sales and receipts cycle

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.

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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.

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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.

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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.

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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

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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.

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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.

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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.

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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

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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

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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

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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

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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.


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Classification

Review the trade debtors list to see if there are any

receivables from related parties which should be

separately disclosed.

Cut-off


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

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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

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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

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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



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


S0928 4 January 2002 D2199 6 January 2002 $18,000


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)

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(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)

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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.,

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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

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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

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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.

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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

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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

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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

Performed

By

Workpaper

Reference

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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Performed

By

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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.

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Reviewed and approved by Date

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Appendix III – Sales and Receipts Cycle Flowchart

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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:

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