Audit of the Sales and
Collection Cycle
Chapter 11
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Learning Objective 1
Identify the accounts and the
classes of transactions in the
sales and collection cycle.
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Accounts in the Sales
and Collection Cycle
Sales
Cash
sales
Sales on
account
Cash in Bank
Accounts Receivable
Beginning Cash receipts
balance
Sales returns
Sales on
and allowances
account
Charge-off of
Ending
uncollectible
balance
accounts
Cash Discounts
Taken
Sales Returns
and Allowances
Bad Debt
Expense
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Accounts in the Sales
and Collection Cycle
Accounts Receivable
Beginning Cash receipts
balance
Sales returns
Sales on
and allowances
account
Charge-off of
Ending
uncollectible
balance
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
Identify the business functions
and the related documents and
records in the sales and
collection cycle.
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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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Sales Transaction
Accounts
Sales
Accounts receivable
Business
Functions
Processing customer orders,
Granting credit, Shipping goods,
Billing customers and recording sales
Sales invoice, Sales journal or listing, Sales
Documents
transaction file, Accounts receivable master
and Records
file and trial balance, Monthly statements
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Cash Receipts Transaction
Accounts
Cash in bank (debits from cash receipts)
Accounts receivable
Business
Functions
Processing and recording cash receipts
Remittance advise, Prelisting of cash receipts,
Documents
Cash receipts transaction file,
and Records
Cash receipts journal or listing
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Sales Returns and
Allowances Transaction
Accounts
Sales returns and allowances
Accounts receivable
Business
Functions
Processing and recording
sales returns and allowances
Documents Credit memo
and Records Sales returns and allowances journal
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Charge-off of Uncollectible
Accounts Transaction
Accounts
Accounts receivable
Allowance for uncollectible accounts
Business
Functions
Charging off uncollectible
accounts receivable
Documents Uncollectible account authorization form
and Records General journal
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Bad Debt Expense
Transaction
Accounts
Bad debt expense
Allowance for uncollectible accounts
Business
Functions
Providing for bad debts
Documents
General journal
and Records
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Shipping Goods
This is the first point in the cycle
where company assets are given up.
Shipping
document
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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
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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Understanding Internal
Control – Sales
Study the client’s flowcharts,
prepare an internal control
questionnaire, and perform
walk-through tests of sales.
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Methodology for Designing Controls
and Substantive Tests: Sales
Understand internal
control – sales
Assess planned
control risk – sales
Evaluate cost-benefit
of testing controls.
Design tests of controls
and substantive tests
of transactions for sales
to meet transactionrelated audit objectives.
Audit procedures
Sample size
Items to select
Timing
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Assess Planned
Control Risk – Sales
Adequate separation
of duties
Adequate documents
and records
Monthly statements
Proper authorization
Prenumbered
documents
Internal verification
procedures
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Internal Verification Procedures
Evaluate cost-benefit
of testing controls.
Design tests of
controls for sales.
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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.
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Design Substantive Tests
of Transactions 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.
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Direction of Tests for Sales
Customer
order
Shipping
document
Duplicate
sales invoice
Completeness Start
Sales
journal
General
ledger
=
Accounts
receivable
master file
Existence Start
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Summary of Methodology
for Sales
Column 1: Transaction-related audit objectives
Column 2: Key internal controls
Column 3: Test of controls
Column 4: Weaknesses
Column 5: Substantive tests of transactions
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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.
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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
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Additional Internal Controls
Over Account Balances
Realizable value
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
Bad debt
expense
Cash
Allowance for
doubtful accounts
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Role of all Audit Tests in the
Sales and Collection Cycle
Sales
Sales
transactions
Accounts
Receivable
Audited by
TOC, STOT, and AP
Ending
balance
Cash receipts
transactions
Cash in
Bank
Audited by
TOC, STOT, and AP
Ending
balance
Audited by AP and TDP
TOC + STOT + AP + TDP
= Sufficient competent evidence per GAAS
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End of Chapter 11
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
11 - 36