Sales and Collection Cycle Audit: Test of control and Substantive Testing of Transaction.

In this video I discuss the sales and collection cycle audit.

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Adequate Separation of Duties
Proper separation of duties helps prevent various types of misstatements due to both errors and fraud. To prevent fraud, management should deny cash access to anyone responsible for entering sales and cash receipts transaction information into the computer. The credit-granting function should be separated from the sales function, because credit checks are intended to offset the natural tendency of sales personnel to optimize volume even at the expense of high bad debt write-offs. Personnel responsible for doing internal comparisons should be independent of those entering the original data. For example, comparison of batch control totals with summary reports and comparison of accounts receivable master file totals with the general ledger balance should be done by someone independent of those who input sales and cash receipt transactions.

Proper Authorization
The auditor is concerned about authorization at three key points:

Credit must be properly authorized before a sale takes place.
Goods should be shipped only after proper authorization.
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. Price authorization is meant to ensure that the sale is billed at the price set by company policy. Authorization may be done for each individual transaction or general authorization may be given for specific classes of transactions. General authorizations are often done automatically by computer.

Adequate Documents and Records
Because each company has a unique system of originating, processing, and recording transactions, auditors may find it difficult to evaluate whether each client’s procedures are designed for maximum control. Nevertheless, adequate record-keeping procedures must exist before most of the transaction-related assertions can be met. Some companies, for example, automatically prepare a multicopy prenumbered sales invoice at the time a customer order is received. Copies of this document are used to approve credit, authorize shipment, record the number of units shipped, and bill customers. This system greatly reduces the chance of the failure to bill a customer if all invoices are accounted for periodically, but controls have to exist to ensure the sale isn’t recorded until shipment occurs. Under a system in which the sales invoice is prepared only after a shipment has been made, the likelihood of failure to bill a customer is high unless some compensating control exists. In many organizations, all sales documents are electronic and no paper documents are prepared.

Prenumbered Documents
Prenumbering is meant to prevent both the failure to bill or record sales and the occurrence of duplicate billings and recordings. Of course, it does not do much good to have prenumbered documents unless they are properly accounted for. 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
Sending monthly statements is a useful control because it encourages customers to respond if the balance is incorrectly stated. These statements should be controlled by persons who have no responsibility for handling cash or recording sales or accounts receivable to avoid the intentional failure to send the statements. For maximum effectiveness, all disagreements about the account balance should be directed to a designated person who has no responsibility for handling cash or recording sales or accounts receivable.

Internal Verification Procedures
Computer programs or independent personnel should check that the processing and recording of sales transactions fulfill each of the six transaction-related audit objectives. Examples include accounting for the numerical sequence of prenumbered documents, checking the accuracy of document preparation, and reviewing reports for unusual or incorrect items.

Determine Extent of Tests of Controls

After auditors identify the key internal controls and control deficiencies, they assess control risk, often using a matrix format similar to Figure 12-3.