Audit of the Sales and
Collection Cycle: Tests of
Controls and Substantive
Tests of Transactions
Chapter 14
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley
14 - 1
Learning Objective 1
Identify the accounts and the
classes of transactions in the
sales and collection cycle.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 2
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
Write-off of
uncollectible
accounts
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
Bad Debt
Expense
14 - 3
Accounts in the Sales and
Collection Cycle
Accounts Receivable
Beginning Cash receipts
balance
Sales on
account
Sales returns
and allowances
Ending
balance
Write-off of
uncollectible
accounts
Allowance for
Uncollectible Accounts
Write-off of
Beginning
uncollectible balance
accounts
Estimate of
bad debt
expense
Ending
balance
Bad Debt
Expense
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 4
Learning Objective 2
Describe the business functions
and the related documents and
records in the sales and
collection cycle.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 5
Sales Transaction
Accounts
Business Functions Documents and Records
Sales
Accounts
receivable
Processing
customer orders
Granting credit
Shipping goods
Billing customers
and recording
sales
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
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
14 - 6
Cash Receipts Transaction
Accounts
Business Functions Documents and Records
Cash in bank Processing and
(debits from
recording cash
cash receipts) receipts
Accounts
receivable
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
Remittance advice
Prelisting of cash
receipts
Cash receipts
transaction file
Cash receipts journal
or listing
14 - 7
Sales Returns and Allowances
Transaction
Accounts
Business Functions Documents and Records
Sales returns
and
allowances
Accounts
receivable
Processing and
recording sales
returns and
allowances
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
Credit memo
Sales and returns and
allowances journal
14 - 8
Write-off of Uncollectible
Accounts Transaction
Accounts
Business Functions Documents and Records
Accounts
Writing off
receivable
uncollectible
Allowance for
accounts
uncollectible receivable
accounts
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
Uncollectible account
authorization form
General journal
14 - 9
Bad Debt Expense Transaction
Accounts
Business Functions Documents and Records
Bad debt
Providing for bad
expense
debts
Allowance for
uncollectible
accounts
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
General journal
14 - 10
Processing Customer Orders
Customer Order:
 A request for merchandise by a customer
Sales Order:
 A document describing the goods ordered
by a customer
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 11
Granting Credit
 Before goods are shipped, a properly
authorized person must approve credit
to the customer for sales on account
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 12
Shipping Goods
 This is the first point in the cycle
where company assets are given up
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 13
Billing Customers and
Recording Sales
 Sales invoice
 Sales transaction file
 Sales journal or listing
 Accounts receivable master file
 Accounts receivable trial balance
 Monthly statement
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 14
Processing and Recording Cash
Receipts
 Remittance advice
 Prelisting of cash receipts
 Cash receipts transaction file
 Cash receipts journal or listing
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 15
Processing and Recording
Sales Returns and Allowances
 Credit memo
 Sales returns and allowances journal
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 16
Writing 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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 17
Providing for Bad Debts
 This provision represents a residual,
resulting from management’s
end-of-period adjustment of the
allowance for uncollectible accounts
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 18
Learning Objective 3
Understand internal control, and
design and perform tests of
controls and substantive tests
of transactions for sales.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 19
Methodology for Designing Controls
and Substantive Tests
Understand internal control – sales
Assess planned control risk – sales
Determine extent of testing controls
Audit procedures
Design tests of controls and
Sample size
substantive tests of transactions
for sales to meet transactionItems to select
related audit objectives
Timing
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 20
Understand Internal Control –
Sales
Study the client’s flowcharts, prepare
an internal control questionnaire, and
perform walk-through tests of sales.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 21
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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 22
Assess Planned Control Risk –
Sales
 Adequate separation of duties
 Proper authorization
 Adequate documents and records
 Prenumbered documents
 Monthly statements
 Internal verification procedures
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 23
Determine Extent of Testing
Controls
 Audits of public companies
 Audits of nonpublic companies
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 24
Transaction-related Audit
Objectives for Sales
Occurrence:
Recorded sales are for shipments actually made.
Completeness:
Existing sales transactions are recorded.
Accuracy:
Recorded sales are for the amount shipped.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 25
Transaction-related Audit
Objectives for Sales
Posting and summarization:
Sales transactions are correctly included
in the accounts receivable master file.
Classification:
Sales transactions are correctly classified.
Timing:
Sales are recorded on the correct dates.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 26
Direction of Tests for Sales
Customer
order
Sales
journal
Shipping
document
Duplicate
sales
invoice
General
journal
Accounts
receivable
master file
Completeness
start
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
=
Occurrence
start
14 - 27
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)
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 28
Learning Objective 4
Apply the methodology for controls
over sales transactions to controls
over sales returns and allowances.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 29
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.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 30
Sales Returns and Allowances
There are, however, two important differences.
 Materiality
 Emphasis on objectives
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 31
Learning Objective 5
Understand internal control, and
design and perform tests of
controls and substantive tests
of transactions for cash receipts.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 32
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*
* Only performed when fraud is suspected
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 33
Learning Objective 6
Apply the methodology for
controls over the sales and
collection cycle to write-offs
of uncollectible accounts
receivable.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 34
Audit Tests for the Write-Off
of Uncollectible Accounts
 Occurrence transaction-related audit objective
 Proper authorization of the write-off of
uncollectible accounts
 Verification of accounts written off
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 35
Additional Internal Controls
Over Account Balances
 Realizable value
 Credit approval
 Aged accounts receivable trial balance
 Writing off uncollectibles
 Rights and obligations
 Presentation and disclosure
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 36
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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 37
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 appropriate evidence
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
14 - 38
End of Chapter 14
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley
14 - 39