Audit of the Revenue Cycle (Sales & Collection)
Auditing II
Accounting Department Faculty of Economics Padjadjaran University 14 - 1
Learning Objective 1
Describe the nature of the revenue cycle and the transaction classes involved and identify transaction and account balance audit objective for the revenue cycle
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Audit Objective
The overall audit objective in the audit of the revenue cycle is to evaluate whether the account balances affected by the cycle are fairly presented in accordance with generally accepted accounting principles
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Nature An entity’s revenue cycle consists of activities related to the exchange of goods and services with customers and to the collection of the revenue in cash Revenue transaction
Sales (cash & credit) Cash receipts Sales return & allowances Provision for bad debts Write-off of uncollectible accounts 14 - 4
Accounts in the Revenue Cycle Sales Cash sales Sales on account
Cash in Bank
Accounts Receivable Beginning Cash receipts balance
Cash Discounts Taken
Sales on account
Sales returns and allowances
Sales Returns and Allowances
Ending balance
Charge-off of uncollectible accounts
Allowance for Uncollectible 14 - 5
Accounts in the Revenue Cycle Accounts Receivable Beginning Cash receipts balance Sales on account
Sales returns and allowances
Ending balance
Charge-off of uncollectible accounts
Allowance for Uncollectible Accounts Charge-off of Beginning uncollectible balance accounts Estimate of bad debt expense Ending balance Bad Debt Expense
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Learning Objective 2
Describe the business functions and the related documents and records in the revenue cycle.
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Business Functions •
The revenue cycle involve the decisions and processes necessary for the transfer of the ownership of goods and services to customers after they are made available for sale. • It begins with a request by a customer and ends with the conversion of goods or service into an account receivable, and ultimately into cash.
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Sales Transaction Accounts
Business functions
Documents and records
Sales Accounts receivable
Processing customer orders Granting credit
Customer order Sales order Customer order or sales order Shipping document Sales invoice Sales transaction file Sales journal or listing Accounts receivable master file Accounts receivable trial balance Monthly statements
Shipping goods Billing customers and recording sales
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Cash Receipts Transaction Accounts
Business functions
Documents and records
Cash in bank (debits from cash receipts) Accounts receivable
Processing and recording cash receipts
Remittance advice Prelisting of cash receipts Cash receipts transaction file Cash receipts journal or listing
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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 and returns and allowances journal
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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
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Bad Debt Expense Transaction Accounts
Business functions
Documents and records
Bad debt expense Allowance for uncollectible accounts
Providing for bad debts
General journal
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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.
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Billing Customers and Recording Sales Billing is the means by which the customer is informed of the amount due for the goods ordered Internal controls : Making sure that all shipments made have been billed
No shipment has been billed more than once Each shipment is billed for the proper amount 14 - 17
Billing Customers and Recording Sales Sales invoice
Sales transaction file Sales journal or listing Accounts receivable master file Accounts receivable trial balance Monthly statement 14 - 18
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 management’s 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 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)
Management’s assertions for sales and collection activities remain the same.
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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.
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Learning Objective 4
Understand internal control, and design and perform tests of controls and substantive tests of transactions for sales.
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Methodology for Designing Controls and Substantive Tests of Sales Transactions for Sales Understand internal control – sales. Assess planned control risk – sales. Determine extent 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 14 - 28
Understand Internal Control – Sales
Study the client’s flowcharts, prepare an internal control questionnaire, and perform walk-through tests of sales.
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Assess Planned Control Risk – Sales 1. Framework for assessing control risk 2. Identify key internal controls and deficiencies
3. Associate controls and deficiencies with the objectives 4. Assess control risk for each objective 14 - 30
Assess Planned Control Risk – Sales Adequate separation of duties Proper authorization Adequate documents and records
Prenumbered documents
Monthly statements Internal verification procedures 14 - 31
Determine Extent of Testing Controls Audits of public companies
Audits of nonpublic companies 14 - 32
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. 14 - 33
Transaction-Related Audit Objectives 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. 14 - 34
Direction of Tests for Sales
Customer order
Shipping document
Completeness start
Duplicate sales invoice
Sales journal
General journal
=
Accounts receivable master file
Existence start
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Summary of Methodology for Sales Transaction-related audit objectives (Column 1) Key existing controls (Column 2) Tests of control (Column 3) Deficiencies (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 client’s 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.
Materiality
Emphasis on objectives
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Learning Objective 6
Understand internal control, and design and perform tests of controls and substantive tests of transactions for cash receipts.
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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.
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Learning Objective 7 Apply the methodology for controls over the sales and collection cycle to write-offs of uncollectible accounts receivable. 14 - 42
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 14 - 43
Additional Internal Controls Over Account Balances Realizable value
Credit approval Aged accounts receivable trial balance Charging off uncollectibles 14 - 44
Additional Internal Controls Over Account Balances 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 receivable
Cash
Bad debt expense
Allowance for doubtful accounts 14 - 46
Types of Audit Tests for the Sales and Collection Cycle Sales
Accounts Cash in Receivable Bank Sales Cash receipts transactions transactions Audited by TOC, STOT, and AP
Ending balance
Audited by TOC, STOT, and AP
Ending balance
Audited by AP and TDB
TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS 14 - 47
End
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