Module 2 - Audit of the Sales and Collection Cycle

Question 1

What are the auditors responsibilities when it comes to internal controls testing for public and private companies?

Answer 1

Public company:

• Understand controls
• issue report on effectiveness of internal controls

Private company:

• Understand controls (no report required)

Question 2

What accounts are associated with the sales and collection cycle?

• Separate the accounts between transaction accounts and balance accounts:

Answer 2

Transaction related:

1. Sales
2. Sales returns and allowances
3. Bad Debt Expense

Balance related:

1. Cash
2. Accounts receivable
3. Allowance for doubtful accounts

Question 3

What are the 4 business functions related to Sales transaction account?

Answer 3

1. Processing customer orders
2. Granting Credit
3. Shipping goods
4. Billing customers and recording sales

Question 4

What forms and documents would be used for this business function:

Processing customer orders

Answer 4

Customer order form

External document for request of merchandise by customer

Sales Order form

Internal document that describes information of goods ordered by costomer

Question 5

What forms/documents would be used for this business function:

Shipping goods

Answer 5

Shipping document/Bill of Lading

• Prepared at time of shipment
• Describes merchandise
• Initiates billing upon shipment

Question 6

What transaction related audit objectives must be satisfied when inspecting this business function:

Billing customers and recording sales

Answer 6

Completeness**: All shipments have been billed

Occurence: No double billing

Accuracy: Each bill is correct amount

** Occurence is most important: look for controls that ensure completeness

Question 7

What documents would be associated with this business function:

Processing and recording cash receipts

Answer 7

Remittance Advice:

Document mailed to customer and returned to seller containing details of invoice amounts.(improves control of cash)

Prelisting of Cash Receipts:

List prepared when cash received by someone that has no access to accounting records (verifies cash was received/deposited at correct amounts)

Question 8

What document would be associated with this business function:

Processing and recording sales returns and allowances

Answer 8

Credit memos

Indicates reduction in amount due from customer; supports reductions to A/R

Question 9

What documents would be associated with this business function:

Writing off Uncollectible Accounts Receivable

Answer 9

Uncollectible account authroization form:

Internally generated by A/R department; allows authority to write off A/R

Question 10

Methodology for designing tests of controls and substantive tests

What steps do auditors go through to obtain an understanding of internal controls and design tests?

Answer 10

1. Understand internal control
2. Assess planned control risk
3. Determine extent of testing controls
4. Design tests of controls and substantive tests of transactions

Question 11

What steps can auditors perform to gain an understanding of internal controls?

Answer 11

• Study the client’s flowchart
• Perform internal control questionairre
• Perform walk-through (test of sales)
• Create audit documentation of assessed risks and controls in place

Question 12

What is the purpose of a walk-through?

Answer 12

To better understand these components of the business:

• The flow of information
• Key documents produced
• who’s involved
• What risks are present
• What controls mitigate risk

Question 13

What are control gaps?

Answer 13

Control risks found during the walk-through with no corrective internal controls in place to mitigate risk

Question 14

When two things should auditors keep in mind when assessing the planned control risk?

Answer 14

1. Do they have a control in place to mitigate assessed risk
2. Do they have the right kind of controls?

Question 15

What are some internal controls that can mitigate control risk in the sales and collection cycle?

Answer 15

• Proper separation of duties (S.O.D)
• Proper authorization of processes
• Adequate documentation
• Pre-numbered documents
• Monthly Statements
• Internal verification system

Question 16

How do these internal controls help reduce risk for sales and collection cycle:

• Pre-numbered documents
• Monthly Statements
• Internal verification system

Answer 16

Pre-numbered documents:

prevents ommision/duplication of documents

Monthly Statements:

Timely check of A/R balances

Internal verification system:

system to prevent certain actions until certain conditions have been fulfilled

Question 17

What emphasis do the PCAOB standards place on the sales cycle?

Answer 17

Auditors should have presumed risk of overstatement of sales due to fraud (high level of risk)

Question 18

What are some things that auditors should keep in mind when determining the extent of testing for controls?

Answer 18

1. Reliance on controls: the more a company relies on controls, the more testing required
2. Frequency of control: more times the control is executed. the more testing
3. Control risk has inverse relationship with evidence required

Question 19

What should auditors keep in mind when designing tests of controls:

Answer 19

Tests should solve to meet the specific audit objective that is being tested.

Question 20

Tracing vs. vouching

What are they?

What audit objective do these tests satisfy?

Answer 20

Tracing

From source documents to the journals

Completeness: tests for omitted transactions

Vouching

From journals to source documents

Occurence: Tests for nonexistent accounts

Question 21

What 3 misstatements should the auditor be concerned with regarding whether recorded sales have occured (occurence)?

Answer 21

1. Sales included in the journals for which no shipment was made
2. Sales recorded more than once
3. Shipments made to nonexistent customers