is also important not to classify sales of operating assets as sales. A common procedure is to examine duplicate sales invoice for proper account classification.

E. Sales Transactions Timing Test of control –Account for sequence of shipping documents. Substantive test – Sales should be billed when ownership is transferred to the customer. A common procedure is to compare the date of recording a sale in the sales journal with the date on the duplicate sales invoice and bill of lading.

F. Sales Transactions Posting and Summarization Test of control – Examine evidence that accounts receivable master file is reconciled to the general ledger. Substantive test – Use audit software to foot and cross-foot the sales journal and trace totals to the general ledger.

IV. Sales Return and Allowance Audit Objectives An Internal Control for Existence An Internal Control for Completeness Common Types of Transactions The objectives and methodology for auditing sales returns and allowances is the same as for sales. The same procedure can be used to develop suitable controls, tests of controls, and substantive tests of transactions to verify the amounts.

Sales Adjustment Existence Ensure that all sales returns and allowances and charge- offs are approved by appropriate personnel. Ensuring that recorded sales adjustments actually occurred is important because a diversion of cash from an account receivable collection could be covered up by a fictitious sales return or allowance.

B. Sales Adjustment Completeness Sales Adjustment Form Discount for Damaged merchandise Form #36 Unrecorded sales returns and allowances can be material and can be used by a company’s management to overstate net income. $5 Approval RS General Journal Ensure that prenumbered sales adjustment forms are used, and that all forms are accounted for. Sales Allowance 5 Acc. Rec. 5 Record Adjustment #36

C. Major Types of Sales Adjustment Transactions Customers may receive discounts for paying early. Customers may return goods or request selling price reductions. Incorrect billing. Bad debt write-offs.

V. Cash Collection Transaction Audit Objectives Existence Completeness Accuracy Classification Timing Posting and Summarization

A. Cash Collections Existence Test of control – Observe whether accountant reconciles bank account. Substantive test – Trace cash receipts entries from the cash receipts journal entries to the bank statement.

B. Cash Collections Completeness Test of control – Observe prelisting of cash receipts. Substantive test – Compare the prelisting with the duplicate deposit slip.

C. Cash Collections Accuracy Test of control – Observe whether accountant reconciles bank account. Substantive test – Prepare a proof of cash receipts to reconcile cash receipts per books with cash receipts per bank.

D. Cash Collections Classification Test of control – Examine evidence of internal verification. Substantive test – Examine prelisting for proper account classification.

E. Cash Collections Timing Test of control – Observe unrecorded cash at a point in time to see when it is recorded. Substantive test – Compare date of deposit in bank statement to the dates in the cash receipts journal and prelisting of cash receipts.

E. Cash Collections Posting and Summarization Test of control – Examine evidence that accounts receivable master file is reconciled to general ledger. Substantive test – Use audit software to foot and cross-foot the cash receipts journal and trace to the general ledger.

VI. Other Sales and Collection Cycle Considerations Lapping of Accounts Receivable Audit Tests for Uncollectible Accounts

A. Lapping of Accounts Receivable Lapping is when, to cover a cash theft, an employee defers recording cash receipts from one customer and covers the shortage with receipts from another customer. It can be detected by comparing the name, amount, and dates shown on remittance advices with cash receipts journal entries and related duplicate deposit slips. Dishonest Employee Customer B’s Account Customer A’s Account Customer A Customer B

B. Audit Tests for Uncollectible Accounts Major concern is that client covers up a theft by charging off accounts receivable that have actually been collected. Audit tests for proper authorization of write-off. This often involves an aged analysis of receivables. It is also usually necessary to examine correspondence in client files to establish uncollectibility. After the auditor has concluded that the accounts should be charged off, the auditor should verify the corresponding journal entries and postings into the general and subsidiary ledgers.

Summary Accounts and Documents in the Sales and Collection Cycle Segregation of Duties Sales Transaction Audit Objectives Sales Return and Allowance Transaction Audit Objectives Cash Collection Transaction Audit Objectives Lapping of Accounts Receivable Uncollectible Accounts