Chapter 14

Questions:14-21 to 14-25, 14-27 to 14-30

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14-2

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1.Processing Customer Orders

Customer order A request for merchandise by a customer

Sales orderA sales order is a document for communicating the
description, quantity, and related information for goods ordered by a
customer
2.Granting Credits
Before goods are shipped, a properly authorized person must
approve credit to the customer for sales on account.
Weak practices in credit approval often result in excessive bad debts
and account receivable that may be uncollectible.
An indication of credit approval often serves as the approval to ship
the goods
Automatic approval of a credit sales on preapproved credit limit in
the customer master file
Computer allow the process of sales order ONLY if not exceeding
the preapproved credit limit.
3.Shipping Goods
Shipping document (e.g., bill of lading)
Serve as a signal to bill customer, remove inventory from
4 warehouse, update the perpetual system.
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4. Billing Customers and Recording Sale

Must be done correctly and on a timely basis.

All shipments made have been billed (completeness)
No shipment has been billed more than once (occurrence)
Each one is billed for the proper amounts (accuracy).
Charging the customer for the quantity shipped at the authorized price, which
includes consideration for freight charges, insurances and terms of payment
(credit discount, advance payment, etc).
Document includes
sales invoice (description and quantity of goods sold, the price, freight charges,
insurance terms, destination of shipment, total amount an due date).
sales transaction files (all information related to each sales transaction,
including customer name, date, amount, account classification, sales person,
commission rate, and returns and allowances).
Sales journal/list (generated from sales transaction file, include customer
name, date, amount and account classification-cash vs. credit sales )
AR master file (by customer name, the beginning balance in AR, each sales
transaction, sales returns and allowances, cash receipts, and the ending bal.)
AR trial balance (AR from each customer at a point in time, directly from the
AR master file)
Aged trial balance: (with the information on outstanding period )
Monthly
statement (customer portion of AR master file)
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Sales
transaction
file

Accounts
receivable
file

Sales
journal

Accounts
receivable
trial balance

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5. Processing and Recording Cash Receipts

Including receiving, depositing and recording cash
The most important concern is about theft occur before receipts are entered in the
records.
Remittance advice=a document mailed to the customer and typically returned to
the seller with the cash payment. It indicates the customer name, the sales invoice
number and the amount of the invoice.
Prelisting of cash receipts= a list prepared when cash is received by someone
who has no responsibility for recording sales, account receivable, or cash and who
has no access to accounting records. It is used to verify whether cash received was
recorded and deposited at the correct amounts and on a timely basis.
Lockbox system
Electronic fund transfer
Cash Receipts transaction files
Include same info as in the sales transaction file, including customer name, date,
amount, account classification, sales person, commission rate, and returns and
allowances
Cash receipts journal / listing
Generated from cash receipt transaction file and includes similar info in AR
master file, including the customer name, date, amount
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Prelisting of
Cash receipts

Cash receipts
Transaction file

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6. Processing and Recording Sales Returns and Allowance

When a customer is dissatisfied with the goods, the seller often
accepts the return of the goods or grants a reduction in the
chargers.
The company prepares a receiving report for returned goods
and returns them to storage.
Returns and allowances are recorded in the sales returns and
allowances transaction file, as well as AR master file.
Credit memo indicates a reduction in the amount due from a
customer because of returned goods or an allowance. It often
takes the same general form as a sales invoice, but it supports
reductions in the AR rather than increases
Sales returns and allowances journal performs the same
function as sales journal. Some company just use sales journal
rather than in a separate journal (Dr sales)

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7. Writing Off Uncollectible Accounts Receivable

After concluding that an amount can not be collected, the company
must write it off. Typically, when a customer files a bankruptcy or the
amount is turned over to a collection agency.
Uncollectable account authorization form an internal
document to write an A/R off as uncollectible.
Dr. Allowance for Uncollectible Accounts
Cr. Account Receivable
8. Providing for Bad Debt
Accounting principles requires them to record bad debt expense
for the amount they do not expect to collect.
Most companies record this transaction at quarter/month end.
Dr. Bad Debt Expense
Cr. Allowance for Uncollectible Accounts
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Auditors study the clients flowcharts, make inquiries of the client using an internal
control questionnaire, and perform walk-through tests of sales.

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Adequate separation of duties

Proper separation of duties prevents various types of misstatements due

to both errors and fraud.
Management should deny cash access to anyone responsible for entering
sales and cash receipts transaction information into computer.
Credit-granting function should be separate from the sales function
Personnel responsible for doing internal comparisons should be
independent of those entering the original data
Proper authorization

The auditor is concerned about authorization at three key points

1. credit must be properly authorized before a sale takes place.
2. goods should be shipped only after proper authorization
3. prices including basic terms, freight and discounts must be
authorized.
The first two controls are meant to prevent the loss of company assets by
shipping to fictitious customers or those who will fail to pay for the goods.
The third control, price authorization, is meant to ensure that the sale is
billed at the price set by company policy.
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Adequate documents and records

Pre-numbered documents

To prevent both the failure to bill or record sales and the occurrence of duplicate
billings and recordings.
To use this control effectively, a billing clerk will file a copy of all shipping
documents in sequential order after each shipment is billed, while someone
else will periodically account for all numbers and investigate the reason for any
missing documents.

Monthly statements
Be handled by persons who have no responsibility for hardly cash or recording
sales or AR to avoid the intentional failure to sent the statements.
For maximum effectiveness, all disagreements about the account balance should
be directly to a designated person who has no responsibility for handling cash or
recording sales or AR.

Internal verification procedures

Examples include accounting for the numerical sequence of prenumbered
documents, checking the accuracy of document preparation, and reviewing
reports for unusual or incorrect items.
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Control
effectiveness
Control
risk
A lower assessed level of control risk will

result in increased testing of controls to support the

lower control risk,
have a corresponding increase in detection risk and
decrease in the amount of substantive tests.
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Design tests of controls for sales (1/2)

The nature of the control determines the nature of test of
controls.
If the internal control is to initial customer orders after credit
approval then the test of control is to examine the customer
order for proper initial.
Test of controls for separation of duties are ordinarily restricted
to the auditors observations of activities and discussions with
personnel.
Testing of controls using computer.
Auditor can test whether credit is properly authorized by the computer by
attempting to initiate transactions that exceed a customers credit limit.
Auditor can test for likelihood of fictitious sales by attempting to input nonexistent customer numbers, which should be rejected by the computer.

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Design tests of controls for sales (2/2)

TOC organized by transaction related objectives
[occurrence] Sales are supported by authorized shipping documents and approved
customer orders
[TOC] is to examine sales invoice for supporting bill of lading and customer
order. The auditor should start with sales invoice and examine documents in
support of the sales invoice.
[completeness] Account for a sequence of various types of documents.
[TOC] to account for a sequence of various types of documents. For example,
accounting for a sequence of shipping documents and tracing each one to the
duplicate sales invoice and recording in the sales journal provide evidence of
completeness.
[TOC] for both occurrence and completeness simultaneously
Auditors check the sequence of sales invoices selected from the sales journal
and watch for duplicate and omitted numbers or invoices outside the normal
sequence. Assume the auditor selects sales invoices #18100 to #18199,
Completeness objective will be satisfied if all 100 invoices recorded.
Occurrence objective will be satisfied if there is no duplicate recording of any of
the invoice numbers.
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Occurrence: Recorded sales are for shipments actually made.

Unintentional overstatement sales can be easily discovered:
monthly statement to customers.
Year-end AR confirmation.
Three types of misstatements and tests of substantive transactions
1)Sales included in the journal for which no shipment was made (error/fraud)
Auditors vouch selected entries in the sales journal to related copies of
shipping documents.
Trace to perpetual inventory records to test whether inventory was reduced.
2)Sales recorded more than once(error/fraud)
Review numerically sorted list of recorded sales transactions for duplicate
Test for proper cancellation of shipping documents.
3)Shipment made to nonexistent customers and recorded as sales (always fraud,
Sham Sales)
Happen if the person who record sales also authorize shipments.
Trace customer information on the sales invoice to the customer master file.
Another effective approach in detecting the three types of misstatements of
sales is to trace the credit in AR to its source
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Completeness: existing sales transactions are recorded

Overstatement of sales is more likely than understatement of sales. In most audit, no

substantive test for completeness objective for sales transactions.
Possible ICOFR weakness triggers concerns on completeness objective: lack of
independent internal tracing from shipping documents to the sales journal.
Auditors test for unbilled shipments, auditors can trace selected shipping documents
from a file in the shipping department to related duplicated sales invoice and the sales
journal.
Accuracy: Sales are accurately recorded
Accuracy concerns:
Shipping the amount of goods ordered
Accurately billing for the amount of goods shipped
Accurately recording the amount billed in the accounting records
Auditors commonly
compare prices on duplicate sales invoices with an approved price list
recalculating extension and footings
compare the details on the invoices with shipping records for description, quantity,
and customer ID.
Computer generated invoice
The auditor focus on whether the calculation is programmed accurately and the
price
14-19 list master file is authorized and correct.
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Posting and summarization: Sales transactions are correctly included in the master
file and correctly summarized.
Auditor perform some clerical accuracy tests, such as footing the journals and
tracing totals and details to G/S and the master files.
Posting and summarization differ from accuracy
Accuracy If auditor compare an amount on sales invoice with sale journal
Posting and summarization if an auditor trace an entry from sales journal to
sales master file.
Classification: sales transactions are correctly classified.
Should NOT
Debit AR for cash sales
Credit sales for a collection of AR
Classify disposal of fixed assets (e.g., PPE) as sales.
Timing: sales are recorded on the correct dates
Sales should be billed and recorded as soon after shipment take place
Auditors commonly compare the date on selected shipping documents with the date
on related duplicated sales invoices, the sales journal, and the account receivable
master file.
Significant difference indicate potential cutoff problems in the tests of year-end
balance.
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Materiality
In most cases, sales returns and allowance are so
immaterial that the auditor can ignore them.
Emphasis on the occurrence objective
Auditor emphasize testing recorded transactions to uncover
any theft of cash from the collection of account receivable
that was cover up by a fictions sales returns or allowance.
Other objectives are also important
For example, completeness of sales returns and allowance
is important for year-end audit to the concern of
overstatement of sales and receivables through
understatement of sales and returns.
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 Determine whether cash received was recorded

Prepare proof of cash receipts
Test to discover lapping of accounts receivable
Lapping

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 Occurrence transaction-related audit objective

Proper authorization of the write-off of

uncollectible accounts
Verification of accounts written off

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