AUDIT OF THE SALES AND

COLLECTION CYCLE: TESTS OF

CONTROLS AND SUBSTANTIVE
TESTS OF TRANSACTIONS
LEARNING OBJECTIVE 1
Identify the accounts and the classes of transactions in the sales and collection cycle.
ACCOUNTS IN THE SALES
AND COLLECTION CYCLE
Sales Cash in Bank
Cash
sales
Accounts Receivable Cash Discounts
Sales on Taken
account Beginning Cash receipts
balance

Sales on Sales returns Sales Returns

account and allowances and Allowances

Ending Write-off of
balance uncollectible Bad Debt
accounts Expense
ACCOUNTS IN THE SALES
AND COLLECTION CYCLE
Allowance for
Accounts Receivable Uncollectible Accounts
Beginning Cash receipts Write-off of Beginning
balance uncollectible balance
accounts
Sales on Sales returns Estimate of
account and allowances bad debt
expense
Ending Write-off of
balance uncollectible Ending
accounts balance
Bad Debt
Expense
LEARNING OBJECTIVE 2
Describe the business functions and the related documents and records in the sales
and collection cycle.
SALES TRANSACTION
Accounts Business Functions Documents and Records
Sales Processing Customer order
Accounts customer orders Sales order
Customer order or
receivable sales order
Granting credit Shipping document
Shipping goods Sales invoice
Billing customers Sales transaction file
and recording Sales journal or listing
sales Accounts receivable
master file
Accounts receivable
trial balance
Monthly statements
CASH RECEIPTS
TRANSACTION
Accounts Business Functions Documents and Records
Cash in bank Processing and Remittance advice
(debits from recording cash Prelisting of cash
cash receipts) receipts receipts
Accounts Cash receipts
receivable transaction file
Cash receipts journal
or listing
SALES RETURNS AND
ALLOWANCES
Accounts
TRANSACTION
Business Functions Documents and Records
Sales returns Processing and Credit memo
and recording sales Sales and returns and
allowances returns and allowances journal
Accounts allowances
receivable
WRITE-OFF OF
UNCOLLECTIBLE ACCOUNTS
TRANSACTION
Accounts Business Functions Documents and Records
Accounts Writing off Uncollectible account
receivable uncollectible authorization from
Allowance for accounts general journal
uncollectible receivable
accounts
BAD DEBT EXPENSE
TRANSACTION
Accounts Business Functions Documents and Records
Bad debt Providing for bad General journal
expense debts
Allowance for
uncollectible
accounts
PROCESSING CUSTOMER
ORDERS
Customer Order:
 A request for merchandise by a customer

Sales Order:
 A document describing the goods ordered
by a customer
GRANTING CREDIT
 Before goods are shipped, a properly
authorized person must approve credit
to the customer for sales on account
SHIPPING GOODS
 This is the first point in the cycle
where company assets are given up
BILLING CUSTOMERS AND
RECORDING SALES
 Sales invoice

 Sales transaction file

 Sales journal or listing

 Accounts receivable master file

 Accounts receivable trial balance

 Monthly statement
PROCESSING AND
RECORDING CASH RECEIPTS
 Remittance advice

 Prelisting of cash receipts

 Cash receipts transaction file

 Cash receipts journal or listing

PROCESSING AND
RECORDING SALES RETURNS
AND ALLOWANCES
 Credit memo

 Sales returns and allowances journal

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
PROVIDING FOR BAD DEBTS
 This provision represents a residual,
resulting from management’s
end-of-period adjustment of the
allowance for uncollectible accounts
LEARNING OBJECTIVE 3
Understand internal control, and design and perform tests of controls and substantive
tests of transactions for sales.
METHODOLOGY FOR DESIGNING
CONTROLS AND SUBSTANTIVE TESTS
Understand internal control – sales

Assess planned control risk – sales

Determine extent of testing controls

Design tests of controls and Audit procedures

substantive tests of transactions Sample size
for sales to meet transaction- Items to select
related audit objectives Timing
UNDERSTAND INTERNAL
CONTROL – SALES
Study the client’s flowcharts, prepare
an internal control questionnaire, and
perform walk-through tests of sales.
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

ASSESS PLANNED CONTROL
RISK – SALES
 Adequate separation of duties
 Proper authorization
 Adequate documents and records
 Prenumbered documents
 Monthly statements
 Internal verification procedures
DETERMINE EXTENT OF
TESTING CONTROLS
 Audits of public companies

 Audits of nonpublic companies

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.
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.
DIRECTION OF TESTS FOR
SALES
Duplicate
Customer Shipping
sales
order document
invoice

Accounts
Sales General
= receivable
journal journal
master file

Completeness Existence
start start
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)
LEARNING OBJECTIVE 4
Apply the methodology for controls
over sales transactions to controls
over sales returns and allowances.
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.
SALES RETURNS AND
ALLOWANCES
There are, however, two important differences.

 Materiality

 Emphasis on objectives
LEARNING OBJECTIVE 5
Understand internal control, and
design and perform tests of
controls and substantive tests
of transactions for cash receipts.
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
LEARNING OBJECTIVE 6
Apply the methodology for
controls over the sales and
collection cycle to write-offs
of uncollectible accounts
receivable.
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

ADDITIONAL INTERNAL
CONTROLS OVER ACCOUNT
BALANCES
 Realizable value

 Credit approval

 Aged accounts receivable trial balance

 Writing off uncollectibles

 Rights and obligations

 Presentation and disclosure

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

TYPES OF AUDIT TESTS FOR
THE SALES AND COLLECTION
CYCLE
Sales
Accounts
Receivable
Cash in
Bank
Sales Cash receipts
transactions transactions

Audited by Audited by
TOC, STOT, and AP TOC, STOT, and AP

Ending Ending
balance balance

Audited by AP and TDB

TOC + STOT + AP + TDB

= Sufficient appropriate evidence
END OF CHAPTER