CHAPTER 12

Audit of the Sales and

Collection Cycle:
Tests of Controls

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What accounts are typically involved in the sales and
collection cycle?

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What accounts are typically involved in the sales and
collection cycle?

- sales
- sales returns and allowances
- bad debt expense
- cash discounts taken
- trade accounts receivable
- allowance for uncollectible
accounts
- cash in the bank Copyright 2003 Pearson Education Canada Inc. 12 - 3
What classes of transactions occur in the sales
and collection cycle?

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What classes of transactions occur in the sales
and collection cycle?

- sales (cash and credit)

- cash receipts
- sales returns and allowances
- charge-off of uncollectible
accounts
- bad debt expense
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What is the sequence of business functions
that occurs in the sales and collection
cycle?

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 What is the sequence of
business functions that occurs
in the sales and collection cycle?

1. A customer order is processed.

Pace Company
Customer Order
To: Ace Company
Please send us 45 gadgets on or
before 10/25/04. Upon receipt, we
will send payment of $3 each.

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 What is the sequence of
business functions that occurs
in the sales and collection cycle?

2. Customer credit is approved or

declined.

If credit is extended to a
customer, will that customer
pay their balance at some
point in the future?

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 What is the sequence of
business functions that occurs
in the sales and collection cycle?

3. Sale Order is Prepared

Ace Company
Sales Order
Quantity, description of goods.

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 What is the sequence of
business functions that occurs
in the sales and collection cycle?

4. The goods are shipped.

Ace Company
Shipping Document
(Bill of Lading)
45 gadgets were
shipped to Pace
Company on
10/22/04.

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 What is the sequence of
business functions that occurs
in the sales and collection cycle?

5. The customer is billed and the sale is

recorded.

Ace Company
Sales Invoice
To: Pace Company
Date: 10/22/04
Thanks for purchasing 45 gadgets.
Please remit $135 ($3 each) within 30 days.

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 Ace Company
Sales Invoice
To: Pace Company
Date: 10/22/04
Thanks for purchasing 45 gadgets.
Please remit $135 ($3 each) within 30 days.

a/r master file

sales journal customer _ $$ _
description _ $$ Pace Company 135
_ balance 135
Oct. 22, 2004
Pace Company 135

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 sales journal a/r master file
description _ $$ _ customer _ $$ _
Oct. 22, 2004 Pace Company 135
Pace Company 135 balance 135

Summary Accounts
Sales Receivable
Report Trial Balance
This report sum-
This report lists
marizes all sales
the amount owed
for a period.
by each customer
at a point in time.

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 a/r master file
customer _ $$ _
Pace Company 135 At month-end,
balance 135
customer state-
ments are mailed
indicating activity
Accounts and amount owed.
Receivable
Trial Balance
Ace Company Canada 48

This report lists

the amount owed Pace Company
by each customer
at a point in time.

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 What is the sequence of
business functions that occurs
in the sales and collection cycle?

5. Cash receipts are processed and recorded.

Remittance Advice
Ace Company Canada 48

Pace Company
Pace Company
Ace Company

CANADIAN BANK

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 A remittance advice is sent to the cus-
tomer with the sales invoice. It indicates
Ace Company Canada 48
the customer name, sales invoice num-
ber, and
Paceamount
Companyowed. The advice is re-
turned to theAce
vendor with
Pacethe
Company customer
Company
payment.
CANADIAN BANK

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Remittance Advice
Ace Company Canada48

Pace Company
Ace Company
Pace Company

CANADIAN BANK

A prelisting of cash receipts

is prepared each day by some-
one independent of accounting
and cash custody. The prelisting
indicates each cash receipt.
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 Remittance Advice
Ace Company Canada 48

Pace Company
Ace Company
Pace Company

CANADIAN BANK

a/r master file

cash receipts journal customer _ $$ _
description _ $$ _ Pace Company 135
Nov. 2, 2004 payment-11/2 (135)
Pace Company 135 balance 0

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 CREDIT MEMO
When a vendor grants credit
to a customer for returned
goods, a credit memo is
prepared and the transac-
tion is recorded in the sales
returns and allowances
journal.
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AUTHORIZATION FOR
UNCOLLECTIBLE
ACCOUNT WRITE-OFF
This form is used when a
specific accounts receivable
is judged uncollectible.

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How does an auditor
design tests of
controls for sales?

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 Understand internal
As discussed control as it relates
in chapter 9 to sales

How does an auditor

design tests of
controls and
substantive tests for
sales?

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 Understand internal
control as it relates
to sales
Assess the planned
How does an auditor control risk related
design tests of to sales
controls and
substantive tests for
sales?

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 Understand internal
control as it relates
In assessing control risk, the to sales
auditor should consider:
Assess the planned
control risk related
to sales

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 In assessing control risk, the
Understand internal
auditor should consider: control as it relates
to sales
- adequate segregation Assess the planned
of duties control risk related
- proper authorization to sales
- adequate documents
and records
- use of prenumbered
documents
- mailing of monthly
statements
- internal verification
procedures Copyright 2003 Pearson Education Canada Inc. 12 - 25
 Understand internal
control as it relates
to sales
Assess the planned
How does an auditor control risk related
design tests of to sales
controls and Evaluate
cost-benefit
substantive tests for of testing
sales? controls

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 Understand internal
control as it relates
to sales
Assess the planned
control risk related
Will substantive to sales
tests be reduced Evaluate
cost-benefit
sufficiently to of testing
justify the cost of controls
performing tests
of controls?

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 Understand internal
control as it relates
to sales
Assess the planned
control risk related
How does an auditor to sales
design tests of Evaluate
cost-benefit
controls for sales? of testing
controls

Design tests of controls

for sales

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 Understand internal
control as it relates
In designing other tests to sales
of controls for sales, the
auditor should consider: Assess the planned
control risk related
to sales
Evaluate
cost-benefit
of testing
Do recorded controls
sales actually
Design tests of controls
exist? for sales

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 Understand internal
control as it relates
In designing other tests to sales
of controls for sales, the
auditor should consider: Assess the planned
control risk related
to sales
Evaluate
Are all cost-benefit
of testing
existing sales controls

transactions Design tests of controls

for sales
recorded?
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 Understand internal
control as it relates
In designing other tests to sales
of controls for sales, the
auditor should consider: Assess the planned
control risk related
to sales
Evaluate
cost-
Are sales benefit
of testing
accurately controls
Design tests of controls
recorded? for sales

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 Understand internal
control as it relates
In designing other tests to sales
of controls for sales, the
auditor should consider: Assess the planned
control risk related
to sales
Evaluate
cost-benefit
Are recorded of testing
controls
sales properly
Design tests of controls
classified? for sales

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 Understand internal
control as it relates
In designing other tests to sales
of controls for sales, the
auditor should consider: Assess the planned
control risk related
to sales
Evaluate
Are sales cost-benefit
of testing
recorded on controls
the correct Design tests of controls
for sales
dates?
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 Understand internal
control as it relates
In designing othe tests of to sales
controls for sales, the
auditor should consider: Assess the planned
control risk related
to sales
Evaluate
Are sales
cost-benefit
transactions of testing
properly included controls
in the master file
and correctly Design tests of controls
summarized? for sales

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The auditor should also perform procedures
to detect fraud related to cash receipts.

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The auditor should also perform procedures
to detect fraud related to cash receipts:

Determine whether
cash received was
recorded.

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The auditor should also perform procedures
to detect fraud related to cash receipts:

Prepare a proof
of cash receipts.

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The auditor should also perform procedures
to detect fraud related to cash receipts:

A proof of
cash receipts
reconciles cash
receipts record-
ed in the cash
receipts journal
with actual bank
deposits.
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The auditor should also perform procedures
to detect fraud related to cash receipts:

Test to discover
lapping of accounts
receivable.

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 Lapping is a fraud
scheme that occurs
because of inadequate
segregation of duties
related to mail, cash
receipts, and
accounting.
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 a lapping example
A/R A/R A/R
Able $1000 Baker $1000 Cain $1000

CANADIAN BANK

On Monday, a cheque is received from

Able Co. in payment of their a/r. The
cheque is stolen by the bookkeeper! No
entry is made and all evidence of the
payment receipt is destroyed.
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 a lapping example
A/R A/R A/R
Able $1000 Baker $1000 Cain $1000
-1000
0

CANADIAN BANK

On Tuesday, a cheque is received from

Baker Co. in payment of their a/r. The
payment, however, is credited to Able’s
account.
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 a lapping example
A/R A/R A/R
Able $1000 Baker $1000 Cain $1000
-1000 -1000
0 0

CANADIAN BANK

On Wednesday, a cheque is received

from Cain Co. in payment of their a/r.
The payment, however, is credited to
Baker’s account.
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What audit procedures may
detect lapping?

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 What audit procedures may
detect lapping?
- a/r confirmations (disputed balances,
disputed timing of payments)
Canada 48

client

client’s a/r customer

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 What audit procedures may
detect lapping?

- a/r confirmations (disputed balances,

disputed timing of payments)

- comparison of deposit slips to cash

receipts journal (different amounts,
different timing)

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Other than adequate segregation of duties, what
client internal control may prevent or detect
lapping?

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Other than adequate segregation of duties, what
client internal control may prevent or detect
lapping?

required
vacations
(and rotation of
duties during
vacations)

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Attributes Sampling Sequence

The attributes
sampling sequence is
similar to that of audit
sampling. The same
credit approval example
will be used to illustrate
attributes sampling.

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