Tests of Controls

in the Revenue Cycle

 TOPICS
• Nature of revenue cycle
• Auditor’s consideration of internal controls
• Computer auditing, sampling, & tests of
controls
• Assurance & consulting opportunities
REVENUE/RECEIPT CYCLE

• Sale of goods or services

• Collection of cash
 FLOW OF INFORMATION
• Customer order received
• Credit decision made
• Goods shipped
• Sale recorded
• Customer billed
• Account collected
 SELLER’S DOCUMENTS
• Sales order
– Identifies goods ordered, price, quantity, terms,
etc.
• Shipping document (bill of lading)
– Identifies good shipped
• Contract between seller & carrier
• Sales invoice
– Formal notice to customer of amount & payment
terms
• Customer remittance advice
– Returned with payment
 CUSTOMER ORDER
DEPARTMENT:
Responsibilities

• Accept customer order

• Prepare & distribute sales order
 CREDIT DEPARTMENT:
Responsibilities

• Review sales order

• Investigate credit information
• Credit approval
• Forward order to inventory control or notify
customer order dept. if credit denied
 INVENTORY CONTROL:
Responsibilities

• Review sales order

• Authorize release of goods from
warehouse
• Forward goods & sales order
copy to shipping
 SHIPPING:
Responsibilities
• Compare sales orders from inventory control &
customer order
• Examine goods from warehouse; compare with
sales order
• Prepare for shipping; complete shipping document
• Release goods to carrier; obtain receipt
• Notify customer order dept. of shipment
• Forward copy sales order & shipping documents
to billing
 BILLING:
Responsibilities
• Compare documents from shipping
with sales order from customer order
dept.
• Prepare sales invoice; send to
customer & to inventory accounting
• Prepare daily sales summary; send
copy to general accounting
 RECORDING:
Responsibilities
• Inventory Accounting: enter cost on
invoices; update inventory records, forward
invoices to general accounting
• General Accounting: record sales &
forward documents to accounts receivable
• Accounts Receivable: post to customer
account; file documents
 CASH COLLECTION
PROCESS
• Assuming cash remittances mailed
– Incoming checks listed, restrictively endorsed by
mail room personnel
– Listing & remittances sent to accounts
receivable for posting
– Listing & checks sent to cash receipts dept
– Cash Receipts dept. prepares daily bank deposit,
cash summaries, updates cash records
– Listing of totals forwarded to general accounting
for recording in cash receipts journal & general
ledger
 SALES RETURNS &
ALLOWANCES PROCESS
• Reviewed by Customer Order personnel
– Independent of cash collection & recording
• Approved request documented by credit
memorandum
– Credit memorandum posted by
• Accounts Receivable, Inventory Control & General Accounting
• Receiving Dept. prepares receiving report & sends
to Inventory Control
• Inventory Control compares receiving report &
credit memorandum
 UNCOLLECTED
ACCOUNTS PROCESS
• Accounts Receivable personnel
– Review accounts
– Check credit limits
– Prepare monthly trial balances
– Prepare aging schedule
• Treasurer’s office authorizes write-off of
uncollectible accounts
 INTERNAL CONTROL
OBJECTIVES

• Authorization
• Execution
• Recording
• Access to assets
 INTERNAL CONTROL
OBJECTIVES: Authorization

• Credit approval prior to shipment

of goods
• Unit prices & sales terms
established
• Discounts & adjustments made
in accordance with management
authorization
 INTERNAL CONTROL
OBJECTIVES: Execution

• Approved orders shipped in accordance

with specifications in timely manner
• Shipments billed in timely manner
 INTERNAL CONTROL
OBJECTIVES: Recording
• Sales, cash receipts recorded
– At correct amounts
– In proper period
– Properly classified
• Billings, collections, adjustments posted
accurately to accounts
• Recorded accounts receivable fairly reflects
underlying transactions & events
 INTERNAL CONTROL
OBJECTIVES: Access to Assets
• Access to cash & records restricted to
authorized personnel
• Access to shipping, billing, inventory
control & accounting records restricted to
authorized personnel
 CONTROL OBJECTIVES,
ERRORS, CONTROLS
Authorization
Error Control Procedure
Unauthorized shipments, Credit check; update authorized
uncollectible customer list
Unauthorized prices, terms, Updated price lists, terms;
reduced cash flow procedures for review, approval
Unauthorized discounts, Policies for discounts; control &
improper account write-off prenumber credit memorandum
 CONTROL OBJECTIVES,
ERRORS, CONTROLS
Execution
Error Control Procedure
Shipments to wrong party, Verify stock & shipping
too late; uncollectible terms; policies for shipments
accounts

Shipments not billed or billed Prenumber bills of lading &

late; delayed cash receipt deliver promptly to Billing
dept.
 CONTROL OBJECTIVES,
ERRORS, CONTROLS
Recording
Error Control Procedure
Account balances inaccurate Total, reconcile documents & accounts
Detailed summaries do not Reconcile summaries with control totals
agree with control accounts; & input with output; investigate
posted to wrong accounts customer correspondence;
Accounts include errors, Evaluate account balances; reconcile
fraud; improper subsidiary, general ledger; policies,
management decisions organization charts; follow up on
complaints
 CONTROL OBJECTIVES,
ERRORS, CONTROLS
Access to Assets
Error Control Procedure
Cash receipts lost, Centralized cash receipts, daily reconciliation,
unreported; shortages deposit, prenumbered remittances; listing of
undetected; cash cash; separate custody & recording; reconcile
overstated bank statements; secure cash & checks;
bonding; authorized signatures; restrictive
endorsements
Records, assets Segregate authorization, execution, recording
misused,
misappropriated
 INTERNAL CONTROL IN
AUDITS
• Preliminary review
• Document system
• Perform transaction walk-through
• Determine whether controls are potentially
reliable in assessing control risk below
maximum
– Test controls
 INTERNAL CONTROL IN
AUDITS:Preliminary Review
• Purpose: determine whether further
consideration of internal control might
justify assessing control risk below
maximum
• Obtain understanding
– Review procedures manual
– Interview employees
– If adequate, continue documenting system
 INTERNAL CONTROL IN
AUDITS: System Documentation

• Flowcharts
• Questionnaires
• Written narratives
 INTERNAL CONTROL IN
AUDITS: Walk-Through

• Testing auditor’s understanding of system by

tracing several transactions through system
• Identify control procedures
– Identify objectives
– Consider potential errors or frauds
– Determine what procedures used
– Design tests of controls
 TESTS OF CONTROLS:
Shipping
• Select random sample shipping documents
• Examine sample for authorized sales order &
agreement
• Trace sample shipping documents to invoices
(completeness)
• Trace invoices to sales journal, A/R ledgers
• Trace invoices to inventory records
 TESTS OF CONTROLS:
Billing
• Select sample invoices from billing
dept.
• Verify unit prices & mathematical
accuracy
• Trace invoices to shipping documents
(existence/occurrence)
• Trace invoices to sales journal, A/R
ledgers
• Trace invoices to inventory records
 TESTS OF CONTROLS:
Recording
• Review evidence of procedures for
– Reconciliation daily sales summaries with sales journal
totals
– Periodic reconciliation A/R trial balance with general
ledger control
• Scan sales journal for unusual transactions, large
amounts
• Verify mathematical accuracy sales journal for
selected periods; trace postings to general ledger
 TESTS OF CONTROLS:
Cash Collection & Deposit
• Cash collection
– Surprise basis: take control bank deposits
– Compare total checks to total deposit slip
– Compare check details to cash receipt records &
A/R ledger
– Determine timeliness
• Deposits
– Interim: compare deposits CRJ with bank
statements
– Trace CRJ to general ledger
 TESTS OF CONTROLS:
Sales Returns & Allowances
• Test details random sample credit
memoranda
– Receiving reports
– Perpetual inventory records
– Entries A/R ledger & general ledger
• Review credit register for unusual items
 TESTS OF CONTROLS:
Uncollectible Accounts
For written-off entries:
– Select sample
– Trace to authorization
– Trace to posting
• Review write-offs for unusual entries
 COMPUTER AUDITING &
SAMPLING
• Understand the system
• Tests of controls
– Input controls
– Processing controls
• Assess control risk
 ASSURANCE &
CONSULTING SERVICES
• CPA’s have comparative advantage in
internal controls
– Knowledge spillovers
– Technological savvy
– Existing client base