Audit of the Sales and

Collection Cycle:
Tests of Controls and
Substantive Tests of
Transactions

Chapter 14

Overview of Accounts in the Sales and

Collection 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

Bad Debt
Expense

Accounts in the Sales and Collection 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

Bad Debt
Expense

Ending
balance

Analysis of the Sales and Collection Cycle

Excellent format for analysis:

Business Functions
Accounts involved
Documents and Records

Think Accounting Information Systems

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

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

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

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

Bad Debt Expense Transaction

Accounts

Business functions

Documents and records

Bad debt
expense
Allowance for
uncollectible
accounts

Providing for bad

debts

General journal

Processing Customer Orders

Customer Order:
A request for merchandise by a customer
Sales Order:
A document describing the goods ordered
by a customer

Granting Credit

Before goods are shipped, a properly

authorized person must approve credit
to the customer for sales on account.

Shipping Goods

This is the first point in the cycle

where company assets are given up.

Billing Customers and Recording Sales

Sales invoice
Sales transaction file
Sales journal or listing
Accounts receivable master file
Accounts receivable trial balance
Monthly statement

Processing and Recording Cash Receipts

Remittance advice
Prelisting of cash receipts
Cash receipts transaction file
Cash receipts journal or listing

Processing and Recording Sales Returns

and Allowances

Credit memo

Sales returns and allowances journal

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.

Providing for Bad Debts

This provision represents a residual,

resulting from managements
end-of-period adjustment of the
allowance for uncollectible accounts .

Effect of E-Commerce on the Sales and

Collection Cycle
The Internet and other developing
technologies allow companies to
develop new business models.

Effect of E-Commerce on the Sales and

Collection Cycle
Business-to-business (B2B)
Business-to-consumer (B2C)
Managements assertions for sales and
collection activities remain the same.

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.

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

Understand Internal Control Sales

Study the clients flowcharts, prepare

an internal control questionnaire, and
perform walk-through tests of sales.

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

Assess Planned Control Risk Sales

Adequate separation
of duties
Adequate documents
and records
Monthly statements

Proper authorization
Prenumbered
documents
Internal verification
procedures

Determine Extent of Testing Controls

Audits of public
companies

Audits of nonpublic
companies

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.

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.

Direction of Tests for Sales

Customer
order

Shipping
document

Completeness
start

Duplicate
sales
invoice

Sales
journal

Existence
start

General
journal

Accounts
receivable
master file

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)

Sales Returns and Allowances

The transaction-related audit objectives and

clients methods of controlling misstatements
are essentially the same for processing credit
memos as those described for sales.

Sales Returns and Allowances

There are, however, two important differences.

Materiality

Emphasis on
objectives

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.

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

Additional Internal Controls Over Account

Balances
Realizable value
Credit approval
Aged accounts receivable trial balance
Charging off uncollectibles

Additional Internal Controls Over Account

Balances

Rights and obligations

Presentation and disclosure

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

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