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The sales and collections transactions cycle deals with business activities through which a company provides goods or services to a customer and receives payment. The cycle can also be defined in a broader way called a revenue cycle and include all revenues, such as investment income, in addition to operating revenues. This chapter begins with overviews of the health-care provider and retail industries, and then presents details of sales, billing, and collection processes that are found in most businesses. Next, the chapter discusses audit activities that apply to the revenue cycle. Finally, the chapter ends by discussing auditing the revenue cycle in the context of health-care provider and retail industries.
Virtually all businesses have a revenue and collection function that is fundamental to the primary productive activity of a company. As a result, the revenue cycle interacts with and depends on other cycles. A company must either purchase or manufacture the goods it sells, and it must have the human resources to produce goods and provide services. The customer may take possession of goods at the time of the sale, or the transaction may require a process to deliver the goods separate from the point of sale. The receipt of payment in the cycle may result from sales for cash at the point of sale or sales on credit. Sales on credit require a billing and collection function in addition to the activities that occur at the time of the sale. The process of granting credit and handling bad debt must be managed. All sellers of goods and services also have some policies and provisions that address and deal with sales returns and allowances. Typical transaction activities for sales, billing, and cash receipts are as follows:
Sales for cash and for accounts receivable
Cash receipts Sales returns and allowances
Writing off uncollectible accounts receivable
Estimating bad debt expense
Accounts involved in the cycle are: Cash, Accounts Receivable, Allowance for Uncollectible, Accounts Sales Sales returns and allowances, Bad debt expense.
The customer order is a request from the customer indicating the quantity and the description of the merchandise ordered.
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.
A prelisting of cash receipts is a list prepared when cash is received by someone who has no responsibility for recording sales, accounts 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.
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.
A shipping document is prepared at the time of shipment indicating the quantity and description of goods ordered. It is used to generate an invoice to the customer. Assuring that all shipments are recorded and billed is important to addressing the completeness assertion, as well as the accuracy of the quantities billed.
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 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.
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.
A remittance advice is a document mailed to the customer and typically returned to the seller with the customer’s payment. It indicates the customer name, the sales invoice number, and the amount of the invoice. A remittance advice is used as a record of the payment received to permit the immediate deposit of checks received and to improve control over the custody of assets.
The accounts receivable trial balance is a report from the accounts receivable master file that shows the amount receivable from each customer at a point in time. An aged trial balance includes the total balance outstanding and the number of days the receivable has been outstanding, grouped by category of days (such as less than 30 days, 31 to 60 days, and so on).
Proper credit approval for sales helps minimize 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. Without 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.
The sales journal contains the record of each sales transaction that includes the customer name, date, amount, and the account classification for each transaction. The sales journal generally represents the record of each individual transaction. Typically, the sales journal accumulates transactions for a period of time, which is often monthly. Transactions recorded in the sales journal 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 journal, sales return journal, and cash receipts journal. The total in the accounts receivable master file equals the total in the accounts receivable general ledger account.
Tests of Controls for Sales.
Sales activity controls are intended to ensure that transactions recorded as sales are bona fide sales. Either the cash was collected or invoices were sent so that the cash will be collected at a later time. Furthermore, the amounts recorded in the financial statements rep- resent the correct dollar amount of sales. Tests of controls for sales address: Credit approval Billing evidence for all items shipped Completeness of recorded sales Actual occurrence and validity of any transactions recorded as sales Tests of controls for proper recording of sales transactions address whether sales are posted to the correct account, in the correct period and for the correct amount.
Tests of Controls for Cash Receipts Controls over cash receipts focus on safeguarding cash and on cash-related documentation procedures. Tests of controls for cash receipts address how the company safeguards the cash both physically and with documentation. Safeguarding begins at the time the cash comes in and continues through the deposit in the bank. Controls cover processes through which the company updates its records for cash received, and reconciles its records with a reliable external record—typically a bank statement.
Substantive procedures provide the auditor with evidence on financial statement amounts and disclosures. The three categories of substantive procedures are discussed in the remain- der of the chapter: dual purpose tests, substantive analytical procedures, and tests of details of balances. The extent to which the auditor uses substantive procedures is affected by the auditor’s assessment of risk and resulting reliance on ICFR. Substantive procedures of some type are performed for all relevant assertions on all significant accounts and disclosures. For certain accounts and disclosures, the auditor may choose to perform more extensive substantive tests and procedures rather than rely on controls. The auditor might choose a substantive approach even after concluding that ICFR was functioning effectively as of management’s report date. For example, suppose ICFR was not functioning effectively early in the year. Consequently, management made changes, and ICFR was functioning effectively at fiscal year end. In this situation the auditor could not rely on ICFR during the period of time before it was improved. For that time frame the auditor must rely on substantive procedures for audit evidence.
The term analytical procedures covers a wide variety of audit steps. Regardless of the spe- cific step, the overall purpose of any analytical procedure is to collect audit evidence that is based on relationships among items. For example, looking at the aggregated amount of all sales transactions for the current year compared to the prior year tells the auditor whether the dollar amount of sales have increased or decreased. Noting this type of change, or lack thereof, has no real value in isolation. But the auditor can evaluate the result of an analyt- ical procedure using other information and come to conclusions.