TESTING CONTROLS: Shipping

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AUDITING
CHAPTER 10
Sales & Cash Receipts
Transactions
By
David N. Ricchiute
TOPICS
Nature of revenue/receipt cycle

Flow of information
Auditor’s assessment of control risk

Audit of internal2 control for sales, cash
receipts
Computer auditing, sampling, tests of
controls
Assurance, consulting services
2
GBW 8th ed. Ch. 10
NATURE OF
REVENUE/RECEIPT CYCLE
Goods, services sold to customers in
exchange for future promises to pay
Cash collected from customers
3
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REVENUE/RECEIPT CYCLE
Flow of Information
Customer order received
Sales order prepared

Price, quantity, goods, terms
Shipping document


Identifies goods shipped
Contract between seller, carrier
Sales invoice (bill)
Customer remittance advice

4
Returned with payment from customer
GBW 8th ed. Ch. 10
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

5
Returned with payment
GBW 8th ed. Ch. 10
CONTROLS FOR CREDIT
SALES
Multicopy, prenumbered sales order prepared
Customer credit reviewed, approved
Authorized copy sales order accompanies goods
from Inventory Control to Shipping
Goods received in Shipping compared with sales
order; shipping document prepared
Common carrier provides receipt for goods
shipped
Shipping document, approved sales order sent to
billing for preparation of invoice, daily sales
summaries
Invoice copy sent to General Accounting for
6 recording
GBW 8th ed. Ch. 10
CASH COLLECTION
Process



Checks by mail listed, endorsed
List copy to Accounts Receivable with remittance
for posting
List copy with checks to Cash Receipts Dept. for
daily deposit
Sales returns separate from cash collection
Uncollected accounts

7
Reviewed for credit limits, aged, written off as
necessary
GBW 8th ed. Ch. 10
INTERNAL CONTROL & RISK
Controls
Risks
Authorization
Credit risk, uncollectible
accounts
Shipment, billing not timely
Prenumbered
shipping documents
Recording controls Items recorded in improper
amounts, accounts
Theft
Restricted access
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GBW 8th ed. Ch. 10
ASSESSING CONTROL RISK
Obtain Understanding
Review Sarbanes-Oxley Section 404
documentation for sales process
Document the client’s system

Flowchart, questionnaire, narrative
Perform transaction walk-through
Identify control activities
Test controls to reduce control risk below
maximum
Assess control risk
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TESTS OF CONTROLS
Sales, Collection
Provide a reasonable degree assurance that
employees comply with management’s
procedures
Sales

Properly authorized, executed, recorded
Cash collections

Cash receipts recorded, deposited promptly
Returns, uncollectible accounts

10
Proper authorization, recording
GBW 8th ed. Ch. 10
CONTROL RISK
Shipping
Major risks

Unauthorized shipment
 Fictitious or related parties

11
Goods properly shipped, not billed,
recorded
GBW 8th ed. Ch. 10
TESTING 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
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CONTROL RISK
Billing
Major risks


13
Bills sent but goods not shipped
Bills not properly prepared, recorded
GBW 8th ed. Ch. 10
TESTING 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
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CONTROL RISK
Recording
Periodic summaries not prepared or not
prepared correctly
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TESTING 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
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CONTROL RISK
Cash Collection, Deposit
Risk of embezzlement, deposit into
improper accounts
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TESTING 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


18
Interim: compare deposits CRJ with bank
statements
Trace CRJ to general ledger
GBW 8th ed. Ch. 10
CONTROL RISK
Sales Returns, Allowances
Risk that credit memoranda


19
Not approved
Not properly recorded
GBW 8th ed. Ch. 10
TESTING 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
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CONTROL RISK
Uncollectible Accounts
Risk that account write-offs


21
Properly authorized
Properly recorded
GBW 8th ed. Ch. 10
TESTING CONTROLS:
Uncollectible Accounts
For written-off entries:



Select sample
Trace to authorization
Trace to posting
Review write-offs for unusual entries
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ASSESSING CONTROL
RISK
2 Questions


Are controls effective?
Can controls be relied upon?
If answer is yes to both



23
Assess control risk below maximum
Assess detection risk above minimum
Restrict substantive tests of sales,
receivables, cash
GBW 8th ed. Ch. 10
PRELIMINARY OPINION ON
INTERNAL CONTROL
Required by Sarbanes-Oxley

Auditor must form opinion on
management’s assessment of internal
control over financial reporting based on
 Reports of internal auditors
 Auditor’s tests of controls
 Substantive audit tests
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TESTS OF CONTROLS
Deduction Management
3 Critical questions



25
Does Accounts Receivable monitor
deductions?
Does Account Operations approve
deduction inquiries
Does senior management review decisions
made by Accounts Receivable, Account
Operations?
GBW 8th ed. Ch. 10
COMPUTER AUDITING &
SAMPLING
Understand the system
Tests of controls

Input controls
 Code verification
 Data entry controls

Processing controls
 Control totals
 Limit tests
Assess control risk
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TESTS OF BILLING CONTROLS
An Example
Randomly select sample sales invoices
Verify unit prices, clerical accuracy
Trace details of invoices to shipping
documents
Trace sales invoices to inventory records
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ASSURANCE, CONSULTING
SERVICES
Sarbanes-Oxley restricts

28
Information systems consulting to nonaudit public clients, and any non-public
clients
GBW 8th ed. Ch. 10
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