Chapter 14 Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions

Review Questions a. The bill of lading is a document prepared at the time of shipment of goods to a customer indicating the description of the merchandise, the quantity shipped, and other relevant data. Formally, it is a written contract of the shipment and receipt of goods between the seller and carrier. It is also used as a signal to bill the client. The original is sent to the customer and one or more copies are retained. A sales invoice is a document indicating the description and quantity of goods sold, the price including freight, insurance, terms, and other relevant data. It is the method of indicating to the customer the amount owed for the sale and the due date of the payments. The original is sent to the customer and one or more copies are retained. The sales invoice is the document for recording sales in the accounting records. The credit memo is a document indicating a reduction in the amount due from a customer because of returned goods or an allowance granted. It often takes the same general form as a sales invoice, but it reduces the customer's accounts receivable balance rather than increasing it. The remittance advice is a document that accompanies the sales invoice mailed to the customer and can be returned to the seller with the payment. It is used to indicate the customer name, sales invoice number, and the amount of the invoice when the payment is received. A remittance advice is used to permit the immediate deposit of cash receipts as a means of improving control over the custody of assets. The monthly statement to customers is the document prepared monthly and sent to each customer indicating the beginning balance of that customer's accounts receivable, the amount and date of each sale, cash payments received, credit memos issued, and the ending balance due. It is, in essence, a copy of the customer's portion of the accounts receivable master file.

14-1

b.

c.

d.

e.

14-2 roper credit approval for sales helps minimi!e the amount of bad debts and the collection effort for accounts receivable by requiring that each sale be evaluated for collection potential. Adequate controls in the credit function enable the auditor to place more reliance on the client's estimate of uncollectible accounts. "ithout these controls, the auditor would have to make his or her own credit checks on the customers in #$%#

order to be convinced that the allowance for uncollectible accounts is reasonable.

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14The sales 'ournal contains the record of each sales transaction that includes the customer name, date, amount, and the account classification for each transaction. The sales 'ournal generally represents the record of each individual transaction. Typically, the sales 'ournal accumulates transactions for a period of time, which is often monthly. Transactions recorded in the sales 'ournal are then posted to the general ledger, and if the transaction is for sales on account the accounts receivable master file is updated for each transaction. The accounts receivable master file is used to record individual sales, cash receipts, and sales returns and allowances for each customer and to maintain customer account balances. The master file is updated using data from the sales 'ournal, sales return 'ournal, cash receipts 'ournal. The total in the accounts receivable master file equals the total in the accounts receivable general ledger account. 14-4 (est)ellers.com could integrate its online ordering system with its inventory system so that a book shipment is made only after the customer*s credit card company approves the customer*s purchase. (ecause credit card issuers often transfer funds electronically almost immediately after a sale, (est)ellers.com could also set up their system to ship books only after payment has been received by the credit card issuer. Finally, (est)ellers.com could arrange with an online credit service bureau to run credit checks on customers purchasing over a preset minimum amount. Although (est)ellers.com sells its goods through the Internet, the company should still record sales revenue when the books are shipped to customers. 14-!
TRA"SACT#$"-R%&AT%' A('#T $)*%CT#+% #. +ecorded sales are for shipments actually made to e,isting customers -occurrence..

,%- #"T%R"A& C$"TR$&S

+ecording of sales is supported by authori!ed

shipping documents and approved customer orders. /redit is authori!ed before shipment takes place. )ales invoices are prenumbered and properly accounted for. 0nly customer numbers e,isting in the computer data files are accepted when they are entered. 1onthly statements are sent to customers2 complaints receive independent follow%up. accounted for.

&. 3,isting sales transactions are recorded -completeness..

)hipping documents are prenumbered and )ales invoices are prenumbered and

accounted for.

#$%4

14-! .continued/
TRA"SACT#$"-R%&AT%' A('#T $)*%CT#+% 4. +ecorded sales are for the amount of goods shipped and are correctly billed and recorded -accuracy..

,%- #"T%R"A& C$"TR$&S

5etermination of prices, terms, freight, and

discounts is properly authori!ed.

Internal verification of invoice preparation. Approved unit selling prices are entered into

the computer and used for sales.

(atch totals are compared with computer

summary reports. $. )ales transactions are properly included in the accounts receivable master file and are correctly summari!ed -posting and summari!ation.. 6. )ales transactions are properly classified -classification.. 8. )ales are recorded on the correct dates -timing..
+egular monthly statements sent to customers. Internal verification of accounts receivable

master file contents.

/omparison of accounts receivable master file

or trial balance with general ledger balance.

7se of adequate chart of accounts. Internal review and verification of the account

classifications. rocedures requiring billing and recording of sales on a daily basis as close to the time of occurrence as possible. Internal verification of timely recording of transactions.

14-0 Tests of controls: #. &. 4. 0n a sample of sales invoices, e,amine proper authori!ation and indication of internal verification of sales amounts. 3,amine approved computer printout of unit selling prices. 3,amine file of batch totals for initials of data control clerk2 compare totals to summary reports.

Substantive tests of transactions: #. &. 4. +ecompute information on sales invoices. Trace entries in sales 'ournal to related sales invoices. Trace detail on sales invoices to shipping documents, approved price lists, and customers' orders.

#$%$

14-1 The most important duties that should be segregated in the sales and collection cycle are9 #. &. 4. $. 6. 8. :. ;. +eceiving orders for sales )hipping goods (illing customers and recording sales 1aintaining inventory records 1aintaining general accounting records 1aintaining detailed accounts receivable records rocessing cash receipts <ranting credit and pursuing unpaid accounts

)egregation of duties should be used e,tensively in the sales and collection cycle for two reasons. First, cash receipts are sub'ect to easy manipulation. )econd, the large number and nature of transactions within the cycle make the procedure of cross%checking, where one employee's duties automatically serve to verify the accuracy of another's, highly desirable. If the asset%handling activities -shipping goods and processing cash receipts. are combined with their respective accountability activities -maintaining inventory, accounts receivable, and general accounting records., a serious deficiency with respect to safeguarding those assets e,ists. It would be easy for an employee, by either omitting or adding an entry, to use the company's assets for his or her own purpose. If the credit granting function is combined with the sales function, there may be a tendency of sales staff to optimi!e volume even at the e,pense of high bad debt write%offs. 14-2 The use of prenumbered documents is meant to prevent the failure to bill or record sales as well as to prevent duplicate billings and recordings. An e,ample of a useful control to provide reasonable assurance that all shipments are billed is for the billing clerk to file a copy of all shipping documents in sequential order after a shipment has been billed. eriodically, someone can account for all numbers in the sequence and investigate the reason for missing documents. /omputer programs can be used to identify gaps and duplicates in the sequence. The same type of a useful test in this area is to account for the sequence of duplicate sales invoices in the sales 'ournal, watching for omitted numbers, duplicate numbers, or invoices outside the normal sequence. This test simultaneously provides evidence of both the occurrence and completeness ob'ectives.

#$%6

14-3

#.

/redit is authori!ed before a sale takes place. Test9 Analy!e the allowance for uncollectible accounts and write% offs of accounts receivable during the period to determine the effectiveness of the credit approval system.

&.

<oods are shipped only after proper authori!ation. Test9 +eview physical inventory shortages to determine the effectiveness of inventory control.

4.

rices, including payment terms, freight, and discounts, are properly authori!ed. Test9 /ompare actual price charged for different products, including freight and terms, to the price list authori!ed by management.

14-14 The purpose of footing and crossfooting the sales 'ournal and tracing the totals to the general ledger is to determine that sales transactions are properly included in the accounts receivable master file and are correctly summari!ed. The auditor will make a sample selection from the sales 'ournal to perform tests of controls and substantive tests of transactions, so he or she must determine that the general ledger agrees with the sales 'ournal. 14-11 The verification of sales returns and allowances is quite different from the verification of sales for three primary reasons9 #. &. )ales returns and allowances are normally an insignificant portion of operations and therefore receive little attention from the auditor. The primary emphasis the auditor places on sales returns and allowances is to determine that returns and allowances are properly authori!ed and that sales are not overstated at year%end and subsequently reversed by the issuance of returns. The completeness ob'ective cannot be ignored because unrecorded sales returns and allowances can materially overstate net income.

4.

14-12 /ash is the most liquid asset that a company owns and thus it is the most likely target of misappropriation. The emphasis the auditor places on the possibility of misappropriation of cash is not inconsistent with his or her responsibility, which is to determine the fairness of the presentation of the financial statements. If material fraud has occurred, and it is not fully disclosed in the financial statements, those statements are not fairly presented.

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14-1
TRA"SACT#$"-R%&AT%' A('#T $)*%CT#+% #. +ecorded cash receipts are for funds actually received by the company -occurrence.. &. /ash received is recorded in the cash receipts 'ournal -completeness..

,%- #"T%R"A& C$"TR$&S

)eparation of duties between

handling cash and record keeping.

Independent reconciliation of bank

accounts.
)eparation of duties between

handling cash and record keeping. 7se of remittance advices or a prelisting of cash. Immediate endorsement of incoming checks. Internal verification of the recording of cash receipts. +egular monthly statements to customers.

4. /ash receipts are deposited and recorded at the amounts received -accuracy..

)ame as & above. Approval of cash discounts. +egular reconciliation of bank

accounts. (atch totals are compared with computer summary reports. $. /ash receipts are properly included in the accounts receivable master file and are correctly summari!ed -posting and summari!ation..
+egular monthly statements to

customers.
Internal verification of accounts

receivable master file contents.

/omparison of accounts receivable

master file or trial balance totals with general ledger balance. 6. /ash receipts transactions are properly classified -classification.. 8. /ash receipts are recorded on the correct dates -timing..
7se of adequate chart of accounts. Internal review and verification.

rocedure requiring recording of cash receipts on a daily basis. Internal verification.

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14-14 Audit procedures that the auditor can use to determine whether all cash receipts were recorded are9

5iscussion with personnel and observation of the separation of duties between handling cash and record keeping. Account for numerical sequence of remittance advices or e,amine prelisting of cash receipts. 0bserve immediate endorsement of incoming checks. 3,amine indication of internal verification of the recording of cash receipts. 0bserve whether monthly statements are sent to customers. Trace from remittance advices or prelisting to cash receipts 'ournal.

14-1! roof of cash receipts is a procedure to test whether all recorded cash receipts have been deposited in the bank account. In this test, the total cash receipts recorded in the cash receipts 'ournal for a period of time, such as a month, are reconciled to the actual deposits made to the bank during the same time period. The procedure is not useful to discover cash receipts that have not been recorded in the 'ournals or time lags in making deposits, but it is useful to discover recorded cash receipts that have not been deposited, unrecorded deposits, unrecorded loans, bank loans deposited directly into the bank account, and similar misstatements. 14-10 =apping is the postponement of entries for the collection of receivables to conceal an e,isting cash shortage. The fraud is perpetrated by someone who records cash in the cash receipts 'ournal and then enters them into the computer system. The person defers recording the cash receipts from one customer and covers the shortage with receipts from another customer. These in turn are covered by the receipts from a third customer a few days later. The employee must either continue to cover the shortage through lapping, replace the stolen money, or find another way to conceal the shortage. This fraud can be detected by comparing the name, amount and dates shown on remittance advices to cash receipts 'ournal entries and related duplicate deposit slips. )ince the procedure is relatively time%consuming, auditors ordinarily perform the procedure only where there is a specific concern with fraud because of internal control deficiencies discovered. 14-11 The audit procedures most likely to be used to verify accounts receivable charged off as uncollectible and the purpose of each procedure are as follows9

3,amine approvals by the appropriate persons of individual accounts charged off. The purpose is to determine that charge%offs are approved. 3,amine correspondence in client's files that indicates the uncollectibility of the accounts for a selected number of write%offs. The purpose is to determine that the account appears to be uncollectible. 3,amine 5un and (radstreet credit records as an indication of the #$%;

uncollectibility of an account. The purpose is the same as the previous procedure.

#$%>

14-11 .continued/

/onsider the reason for the charge%off compared to the company policy for writing off uncollectible accounts. The purpose is to determine whether or not company policy is being followed.

14-12 The primary ob'ective of the tests of controls and substantive tests of transactions for sales and cash receipts is to determine whether or not the auditor may rely on internal controls to produce accurate information. If it is determined through tests of controls and substantive tests of transactions that the system provides reliable information as to accounts receivable balances, the auditor may reduce the sample si!e for the confirmation of accounts receivable and ad'ust the type of confirmation and timing of the tests. If the system is not considered effective because of deficiencies in internal control, the sample si!e must be increased, positive confirmations will probably be necessary, and the confirmations will most likely be as of the balance sheet date. 14-13 It is often acceptable to perform tests of controls and substantive tests of transactions at an interim date. The auditor may decide it is necessary to test the untested period at year%end. It is acceptable to perform tests of controls and substantive tests of transactions for sales and cash receipts at an interim date and not perform additional tests of the system at year%end under the following circumstances9

The auditor believes that internal controls are effective. The auditor does not anticipate significant changes in the internal controls during the remaining period. The transactions normally occurring between the completion of the tests of controls and substantive tests of transactions and the end of the year are similar to the transactions prior to the test date. The remaining period is not too long.

14-24 <enerally, successful tests of controls and substantive tests of transactions allow for a reduction of tests of details of balance at year%end. ?owever, 5iane )mith chose the month of 1arch, which only represents one% twelfth of the year, as her test period. "ith such a short test period, 5iane cannot conclude that she has selected a representative sample from the total population2 therefore, without testing additional months -consensus of several / A firms requires at least nine months coverage., 5iane should not change the scope of her tests of details of balances at year%end.

5ultiple Choice Questions 6ro7 C8A %9a7inations a. a. a. -$. -$. -$. b. b. b. -$. -4. -$. c. c. c. -4. -#. -&. d. -#.

14-21 14-22 14-2

#$%#@

'iscussion Questions and 8roble7s #. a. +ecorded sales are for the amount of goods ordered and are correctly billed and recorded. -Accuracy. b. 3,amine indication of internal verification on sales documents. c. Incorrect prices may be charged, the customer may be billed for the wrong quantity, or the total amount may be computed incorrectly. d.+ecompute information on the sales invoices. Trace details on sales invoices to shipping records, price lists, and customers' orders. a. b. c. d. +ecorded sales and credit transactions are for shipments actually made and e,isting sales transactions are recorded. -0ccurrence and /ompleteness. Account for the numerical sequences of sales orders, invoices, and credit memoranda. )hipments or returns are not recorded. 0rders from customers are misplaced and not filled. 3,amine correspondence concerning credit memoranda to assure that they were properly issued. Trace sample of shipping documents to related sales invoices and entries into the sales 'ournal and accounts receivable master file. /onfirm accounts receivable. 3,isting transactions are recorded2 recorded transactions e,ist. -/ompleteness and 0ccurrence. The auditor should observe the employees and discuss the procedures with personnel. )ales could be made and not recorded, with the employee keeping the proceeds of the sale. Trace selected shipping documents to related duplicate sales invoices, the sales 'ournal, and accounts receivable master file. 3,isting transactions are recorded. -/ompleteness. 0nline shipping documents are prenumbered and accounted for weekly. 0nline sales could be made but not recorded. )elect a sample of online shipments -using the prenumbered online shipping documents., and trace to a sales invoice, sales 'ournal or listing, and the accounts receivable master file. 3,isting transactions are recorded. -/ompleteness. The auditor should observe the activities of those employees and discuss the procedures with personnel. These unusual sales could be made but not recorded and the proceeds kept from the company. #$%##

14-24

&.

4.

a. b. c. d.

$.

a. b. c. d.

6.

a. b. c.

d.

3,amine sales documents for these sales and trace the entries into the cash receipts 'ournal.

#$%#&

14-24 .continued/ 8. a. b. c. d. 3,isting transactions are recorded and recorded sales are for the amount of goods ordered and are correctly billed. -/ompleteness and Accuracy. The auditor should observe the activities of employees and discuss the procedures with personnel. A receivable might intentionally not be recorded, allowing the cash to be kept from the company. Trace from the shipping records to the sales invoice, to the accounts receivable master file, and to the cash receipts 'ournal. )ales and cash receipts transactions are properly included in the accounts receivable master file and are correctly summari!ed. - osting and summari!ation. 0bservation of procedures and e,amination of indication of internal verification. 7nintentional errors could be posted in the control accounts and left undetected for long periods of time. erform tests of clerical accuracyfoot 'ournals and trace postings from 'ournal to general ledger and accounts receivable master file. 3,isting cash receipts transactions are recorded. -/ompleteness. 0bservation and discussion of procedures with employees. /ash could be received, not recorded, and kept from the company by an employee or lost prior to deposit. Trace receipts recorded on a list such as from a prelisting of cash to the books of original entry. /onfirm accounts receivable. Transactions are recorded on the correct dates. -Timing. /ompare date per books to the date that the deposit appears on the bank statement. /ash receipts might be recorded in the wrong accounting period, lost, or stolen. Trace cash recorded on a list, such as a prelisting of cash, to the cash receipts 'ournal and to the bank statement. Test of control 3,isting sales transactions are recorded. -/ompleteness. 5ocumentation Test of control +ecorded sales are for shipments actually made to e,isting customers. -0ccurrence. #$%#4

:.

a. b. c. d.

;.

a. b. c. d.

>.

a. b. c. d.

14-2!

#.

a. b. c. a. b.

&.

c.

5ocumentation

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14-2! .continued/ 4. a. b. c. $. a. b. c. 6. a. b. c. 8. a. b. )ubstantive test of transactions +ecorded sales are for the amount of goods shipped. -Accuracy. 5ocumentation )ubstantive test of transactions )ales transactions are properly included in the accounts receivable master file and are correctly summari!ed. - osting and summari!ation. +eperformance Test of control +ecorded sales returns are for returns from e,isting customers. -0ccurrence. 5ocumentation Test of control -#. /ash received is recorded in the cash receipts 'ournal. -/ompleteness. -&. /ash receipts are recorded on the correct dates. -Timing. 0bservation or documentation )ubstantive test of transactions -#. +ecorded receipts are for funds actually received by the company. -0ccurrence. -&. /ash received is recorded in the cash receipts 'ournal. -/ompleteness. -4. /ash receipts are deposited at the amount received. -Accuracy. -$. /ash receipts are recorded on the correct dates. -Timing. 5ocumentation A given sale is recorded more than once, or a sale is recorded for which a shipment was not made. A shipment took place for which no sale was recorded. A sales 'ournal was incorrectly footed, or a sales transaction was posted to the incorrect customer account.

c. :. a. b.

c. 14-20 a.

Objective 1 Objective 2 Objective 3

b.

The first ob'ective deals with overstatement of sales resulting from recording sales for which no shipment had occurred. The second ob'ective concerns understatement of sales. It results from a shipment that has not been recorded. #$%#6

c.

rocedures &, 4, and $ are tests of controls. rocedures #, 6, and 8 are substantive tests of transactions.

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14-20 .continued/ d. .1/ $CC(RR%"C% )7()TAATIB3 T3)T 0F T+AA)A/TI0A) T3)T 0F /0AT+0= e. "AT(R% $6 5#SSTAT%5%"T TR-#": T$ 8R%+%"T To prevent billing to a customer or recording a sale for which no shipment has been made. reventing misstatements in failure to post to the accounts receivable master file, posting to the wrong customer, at the wrong amount, or at the wrong date. The failure to bill customers for shipments actually made. rocedure 8 rocedure & .2/ C$58&%T%"%SS rocedure # rocedure $ . / 8$ST#": A"' S(55AR#;AT#$" rocedure 6 rocedure 4

8R$C%'(R% &

C$"TR$& )%#": T%ST%' A shipping document is attached to each duplicate sales invoice. An independent person traces from the sales 'ournal to the accounts receivable master file. A tick mark is shown in the margin of the sales 'ournal after a transaction is traced. At the time of billing, the duplicate sales invoice number is written on the bottom left%hand corner of each shipping document. eriodically, the entire sequence of shipping documents is accounted for and each is e,amined to make certain there is an invoice number, which indicates that a given shipment has been billed.

14-21

a.

-$.

b.

-&.

c.

-4. #$%#:

14-22 T%ST $6 C$"TR$& $R S()STA"T#+% T%ST $6 TRA"SACT#$"S 1< ) T of T 2< ) T of T < T of /

TRA"SACT#$"R%&AT%' A('#T $)*%CT#+%.S/ Accuracy osting and summari!ation Accuracy

S()STA"T#+% T%ST Aot applicable Aot applicable /ompare unit selling prices on duplicate sales invoices to the approved price list. 3,amine a sample of sales transactions to determine if each one is correctly classified in the sales 'ournal. Aot applicable Aot applicable

4< T of /

/lassification

!< ) T of T 0< ) T of T

/lassification /ompleteness Accuracy Timing osting and summari!ation

1< ) T of T

0ccurrence /ompleteness Accuracy Timing

Aot applicable

2< T of /

Accuracy

+ecalculate the cash discounts for a sample of remittances and determine whether each one was consistent with company policy. Trace from a sample of remittance advices to the cash receipts 'ournal to determine if the related cash is recorded.

3< T of /

/ompleteness

#$%#;

14-23 8$SS#)&% %RR$R $R 6RA(' #. Invoices for goods sold are posted to incorrect customer accounts. &. <oods ordered by customers are shipped, but not billed to anyone. 4. Invoices are sent for shipped goods, but are not recorded in the sales 'ournal. $. Invoices are sent for shipped goods and are recorded in the sales 'ournal, but are not posted to any customer account. 6. /redit sales are made to customers with unsatisfactory credit ratings. 8. <oods are removed from inventory for unauthori!ed orders. :. <oods shipped to customers do not agree with goods ordered by customers. ;. Invoices are sent to colluding parties in a fraudulent scheme and sales are recorded for fictitious transactions. C$"TR$& c. 1onthly statements are mailed to all customers with outstanding balances. g. )hipping documents are compared with sales invoices when goods are shipped. f. 5aily sales summaries are compared with sales invoices when goods are shipped. k. /ontrol amounts posted to the accounts receivable ledger are compared with the control totals of invoices. i. /ustomer orders are compared to an approved customer list. b. Approved sales orders are required for goods to be removed from the warehouse. d. )hipping clerks compare goods received from the warehouse with approved sales orders. h. )ales invoices are compared with shipping documents and approved customer orders before invoices are mailed.

#$%#>

14- 4

a. '%6#C#%"CR%C$55%"'%' #58R$+%5%"T To e,tent possible, financial secretary's responsibilities should be confined to record keeping. Finance committee should assume a more active supervisory role. An audit committee should be appointed to perform periodic auditing procedures or engage outside auditors.

#. Financial secretary e,ercises too much control over collections. &. Finance committee is not e,ercising its assigned responsibility for collection. 4. The finance committee is responsible for the auditing function and administration of the cash function. 1oreover, the finance committee has not performed the auditing functions. $. The head usher has sole access to cash during the period of the count. 0ne person should not be left alone with the cash until the amount has been recorded or control established in some other way. 6. The collection is vulnerable to robbery while it is being counted and from the church safe prior to its deposit in the bank.

The number of counters should be increased to at least two, and cash should remain under 'oint surveillance until counted and recorded so that any discrepancies will be brought to attention. The collection should be deposited in the bank's night depository immediately after the count. hysical safeguards, such as locking and bolting the door during the period of the count, should be instituted. Bulnerability to robbery will also be reduced by increasing the number of counters. The financial secretary should receive a copy of the collection report for posting to the financial records. The head usher should maintain a copy of the report for use by the audit committee.

8. The head usher's count lacks usefulness from a control standpoint because he surrenders custody of both the cash and the record of the count.

#$%&@

14- 4 .continued/ '%6#C#%"C:. /ontributions are not deposited intact. There is no assurance that amounts withheld by the financial secretary for e,penditures will be properly accounted for. R%C$55%"'%' #58R$+%5%"T /ontributions should be deposited intact. If it is considered necessary for the financial secretary to make cash e,penditures, he should be provided with a petty cash fund. The fund should be replenished by a check based upon a properly approved reimbursement request and satisfactory support. 1embers should be asked to make checks payable to the church. At the time of the count, ushers should stamp the church's restrictive endorsement -For 5eposit 0nly. on the back of the check. Dey employees and members involved in receiving and disbursing cash should be bonded. 3specially because much of the work involved in cash collections is performed by unpaid, untrained church members, often on a short% term basis, detailed written instructions should be prepared. The envelope system should be encouraged. 7shers should indicate on the outside of each envelope the amount contributed. 3nvelope contributions should be reported separately and supported by the empty collection envelopes. renumbered envelopes will permit ready identification of the donor by authori!ed persons without general loss of confidentiality.

;. 1embers are asked to draw checks to Ccash,C thus making the checks completely negotiable and vulnerable to misappropriation.

>. Ao mention is made of bonding.

#@. "ritten instructions for handling cash collections apparently have not been prepared.

##. The envelope system has not been encouraged. /ontrol features that it could provide have been ignored.

#$%&#

14- 1
a< #"T%R"A& C$"TR$&
#. /redit is granted by a credit department. &. )ales returns are presented to a sales department clerk who prepares a written, prenumbered receiving report.

STR%":T= $R '%6#C#%"C)trength 5eficiency

b< TRA"SACT#$" R%&AT%' A('#T $)*%CT#+%

0ccurrence of sales.

c< "AT(R% $6 '%6#C#%"C-

renumbered receiving reports should be prepared by receiving department clerks immediately upon receipt of returned goods. A duplicate copy of the receiving report should be sent to the credit department for approval and preparation of a credit memorandum that is then forwarded to accounting to record the sales return.

#$%#:

4. )tatements are sent monthly to customers.

)trength

0ccurrence of sales Accuracy of sales osting and

summari!ation of sales

/ompleteness of
cash receipts

Accuracy of cash
receipts osting and summari!ation of cash receipts This is an inappropriate segregation of duties. The controller has recordkeeping responsibilities. The write%off of accounts involves authori!ation responsibilities. The write%offs should be approved by the credit department, not the controller.

$. "rite%offs of accounts receivable are approved by the controller.

5eficiency

14- 1 .continued/
a< #"T%R"A& C$"TR$&
6. /ash receipts received in the mail are received by a secretary with no record% keeping responsibility. 8. /ash receipts received in the mail are forwarded unopened with remittance advices to accounting.

STR%":T= $R '%6#C#%"C)trength

b< TRA"SACT#$" R%&AT%' A('#T $)*%CT#+%

/ompleteness of cash receipts.

c< "AT(R% $6 '%6#C#%"C-

5eficiency

This represents inadequate segregation of duties because it gives custody of the cash to those in accounting who are responsible for recordkeeping activities. ersonnel in accounting could misappropriate cash receipts and alter accounting records to hide the fraud. The cash receipts 'ournal represents the primary accounting record for all cash received. It should be prepared by personnel within the accounting function, not the treasury function. The treasury function has primarily responsibilities surrounding the custody of cash. Thus, they should not have any recordkeeping responsibilities. /ash should be deposited at least daily to prevent loss or theft of cash. /ompleteness of sales.

:. The cash receipts 'ournal is prepared by the treasurer*s department

5eficiency

#$%#;

;. /ash is deposited weekly. >. 0nce shipment occurs and is recorded in the sales 'ournal, all shipping documents are marked ErecordedF by the accounting staff. #@. The bank reconciliation is prepared by individuals independent of cash receipts recordkeeping.

5eficiency )trength

)trength

0ccurrence of cash
receipts

/ompleteness of cash
receipts

Accuracy of cash receipts

14- 2 TRA"SACT#$"R%&AT%' A('#T $)*%CT#+% 0ccurrence Accuracy &. 0ccurrence Accuracy

C$"TR$& #.

8$T%"T#A& 6#"A"C#A& STAT%5%"T 5#SSTAT%5%"T #6 C$"TR$& #S A)S%"T )ales may be recorded for invalid or non% e,istent products. )ales may be processed based on inaccurate price information. )ales may be recorded for non%e,istent products. )ales may be processed for e,isting products using quantities ordered, even when ordered quantities are not on hand. )ales may be processed for customers who are unable to pay. )hipments may be made to persons making an unauthori!ed credit card purchase -e.g., with a stolen credit card.. )ales may be processed inaccurately -e.g., wrong product, wrong price, wrong quantity.. )ales may be recorded even though shipment has not occurred. )ales may be recorded in the wrong time period.

4. $.

0ccurrence 0ccurrence

6. 8.

Accuracy 0ccurrence Timing

#$%&$

G Case 14a.

#$%&6

14-

.continued/

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14-

.continued/ b. and c. TRA"SACT#$"R%&AT%' A('#T $)*%CT#+%

#"T%R"A& C$"TR$&S (ill of lading and sales order form are attached to invoice. )ales are initiated by sales order form from customer. /redit department investigates customer credit and approves sales before shipment of merchandise is authori!ed.

T%ST $6 C$"TR$& 3,amine invoice package for presence of bill of lading and sales order form. 3,amine sales order form for indication of credit approval. +eview client's credit approval system for effectiveness. Account for numerical sequences of bills of lading and sales invoices and determine that all have been recorded. 3,amine computer edit reports for indication of errors and disposition thereof. Trace sales transactions to sales 'ournal.

#. +ecorded sales occurred.

&. 3,isting sales transactions are recorded.

(ill of lading and invoices are prenumbered -numerical sequence is not accounted for. and must be prepared before merchandise is shipped. /ontrol totals are prepared and checked by computer. -Ao verification of the sales price is performed.. )ales transactions are simultaneously recorded in sales, accounts receivable, cost of sales, and relieved from the perpetual inventory. Aone. Aone.

4. +ecorded sales are at the correct amounts.

$. )ales transactions are properly included in the accounts receivable master file and are correctly summari!ed. 6. +ecorded sales are properly classified. 8. )ales are recorded on the correct dates.

Aot applicable. Aot applicable.

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14-

.continued/ d. TRA"SACT#$"R%&AT%' A('#T $)*%CT#+%

S()STA"T#+% T%ST $6 TRA"SACT#$"S A('#T 8R$C%'(R%S )elect a sample of sales from sales 'ournal and e,amine customer's purchase order, sales order form, and bill of lading to determine that the goods were ordered and shipped. erform analytical tests, including comparisons of operating statistics to prior years and month to month at year%end. /ompare sales prices to price lists. 3,amine customer correspondence indicating pricing disputes. Test clerical accuracy of a sample of sales invoices. Foot the sales 'ournal and trace the balance to the general ledger.

#. +ecorded sales occurred.

&. 3,isting sales transactions are recorded. 4. +ecorded sales transactions are stated at the correct amounts. $. )ales transactions are properly included in the accounts receivable master file and are correctly summari!ed. 6. +ecorded sales are properly classified. 8. )ales are recorded on the correct dates.

3,amine sales documents to determine that sales transactions are properly classified. /ompare dates on bills of lading to the sales 'ournal to determine that sales are recorded on a timely basis. /ompare sales month to month and investigate any significant fluctuations, especially near year%end.

e.

An audit program for conducting the audit of sales is as follows9 #. 0btain the sales 'ournal for the year and perform the following procedures9 -a. Foot the 'ournal for one month and reconcile to the general ledger balance. -b. From the 'ournal, select a sample of invoices and perform the following9

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14-

.continued/ )ee that the customer's purchase order, sales order form, and bill of lading are available. /ompare quantity, sales price, customer name, and date of shipment to sales 'ournal. 0btain e,planation of any differences. -&. 3,amine sales order form for indication of credit approved. -4. /ompare sales price to price list. -$. Test clerical accuracy of sales invoices. -6. 5etermine propriety of classification of sales transactions. )elect a sample of bill of lading numbers. =ocate the corresponding bills of lading and trace them to the sales 'ournal to determine that the shipments were recorded. /ompare the date per the bill of lading to the date per the sales 'ournal to determine the promptness of recording. 3,amine customer correspondence during the year for disputes on pricing of invoices. repare a schedule of sales, cost of sales, and gross margin percentage, showing comparison between recent years and month to month. 0btain e,planation of any significant fluctuations. -#.

&.

4. $.

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#nte>rated Case Application a., b., c., and d. 8#""AC&% 5A"(6ACT(R#":?8art #+

a< ,ey #nternal Control )egregation of the purchasing, receiving, and cash disbursements functions. Independent reconciliation of the monthly bank statements. 7se of prenumbered voucher packages, properly accounted for. 7se of prenumbered checks, properly accounted for. b< Transaction Related Audit $bAectives +ecorded acquisitions are for goods and services actually received -occurrence.. +ecorded cash disbursements are for goods and services actually received -occurrence.. 3,isting cash disbursement transactions are recorded -completeness.. +ecorded cash disbursement transactions are stated at the correct amounts -accuracy.. 3,isting acquisition transactions are recorded -completeness.. c< Test of Control 5iscuss segregation of duties with personnel and observe activities. 3,amine file of completed bank reconciliations. Account for a sequence of voucher packages. Account for a sequence of checks. d< Substantive Test of Transaction Trace entries in the acquisitions 'ournal to related vendors' invoices, receiving reports, and purchase orders. +econcile recorded cash disbursements with the cash disbursements on the bank statement -proof of cash disbursements.. Trace from a file of vendors' invoices to the acquisitions 'ournal.

14- 4

@ #.

&.

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4. $. 6.

3,isting cash disbursement transactions are recorded -completeness..

+econcile recorded cash disbursements with the cash disbursements on the bank statement -proof of cash disbursements.. Trace from a file of receiving reports to the acquisitions 'ournal.

7se of prenumbered receiving reports, properly accounted for.

3,isting acquisition transactions are recorded -completeness..

Account for a sequence of receiving reports.

14- 4 .continued/ a., b., c., and d.

a< ,ey #nternal Control Internal verification of document package before check preparation. b< Transaction Related Audit $bAectives c< Test of Control 3,amine document package for indication of internal verification. d< Substantive Test of Transaction 3,amine supporting documents for propriety and recompute information on the supporting documents.

@ 8.

+ecorded acquisitions are for goods

and services actually received -occurrence.. +ecorded acquisitions are stated at the correct amounts -accuracy.. Acquisition transactions are properly included in the master files, and are properly summari!ed -posting and summari!ation.. Acquisitions are properly classified -classification.. Acquisitions are recorded on the correct dates -timing..

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:. +eview of supporting documents and signing of checks by an independent, authori!ed person. /ancellation of documents prior to signing of the check. 1onthly reconciliation of the accounts payable master file with the general ledger. ;. >.

+ecorded cash disbursements are for goods and services actually received -occurrence..

3,amine checks for signature.

Trace the cancelled check to the related acquisitions 'ournal entry and e,amine for payee name and amount. 3,amine the acquisitions 'ournal for duplicate entries to a vendor. Foot acquisitions and cash disbursements 'ournals and trace postings to the general ledger and accounts payable and inventory master files.

+ecorded acquisitions are for goods and services actually received -occurrence..

3,amine indication of cancellation. Inquire of client about monthly reconciliation procedures.

Acquisition transactions are properly

included in the master files, and are properly summari!ed -posting and summari!ation.. /ash disbursement transactions are properly included in the master file, and are properly summari!ed -posting and summari!ation..

14- 4 .continued/ e.

AcBuisitions Substantive Tests of Transactions

Aote9 1ore than one audit procedure is listed for certain ob'ectives even though the requirement is for only one procedure.

TRA"SACT#$"-R%&AT%' A('#T $)*%CT#+%S $ccurrence

S()STA"T#+% A('#T 8R$C%'(R%S /ompare prices on vendor invoices with approved price limits established by management. +eview the acquisitions 'ournal, general ledger, and accounts payable master file for large or unusual amounts. Trace a sample of receiving reports to the acquisitions 'ournal. Trace from a file of vendors' invoices to the acquisitions 'ournal. Trace from additions in perpetual inventory records to recorded acquisitions. /ompare amounts for entries in acquisitions 'ournal to related vendors' invoices, purchase orders and receiving reports. +ecompute information on vendor invoices. /ompare prices on vendor invoices with approved price limits established by management. Trace individual entries in accounts payable master file to acquisitions 'ournal. 3,amine vendors' invoices for proper classification. /ompare classification with chart of accounts by reference to vendors' invoices. /ompare dates of receiving reports and vendors' invoices with dates in the acquisitions 'ournal.

Co7pleteness

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Accuracy

8ostin> and Su77ariCation Classification Ti7in>

14- 4 .continued/ f.

Cash 'isburse7ents Substantive Tests of Transactions

Aote9 1ore than one audit procedure is listed for certain ob'ectives even though the requirement is for only one procedure.

TRA"SACT#$"-R%&AT%' A('#T $)*%CT#+%S $ccurrence

S()STA"T#+% A('#T 8R$C%'(R%S Trace cancelled check numbers in the cash disbursements 'ournal to related cancelled checks and e,amine for payee, name, and amount. 3,amine cancelled check for authori!ed signature, proper endorsement, and cancellation by the bank. +eview the cash disbursements 'ournal, general ledger, and accounts payable master file for large or unusual amounts. Trace cancelled check to the related acquisitions 'ournal entry and e,amine for payee name and amount. Trace entries in acquisitions 'ournal to subsequent payment in cash disbursements 'ournal. /ompare cancelled checks with the related acquisitions 'ournal and cash disbursements 'ournal entries. +ecompute cash discounts. Trace individual entries in accounts payable master file to cash disbursements 'ournal. /ompare classification with chart of accounts by reference to vendors' invoices and acquisitions 'ournal. /ompare dates on cancelled checks with cash disbursements 'ournal. /ompare dates on cancelled checks with the bank cancellation date.

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Co7pleteness Accuracy 8ostin> and Su77ariCation Classification Ti7in>

14- 4 .continued/ g. Note: Student answers will depend on answers in re uirements b through f! :eneral #. 5iscuss the following items with client personnel and observe activities9 a. )egregation of duties b. 1onthly reconciliation of accounts payable master file with the general ledger. Test 'ournal summari!ation and posting for a test month9 a. Foot acquisition 'ournal and trace postings to the general ledger and accounts payable and inventory master files. b. Foot cash disbursements 'ournal and trace postings to general ledger and accounts payable master file. 3,amine file of completed bank reconciliations. Account for a sequence of cancelled checks. +econcile recorded cash disbursements with cash disbursements on the bank statement. +eview the acquisitions 'ournal, cash disbursements 'ournal, general ledger, and accounts payable master file for large or unusual amounts. 3,amine underlying documents -vendors* invoices, receiving reports, purchase orders, and purchase requisitions. for indication of cancellation and reasonableness.

&.

4. $. 6. 8. :.

AcBuisitions ;. Trace entries in the acquisitions 'ournal to related vendors* invoices, receiving reports, and purchase orders. a. 3,amine indication of internal verification of dates, unit costs, prices, e,tensions and footings, account classification, recording in the 'ournal, and posting and summari!ation. b. 3,amine supporting documents for propriety. c. /ompare prices on vendors* invoices with approved price limits established by management. d. +ecompute information on vendors* invoices. e. 3,amine vendors* invoices for proper classification. f. /ompare dates on recorded acquisitions with dates on receiving reports and vendors* invoices. g. 3,amine document package for indication of internal verification.

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14- 4 .continued/ >. #@. Account for a sequence of receiving reports and voucher packages. Trace a sample of receiving reports and vendors* invoices to the acquisitions 'ournal.

Cash 'isburse7ents ##. )elect a sample of cancelled checks and9 a. Trace cancelled check to the related cash disbursements 'ournal entry and acquisitions 'ournal entry and e,amine for payee, name, amount, and date. b. 3,amine check for signature, proper endorsement, and cancellation by the bank. c. /ompare date on cancelled check with bank cancellation date. d. +ecompute cash discounts.

14- ! D AC& 8roble7 a. There are ##& transactions in the month of )eptember, &@@&. The total amount of these transactions is H#&:,>$#.#4 -Filter e,pression is 5AT3# IJ K&@@&@>@#* AA5 5AT3# LJ K&@@&@>4@*2 /ount command2 then Total command.. Type EIAF has the highest count. )ee the following report created using the )ummari!e command9
Page 1 04/10/2009 12:09:18 Produced with ACL by: ACL Educational Edition ot !or Co""ercial #$e %&PE AA C , P' %/ A'(# % -)**+)9 -902)+02 )2)2)9+1-4)281+*8 -1)*8+48 4-8880+-9 C(# % 1 108 )88 .1 4 ..2

b.

c.

There are 6;; sales invoices -IA., totaling H6&6,&6>.#8. The largest single invoice amount is H6,6$>.#> and the average invoice amount is H;>4.4@. -Filter by invoice type J IA2 then use )tatistics command on the Amount column..

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14- ! D AC& 8roble7 .continued/ d. =eaving the filter from part c intact, create a computed field with the following e,pression9 573 M 5AT3# and then add this column to the table view. )everal of the invoices have negative results, which means that possibly the wrong year was used for the due date. Also, some are >@ days old, which indicates potential collection problems. )ee the following printout9, which is the result of using the )tratify command after a filter is applied to isolate EIAF transactions greater than or equal to H4@@.

e.

#nternet 8roble7 Solution: 8oint of Sales Syste7s Controls

14-1 /onsider the many economic transactions in which you participate on a daily basis. Nou may purchase a cup of coffee at a coffee shop2 pay your telephone bill2 purchase stamps at the post office, and so forth. In many cases, the transaction is documented using a Epoint of saleF system. 7sing the Internet, find the definition of a point of sale system and read about the controls that have been established by the 7niversity of Toronto related to these systems to answer the following questions Ohttp9PPwww.internalaudit.utoronto.caPresourcesPcontrols.htmQ(4R 9 #. "hat is a point of sale systemS Answer: A point of sale system is one that allows the entering of #$%48

transactions details and the printing of sales invoicesPreceipts as transactions occur.

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#nternet 8roble7 14-1 .continued/ &. In your opinion, does a point of sale system increase or decrease the likelihood that cash will be stolen by employeesS Answer: If a point of sale system is properly implemented and monitored there should be a reduced likelihood that employees could steal cash. )o, the system must be properly used and controlled if it is to be effective. 4. "hat are the key controls around point of sale systems implemented by the 7niversity of TorontoS Answer: The 7niversity of Toronto*s Internal Audit website Ohttp9PPwww.internal audit.utoronto.caPresourcesPcontrols.htmQ(4R includes the following9 These controls are designed to prevent the loss of assets due to error or misappropriation and to protect customers from misuse of their credit cards or breaches of their confidentiality. oint%of%sale systems are configured to require a supervisorP manager password authori!ation to process refunds and void transactions /redit card refunds are processed only by crediting the original card so that service charges are recovered /reditPdebit card sales transactions are reconciled to point%of% sale system totals report-s. at least daily by a supervisor who does not process transactions oint%of%sale system daily totals reports are reconciled to FI) )tatement of Accounts or 1anagement +eports at least monthly by a supervisorPmanager independent of transaction processing oint%of%sale system terminals are kept in a secure location and staff log off when away from them All records containing credit card details are kept in a secure area with access restricted to only those employees who require it

-"ote9 Internet problems address current issues using Internet sources. (ecause Internet sites are sub'ect to change, Internet problems and solutions may change. /urrent information on Internet problems is available at www.pearsonhighered.comParens..

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