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Chapter 8 Audit of the Sales and Receipts Cycle
1. Objectives
1.1 To describe the documents and records that are usually found in the sales and
receipts cycle.
1.2 To state the general audit procedures for the test of internal controls of this
cycle.
1.3 To mention the substantive tests used for the trade debtors.
2. Documents and Records
2.1 Customer order (客戶訂單) – a request for goods from an existing or a new
customer received by sales representative or other personnel in the sales
department.
N8-1
2.2 Sales order (銷售訂單 ) – a document recording the description, quantity
and/or related information of the goods and services ordered to confirm the
order received. It is also used internally for credit approval and
authorization for delivery of goods or services.
2.3 Shipping document/goods delivery note (送貨單) –
(a) a document prepared at the time when the goods are shipped or
delivered, detailing the description, the quantity shipped and other
relevant data.
(b) bill of lading (提單 ) is an example of the shipping document that is
prepared by the carrier to acknowledge the receipts of goods and also
serves as a notice to customer for shipment by the seller.
N8-2
Basic Contact Details of Company
To: Date: 21 June 2007
Goods Delivery NoteNo.: DN/02/6/104
Cat. No. Product Name Quantity
1. B201 Japan-made Blue Ball Pen 15 dozens
2. R440 China-made Pencil and Eraser 20 dozens
Remarks:
If there is any defect, please inform us immediately. Returns will not be accepted
after 7 days.
N8-3
Representative Signature Recipient Signature
& Company Chop
E & E O
2.4 Sales invoice – a document indicating the details of goods sold, such as
descriptions, quantity, terms of sales and the total price billed.
2.5 Sales journal (sales day book) – a journal for recording sales and it serves as
a posting summary to the general ledger.
2.6 Credit note (貸記單)
(a) It is raised as a result of approval for customers’ returns or granting
allowances to customers.
(b) Its function is like an invoice but acts in the opposite way that it
indicates the amount to be deducted from a customer’s account.
2.7 Sales returns and allowances journal – similar to the sales journal
mentioned above but it records the sales returns and allowances on the other
hand (i.e., the credit notes)
2.8 Remittance advice (付款通知書 ) – a document prepared by the customer
indicating his name, the numbers and the amounts of the individual invoices
paid by him. That is, this document is received from the customer with his
payment.
2.9 Cash receipt journal – a journal for recording cash receipts from cash sales,
collections and all other cash received.
2.10 Accounts receivable ledger – a subsidiary ledger of customers accounts for
recording individual sales, cash receipts, sales returns and allowances.
2.11 Monthly statement (月結單) – a document sent to each customer detailing
the beginning balance of the month, the movement of transactions during the
month like the amount and date of each sale, return and cash receipt, and the
ending balance due.
N8-4
3. Audit Testing and Internal Controls
3.1 The following description of the primary functions, internal controls to be
identified and transaction-related audit objectives (control objectives) will
clarify what an auditor is trying to accomplish in the audit of the cycle
(Sample of the audit program for the test of controls, refer to Appendix I).
3.2 Transaction-related audit objectives for sales transactions.
Objectives Descriptions
Existence Recorded sales are for goods actually sent to customers
which actually exist.
Completeness Goods sent or services performed are correctly billed and
properly recorded.
Accuracy All sales are correctly billed and accurately recorded.
Classification All sales transactions are properly classified into the
appropriate account.
Timing All invoices are raised shortly after the delivery of goods
or services performed, and are recorded on a correct date
in a timely manner.
Posting and
summarization
All sales are properly posted to the correct accounting
records.
3.3 Transaction-related audit objectives for cash receipts transactions.
Objectives Descriptions
Existence Cash receipts recorded in the accounting record have
actually been received by the company and all cash
discounts are properly authorized.
Completeness Cash received by the company have all been recorded in
the accounting records and promptly deposited.
Accuracy All goods sold or services performed are only made to
customers with good credit rating and have been properly
authorized.
Classification Cash receipts transactions are properly classified to the
appropriate account (e.g. according to the company’s chart
of accounts).
Timing All cash receipts are recorded on a timely basis.
Posting and
summarization
Cash receipts made are included in the debtor’s accounts
of accounts receivable ledger and properly summarized in
N8-5
the control accounts in general ledger.
3.4 This is a summary of the sales cycle, showing the possible problems and the
related controls:
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3.5 The table shows the various assertions of the revenue cycle, together with
control objectives, controls and tests of controls
Assertion Control objectives Controls Tests of controls
Occurrence
and existence
One person is not
responsible for
taking orders,
recording sales
and receiving
payment
Recorded sales
transactions
represent goods
shipped.
Segregation of
duties
Sales recorded only
with approved
sales order form
and shipping
documentation.
Accounting for
numerical
sequences of
invoices
Monthly customer
statements sent out
and customer
queries and
complaints handled
independently.
Observe and
evaluate whether
proper segregation
of duties is
operating.
Test a sample of
sales invoices for
authorized sales
order form and
shipping
documentation.
Examine application
controls for
authroisation.
Review and test
entity’s procedures
for accounting for
numerical sequences
of invoices.
Review entity’s
procedures for
sending out monthly
statements and
dealing with
customer queries
and complaints.
N8-7
Assertion Control objectives Controls Tests of controls
Occurrence
and existence
Goods and
services are only
supplied to
customers with
good credit rating
Goods and
services are
provided at
authorized prices
and on authorized
terms.
Authorisation of
credit terms to
customers (senior
staff authorization,
references / credit
checks for new
customers, regular
review of credit
limits).
Authorisation by
senior staff
required for
changes in other
customer data such
as address, etc.
Order not accepted
unless credit limits
reviewed first.
Authorised price
lists and specified
terms of trade in
practice
Review entity’s
procedures for
granting credit to
customers.
Examine a sample
of sales orders for
evidence of proper
credit approval by
the appropriate
senior staff member.
Examine application
controls for credit
limits.
Review all new
customer files to
ensure satisfactory
credit references
have been obtained.
Compare prices and
terms on a sample of
sales invoices to the
authorized price list
and terms of trade.
Examine application
controls for
authorized prices
and terms.
N8-8
Assertion Control objectives Controls Tests of controls
Completeness All revenue
relating to goods
dispatched is
recorded.
All goods and
services sold are
correctly
invoiced.
Accounting for
numerical
sequences of
invoices.
Shipping
documentation is
matched to sales
invoices.
Sales invoices are
reconciled to the
daily sales report.
An open-order file
is maintained and
reviewed regularly.
Review and test
entity’s procedures
for accounting for
numerical sequences
of invoices.
Trace a sample of
shipping documents
to the sales invoices
and ledger.
Review a sample of
reconciliations
performed.
Inspect the open-
order file for
unfilled orders.
Accuracy All sales and
adjustments are
correctly
journalized,
summarized and
posted to the
correct accounts.
Sales invoices and
matching
documents required
for all entries.
Vouch recorded
sales to supporting
documents.
Cut-off Transactions have
been recorded in
the correct period
All shipping
documentation is
forwarded to the
invoicing section
on a daily basis.
Daily invoicing of
goods shipped.
Compare dates on
sales invoices with
dates of
corresponding
shipping
documentation.
Compare dates on
sales invoices with
dates recorded in the
sales ledger.
N8-9
Assertion Control objectives Controls Tests of controls
Classification All transactions
are properly
classified in
accounts.
Chart of accounts
in place.
Codes in place for
different types of
products or
services.
Review sales ledger
for proper
classification.
Examine a sample
of sales invoices for
proper
classification.
Test application
controls for proper
codes.
3.6 Control activities over sales and receipts – six major functions in a typical
sales and receipts cycle
(a) Processing customer orders
(b) Shipping/dispatching goods
(c) Billing customers and recording sales
(d) Processing and recording cash receipts
(e) Processing sales returns and allowances
(f) Writing off bad debts and providing for doubtful debts
Control Activities Test of Controls
1. Processing customer orders
All customer orders should be checked
for credit limit and proper
authorization. Special approval needed
if credit limit exceeded
Orders should be matched with
invoices to follow up delivery and
billing. Outstanding orders should be
prepared periodically for management
review and actions.
Examine the orders for proper
approval on granting credit to both
existing and new customers.
(existence)
Scrutinize the sales order forms to
identify if they are properly
accounted for, e.g. sequentially
prenumbered. (completeness)
Ensure that outstanding orders are
properly followed up by senior
staff and sequence checks are done
by senior staff. (completeness)
2. Shipping/dispatching goods
N8-10
Goods cannot be shipped without prior
approval.
Despatch notes should be pre-
numbered and a register kept of them
to relate to sales invoices and orders.
Select a sample of shipping
documents to ensure that
shipments of goods are done after
proper authorization. (existence)
Ensure that deliveries of goods are
recorded and properly accounted
for by using pre-numbered
dispatch notes. (completeness)
Examine the duplicate of goods
delivery note for customer’s
signature as evidence of receipt of
goods. (existence)
3. Billing customers and recording sales
Customers should be correctly and
timely billed.
Ensure that sales journal and the
accounts receivable subsidiary ledger
are updated frequently to provide latest
information.
Examine copies of sales invoices
for supporting shipping documents,
e.g. bills of lading and customers’
orders. (existence)
Select a sample of sales invoices
and examine for the numerical
sequence. (completeness)
Examine documents for unbilled
shipments and unrecorded sales at
any time. (completeness)
Observe the mailing of monthly
statements to customers by a
properly designated person.
(existence and accuracy)
4. Processing and recording cash receipts
All cash/cheques receipts should be
recorded in cash receipts journal and
deposited in the bank on a timely
basis.
Accounts receivable subsidiary ledger
should be updated promptly.
Policy on granting cash discounts must
exist.
Observe the procedures of
handling cash receipts to ensure
that the persons are completely
independent of the handling
accounts receivable functions.
(existence)
Ensure that cash/cheques received
are banked promptly and intact.
(existence)
Control account reconciliation is
N8-11
prepared promptly and having
supervisor’s review. (accuracy)
Discuss with management for
policy established for granting of
cash discounts.
5. Processing sales returns and allowances
Sales returns and allowances should be
promptly investigated and then
recorded with confirmation.
Pre-numbered credit notes should be
issued and recorded promptly.
Examine credit notes to ensure that
they are pre-numbered and
sequentially accounted for.
(completeness)
Examine relevant documents, e.g.
correspondence with customers,
credit notes issued with approval,
etc. (existence)
6. Writing off bad debts and for doubtful
debts
Credit manager’s approval should be
obtained.
Adequate allowance should be
provided for outstanding debts.
Examine the policy for bad debts
written-off and provision for bad
debts. (existence)
Examine documents, e.g. bad debts
written off form, to obtain evidence
of whether policy has been
followed up and authorization has
been granted. (existence)
Examine manager’s approval for
calculation of provision for
doubtful debts. (accuracy)
3.7 Test your understanding 1 – Internal control weaknesses
The following narrative notes on the sales and cash receipts are found in the
current year audit file:
SALES
Prenumbered Customer Order is raised by the Order Clerk upon receipt of
written purchase order from the customers. The Customers Order is then
passed to the Credit Control Clerk to check for outstanding balance. The
Credit Control Clerk records the outstanding balance and initials on the
Customer Order, thereafter the Customer Order will be returned to the Order
N8-12
Clerk for further ordering process. If it is a new customer, the Credit Control
Clerk will simply mark nil on the Customer Order. As Milka Ltd. is a
distributor, all sales are on credit terms.
The Customer Order reaches the Shipping Department where the Shipping
Clerk will prepare a prenumbered Delivery Note which consists of five copies.
Copy 1 of the Delivery Note is passed to the Accounts Department, Copy 2 is
filed in the Shipping Department, and Copy 3 is sent to the warehouse for
packing. Copy 4 and 5 are taken by the Driver when delivering the goods. The
customer is requested to sign and chop on Copy 4 as acknowledgement of
receipt of goods ordered. Copy 5 will be retained by the customer. During the
packing process, one Warehouse Clerk performs the packing, while the Driver
is only responsible to deliver the goods to the customers.
The Driver after delivery, returns Copy 4 to the Warehouse Clerk who will
pass Copy 4 to the Accounts Department for the preparation of sales invoice.
An Accounts Clerk will key in the necessary data except for the unit selling
price into the computer for automatic generation of sales invoice. The
automation involves the extract of unit selling price from the Unit Selling
Price Master File for the calculation of sales value. Whenever there is a
change in the price list, the Accounts Clerk will update the Unit Selling Price
Master File according to the memo approved by both the Sales Manager and
Sales Director, thereafter the memo will be filed by the Accounts Clerk. A
sales invoice of 2 copies is generated by the computer with a sequential
number assigned for each sales invoice. One copy of the sales invoice is kept
by the Accounts Department for posting to accounting records, and another
copy is mailed to the customer by the Mailing Clerk.
CASH RECEIPT
On a monthly basis, Accounts Department generates an ageing report of
outstanding debtors for the review of the Financial Controller, who will inform
the Sales Manager to take follow-up actions, but it is noted that the ageing
reports for the last four months are still in the in-tray of the Financial
Controller untouched. Cheques and cash collected are banked-in every Friday
afternoon by the Accounts Clerk, who is responsible for the preparation of
bank reconciliation statement and posting of entries to debtors ledger.
Incoming mails are opened and recorded in an incoming mail log book by the
N8-13
Mailing Clerk.
Required:
Identify TEN internal control weaknesses of the sales and cash receipt cycles
and make recommendations for improvement. (20 marks)
(Adapted HKAAT June 1996)
4. Trade Debtors – Substantive Tests
4.1 The internal controls for establishing sales that give rise to debtors may have
been tested in the audit of sales and receipts cycle, but the audit of trade
debtors emphasizes on the tests of details of balances at balance sheet date.
4.2 Substantive tests
Substantive tests Audit procedures
1. Tests of transactions The tests are procedures designed to discover
whether the transactions recorded in the sales and
receipts cycle have achieved all the transaction
related audit objectives.
2. Tests of details of
balances
Existence
Select balances from the debtors’ list and trace them
to the sales invoices and monthly statements for
correct aging and amount.
Confirm outstanding balances by sending
confirmation letters (positive or negative).
Completeness
Scrutinise shipping documents one month before
and after year end to determine whether any goods
delivered but not billed nor recorded.
Select a sample of shipping documents and trace
them to sales invoices.
Perform cut-off tests.
Accuracy
Confirm the outstanding balance by sending positive
confirmation.
Perform cut-off tests.
N8-14
Classification
Review the trade debtors list to see if there are any
receivables from related parties which should be
separately disclosed.
Cut-off
Perform cut-off tests.
Detail tie-in
Select balances from the debtors’ list and trace them
to the sales invoices and monthly statements for
correct aging and amount.
Check that the aging report is correctly footed, and
that the total balance agrees to the trial balance and
general ledger.
Realisable value
Review any disputes arose before and after year end,
and also the trend of bad debts history.
Rights of client
Review minutes or discuss with client if there is any
evidence of pledging accounts receivable as
collateral.
Send confirmation to bank.
Presentation and disclosure
Evaluate the adequacy of the notes in the financial
statements.
3. Cut-off tests Sales cut-off
- Sales happen when the title of goods passes and
this can happen before shipment.
- Observation of inventory count, the cut-off
information for sales should be obtained.
- Record in the working papers the last goods
dispateched note number.
- Trace these numbers to the sales journal and
accounts receivable records to ensure they are
recorded in the correct accounting period.
Goods in transit
Sales returns and allowances cut-off
- Matched with related sales
N8-15
Cash receipts cut off
- Check bank deposits with the bank statement
after a few days of year end.
- Can check the proper value of accounts
receivable.
4. Debtors’
circularization
Positive confirmation
- Require debtor to confirm the balances.
- Can discovered the overstatement, not
understatement.
- Used when the internal control system is not
strong
Negative confirmation
- Require debtor to reply only when the
balances do not agree.
- Used when the internal control system is good
and with a large number of small accounts.
5. Analytical procedures Objectives – test for reasonableness
Procedures:
- Analyse the sales mix and compare GP margin
with previous years.
- Compare sales returns and allowances as a % of
gross sales with previous years.
- Other ratios, e.g. accounts receivable turnover
days; aging categories as a % of accounts
receivables; doubtful debts expense, etc.
4.3 Test your understanding 2 – Irregularities
QQ Ltd is a garment manufacturing company engaged in the export of
garments to the US market. Over 2001 and 2002, the garment manufacturing
industry suffered from weak demand from the US, but QQ Ltd still reported a
much better return than its competitors in the industry. Its gross profit on sales
was constant at 40% for 2001 and 2002. Due to cost restraints, the auditors
have cut down the number of audit tests, especially cut-off tests. Furthermore,
any discrepancy on debtors’ confirmation not exceeding 5% of the balance
will not be investigated.
Before the auditors signed the 2002 audit report, the finance director fired the
N8-16
company’s accountant. The accountant was angry and told the auditors about
improper accounting practices adopted by the finance director. Firstly, sales
were invoiced on the date of receipt of customer orders. Secondly, customers
were encouraged to settle their invoices early by giving 5% cash discount on
invoice amount if the invoice was settled within 14 days from the delivery
date. However, the booking of discounts allowed was delayed to the last day of
the credit period, i.e. 75 days from the delivery date. The cash receipts records
were correct and showed cash receipts amounting to 95% of the invoice
amount.
The auditors increased the sample size of a few audit procedures and carried
out additional audit procedures aimed to detect fraud. They also studied the
accounting records for 2001 and 2002 and quantified the actual sales and
actual discounts allowed for 2001 and 2002 as below.
Reported data Actual data
2002 2001 2002 2001
$ million $ million $ million $ million
Sales 660 700 640 690
Discounted allowed 6.5 7.1 7.5 7.9
Required:
(a) Identify FOUR possible misstatements to those items on the balance
sheet and profit and loss account of QQ Ltd for 2002. State clearly
whether there may have been an overstatement or an understatement.
(4 marks)
(b) Identify TWO irregularities and make recommendations thereon.
(4 marks)
(c) Suggest audit procedures for detecting the inappropriate accounting
treatment. State clearly the source of the sample (source data) and the
records or documents to be traced to. (10 marks)
(d) Quantify the impact on the net profit for 2002. Your answer should also
take into account the impact brought forward from 2001. [Ignore
taxation] (2 marks)
(Adapted HKIAAT Paper 8 Auditing June 2002)
4.4 Test your understanding 3 – Cut-off tests
N8-17
In the audit of Belmont Manufacturing Co Ltd’s accounts for the year ended
31 December 2001, the following data are extracted from the accounting
records.
Sales
Invoice
No.
Date of Sales
Invoice
(Note I and II)
Goods
Dispatched
Note (GDN)
No.
Date of GDN Invoice
Amount
S0920 27 December 2001 D2193 27 December 2001 $30,000
S0921 29 December 2001 D2198 3 January 2002 $20,000
S0922 30 December 2001 D2195 29 December 2001 $40,000
S0923 30 December 2001 D2196 31 December 2001 $15,000
S0924 31 December 2001 D2200 8 January 2002 $14,000
S0925 2 January 2002 D2201 8 January 2002 $32,000
S0926 2 January 2002 D2192 27 December 2001 $50,000
S0927 3 January 2002 D2194 28 December 2001 $24,000
S0928 4 January 2002 D2199 6 January 2002 $18,000
S0929 5 January 2002 D2197 31 December 2001 $60,000
Note I: All the sales invoices are on FOB origin terms, i.e. the title passes to
the buyer when the goods are shipped.
Note II: The sales journal is updated according to the date of sales invoice.
Belmont Manufacturing Co Ltd recorded all the sales with invoice issued on
or before 31 December 2001 as sales for the year ended 31 December 2001. It
is Belmont’s pricing policy to fix its selling price at cost plus 25%.
Required:
(a) Briefly explain the term “cut-off test”. (2 marks)
(b) When and why do the auditors have to obtain
(i) the number of last GDN on or before the year-end, and
(ii) the number of the first GDN after the year-end?
How would the auditors make use of these data? (4 marks)
(c) Classify each of the sales invoices from S0920 to S0929 into the
correct accounting year. You are required to state the basis of your
classification in general. (11 marks)
N8-18
(d) Based on the cut-off error identified in (c), quantify the impact to the
profit of Belmont for the year ended 31 December 2001. (3 marks)
(Total 20 marks)
(Adapted HKAAT December 2001)
N8-19
Appendix I – AUDIT PROGRAM FOR REVENUES, CASH RECEIPTS, AND
RECEIVABLES – TEST OF CONTROLS
CLIENT NAME:
DATE OF FINANCIAL STATEMENTS:
I. REVENUES, CASH RECEIPTS, AND RECEIVABLES
Performed
By
Workpaper
Reference
Audit Objectives: To obtain an understanding of
the design or operation of internal control relating
to revenues, cash receipts, and receivables in order
to assess their effectiveness in preventing or
detecting material misstatements in financial
statement assertions.
1. Select a sample of sales invoices from the sales
journal for the period under audit and perform
the following:
a. Compare the amount per the sales invoice
with the amount recorded in the sales
journal.
b. Trace the sales invoice amount to the
accounts receivable subsidiary ledger.
c. Trace the sales invoice amount to the cash
receipts journal for evidence of subsequent
payment.
d. Compare data per the sales invoice (e.g.,
description, quantity, price) to the
customer’s sales order, and check for
appropriate credit authorization.
e. Compare data per the sales invoice (e.g.,
N8-20
Performed
By
Workpaper
Reference
customer name, product description,
quantity) to data per the shipping
document.
f. Trace prices, discounts, and payment terms
to price lists, contracts, and established
policies.
g. Test sales invoice extensions, footings, and
discounts for mathematical accuracy.
2. Select a sample of daily sales journals for the
period under audit and perform the following:
a. Foot and crossfoot the sales journal.
b. Trace totals from the sales journal to
postings in the general ledger.
c. Trace selected individual items from the
sales journal to the accounts receivable
subsidiary ledgers.
3. On a test basis, review the numerical sequence
of shipping documents for the period under
audit, and account for missing numbers or
breaks in sequence.
4. Select a sample of shipping documents issued
during the period under audit and perform the
following:
a. Compare data per the shipping document
(e.g., customer name, product description,
quantity) to data per the sales invoice.
b. Compare the date of shipment per the
shipping document to the date of billing per
N8-21
Performed
By
Workpaper
Reference
the sales invoice, and follow up on
significant time lag.
c. Trace amount and date per the sales invoice
to entries in the sales journal.
5. Select a sample of daily cash receipts from the
cash receipts journal for the period under audit
and perform the following:
a. Compare remittance advice amounts with
entries in the daily cash receipts journal.
b. Trace individual amounts of remittance
advices to bank deposit tickets and trace
total amount on deposit tickets to deposit
amount on the bank statement.
c. Determine the promptness of both deposits
and book entries.
d. Trace postings of cash receipts to the
accounts receivable subsidiary ledger and
determine if they are recorded in the proper
period.
e. Recalculate cash discounts and compare to
company policy.
6. Select a sample of daily cash receipts journal
for the period under audit and perform the
following:
a. Foot and crossfoot the cash receipts
journal.
b. Trace total amounts and account
distributions from the cash receipts journal
N8-22
Performed
By
Workpaper
Reference
to postings in the general ledger.
c. Obtain supporting deposit ticket and trace
total amount from the cash receipts journal
to deposit ticket amount and to the bank
statement, noting agreement of date and
amount.
7. Scan the cash receipts journals for a selected
period and investigate any unusual entries.
8. Select a sample of credit memos issued during
the period under audit and perform the
following:
a. Examine and test for proper authorization
and approval in accordance with
established policies and procedures.
b. Trace data (e.g., name, date, amount) to
sales or other appropriate journal and to the
accounts receivable subsidiary ledger.
c. Examine supporting documentation for
propriety (e.g., evidence of returned
goods).
9. Obtain and review the client’s bank
reconciliations on a test basis, and perform the
following:
a. Test the mathematical accuracy.
b. Trace the bank balance to the bank
statement.
c. Trace the balance per books to the general
ledger.
N8-23
Performed
By
Workpaper
Reference
d. Trace deposits per the bank statement to the
cash receipts journal.
e. Trace deposits in transit to the following
month’s bank statement, and determine
reasonableness of the time lag.
f. Trace other reconciling items to supporting
documentation, and determine
reasonableness of their disposition.
10. If the accounting system is extremely
ineffective, or there is high concern about risk
of fraud, consider performing a proof of cash
for a test period, including the following (see
sample workpaper “Proof of Cash” at Section
IV, Item AA-2):
a. Trace the bank balance to the bank
statement.
b. Trace the balance per books to the general
ledger.
c. Trace the totals from the cash receipts and
cash disbursements journals to the general
ledger cash accounts.
d. Check the mathematical accuracy of the
cash receipts and cash disbursements
journals.
e. Account for all cash receipts per books as
deposits per bank or deposits in transit.
f. Trace deposits in transit to the following
month’s bank statement, and determine
N8-24
Performed
By
Workpaper
Reference
reasonableness of the time lag.
g. Review the numerical sequence of checks
issued and account for all checks as paid,
outstanding, or void.
h. Test the list of outstanding checks and trace
paid checks to the bank statement for the
month subsequent to the period tested.
i. Trace paid checks to the cash
disbursements journal.
j. Trace other reconciling items to supporting
documentation, and determine
reasonableness of their disposition.
Based on the procedures performed and the results obtained, it is my opinion that the
objectives listed in this audit program have been achieved.
Performed by Date
Reviewed and approved by Date
N8-25
Appendix II – AUDIT PROGRAM FOR ACCOUNTS RECEIVABLE AND
SALES – SUBSTANTIVE TESTS
CLIENT NAME:
DATE OF FINANCIAL STATEMENTS:
Audit Objectives Financial Statement Assertions
A. Receivables reflected in the balance sheet
exist, are for valid transactions, and include
all authentic obligations of third parties to
the entity.
Existence or occurrence
Completeness
Rights and obligations
B. Billings are for the correct amount and
uncollectible accounts are promptly
identified and provided for. The allowance
for uncollectible accounts is adequate.
Existence or occurrence
Valuation or allocation
C. Receivables are properly classified in the
balance sheet between current and
noncurrent assets and disclosures are
adequate with respect to assigned, pledged,
unbilled, discounted and related-party
receivables, and transfers of receivables.
Presentation and disclosure
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1. Perform the following analytical procedures
for accounts receivable and investigate any
significant fluctuations or deviations from the
expected balances [A, B, C]:
a. Compare the current year’s account
balances with the prior year’s account
balances for gross receivables; allowance
for doubtful accounts; bad debts; and sales
returns and allowances.
___________ __________
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b. Compare monthly sales by product line for
the current year with monthly sales for the
prior year and the first few months
subsequent to year end.
___________ __________
c. Compare monthly sales returns and
allowances and credit memos for the
current year with those of the prior year
and the first few months subsequent to year
end.
___________ __________
d. Compare the aging categories (e.g., 0-30
days; 31-60 days, etc.) of the current year’s
accounts receivable with the prior year’s
and/or industry data.
___________ __________
e. Compute the following ratios for the
current year and compare with the prior
year’s ratios and/or industry data (see
sample workpaper “A/R Analytical
Procedures” at Section IV, Item AD-3):
___________ __________
(1) Accounts receivable turnover. ___________ __________
(2) Days sales in accounts receivable. ___________ __________
(3) Ratio of allowance for uncollectible
accounts to gross accounts receivable
and credit sales.
___________ __________
(4) Ratio of write-offs to credit sales. ___________ __________
(5) Ratio of sales returns and allowances to
credit sales. ___________ __________
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(6) Ratio of customer discounts to credit
sales.
___________ __________
(7) Ratio of gross profit to credit sales, in
total and by major product or division. ___________ __________
2. Prepare or obtain from the client an aged trial
balance of trade accounts receivable and
perform the following [A]:
a. Test the arithmetical accuracy of the aged
trial balance and the aging categories
therein.
b. Reconcile the total balance to the general
ledger control account balance (see sample
workpaper “A/R Reconciliation to General
Ledger” at Section IV, Item AD-5).
c. Note and investigate any unusual entries.
d. Summarize the total of credit balances and
make appropriate reclassification entry, if
material.
e. On a selective basis, trace individual
account balances in the aged trial balance
to individual subsidiary ledgers and vice
versa.
f. Determine which accounts receivable
should be confirmed. The auditor may wish
to use the form titled “Audit Sampling
Worksheet for Substantive Tests” at Section
III (FOR09), to determine which accounts
receivable balances should be confirmed.
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3. Select customer accounts from the aged trial
balance for confirmation procedures and
perform the following (see sample
confirmation requests at Section II [COR07],
[COR08], and [COR09]) [A]:
a. Arrange for confirmation requests to be
mailed directly by the auditor and maintain
control over the confirmation process at all
times. (See sample workpaper “A/R
Confirmation Control Summary” at Section
IV, Item AD-1.)
b. Trace balances included in individual
confirmation requests to subsidiary
accounts.
c. Mail confirmations using envelopes with
the auditor’s return address.
d. If the client requests exemption from
confirmation for any accounts selected by
the auditor, obtain and document
satisfactory explanation, and determine
necessity for alternative procedures.
e. Obtain new addresses for confirmations
returned by the post office as
undeliverable, and remail.
f. Send second requests for positive
confirmations on which there is no reply
and consider registered or certified mail for
second requests.
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4. Process the confirmation replies and
summarize the results of confirmation
procedures as follows (see sample workpaper
“A/R Confirmation Results Summary” at
Section IV, Item AD-2) [A, B]:
a. For positive confirmation requests to which
no reply was received and accounts
exempted from confirmation at the client’s
request, perform alternative procedures for
those customers by examining cash receipts
subsequent to the confirmation date and, if
no cash has been received, by examining
sales invoices and corresponding shipping
documents (see sample workpaper “A/R
Alternative Procedures and Review for
Uncollectibles” at Section IV, Item AD-6).
b. Indicate the total accounts and balances
confirmed without exceptions,
confirmations reconciled, and nonreplies or
exempted accounts with alternative
procedures performed.
5. For accounts receivable confirmed on a date
other than the balance-sheet date, prepare or
obtain from the client an analysis of
transactions (e.g., cash receipts, sales) between
the confirmation date and the balance-sheet
date, and perform the following (see sample
workpaper “A/R Rollforward from
Confirmation Date to Balance-Sheet Date” at
Section IV, Item AD-4) [A]:
a. Trace the balance as of the confirmation
date to the aged trial balance.
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b. Trace cash received per the analysis to the
cash receipts journal and/or bank
statements.
c. Trace sales/revenue amounts per the
analysis to the sales/revenue journal.
d. Determine the reasonableness and propriety
of any other reconciling items.
e. Trace the ending balance per the analysis to
the trial balance as of the balance-sheet
date.
f. Scan the accounts receivable and sales
activity during the period from the interim
date to the balance-sheet date and
investigate any unusual activity.
6. Prepare or obtain from the client an analysis of
trade notes receivable, showing the following:
(a) maker, (b) date note issued and due, (c)
original terms of repayment, (d) collateral, (e)
interest rate, (f) principal balance at the end of
the prior period, (g) principal additions and
repayments in the current period, (h) principal
balance at the end of the current period, (i)
accrued interest receivable at the end of the
prior period, (j) interest earned and interest
received in the current period, and (k) accrued
interest receivable at the end of the current
period, and perform the following (see sample
workpaper “Notes Receivable Analysis” at
Section IV, Item AE-1.) [A, B, C]:
a. Test the arithmetical accuracy of the
analysis.
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b. Trace totals to the general ledger.
c. Examine copies of the notes.
d. Determine whether positive confirmation
requests are necessary and, if so, perform
procedures as outlined in Steps 2 and 3
above.
e. Determine the type of collateral for the
notes.
f. Recompute interest income and accrual.
g. Trace interest collections to the cash
receipts journal, if material.
7. Determine whether any accounts or notes
receivable have been pledged, assigned, or
discounted [A, C].
8. Determine whether any accounts or notes
receivable are owed by employees or related
parties and, if so, perform the following [A, B,
C]:
a. Determine the nature and purpose of the
transaction that resulted in the receivable
balance.
b. Determine whether transactions were
properly executed and approved by an
official of the company or the board of
directors.
c. Consider obtaining positive confirmation
requests of such balances.
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d. Evaluate the collectibility of the balances
outstanding.
9. For notes and accounts receivable with
maturities greater than one year, perform the
following [A, B, C]:
a. Evaluate if the principal and interest
payments will be collected in accordance
with their contractual terms.
b. If either interest or principal payments will
not be collected in accordance with their
contractual terms, determine whether an
allowance for credit loss has been
computed.
10. Test the adequacy of the allowance for
uncollectible accounts, as follows (see sample
workpaper “A/R Allowance for Uncollectible
Accounts” at Section IV, Item AD-7) [B]:
a. Review subsequent cash collections of
account balances.
b. Review accounts written off during the
period.
c. Determine if write-offs have been properly
authorized and examine related supporting
documentation.
d. Ask the client if there are any collection
problems with accounts receivable
currently classified as current assets. If so,
consider whether such accounts should be
reclassified to noncurrent assets.
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e. Perform and review ratio analyses for
relationships such as (1) accounts
receivable turnover, (2) allowance for
uncollectible accounts to accounts
receivable, (3) allowance for uncollectible
accounts to sales, and (4) accounts written
off to sales.
f. Review post-balance-sheet transactions
related to receivables, particularly for
discounts taken, credits allowed, and
accounts written off, and determine
whether any adjustments should be made as
of the balance-sheet date.
11. Perform the following sales cutoff procedures
and ascertain that receivables are recorded in
the proper accounting period [A, B, C]:
a. From the population of shipping
documents, trace the last few shipments of
the year to the sales journal and determine
that they were properly included in
accounts receivable as of the balance-sheet
date.
___________ __________
b. From the population of shipping
documents, trace the first few shipments
subsequent to year-end to the sales journal
and determine that they were properly
excluded from accounts receivable as of the
balance-sheet date.
___________ __________
c. Using the sales journal, trace the last few
sales entries of the year from the sales
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journal to the shipping documents and
determine that they were properly included
in accounts receivable as of the balance-
sheet date.
___________ __________
d. Using the sales journal, trace the first few
sales entries subsequent to year-end from
the sales journal to the shipping documents
and determine that they were properly
excluded from accounts receivable as of the
balance-sheet date.
___________ __________
12. If the auditor is highly concerned about the risk
of fraud, audit procedures such as the
following should be considered in addition to
the ones listed above [A, B, C]:
a. Perform a proof of cash (see sample
workpaper “Proof of Cash” at Section IV,
Item AA-2).
___________ __________
b. Expand the number of accounts receivable
confirmations and pursue all non-replies
and discrepancies. ___________ __________
c. Confirm amounts written off that appear
unusual, such as write-offs of balances due
from continuing customers. ___________ __________
d. Compare sales price to list price. ___________ __________
e. Ascertain that shipped merchandise
actually arrived at the customer’s location
and that the merchandise was not shipped
to a warehouse or location controlled by ___________ __________
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the client.
f. Ascertain that shipping documents and
invoices are pre-numbered sequentially and
accounted for.
___________ __________
g. Examine original documents for sales
invoices and shipping documents and be
alert for possible alterations. ___________ __________
h. Telephone customers directly and confirm
items such as: unusual payment terms,
sales returns, credit memos, side
agreements, merchandise receipt date, or
other concerns.
___________ __________
i. Review customer complaints and look for
unusual trends. ___________ __________
j. Look for evidence of salespeople trying to
meet or exceed sales goals in order to
achieve quotas or increase their
commissions or bonuses.
___________ __________
k. Agree daily cash receipts detail to the bank
statements and investigate unusual lags. ___________ __________
13. If disclosures about fair value are required, or
the entity chooses to provide voluntary fair
value information, perform the following [C]:
a. Obtain information about the fair values of
accounts receivable and notes receivable
and determine that the valuation principles
are being consistently applied under ___________ __________
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GAAP.
b. Determine that the fair value amounts are
supported by the underlying
documentation.
___________ __________
c. Determine that the method of estimation
and significant assumptions used are
properly disclosed.
___________ __________
14. For transfers of accounts receivable to a third
party, determine that the transaction has been
accounted for in accordance with FAS-140,
Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of
Liabilities (a replacement of FASB Statement
125), as follows [A,C]:
a. If a transfer of accounts receivable has
been accounted for as a sale by the client,
determine that all of the following
conditions have been met:
___________ __________
(1) The transferred receivables have been
isolated from the client—put
presumptively beyond the reach of the
client and its creditors, even in
bankruptcy or other receivership.
___________ __________
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(2) Each transferee has the right to pledge
or exchange the receivables (or
beneficial interests) it received, and no
condition both constrains the transferee
from taking advantage of its right to
pledge or exchange and provides more
than a trivial benefit to the client.
___________ __________
(3) The client does not maintain effective
control over the transferred receivables. ___________ __________
b. Upon completion of a transfer of
receivables by a client that satisfies the
conditions to be accounted for as a sale as
described in step a. above, determine that
the client:
(1) Has derecognized all receivables sold. ___________ __________
(2) Has recognized all assets obtained and
liabilities incurred in consideration as
proceeds of the sale, including: cash;
put or call options held or written (for
example, guarantee or recourse
obligations); forward commitments (for
example, commitments to deliver
additional receivables during the
revolving periods of some
securitizations); swaps (for example,
provisions that convert interest rates
from fixed to variable); and servicing
liabilities, if applicable.
___________ __________
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(3) Has initially measured at fair value
assets obtained and liabilities incurred
in a sale or, if it is not practicable to
estimate the fair value of an asset or a
liability, has applied alternative
measures.
___________ __________
(4) Has recognized in earnings any gain or
loss on the sale. ___________ __________
c. Upon completion of any transfer of
accounts receivable in which the client is
the transferor, determine that the client:
(1) Has continued to carry in its
statement of financial position any
retained interest in the transferred
receivables, including, if applicable:
servicing assets, beneficial interests
in assets transferred to a qualifying
special-purpose entity in a
securitization, and retained
undivided interests.
___________ __________
(2) Has allocated the previous carrying
amount between the receivables
sold, if any, and the retained
interests, if any, based on their
relative fair values at the date of
transfer.
___________ __________
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d. If a transfer of accounts receivable in
exchange for cash or other consideration
(other than beneficial interests in the
transferred assets) does not meet the
criteria for a sale in step a. above,
determine that the transfer has been
accounted for as a secured borrowing with
pledge of collateral.
___________ __________
15. Document the following items when an
analytical procedure is used as the
principal substantive test:
a. The expectation, if not readily determinable
from the documentation of the work
performed, and the factors that were
considered in developing the expectation.
b. Results of the comparison of the
expectation to the recorded amounts or
ratios developed from recorded amounts.
c. Any additional auditing procedures that
were performed in response to significant
unexpected differences arising from the
analytical procedure, and the results of
such additional procedures.
16. If detailed tests of transactions or controls are
considered necessary, perform the applicable
audit procedures contained in “Audit Program
—Tests of Controls” in Section I (AUD03).
Based on the procedures performed and the results obtained, it is my opinion that the
objectives listed in this audit program have been achieved.
N8-40
Performed by Date
Reviewed and approved by Date
N8-41
Appendix III – Sales and Receipts Cycle Flowchart
N8-42
Appendix IV – Debtor’s Confirmation
REQUEST FOR CONFIRMATION OF ACCOUNTS RECEIVABLE—
POSITIVE REQUEST
(Prepared on client’s letterhead)
(Date)
(Customer’s name and address)
Dear__________:
In connection with an audit of the financial statements of (insert name of client) as of
(insert date) and for the (insert period [e.g., year, quarter]) then ended, please confirm
directly to our auditors (insert name and address of auditors) the amount of your
indebtedness to us as of (insert date), which according to our records amounted to
$______.2
Please check the appropriate response below after determining whether this is in
agreement with your records. If there are differences, please provide any information
in sufficient detail to assist our auditors in reconciling the difference.
After checking the appropriate response below, please sign and date your reply and
mail it directly to our auditors in the enclosed return envelope. DO NOT SEND ANY
PAYMENTS TO OUR AUDITORS.
Thank you for your anticipated timely cooperation with this request.
Respectfully,
(Name of client)
(Client’s authorized signature and title)
***********************************************
TO: (Insert auditor’s name)
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( ) The balance due (insert client’s name) shown above as of (insert date) is correct.
( ) Our records show a balance of $_______ as of (insert date) and the difference may
be due to the following:
Signature:
Title:
Date:
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REQUEST FOR CONFIRMATION OF ACCOUNTS RECEIVABLE—
NEGATIVE REQUEST
(Prepared on client’s letterhead)
(Date)
(Customer’s name and address)
Dear__________:
Our auditors (insert name and address of auditors) are conducting an audit of our
financial statements as of (insert date) and for the (insert period [e.g., year, quarter])
then ended. Our records show the amount of your indebtedness to us as of (insert
date) to be $_______. If this amount is not correct, please report details of any
differences directly to our auditors in the space provided below and use the enclosed
return envelope.
IF YOU DO NOT WRITE TO OUR AUDITORS, THEY WILL CONSIDER THE
BALANCE SHOWN ABOVE TO BE CORRECT. NO REPLY IS NECESSARY IF
THE AMOUNT SHOWN ABOVE AGREES WITH YOUR RECORDS.
DO NOT SEND ANY PAYMENTS TO OUR AUDITORS.
Thank you for your anticipated timely cooperation with this request.
Respectfully,
(Name of client)
(Client’s authorized signature and title)
***********************************************
TO: (Insert auditor’s name)
The balance due (insert client’s name) shown above as of (insert date) is not correct.
Our records show a balance of $_______ and the difference may be due to the
following:
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Signature:
Title:
Date:
N8-46