6. Sales And Transaction Cycle

Question 1

Steps of the sales process

Answer 1

• Processing customer orders
• Granting credit
• Shipping goods
• Billing customers and recording sales
• Processing and recording cash and bank receipts
• Processing and recording sales returns and allowances
• Writing off uncollectible accounts receivable
• Providing for bad debts

Question 2

How can you artificially increase revenues and manipulate their market price.

Answer 2

– Bill-and-Hold Transactions (customer agrees to purchase goods, but the seller retains possession until the customer requests shipment)

– Sales without substance, including funding the buyer, for example, so collection is assured

– Sales with a commitment from the seller to repurchase that, if known to the auditor, would preclude revenue recognition

– Sales with a guarantee by an entity financed by the seller of what would otherwise be viewed as an uncollectible receivable

– Shipping after a quarter ends, but keeping books open so revenue is recorded in that quarter (cut-off)

– Shipping in advance of the scheduled date without the customer’s agreement

– Shipping to a warehouse without the customer’s instructions

– Making sales in which substantial uncertainty exists about either collectability or the seller’s ability to comply with performance guarantees

Question 3

Revenue from sales recognition should be recognized at time of sale only if all of the following conditions are met:

Answer 3

• The seller’s price to the buyer is substantially fixed or determinable at the date of the sale
• The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product
• The buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product
• The buyer acquiring the product for resale has economic substance apart from that provided by the seller
• The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer
• The amount of future returns can be reasonably estimated

Question 4

Examples of red flags

Answer 4

Integrity of evidence
• Responses from management or employees to inquiries about sales transactions or about the basis for estimating sales returns are inconsistent, vague or implausible
• Documents to support sales transactions are missing
• Bills of lading have been signed by company personnel rather than a common carrier
• Documents such as shipping logs or purchase orders have been altered

Absence of an agreement
• Use of letters of intent in lieu of signed contracts or agreements
• Sales of merchandise that is shipped in advance of the scheduled shipment date without evidence of the customer’s agreement or consent for such shipment
• Sales recorded upon shipment of a product to customers have unilateral cancellation or termination provisions
• Sales in which evidence indicates the customer’s obligation to pay for the product is contingent on a resale to another party or the receipt of financing from another party

Question 5

4 steps to assess control risk

Answer 5

1. The auditor needs a framework for assessing control risk. This framework for all
   types of transactions consist of the following six transaction-related audit objectives:
   – Occurrence, Completeness, Accuracy, Posting and Summarization, Classification, Timing

2. The auditor must identify key internal controls and deficiencies for sales, such as:
– Adequate separation of duties
– Proper authorization
– Adequate documents and records 
– Prenumbered documents (e.g., numbered cash receipts, in order to check for missing 
numbers)
– Monthly statements
– Internal verification procedures

3. Controls and deficiencies should be associated with the objectives
4. The auditor assesses control risks for each objective by evaluating the controls and deficiencies for each objective

Question 6

On what does the extent of testing of controls depend?

Answer 6

– The effectiveness of the controls
– The extent to which the auditor believes they can be relied on to reduce control risk
– The cost of the increased tests of controls compared to the potential reduction in substantive tests

Question 7

What is the Impact of the Results of Tests of Controls and

Substantive Tests of Transactions?

Answer 7

• Results of tests of controls and substantive tests of transactions substantially impact the remaining audit of the sales and collection cycle (particularly on the tests of details of balances)
• If tests of controls and substantive tests of transactions are not satisfactory, further substantive tests of transactions are required

• After the tests of controls and substantive tests of transactions, each deviation must be analyzed in order to assess the impact on the assessed control risk (which impacts the planned detection risk) and determine the
extent of the remaining substantive tests of transactions

Question 8

State the nine general management assertions for accounts

Answer 8

– Detail tie-in
– Existence
– Completeness 
– Accuracy (of amounts booked)
– Classification (of debtors)
– Cut-off
– Realizable value
– Rights
– Presentation and disclosure