Bac2664auditing L8 Sales Cycle

AUDITING BAC2664 (New), BAC2287(Old) Topic 7, Lecture 8 Audit of Sales and Collection Cycle 1

Audit of Sales and Collection Cycle • Tests of Controls and Substantive Tests of transactions • Nature of the sales and collection cycle • Business function, documents and records • Internal Controls • Objective of audit on sales and account receivable • Test on real transaction • Audit tests for uncollectible accounts • Balance confirmation including debtors’ balances 2

Overview of the Sales Cycle Two classes of transactions (credit sales and cash receipts) are processed by the accounting system, in different manner. The transactions cycle and classes of transaction for credit cycle includes: 4 Receiving order from customer – written order, telephone, mail, facsimile 5 Grant credit – approval from credit department (credit standing, credit limit) 6 Deliver goods – authority to dispatch/deliver goods to customer 7 Billing – after satisfactory delivery of goods to customer 8 Receive cash – customer settles debts by cheques/cash, within credit term The sales cycle ends when customer makes payment. In addition, different internal controls are applied to ensure: 13 Complete processing of transactions 14 Transactions are processed accurately, and 15 Only valid transactions are processed.

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The Account Balance in the Sales Cycle Credit Sales: Debit: Sales Ledger Control Account Credit: Sales Customer Pays by Cheque: Debit: Bank Account Credit: Sales ledger Control Account The accounts pertinent to the test of details of transactions are sales account and bank account. Test of details of balances are performed on sales ledger control account and its detail counterpart, the sales ledger. 4

Sales Activities, Documents, and Records Activity Authorization 1 Accepting and processing customer order 2 Approving customer credit 3 Delivery of goods 4 Billing of customer

Recording 1 Journalizing and posting of sales 2 Summarizing journal entries, posting summary

Custody

Document

Record

Sales order Approved customer list Approved sales order Delivery note, Sales invoice Sales invoice

Sales journal Sales ledger General ledger

Access to documents, records – limited to authorized personnel 5

Sales Department Activity/Responsibility: Accepting and processing customer order (1) match the order to an approved customer list (2) issue sales order

Possible errors and irregularities, when issuing sales order: (1) sales order could be issued for sale to a fictitious or undesirable customer (2) sales order does not agree with the customer purchase order pertaining to the specification and quantity of the items ordered (3) sales orders are misplaced

Control procedures: (1) matched particulars of customer to an approved customers list (2) matched particulars of sales order with customer purchase order (3) sales orders are pre-numbered

All sales orders are submitted to credit department for the approval of credit. Customers purchase orders are temporarily kept on file (sort according to sales order number) pending credit approval by credit dept.

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Credit Department Activity/Responsibility: Approving customer credit (3) (4)

Establishing credit standing for new customers Evaluating credit to existing customers

Possible errors and irregularities, when issuing sales order: (1) Potential risk of excessive un-collectable accounts and bad debts could happen if sales order by-passed the credit approval procedures or approved without making reference to careful investigation

Control procedures: (9)

To account the numerical sequence of approved sales order

Once approved, copy 1 is kept on file in alphabetical order for future reference, and the rest returned to sales dept.

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Sales Department Activity/Responsibility: Accepting and processing customer order received from the credit dept. (3) (4) (5) (6)

Customer purchase order temporarily filed according to sales order number, stapled with copy 4 of approved sales order File permanently the numerical sequence of sales orders number Copy 2, sent to the store dept to authorize them to deliver the goods Copy 3, is sent to billing dept, as an acknowledgement that the goods is in the delivery process

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Stores Activity/Responsibility: (2) (3)

Packing of goods to customer Delivery of goods

Possible errors and irregularities in this area: • •

Goods delivered may not agree with customer order Goods may be delivered to unauthorized customer

Control procedures: • Delivery note should be matched with approved sales order before authorization to deliver is given • Delivery note should be pre-numbered in order to ensure all goods are delivered are billed Delivery note copy 3, and approved sales order copy 3, are stapled and filed numerically. Delivery note copy 1, is sent together with goods to the customer. Delivery note copy 2, is sent to billing dept to authorize them to prepare the sales invoice. 9

Billing Department Activity/Responsibility: (2) (3) (4)

Billing the customer Demanding the customer for payment Keeping in a safe place the supporting document (approved sales order and delivery note) and ensuring their sequence.

Possible errors and irregularities in this area include: (7) (8)

Goods actually delivered are not billed Amount billed may not be incorrect

Control procedures: • •

Account for pre-numbered delivery notes to determine all delivery are billed Match sales invoice with delivery note and approved sales order to determine the validity of transactions

Sales invoice copy 3, delivery note copy 2, and approved sales order copy 2, are stapled and filed numerically. Sales invoice copy 1, is sent to the customer; copy 2, is sent to accounts dept for recording to the sales journal and sales ledger. 10

Accounts Department Activity/Responsibility: (2) (3) (4)

Journalizing sales invoice Posting the sales to sales ledger Monitor the amount owing

Possible errors and irregularities in this area include: • • •

Sales not recorded Sales are recorded to wrong account Sales are recorded in the wrong financial year

Control procedures: • • • •

Account for pre-numbered sales invoice Establish proper chart of account Establish internal verification of pricing, extensions and footings Establish proper cut-off, i.e., all delivery not issued before the year end are not billed in the following year.

Sales invoice copy 2, are filed numerically. 11

Cash Receipts Activity Authorization Receiving and processing payment from credit customer Receipts from cash sales Bank-in Acknowledging receipts from credit customer

Document

Record

Cheque Remittance advice Cash, Cash count sheet Bank-in slip Official receipts

Recording Journalizing and posting the receipts Summarizing the journal entries

Custody

Official receipts

Cash book Sales ledger General ledger

Access to documents and records are limited to authorized personnel 12

Mail Room Activity/Responsibility: Receiving and processing payment from credit customers. (3) All mails are received by the mail room (4) Segregate ordinary mails and payment made by customers (5) Preparation of prelist of mail receipts (particulars obtained from the cheques and remittance advices) (6) Cheques. Supported with the prelist of mail receipts and remittance advice are sent to cashier.

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Cashier Activity/Responsibility: Cash sales • Compare the cash register reading with actual cash receipts • Prepare cash count sheet (to show the denominations) Control procedures: • Custody of cash and cash count sheet • Second copy of cash count sheet is sent to accounts dept. 14

Cashier Activity/Responsibilities: Deposit of cash and cheques • Prepare a deposit slip • Bank-in • Cash count sheet, prelist of mail receipts are kept according to the date of deposit Bank will validate deposit slip. 15

Cashier Activity/Responsibilities: Confirm amount deposited with amount as per cash count sheet and prelist of mail receipts • Bank validated copy of deposit slip are matched with the cash count sheet, prelist of mail receipts • Cashier further process the remittance advice 16

Cashier Activity/Responsibilities: Acknowledging receipts from credit customers • Official receipts are prepared based on remittance advice • Approved official receipt, copy 1, is sent to the customer for acknowledging receipt • Copy 2, is sent to accounts dept • Copy 3 and remittance advice is filed in sequence of official receipt number 17

Accounts Department Activity/Responsibilities: Journalizing and posting the receipts (3) Particulars from the cash count sheet (copy 2) and official receipts are used for posting to the cash book and sales ledger (4) Cash count sheet are kept by date; and the official receipt are kept by serial number 18

Accounts Department Activity/Responsibilities: Summarizing the journal entries and posting the summary (1) Accounts clerk obtains the total sales (for the month) from the sales journal, and the total cash receipts from the cash book, and posts them to the general ledger

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Subsequent Accountability Activity

Record

Agreeing general ledger balance with debtor balances in sales ledger

General ledger Sales ledger Debtors reconciliation statement

Preparing aging report and monthly statement of account

Sales ledger Aging Report Statement of account

Preparing bank reconciliation statement

Cash book Bank statement Bank reconciliation statement 20

Accounts Department Activity/Responsibilities: Agreeing general ledger balances with the debtors’ balances in sales ledger (3) accuracy of recording are determined on monthly basis by verifying agreement of total balances in sales ledger with the sales ledger control account in general ledger (4) Errors in recording are highlighted in the debtors reconciliation statement 21

Accounts Department Activity/Responsibilities: Preparing aging report and statement of accounts (3) Statement of accounts are prepared and sent to debtors on a monthly basis to enable them to check and confirm on the entries made in the account (4) Statements of account highlight the age of the debts (5) Sales ledger are further analysed into debtors aging report 22

Accounts Department Activity/Responsibilities: Preparing bank reconciliation statement every month for the following reasons: (3) Differences between the balances as per bank statement and cash book are valid ones (4) Differences in balances are not a result of errors made by the book-keeper or the bank (5) Ensure that there has been no delay in preparing receipts into the bank account (6) Irregular items such as dishonoured cheques shown in the bank statement, are dealt with in the accounting records expediently 23

Internal Control Questionnaire for Sales (Yes or No Answer) Does the system ensure that sales invoices are correctly made out to all goods leaving the premises or for services rendered? 2 3 4 5 6 7 8 9

Is the numerical continuity of renumbered delivery notes and sales orders independently accounted for? Are delivery notes and sales orders compared with invoices? Are shipping and billing functions segregated from cash receipts? Are daily/weekly delivery note independently prepared and received? Are customer invoices mailed by the billing department? Are prices, quantities, extensions, and freight checked? Are invoice terms and quantities compared to the customer order? Are standard price lists used and exceptions approved?

Do procedures such that all invoices made out are correctly recorded in the books of accounts? • • • •

Is numerical continuity of pre-numbered sales invoices checked and traced to sales journal and sales ledger postings? Are sales invoices promptly recorded? Are customers billing, sales recording, sales ledgers, collections, and shipping functions separated? Is the monthly total sales journal balanced, posted to general ledger and reconciled with total debtor posting? 24

Internal Control Questionnaire for Cash Receipts (Yes or No Answer) Is the system such that cash receipts cannot be misappropriated without prompt detection? 2 3 4 5 6 7 8 9 10 11

Are cashier, sales recording, sales ledger, and general ledger function separated? Are remittance advices used? Are cheques stamped ‘Account Payee Only’ when received? Are cheques received through mail sent directly to the cashier, after being listed individually and control total taken? Are prelisted receipts subsequently compared with cash receipts deposited and posted? Are receipts deposited intact and promptly? Is the numerical continuity of renumbered receipts or remittance advices checked? Are invoice copies locked in registers and independently prepared? Is the cash book independently prepared? Is it forbidden to make disbursements from cash receipts?

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Evaluation of the Internal Control: The Test of Control ISA 400 (AI 400), Risk Assessments and Internal Control, paragraph 27, defines the procedures pertaining to the interim audit: “Test of control are performed to obtain audit evidence about the effectiveness of the: (c) Design of the accounting and internal control systems, that is, whether they are suitably designed to prevent or detect and correct material misstatements: and (d) Operation of the internal controls throughout the period.” In the test of control, the auditor is concerned with the following assertions: 1 Existence: the control exists 2 Effectiveness: the control is operating effectively 3 Continuity: the control has so operated throughout the period of intended reliance. 26

Relationship Between Management Assertions and Objectives of Test of Control Management Assertions

Objectives of Tests of Control

Existence of Occurance Completeness

Validity Authorization Completeness

Valuation of Allocation

Accuracy Classification Timing Posting, Summarization 27

Correlation Between Accounting System, Test of Control, Test of Details of Transactions Auditors would like to ensure those controls that provide evidence with regards to: 2 Only valid authorized transactions are recognized in the accounting system 3 Documents are recognized sequentially 4 Amount stated in documents are accurately added 5 Transactions are classified into the correct journals and ledger (including amounts) 6 Transaction are included in journal on timely basis, and 7 Posting and summarizing are correctly done on timely basis. 28

Test of Controls - Sales Audit Objectives: The audit of sales should be sufficiently comprehensive to determine whether: 3 4

Customer are properly charged for all goods delivered Sales have been correctly recorded in the books

Audit Procedures over Control of invoice books : • • •

Vouch invoice books purchased with printed invoices Verify that invoice books issued have been properly recorded in register At the time of audit, count un-issued invoice books and agree with the register. 29

Test of Controls – Sales

continued

For 1 – 3 months: 1 Account the numerical sequence of sales invoices 2 List any missing sales invoices. 3 Cast total column of sales journal from which items are individually posted (a) check posting from SJ to GL (b) check posting from SJ to Debtors Control Account

Trace 30 items, say 10% of sales invoices to SJ. Test sales invoices to the records below: 9 10 11 12 13

Credit approval documentation Stores quantity records, to make sure that all goods despatched have been invoiced Delivery note, to investigate any occurrences if unusual lags between date of delivery and date of billing, and any instances where billing occurs before delivery Standard price list. Check arithmetic of sales invoices Check posting to debtors ledger. 30

Test of Controls – Sales

continued

Select 30 items, say 10% debtors accounts: 2 3

Scrutinize and ensure that any old unpaid items are being properly followed up by the client Cast each account selected

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Test of Controls – Cash Receipts Audit Objectives: Audit of cash received should be sufficiently comprehensive to determine whether: •

Cash should have been received has actually been received, or

•

Cash have been correctly recorded in the books.

Audit Procedures for control of official receipt books: • • •

Vouch official receipt books purchased with printed invoices. Verify that printed and the range of serial number have been properly recorded in register At the time of audit, count un-issued official receipt books and agree with the register. 32

Test of Controls – Cash Receipts continued

For 1 – 3 months: 2 3 4

Account the numerical sequence of official receipts List any missing official receipts Cast cash sales and debtor’s receipts column of each cash receipts journal from which items are individually posted: (a) check posting the total for both columns from cash receipts journal to GL (b) check posting the total for debtors receipts from cash receipts journal to debtors control account.

Attend at the opening of incoming post to watch the procedure for remittances. 33

Test of Controls – Cash Receipts continued

For 5 – 10 days per quarter: 2

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Trace receipts from the following sources into each receipts journal: (a) cash register tally rolls (b) remittance advices Check arithmetic for each type of document traced above: (a) trace official receipts to each receipts journal (b) check posting to debtor ledger

For 1 – 3 months: 10 11

Check cash received with bank statements, noting that deposits are credited without delay Clear receipts side of bank statement and find out why un-ticked receipts are not entered on debit side of cash book. 34

Substantive Tests ISA 500 (AI 500), Audit Evidence, paragraph 6, defines the procedures pertaining to the final audit: “Substantive procedures means tests performed to obtain audit evidence to detect material misstatements in the financial statements and are of two types: (a) test of details of transactions and balances, and (b) analytical procedures 35

Substantive Tests

continued

During the substantive tests, auditors examine for the ‘substances’ that make up the account balances, e.g., the substances that make up account receivables are sales, receipts, discounts, bad debts written-off. Any misstatement detected on any of the substance should be corrected or disclosed in the financial statements. 36

Substantive Tests

continued

For account receivables, the following methods of obtaining evidence are used in substantive tests: 1 Documentation 2 Inquiries of client 3 Confirmation 4 Arithmetical accuracy, and 5 Analytical review 37

Substantive Tests

continued

If the balance RM48,500 consists of debts that are doubtful, it needs to be adjusted to comply with the prudence concept and disclosed in the notes to the financial statements. Finally, the conclusion derived from substantive tests on accounts receivable would support or refute the following management assertions: 1 Existence or occurrence 2 Rights and obligations 3 Completeness 4 Valuation or allocations, and 5 Presentation and disclosure. 38

Substantive Tests

continued

To promote efficiency, tests of details of transactions are performed at the same time as test of control. The nature and extent of test of details of balances should be determined by the results of the auditor’s tests of control and tests of details of transactions.

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Relationship Between Management Assertions and Objectives of Substantive Tests Management Assertions

Objectives of Substantive Procedures – Tests of Details of Balances

Existence or Occurrence Rights and Obligations Completeness Valuation or Allocation

Existence Ownership Completeness Accuracy Classification Cut-off Detail Tie-in Realisable value Presentation and Disclosure

Presentation and Disclosure

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Correlation Between Accounting System and Substantive Tests – Tests of Details of Balances

Verification of Cash Balances (cash at bank and cash in hand) 1 Cash at bank: in checking the balance of cash at bank, auditor must obtain sufficient appropriate audit evidence – achieved if the evidence are relevant to the audit objective of test of details of balances. 41

Verification of Cash at Bank Management Assertions

Audit Objectives Substantive of Test of Details Audit Procedures of Balances

Existence

Existence

1 Obtain a list of balances with banks 2 Compare the figures of the current year 42

Verification of Cash at Bank Completeness

Completeness

continued

1 obtain bank reconciliation from client 2 agree cash book balances as per bank reconciliation to cash account in GL 3 agree bank balances as per bank reconciliation to bank statements 4 Substantiate the reconciliation items for each bank reconciliation 43

Verification of Cash at Bank

continued

5 investigate outstanding items not cleared at time of audit 6 verify to bank slips for lodgement outstanding to ensure it is actually lodged with the bank 7 investigate on any significant transfer of funds occurred near validation date 44

Verification of Cash at Bank Valuation and Allocation

continued

Accuracy

Obtain confirmation letters from the bankers

Classification

Ensure cash have been properly classified according to chart of accounts

Cut-off

Obtain and trace cash cut-off information into cash books, bank statements, reconciliations 45

Verification of Cash at Bank

continued

Detail tie-in

Figures of cash book balances tie with cash book figures in GL

Rights and Obligation

Ownership

Bank accounts are in client’s name

Presentation and Disclosure

Presentation and Disclosure

1 Review loan agreements, minutes, to ensure restrictions on use and availability of bank and cash 46

Verification of Cash at Bank

continued

2 Ensure bank balance is the balance that should be, and no window dressing 3 ensure proper disclosure in respect of securities and guarantees 4 ensure comparative figures agree with last year’s financial statements

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Verification of Cash in Hand In handling the cash in hand, the appropriate methods in obtaining audit evidence is by counting the cash. Than, the auditor should require the client’s personnel to prepare a confirmation letter to confirm the balance of cash in hand as per cash count. Through the procedures mentioned, the auditor would achieve the following objectives: 1 Existence 2 Completeness 3 Accuracy 4 Ownership Auditor should ensure proper classification as cash in hand. 48

Verification of Trade Debtors The audit of trade debtors balance is to ensure trade debtors are fairly stated in the FS, really exist and realisable. The audit would confirm the accounting policies applied in respect of trade debtors balances are in accordance with the policies stated in the client’s FS and are consistent with those applied in the previous year. 49

Audit Procedures for Debtors Balances Management Assertions

Audit Objectives of Substantive Audit Tests of Details of Procedures Balances

Existence

Existence

Obtain a list of debtor together with a list of provision for doubtful debts 2 agree figures in GL 1

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Audit Procedures for Debtors Balances continued

Completeness

Completeness

1 ensure all year end transactions in respect of debtors are accounted for, and debtors are recorded in the accounting period have actually been recorded 2 Ensure supporting documents are in sequential order (obtain explanation for missing number) 51

Audit Procedures for Debtors Balances continued

Valuation and Allocation

Accuracy

1 review all debtor balances, check or test the additions of the list and reconciliation 2 examine supporting documents 3 determine whether doubtful debts accounts are complete 4 ensure attention given to – long outstanding balances, large balances, inability to comply with credit terms by customers 52

Audit Procedures for Debtors Balances continued

5 discuss with management to ensure determination of doubtful debts and related provisions are consistent with past years 6 examine supporting documents for write-off balances; determine whether the write-off were properly authorized

Classification

Debtors figures are classified properly according to chart of accounts

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Audit Procedures for Debtors Balances continued

Cut-off

Detail tie-in

Rights and Obligations

Obtain and trace debtors cut-off information into SJ and SL Figures of debtor balances in subsidiary ledger tie with debtors figures in the GL

Ownership Send confirmation letters and determine the method of confirmation either positive or negative 54

Audit Procedures for Debtors Balances continued

Presentation and Disclosure

Presentation and Disclosure

1 inquire whether any debtor have been pledged as security 2 ensure comparative figures agree with last year’s FS 3 consider whether significant credit balances should be classified as creditors

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References 1 Audit Text – Chapters 2 Lecture Notes 3 Tutorial Questions 4 Past Examination Questions 5 Relevant Articles – MIA, MICPA, ACCA

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