Revenue & Receipts Cycle
–Internal Controls &
Test of Controls
REFERENCES
• Internal control knowledge
• International Standard on Auditing (ISA) 315 &330
“Identifying and assessing the risks of material misstatement
through understanding the entity and its environment” and
responding thereto – selected paragraphs
LEARNING
OUTCOMES
Revenue & receipts system; controls readdressed (Revision)
Mostly self study
1. Understand the internal control structure of the cycle including major
classes of transactions and affected accounts
2. Understand and describe the cycles functional areas
3. Design a system of controls for the revenue and receipt cycle
4. Identify and explain weaknesses in the control systems and make
recommendations for improvement
Auditors application
1. Understand the decision tree for deciding on when to follow a “test of
control” approach
2. Identify and describe the “key internal controls” on which to place
reliance
3. Understand the direction of testing when performing tests on the key
internal controls
4. Describe the test of control procedures
5. Understand the consequences of exceptions found during the testing of
internal controls
INTRODUCTION
TO THE CYCLE
•Classes of transactions affected:
SALES and SALES RETURNS (revenue)
RECEIPT transactions (movements in cash & bank balances)
•Account balances affected:
ACCOUNTS RECEIVABLE (Including trade debtors and
allowances for doubtful debts)
CASH and BANK
Consider:
2.1 Variation amongst entities
2.2 Cash sales
2.3 Credit sales
2.4 Legislation
BASIC FUNCTIONS
IN THE CYCLE
AN 10/2-10/3
Assumption: wholesale entity selling goods to customers on credit:
Receiving
customer
orders
Warehousing
& Despatch of
inventory
Invoicing
customers
Credit
management
Receiving &
recording of
payments
from debtors
Recording
sales and
raising
debtors
Other: Sales returns & adjustments (credit notes);
Granting of discounts; Write-offs of bad debt
CONTROL ACTIVITIES
IN THE CYCLE
Categories of control activities
Approval and authorisation
What level of staff should
approve/authorize?
Segregation of duties
Between execution, authorization,
custody of asset, recording.
Isolation of responsibility
Employee acknowledges performing duty
Access and custody controls (security)
Protecting assets and information
Comparisons and reconciliations
Between what? Who performs it?
INFORMATION FLOW
IN THE CYCLE
Functional area and
Accounting entries
documents/records prepared
in general ledger
Credit management
•Credit application form
None
Order department
•Customer order
•Internal sales order
None
Warehouse/despatch
•Picking slip
•Delivery note
[Inventory items removed
from inventory register.
G/L entries depend on
periodic vs. perpetual].
INFORMATION FLOW
IN THE CYCLE
Functional area and
Accounting entries
documents/records prepared
in general ledger
Invoicing
•Customer invoice
None
Recording of sales
•Sales journal
•Debtors ledger
Debit Trade debtors
Credit Sales
Receiving cash
•Receipt
•Deposit slip
•Remittance register
None
INFORMATION FLOW
IN THE CYCLE
Functional area and
Accounting entries
documents/records prepared
in financial records
\
Recording of receipts
• Cash book
•Debtors ledger
Debit Bank
Credit Trade debtors
Sales returns and adjustments
• Goods returned voucher (GRV)
• Credit note
Debit (Returns)/sales
Credit Trade debtors
BOOKKEEPING
IN THE CYCLE
•ISO
•DN
Sales journal
General ledger
INV
•Remitt adv.
•Bank stmt.
•Dep. slip
•Receipt
Debtors ledger
Cash book
General ledger
Debtors ledger
Trial balance
Reconciliations:
Bank recon: Bank statement & GL (cash book)
Debtors recon: Debtors ledger & GL debtors control a/c
Financial statements
OBJECTIVES OF INTERNAL CONTROLS (REVISION)
Validity
Completeness
Accuracy
A proper accounting system and related internal controls
will achieve the “control objectives” of Validity, Accuracy and
Completeness of financial information.
•Why does management want V, A and C of financial information?
•Why is an auditor interested in whether controls achieve V, A, C?
AUDIT APPROACH
(REVISION)
Tests of Controls
Performed to obtain audit
evidence of:
• The suitability of the design
of the accounting and internal
control system
• The effective operation of
the system throughout the
period of reliance.
Conclude on the
Control Objectives
Textbook 5/26-27
Substantive Procedures
Performed to obtain evidence to
detect material misstatements in the
financial statements
Consist of:
• Tests of detail of transactions,
balances and disclosures;
•Analytical procedures
Conclude on the
Management Assertions
TESTS OF CONTROLS
- INTRODUCTION
Tests of controls must be performed when (ISA 315, para. 08):
• Risk assessment includes an expectation that controls
are operating effectively
• Risks identified for which substantive procedures alone
do not provide sufficient appropriate evidence
However, even if test of control approach followed, substantive
procedures are compulsory for each material class of
transactions, account balance and disclosure (ISA 330, para. 18)
TESTS OF CONTROLS
- NATURE
Purpose of audit procedures (including tests of controls):
Are the financial statements fairly presented?
:: Focus is thus on the recorded financial information ::
Are there controls in place that can achieve fair presentation through
 Validity,
 Accuracy and
 Completeness
of recorded financial information?
If so, perform test procedures on those controls to determine whether:
 there is evidence of the control having taken place;
 the control operated effectively as intended.
TESTS OF CONTROLS
- NATURE
Perform tests of controls by applying the following procedures:
 Inquiry
 Observation
 Inspection
Evidence control took place
 Reperformance
Evidence control operated effectively
Example:
Manager’s signature on bank recon as evidence of review: Really
reviewed? Reviewed it appropriately?
Therefore, reperform to obtain evidence on operating
effectiveness of the control.
TESTS OF CONTROLS
- NATURE
Direction of testing NB
When we select a sample for testing from where do we make the
selection ?
 Validity & Accuracy: –
the population is the transactions already recorded
from recorded transaction to source document.
i.e. journals/books of prime entry such as the sales journal to the invoice
 Completeness: –
the population is the first record or source document of the transaction
from source document to the recorded transaction
i.e. delivery note to the recorded entry in the sales journal, thus
Applying an incorrect direction of testing when answering a
question will lead to an irrelevant/incorrect answer.
TESTS OF CONTROLS
- EXTENT
“Extent” = “How much to test”
The more reliance placed on controls, the more tests of
controls to perform on those controls in order to
JUSTIFY the reliance.
• However, not test ALL controls (impractical and costly)
• Test only KEY controls (those wish to place reliance on)
• ISA 315, para. A60: “Not all … controls are relevant to the
auditor’s risk assessment.”
•Which controls are “KEY”?
“Key” = measure of extent to which the control addresses the risk
involved.
TESTS OF CONTROLS
- EXTENT
Which controls are “KEY”?
Example: consider RISK OF INCOMPLETE recording of sales
transactions in sales journal:
Control 1: “Invoices are pre-printed and sequentially numbered”
vs.
Control 2: “The senior bookkeeper reviews the sequential
numbering of invoices recorded in the sales journal and follows
up on missing entries”.
Which is “KEY” control?
Distinguish between key controls and
mere supporting (indirect) controls!
TESTS OF CONTROLS
- TIMING
“Timing” = “When to test”
• Tests of control can be performed several months before year end
(“interim audit”).
• Advantages of this include:
Time & opportunity to amend the substantive audit program
(in case exceptions found and reliance not justified);
Reduce time pressure during final audit.
• However, the auditor needs evidence about the operation of controls
throughout the year (ISA 330 para 12).
• Thus also test intervening months between interim and year-end.
TESTS OF CONTROLS
- EXCEPTIONS
Exceptions occur when a internal control procedure is:
• not applied
• not applied correctly and consistently
• applied by an unauthorised person
NOTE: An exception in a transaction of R 1 million carries the same
weight as an exception in a transaction of R 1. Why?
Accordingly, tests of controls are NOT value orientated! The control
is tested, and not the underlying financial value.
What if exceptions in internal controls are found by auditor?
I.e. impact on audit approach?
ANSWERING “TEST OF CONTROL” QUESTIONS IN THE CYCLE
1. Identify key control in scenario (i.e. controls you’d rely on for purpose
of concluding on fair presentation of financial information)
2. Identify control objective applicable (V, A and/or C)
3. Determine direction of testing (recorded financial information to
supporting doc or supporting doc to recorded financial information)
4. State selection and source of sample (e.g. sales journal / invoices)
5. Consider hierarchy of audit evidence reliability (source, nature)
6.
Formulate and describe test of control procedure
 inquire, observe, inspect: evidence that control took place
 reperform: test operating effectiveness of control.
[Audit verb]
[Party/Process/Document]
[Purpose]
EXAMPLE
YOU ARE REQUIRED TO: Identify internal control procedures present in the system
that you would wish to place reliance on, and describe test of control procedures you
would perform to obtain reliable evidence about the performance of each control
identified.
SYSTEM
You are the senior in charge of the audit of Office Space (Pty) Ltd, a wholesale
company which sells office furniture. During the planning phase of the current audit
you established that the system for the processing of sales is as follows:
Sales Orders
Orders are received from retailers across the country. The majority of orders are
faxed to the company, while some are received by phone. A sales order clerk writes
out a sequentially numbered internal sales order (ISO) for both the fax and
telephone orders. A second sales order clerk checks the calculations on the ISO back
to the faxes received.
Credit Control
The sequentially numbered ISOs are, from time to time, passed to the credit
controller during the day who confirms that the customer is still within his/her
credit limit and authorizes the sale by signing the order. The ISOs are given back to
the sales order clerk who transfers a copy of the ISO to the head of stores.
Suggested solution: Office Space (Pty) Ltd
Internal control
procedure
1.
Credit control:
Credit controller
assesses the
credit-worthiness
of each customer
and authorizes
each sale by
signing the ISO.
(Validity of sales :
Authorization)
Test of control
1.1. Select a sample of sales transactions
recorded in sales journal, follow through to
the supporting invoice and:
1.1.1
Inspect the corresponding ISO for
the approval signature of the credit
controller.
(Note: direction of testing)
1.2. Enquire of management regarding the
reliability of the credit control function.
1.3. Enquire of the credit controller regarding his
function and the likelihood of fictitious/invalid
orders getting past him/her.
1.4. Reperform the creditworthiness check to
confirm the check was properly performed by
the credit controller (operating effectiveness).
Warehousing and Dispatch
The head of stores, on the authority of the signed ISO, requests a store man to pick
the goods from the store and authorizes the store man to transfer the goods to the
dispatch clerk. The head of stores agrees the ISO to the goods actually picked, then
stamps the order "filled" and signs it.
The dispatch clerk prepare a sequentially pre-numbered delivery note for each
order. The delivery note and the ISO are cross-referenced. The fast copy remains in
the delivery note book and the two top copies are torn out and packed, with the
boxed goods, into the delivery truck.
Gate control personnel conduct checks on the trucks leaving the premises by
checking that all goods in the truck appears on the delivery note accompanying the
goods.
The top copy of the delivery note is left with the customer and the second copy is
signed by the customer to be returned to the invoicing section.
Internal control procedure
2.
Gate control
Gate personnel conduct
checks on goods leaving
the premises.
(Completeness of
sales)
3.
Customers are required
to sign delivery notes as
acknowledgement of
receipt of goods.
(Validity of sales :
Authenticity)
Test of control
2.1 Observe the checking of trucks and
goods by gate control personnel.
2.2 By reperformance, select trucks
leaving the premises and compare the
content with the accompanying delivery
note.
2.3 Enquire of management as to the
reliability of the gate control and any
problems which may have occurred.
2.4 Enquire of the gate control personnel
regarding their function to ensure
they understand what is expected of
them.
3.1 For the sample of sales invoices
selected in 1.1 above:
 agree by inspection of the invoice
the corresponding customer signed
delivery note to confirm evidence
of the customer ‘s
acknowledgement of receipt.
(Note: direction of testing)
Invoicing
On the basis of the information on the delivery note and an authorized price list, an invoicing
clerk prepares a sequentially pre-numbered invoice. The invoice and the delivery note are
cross referenced. The details and casts and extensions on the invoice are checked by the
invoicing supervisor who signs the fast copy as evidence of this check. The top copy is then
mailed to the customer.
Recording of Sales
The fast copy of the invoice is recorded, in number order, in the sales journal by the accounts
receivable clerk. On a daily basis, the senior bookkeeper checks each sales entry in the sales
journal by comparing the recorded amount to the invoiced amount. He ticks the entry as
evidence of performing the check.
The delivery note is then filed with a copy of the invoice in number order and the sequence
thereof is checked by the invoicing supervisor to ensure all delivery notes have been
invoiced. He signs completed batches as evidence of the check.
4.
Internal control procedure
Test of control
Invoicing
4 For the sample of sales invoices selected in 1.1
The senior bookkeeper
above:
agrees the amounts
4.1 Inspect the entry in the sales journal for
recorded in the sales
evidence of the senior bookkeeper’s tick
journal with the amounts
evidencing his check on the recorded amount.
on the invoices and ticks
each entry in the sales
4.2 Follow the entry through to the invoice and
journal as evidence of
inspect the invoice for the signature of the
performing the check.
invoice supervisor indicating her check on
mathematical accuracy.
The details and casts and
extensions on the invoice
By reperformance, test the operating effectiveness
are checked by the
of the controls as follows:
invoicing supervisor who
signs the fast copy as
4.3 the quantity from the delivery notes have been
evidence of this check.
correctly carried across to the invoice;
4.4 the prices on the invoices are in accordance with
(Accuracy of revenue)
the authorized price list;
4.5 each invoiced amount has been correctly
recorded in the sales journal;
4.6 casts and extensions are correct on invoice and
in the sales journal.
Internal control procedure
5.
Invoicing:
The delivery note is filed
in number order with the
invoice and the
sequence thereof is
checked by the invoicing
supervisor, who signs
completed batches as
evidence of the check.
(Completeness of
revenue)
Test of control
5.1 Inspect the batches of the delivery
notes in the invoicing section for
signature of the invoicing
supervisor indicating the sequence
check for completeness of invoiced
delivery notes.
5.2 Reperform the sequence check on
delivery notes.
Select a sample of delivery notes and,
using the cross-referencing, inspect
the corresponding fast copy invoice,
and trace the invoice to the sales
journal.
(Note: direction of testing)
END
Thank you!
Dankie!
Enkosi Kakhulu!!
ANSWER TECHNIQUE
When answering “weakness” questions, remember the following:
 Read the scenario and the ‘required’ very carefully!
 Know the difference between ‘identify’, ‘explain’ and ‘recommend’.
‘Weakness’ should be in detail and must be relevant to the scenario and required.
‘Explanation’ should explain “what can go wrong/what are the risks involved”.
 Recommendation must be in detail : specify the actual control procedure and
not simply the control objective:
e.g. “All sales should be recorded” (control objective)
vs.
“Sequential numbering of recorded invoices in the sales
journal should be reviewed by Mr A Countant on a
regular basis for missing numbers (control procedure)
ANSWER TECHNIQUE
(CONTINUED)
The following is not acceptable when answering weakness questions:

Stating the control activity category as a weakness (e.g. “No division of duties”)
rather than the control weakness in the activity itself (e.g. “Person receiving orders
from customers also ships inventory items to customers”).

Making vague references to responsibility levels, e.g. stating a control procedure
should be performed by a “second clerk” or “a senior staff member” if the scenario
clearly indicates the titles of the positions in the entity and the staff members’
names. (e.g. “financial accountant”/Mr A Countant).

Making assumptions that are not relevant to the scenario or the type of business.

Allocating tasks to incorrect levels of authority, e.g. “financial manager should
perform the bank reconciliation” while there clearly is a bookkeeping clerk
available to do so. Clerks are the staff performing most functions and executing
most controls! Senior staff and management approve, authorize and review etc.