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Auditing II

Auditing the Revenue Cycle

Lecturer: Taufikur Rahman, SE, MBA, Akt.

Group Members:
Ignatius Denny Kurniawan S. / 296514 Fathan Sabartian / 320291 Novi Prastia Kusumastuti / 320299

Table of Contents

Table of Contents............................................................................................................................. 2 Introduction The Nature of the Revenue Cycle ................................................................. 4


Develop Audit Objectives ........................................................................................................................ 5 Understanding the Clients Business and Industry ....................................................................... 7 Materiality .................................................................................................................................................... 7 Inherent Risk, Including the Risk of Fraud....................................................................................... 7 Analytical Procedures Risk .................................................................................................................... 8 Consideration of Internal Control Components ...........................................................................11 1) 2) 3) 4) Control Environment .............................................................................................................................. 11 Risk Assessment........................................................................................................................................ 11 Information and Communication (Accounting System)........................................................... 12 Monitoring ................................................................................................................................................... 12

Initial Assessments of Control Risk and Preliminary Audit Strategy ............................................ 12

Control Activities - Credit Sales Transactions ..................................................................... 14


Common Documents and Records .....................................................................................................14 Functions and Control Activities ........................................................................................................15 1) 2) 3) Authorizing Sales ...................................................................................................................................... 15 Delivery of Goods and Services........................................................................................................... 17 Recording Sales ......................................................................................................................................... 18

System Flowchart Credit Sales Transactions..............................................................................20

Control Activities - Cash Receipts Transactions ................................................................. 23


Common Documents and Records .....................................................................................................23 Functions and Control Activities ........................................................................................................24 1) 2) 3) Receiving Cash Receipts ........................................................................................................................ 24 Depositing Cash in bank ........................................................................................................................ 25 Recording the Receipts .......................................................................................................................... 25

System Flowchart Cash Receipts Transactions ..........................................................................27

Control Activities - Sales Adjustment Transactions .......................................................... 29


Common Documents and Records .....................................................................................................29 Functions and Control Activities ........................................................................................................29 1) Granting Cash Discounts........................................................................................................................ 29

2) 3)

Granting sales returns and allowances ........................................................................................... 30 Determining uncollectible accounts ................................................................................................. 30

Other Controls in the Revenue Cycle ................................................................................................31

Tests of Controls in Revenue Cycle ......................................................................................... 33


1) 2) Tests of Controls Related to Sales ...................................................................................................... 33 Tests of Controls Related to Collection............................................................................................ 36

Substantive Test of Accounts Receivable.............................................................................. 38


Determining Detection Risk ................................................................................................................38 1) 2) 3) 4) 5) 1) 2) 3) 4) 5) 6) Existence and Occurrence ..................................................................................................................... 38 Completeness ............................................................................................................................................. 39 Rights and Obligations ........................................................................................................................... 39 Valuation and Allocation ....................................................................................................................... 40 Presentation and Disclosure ................................................................................................................ 40 Initial Procedures ..................................................................................................................................... 41 Analytical Procedures ............................................................................................................................. 41 Test of Details of Transactions............................................................................................................ 41 Test of Details of Balances .................................................................................................................... 42 Test of Details of Accounting Estimates .......................................................................................... 44 Test of Details of Disclosures ............................................................................................................... 45

Designing Substantive Tests ................................................................................................................41

References: ...................................................................................................................................... 46

Introduction The Nature of the Revenue Cycle


The revenue cycle is a recurring set of business activities and related information processing operations associated with (1) providing goods and services to customers and (2) collecting their cash payments. Or in another word, an entitys revenue cycle consists of activities related to the exchange of goods and services with customers and to the collection of the revenue in cash. The primary objective of the revenue cycle is to provide the right product in the right place at the right time for the right price. For a merchandising company, the classes of transactions in the revenue cycle include: 1. credit sales (sales made on accounts), 2. cash receipts (collections on accounts and ash sales), and 3. sales adjustments (discounts, sales returns and allowances, and uncollectable accounts provisions and write-offs). The classes of transactions in the revenue cycle affect the accounts, as depicted in the figure below.

Develop Audit Objectives


The audit objectives for the revenue cycle relate to obtaining sufficient competent evidence about each significant financial statement assertion that pertains to revenue cycle transaction and balances. These audit objectives for the revenue cycle are shown in the figure, as follows.

Assertion Category Existence or Occurrence

Transaction Class or Balance Transaction

Specific Audit Objective Recorded sales transactions represent goods shipped or services provided during the period. Recorded cash receipt transactions represent cash received during the period. Recorded sales adjustment transactions during the period represent authorized discounts, returns and allowances, and uncollectable accounts.

Balance Completeness Transaction Balance


Transaction Class or Balance Transaction Balance

Accounts receivable representing amounts owed by customers exists at the balance sheet date. All sales, cash receipts, and sales adjustments made during the period were recorded. Accounts receivable include all claims on customers at the balance sheet date.
Specific Audit Objective The entity has rights to the receivables and cash resulting from recorded revenue cycle transactions. Accounts receivable at the balance sheet date represent legal claims of the entity on customers for payment. All sales and cash receipts and sales adjustments are valued using GAAP and correctly journalized, summarized, and posted. Accounts receivable represent gross claims on customers at the balance sheet date and agree with the sum of the accounts receivable subsidiary ledger. The allowance for uncollectable accounts represents a reasonable estimate of the difference between gross receivables and their net realizable value.

Assertion Category Rights and Obligations

Valuation or Allocation

Transaction

Balance

Assertion Category Presentation and Disclosure

Transaction Class or Balance Transaction

Specific Audit Objective The details of sales, cash receipts, and sales adjustments support their presentation in the financial statements including their classification and related disclosures. Accounts receivable are properly identified and classified in the financial statements. Appropriate disclosures have been made concerning accounts receivable that have been assigned or pledged.

Balance

Understanding the Clients Business and Industry


Auditors develop audit strategy based on the risk of material misstatement. The first step in assessing risk is obtaining an understanding of the clients business and industry because it assists the auditor in: Developing an expectation of total revenues by understanding the clients capacity, market place, and clients. Developing an expectation of gross margin by understanding the clients market share and competitive advantage in the market place. Developing an expectation of net receivables based on the average collection period for the client and industry. Moreover, the process of generating revenues drives many expenses, such as cost of good sold or selling expenses. Thus, understanding the revenue cycle assists in developing expectations of an entitys expenditures associated with other transaction cycles and assessing the risk of material misstatements in unaudited earnings.

Materiality
Revenues are a measure of volume of activity for every entity. Revenues usually have a high volume of transactions and total revenues are so important to the financial statements that they are often used as a gauge of overall materiality for the engagement. Revenues also give rise to accounts receivable and eventually cash and cash flow from operations. The accounts receivable produced by credit sales transactions are almost always material to the balance sheet. The transaction classes and account balances comprising the revenue cycle normally have material effects on the financial statements. To enhance the auditors effectiveness and efficiency in meeting specific audit objectives in this cycle, careful attention should be given to considering inherent risk, analytical procedures risk, and control risk when choosing the audit strategy for each audit objective.

Inherent Risk, Including the Risk of Fraud


In assessing inherent risk for revenue cycle assertions, the auditor should consider pervasive factors that may affect assertions in several cycles, including the revenue cycle, as well as

factors that may pertain only to specific assertions in the revenue cycle. These include factors that provide incentive for management to misstate revenue cycle assertions and fraudulent financial reporting, such as: 1. Pressures to overstate revenues in order to report achieving announced revenue or profitability targets or industry norms that were not achieved in reality owing to such factors as global, national, or regional economic conditions, the impact of technological developments on the entitys competitiveness, or poor management. 2. Pressures to overstate cash and gross receivables or understate the allowance for doubtful accounts in order to report a higher level of working capital in the face of the need to meet debt covenants.

Meanwhile, other factors that might contribute to misstatements in revenue cycle assertions include the following: The volume of sales, cash receipts, and sales adjustment transactions is often high, resulting in numerous opportunities for errors to occur. The timing and amount of revenue to be recognized may be contentious owing to factors such as ambiguous accounting standards, the need to make estimates, the complexity of the calculations involved, and purchasers rights of return. When receivables are factored with recourse, the correct classification of the transaction as a sale or a borrowing may be contentious. Receivables may be misclassified as current or noncurrent owing to difficulties in estimating the likelihood of collection within the next year or the source of events on which collection is contingent. Cash receipt transactions generate liquid assets that are particularly susceptible to misappropriation. Sales adjustment transactions may be used to conceal thefts of cash received from customers by overstating discounts, recording fictitious sales returns, or writing off customers balances as uncollectable.

Analytical Procedures Risk


Analytical procedures risk is the element of detection risk that analytical procedures will fail to detect material misstatements. Analytical procedures are cost effective and rely on the

auditors knowledge of the business and industry. They are not only effective in identifying potential misstatements in the financial statements, but they are also effective in identifying issues that may result in providing other assurance services in addition to the audit report. The first step in performing analytical procedures is obtaining an understanding of total revenues given (1) the clients capacity and (2) the clients market place for those products. 1. The Clients Capacity The auditor should obtain an understanding of the clients capacity, which is the maximum volume of sales that it could generate if it fully utilized its facilities and employees to manufacture and deliver products or services. Auditors should be sensitive to the volume of sales that an entity records given its capacity, the number of shifts that an entity operates, and seasonal variations in the industry. It is much more effective to evaluate total revenues towards a measure of business activity (comparing financial with non-financial information) than comparing current revenues with prior-year revenues. 2. The Clients Market Place The auditor must also be sensitive to trends in the marketplace for the clients products. The auditor must be able to assess the reasonableness of revenue increases. Another important analytical procedure is auditor understands the clients market share, which compares the clients revenues with total revenues in the market for the clients product. This is particularly important because companies with dominant market shares often obtain premium gross margins.

Finally, it is important for the auditor to evaluate the clients accounts receivable turn days, or average collection period, and be able to compare the collection period with industry norms. Increase in the clients collection period are indicators that receivables are growing faster than sales volumes, which means that operating cash flows are consumed, and this may lead to liquidity problems. The table below will present other analytical procedures that the auditor might assess in the revenue cycle, as follows.

Ratio Sales to Capacity Market Share

Formula Net Sales Nonfinancial Measure of Capacity Clients Net Sales Net Sales of Industry

Audit Significance Helpful in assessing the reasonableness of total revenues. Helpful in assessing the reasonableness of both total revenues and gross margins. Larger market share is often associated with larger gross margins. This ratio is useful for manufacturing and other asset-based companies. Describes the relationship between assets and sales revenues. Ratios larger than 1.0 indicate that receivables are growing faster than sales. Large ratios may indicate possible collection problems.
Audit Significance Useful in comparing with industry averages. Longer collection periods may indicate collection problems. Prior experience and current sales volumes may be useful in estimating current net receivables. Useful in evaluating the reasonableness of uncollectable accounts expense. Smaller ratios may indicate an inadequate provision for uncollectable accounts. Useful in evaluating the reasonableness of uncollectable accounts expense. Smaller ratios may indicate an inadequate provision for uncollectable accounts. Companies with a high proportion of revenues from new products may earn a premium gross margin due to the ability to innovate.

Sales to Total Assets

Sales Average Total Assets

Accounts Receivable Growth to Sales Growth

((Accounts Receivable n Accounts Receivable n-1) 1) ((Sales n Sales n-1) 1)

Ratio Accounts Receivable Turn Days

Formula Average Accounts Receivable Sales x 365

Uncollectable Accounts Expense to Net Credit Sales

Uncollectable Accounts Expense Net Sales

Uncollectable Accounts Expense to Accounts Receivable Writeoffs New Product Revenues to Total Revenues

Uncollectable Accounts Expense Actual Accounts Receivable Writeoffs

Revenues from New Products Introduced During the Year Total Revenues

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Consideration of Internal Control Components


The auditor should also consider the applicability of four internal control components to the revenue cycle the control environment, risk assessment, information and communication (including accounting system), and monitoring. The understanding of these components is required under either a primarily substantive audit strategy or a lower assessed level of control risk approach.

1) Control Environment
The control environment consists of several factors that might mitigate several of the inherent risks related to the revenue cycle. In addition, these factors may enhance or negate the effectiveness of other internal control components in controlling the risk of misstatements in revenue cycle assertions. Commitment to integrity and ethical values It is a key control environment factor in reducing the risk of fraudulent financial reporting, such as through overstatement of revenues and receivables. Management philosophy and operating style It is described as attitudes and actions towards financial reporting. This characteristic includes whether management is conservative or aggressive in selecting the alternative accounting principles and developing accounting estimates.

Human resource policies and practices


It is a key control environment factor adopted for employees who handle cash receipts due to the susceptibility of cash to misappropriation, for instance through bonding the employee who handle cash.

2) Risk Assessment
Management should assess business risk, inherent risk, and fraud risks and place controls to address those risks, reducing the risk of misstatements. The important aspect of planning the audit involves obtaining an understanding of managements risk assessment procedures, risk identified, and managements response in placing controls in operation.

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3) Information and Communication (Accounting System)


The primary concern with this component pertains to the portion of the accounting system used in processing cycle transactions and balances. An understanding of the revenue accounting system requires knowledge of how: 1. sales are initiated, 2. goods and services are delivered, 3. receivables are recorded, 4. cash is received, and 5. sales adjustments are made, including the methods of data processing and the key documents and records used.

4) Monitoring
This component should provide management with feedback as to whether internal control pertaining to revenue cycle transactions and balances are operating as intended. The auditor should obtain an understanding of this feedback and whether management has initiated any corrective actions based on the information received from the monitoring activities. Possibilities include information received from: customers concerning billing errors, regulatory agencies concerning disagreements on revenue recognition policies or related internal control matters, and External auditors concerning reportable conditions or material weaknesses in relevant internal controls found in prior audits.

Initial Assessments of Control Risk and Preliminary Audit Strategy


The auditors procedures to obtain an understanding of the 4 internal control components extend to the design of policies and procedures and whether effective control activities have been placed in operation. Auditors often plan to follow a lower assessed level of control risk approach when auditing the revenue cycle, because of the high volume of revenue transactions. Control activities are usually effective in these circumstances. However, if significant weakness are noted in the control environment, the auditor might plan to assess control risk at high or maximum, then the auditor assess the risk of material

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misstatement, and proceed with the design of substantive test (or choose to plan a primarily substantive approach).

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Control Activities - Credit Sales Transactions


Sales orders may be taken over-the-counter, via telephone, mail order, traveling sales representatives, fax, or electronic data interchange. The goods may be picked up by the customer or shipped by the seller. Sales transactions are usually recorded using computer systems that may process transactions in either a real-time or batch processing mode. Control activities over sales transactions should be tailored to these varying circumstances. Virtually every company that requires an audit has a computerized accounting system. Recall that there are 2 types of computer controls: General controls that relate to the computer environment and have a pervasive effect on computer applications. Application controls that relate to the individual computerized accounting applications, such as the expenditure cycle.

Common Documents and Records


1. Customer order It is a form of request for merchandise by a customer received directly from the customer or through a salesperson, and may be a form furnished by the seller or the buyers purchase order form. 2. Sales order It is a form showing the description, quantity, and other data pertaining to a customer order. It serves as the basis for initiating the transaction and internal processing of the customer order by the seller. 3. Shipping Document It includes form used to show the details and date of each shipment. It may be in the form of a bill of lading, which serves as a formal acknowledgment of the receipt of goods for delivery by a freight carrier. Other shipping documents may include a packing slip with details on the items included in a shipment. 4. Sales invoice

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It is a form stating the particulars of a sale, including the amount owed, terms, and date of sale. It is used to bill customers and provides the basis for recording the sale. 5. Authorized price list. It is a listing or computer master file containing authorized prices for goods offered for sale. 6. Sales transactions file It includes a computer file of completed sales transaction used to print the sales invoices and sales journal, and update the accounts receivable, inventory, and general ledger master files. 7. Sales journal It is a journal listing completed sales transactions. 8. Customer master file It contains the customers shipping and billing information and the customers credit limit. 9. Accounts Receivable master file It contains information on transactions with, and the balance due from, each customer, and serves as the basis for the accounts receivable subsidiary ledger. 10. Customer monthly statement It is a form of report sent to each customer showing the beginning balance, transactions during the month, and the ending balance.

Functions and Control Activities


The processing of revenue transactions involves the following revenue functions:

1) Authorizing Sales
It is a request by an entity for a sales transaction with another entity, including: 1. Accepting customer orders Sales orders from customers should be accepted only in accordance with managements authorized criteria. The criteria generally provide for specific approval of the order in the sales order department using a computer terminal to determine that the customer exists in a customer master file with approved credit

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limits. If the customer is not listed, approval by a credit department supervisor is usually required. In many companies, the next step is preparing a prenumbered sales order form. The prenumbered sales order form permit following each transaction from initiation to delivery of goods and service, to recording the sale, to receipt of final consideration. The sales order represents the start of transaction trail of documentary evidence. Information on open (unfilled) and filled sales orders are usually maintained in appropriate computer files. 2. Approving credit The process of approving credit is important in minimizing credit risk and ensuring that goods shipped are paid for on a timely basis. Well managed entities take actions that ensure strong operating cash flows. The credit department gives credit approval in accordance with managements credit policies and authorized credit limits for each customer. Usually the computer can be programmed to compare a customers outstanding receivable balance, plus the anticipated sale, with the customers credit limit in the approved customer master file. Segregating responsibility for initiating a sale and approving credit prevents sales personnel from subjecting the company to undue credit risks to boost sales. A credit check should be made for all new customers, which may include obtaining a credit report from a rating agency such as Dun & Bradstreet. Approval or non approval of credit is indicated by an authorized credit employee following prescribed procedures in having the new customer and credit information added to the accounts receivable master file. Controls over approving credit are designed to reduce the risk of initially recording an individual revenue transaction at an amount in excess of the amount of cash expected to be realized from the transaction. Thus, they relate to the valuation or allocation assertion for sales transactions. Of course, the expectations of realizability for some of these amounts will change over time, resulting in the need for an allowance for uncollectable accounts. Controls over approving credit will enable management to make a more reliable estimate of the size of the allowance needed. Thus, these controls also relate to the valuation or allocation assertion for the allowance for uncollectable accounts.

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2) Delivery of Goods and Services


It is a physical shipment or delivery of a good or service, including: 1. Filling sales orders Company policy generally prohibits the release of any goods from the warehouse without an approved sales order. Furthermore, the computer may be programmed to match items taken from the perpetual inventory with items on an approved sales order. This control procedure is designed to prevent the unauthorized removal items from inventory. The warehouse may receive an electronic copy of the approved sales order as authorization to fill the order and release the goods to the shipping department. When goods are pulled from inventory, a packing slip is normally produced to detail the items that will be shipped to the customer. 2. Shipping sales orders Segregating the responsibility for shipping from approving and filling orders will help to prevent shipping clerks from making unauthorized shipments. In addition, an important manual control requires that shipping clerks make independent checks to determine: That goods received from the warehouse are accompanied by appropriate authorization That the order was properly filled (goods received agree with the details of the sales order) The shipping function also involves preparing multi-copy shipping documents or bills of lading. Shipping documents can be prepared manually on prenumbered forms. Alternatively, the documents can be produced with the computer by using order information already in the computer and adding appropriate shipping data such as quantities shipped carrier, and freight charges. Daily computer checks to account for all shipping documents and to determine that all sales orders result in shipments and that a sales invoice was subsequently prepared for each shipping document provide an important control for the completeness assertion.

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3) Recording Sales
The process of recording sales involves preparing and sending prenumbered sales invoices to customers (billing customers) and recording sales invoices accurately and in the proper accounting period (recording sales). The auditors primary concern s pertaining to these function are that the sales invoices are recorded accurately and in the proper period. The later pertains to when the revenue is earned, which is usually when the goods are shipped. The auditors major concerns regarding billing are that customers are billed, For all shipments Only for actual shipments (no duplicate billings or fictitious transactions) At authorized prices

Programmed application controls that reduce risk of misstatement in the billing and recording process (and related specific audit objectives) include the following: Computer matching of sales invoice information with sales order and shipping information Computer matching of sales prices on the sale invoice with an authorized price list and sales order prices in preparing the sales invoices Computer-programmed checks on the mathematical accuracy of sales invoices Comparison of control totals for shipping documents with corresponding totals for sales invoices Computer comparison of date for recording the sales invoices with the time period in which the goods were shipped. Computer comparison of the customer number on the sales invoice with the account number on the sales order, which should have previously been compared with the master customer file. Run-to-run totals match the sum of beginning receivables balances, plus posted sales, with ending receivables balances.

File copies of the sales invoices may be maintained in the billing department. A computer record of the billings is maintained in a sales transactions file. Two

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important manual controls should be also in place in a system of well-designed internal control: Monthly statements should be mailed to customers with instructions to report any exceptions to a designated accounting supervisor not otherwise involved in the execution or recording of revenue cycle transactions (all revenue cycle objectives). The entity should establish an appropriate level of regular review and accountability by sales executives for sales analyses by product, division, salesperson, or region, and comparisons with budgets (all sales transaction objectives). Sales executives should also be held accountable for gross margins and subsequent collection of sales and accounts receivable write-offs.

It is a formal recognition of revenue by an entity. Each of these major functions should be assigned to different individual or department, providing for adequate segregation of duties.

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System Flowchart Credit Sales Transactions

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The illustration of the system flowchart: In the illustrative system, as orders are received sales order clerks use on-line terminals and an order program to determine that the customer has been approved and that the order will not cause the customers balance to exceed the customers authorized credit limit. If the customer is a new one, the order is transferred to the credit department, which checks credit and enters customer information on the customer master file for approved customers. The program also checks the inventory master file to determine that goods are on hand to fill the order and prices the sales order based on information in an approved master price file. If the order is accepted, the computer enters it into an open order file and a copy of the sales order form is produced on a printer in the sales order department and sent to the customer. When an order is not accepted, a message is displayed on the terminal indicating the reason for the rejection. The approved sales order is electronically forwarded to the warehouse as authorization to release goods to shipping. The warehouse completes a packing slip and forwards goods to shipping. In shipping, personnel first make an independent check on agreement of the goods received with the accompanying sales order form. They then use their on-line terminals and a shipping program to retrieve the corresponding sales order from the open order file and add appropriate shipping data. The perpetual inventory system is also

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updated for the shipment of goods. Next the computer transfers the transaction from the open order file to the shipping file and produces a prenumbered shipping document on the printer in the shipping department. Sales invoices are automatically generated based on shipped goods. The computer checks vendor information and data on goods shipped against data entered in the sales and shipping. The computer prices the sales invoice based on information on the sales order and checks the numerical accuracy of the sales invoice. The computer also checks the dates shipped with dates on the sales invoice. As each billing is completed, the computer enters it into a sales transaction file. After all transactions in the batch have been processed, the billing program compares the total invoices with the total shipments for the day. The transaction file is processed and posted to the sales transaction file, the accounts receivable master file, and the general ledger master file. Run-to-run totals compare beginning balances plus processed transactions with ending balances immediately prior to posting the transactions. Exceptions are printed on an exception report, and these transactions are held in a suspense file to be cleared by the billing supervisor. The program also produces monthly statements. All customer inquiries on monthly statements are directed to the controllers office for follow up. A separate program also prints daily sales reports with sales, gross margins, and inventory-on-hand by product for management review. Management must also coordinate follow up on all past-due receivables with the credit department.

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Control Activities - Cash Receipts Transactions


Cash receipts result from a variety of activities. For example, cash is received from revenue transactions, short-, and long-term borrowings, the issuance of capital stock and the sale of marketable securities, long-term investments, and other assets (Boynton and Johnson, 2006).

Common Documents and Records


The important common documents and records for the cash receipts transactions include the following: 1. Remittance advice It is a document mailed to the customer with the sales invoices to be returned with the payment showing the customers name and account number, invoice number, and amount owed, for example the portion of telephone bill returned with payment. Remittance advices are not mandatory. However they are seen as a courtesy because they help the accounts-receivable department to match invoices with payments. The remittance advice should therefore specify the invoice number(s) for which payment is tendered (Wikipedia). 2. Prelist It is the listing of cash receipts received through the mail. 3. Cash count sheets These include the listing of cash and checks in a cash register. These are used in reconciling total receipts with the total printed by the cash register. 4. Daily cash summary It is a report showing total over-the-counter and mail receipts received by the cashier for deposit. 5. Validated deposit slip It includes the listing prepared by the depositor and stamped by the bank showing the date and total of deposit accepted by the bank and the detail of receipts comprising the deposit. 6. Cash receipts transactions file

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It is a computer file of validated cash receipts transactions accepted for processing, also used to update accounts receivable master file. 7. Cash receipts journal It includes the journal listing cash receipts from cash sales and collections of accounts receivable.

Functions and Control Activities


The cash receipts function, which includes the processing of receipts from cash and credit sales, involves the followings sub functions:

1) Receiving Cash Receipts


A major risk in processing cash receipts transactions is the possible theft of cash before or after a record of the receipt is made. Thus, control procedures should provide reasonable assurance that documentation establishing accountability is created at the moment cash is received and that the cash is subsequently safe-guarded. For over-the-counter receipts, the use of a cash register or point-of-sale terminal is indispensable. These devices provide: Immediate visual display for the customer of the amount of the cash sale and the cash rendered. A printed receipt for the customer and an internal record of the transaction on a computer file or a tape locked inside the register. Printed control totals of the days receipts processed on the device.

The customers expectation of a printed receipt and supervisory surveillance of overthe-counter sales transactions helps to ensure that all cash sales are processed through the cash registers or terminals. In addition, supervisors may be assigned responsibility for performing independent checks on the accuracy of cash count sheets and verifying agreement of cash on hand with totals printed by the register or terminal. The cash, count sheets, and register or terminal-printed totals then are forwarded to the cashiers department for further processing and inclusion in the bank deposit. Meanwhile, in the case of mail receipts, as to minimize the likelihood of diversion of mail receipts, most companies request customers to pay by check. Some companies 24

with a large volume of mail receipts use a lockbox system. A lockbox is a post office box that is controlled by the companys bank. The bank picks up the mail daily, credits the company for the cash, and sends the remittance advices and prelisting of cash receipts to the company for use in updating accounts receivable. This system expedites the depositing of checks, permits the company to receive credit for the receipts sooner, and provides external evidence of the existence of the transactions. It also eliminates the risk of diversion of the receipts by company employees and failure to record the receipts. In companies that process their own mail receipts, mailroom clerks should: Immediately restrictively endorse checks for deposit only List the checks on a multi-copy prelist.

Immediate preparation of the prelist establishes accountability for the receipts and provides a batch control total for use in independent checks on the completeness and accuracy of processing. Remittance advices received with the checks, and a copy of the prelisting of cash receipts, are forwarded to accounts receivable accounting for use in updating customer accounts.

2) Depositing Cash in bank


Proper physical controls over cash require that all cash receipts be deposited intact daily, which means that all receipts should be deposited. This control reduces the risk that receipts will not be recorded, and the resulting bank deposit record establishes the existence or occurrence of the transactions. When the cashier receives over-thecounter and mail receipts, an independent check should be made to determine their agreement with the accompanying cash count sheets and prelist respectively. The totals for each are then entered on a daily cash summary, and the deposit is prepared. After making the deposit, the daily cash summary and validated deposit slip should be forwarded to general accounting.

3) Recording the Receipts


This function involves journalizing over-the counter and mail receipts and posting mail receipts to customer accounts. Controls should ensure that only valid receipts are

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entered at the correct amounts. To ensure that only valid transactions are entered, physical access to the accounting records or computer terminals used in recording should be restricted to authorized personnel. Over-the counter receipts are generally recorded in general accounting based on the daily cash summary received from the cashier. It is common for accounts receivable clerks to use a terminal to enter mail receipts into a cash receipts transactions file, which is subsequently used in updating both accounts receivable and general ledger master files. To ensure the completeness, accuracy, and proper classification of recording the mail receipts, the computer can check the agreement of the amount journalized and posted with the control totals of the amounts shown on the deposit slip received from the cashier. In addition, periodic bank reconciliations should be performed by an employee not otherwise involved in executing or recording cash transactions. In the case of credit sales transactions, segregation of duties in performing those functions is important internal control activity. Many of the controls related to receiving and depositing cash involve manual checks and balances rather than computer checks and balances. However, computer controls are most effective in controlling the recording sub function.

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System Flowchart Cash Receipts Transactions

The cash receipts transactions flowchart explanation: All receipts from customers are received by mail and are accompanied by a preprinted remittance advice (bottom portion of the billing originally sent to the customer). In the mailroom, the checks and remittance advices are separated. The checks are restrictively endorsed (for deposit only) and sent t the cashier for deposit. The remittance advices are used to create a listing (prelist) of checks identifying the customer, the amount, and the specific invoices paid; the prelist is prepared in triplicate and totaled. One copy of the prelist is sent to accounts receivable, and another copy to general accounting.

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The cashier prepares a bank deposit slip in the duplicate and makes the daily bank deposit. The cashier then logs on to the computer system and enters the amount of the daily deposit. The cashier forwards the validated copy of the bank deposit slip (stamped and dated by the bank) to general accounting and files the prelist by date. In accounts receivable, the remittances are posted to the cash receipts transaction file based on the cash prelist, including a control total for the total of the prelisting of cash. A cash receipts program is run at the end of the day and compares the sum of individual cash receipts with the control total and the amount from the deposit slip entered by the cashier. An exception report of any differences is printed and forwarded to the chief financial officers office. Transactions that do not match are held in the suspense file for follow up. The master file update program then processes the cash receipts transaction file. Run-to-run totals compare beginning receivables, plus cash receipts, with ending accounts receivables before the routine is processed. It also updates the general ledger, generates the Cash Receipts Journal (shows the individual transactions and daily totals for cash, discounts, and posting to accounts receivable), accounts receivable aging, and daily cash balances. The remittance advice, prelist, and summary report are the filed by date. An assistant to the chief financial officer follows up on any exception reports and reports the results to the chief financial officer. The chief financial officer also reviews daily cash transactions (including cash receipts) for reasonableness and monitors daily cash balances. The assistant to the chief financial officer also prepares monthly bank reconciliations that are reviewed by the chief financial officer. The credit department receives a weekly aging of receivables and follows up with customers regarding reasons for the delay of payment on past-due accounts.

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Control Activities - Sales Adjustment Transactions


Common Documents and Records
The important documents and records for the sales adjustments include the following: 1. Sales return authorization It is a form showing the description, quantity and other data pertaining to the goods that customer is authorized to return. It serves as the basis for initiating the sales return and internal processing of the customer returns by the seller. 2. Authorization for accounts receivable write-off It is a form showing the procedures taken to attempt collection and document authorization of accounts receivable write-off. 3. Receiving report It is a report prepared on the receipt of goods from customers showing the kinds and the quantities of goods received. 4. Credit memo It is a form stating the particulars of a credit to accounts receivable, including the specific items returned, process, and amounts credited. It provides the basis for recording sales return. 5. Journal entry It is a document used to record adjustments such as an accounts receivable write-off in the general ledger.

Functions and Control Activities


The sales adjustment transactions involve the following:

1) Granting Cash Discounts


Cash discounts are commonly granted for timely receipt of payment from customers, such as a 1 percent discount granted if cash is received within 10 days of the invoice date. Trade terms are often stated on the invoice, and the computer can test the existence and occurrence as well as the accuracy of the discount by comparing cash receipts date and the invoice date and re computing the cash discounts. The accuracy

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of total cash discounts can be tested by comparing cash received plus the cash discount to the amount credited to accounts receivable.

2) Granting sales returns and allowances


Since there is a possibility to record fictitious sales transactions and conceal the fraud, a company needs control activities that focus on establishing the existence and occurrence of such transactions, which include the following: All sales returns should be authorized by sales management Goods should be received with proper sales return authorization, and an independent count of goods returned should be recorded on a receiving report The computer should match the credit memo information with the sales order, authorization of sales return, and the receiving report The computer should print daily reports of authorized sales returns that have not been received in the receiving department, and receivings that have not resulted in the recording of a credit memo. There should be adequate segregation of duties for authorizing sales returns, receiving goods, and recording credit memos. Usually the sales adjustments transactions will be accounted by the management accountable for the financial results. When theres a potential material misstatement in the sales adjustments transactions, the auditor should obtain an understanding of all relevant aspects of the internal control structure and the factors that affect such risk. For example, if the adjustments are estimated at the quarter end, the management should establish control that may ensure that the adjustments are made from reliable information and it is made consistently from quarter to quarter. Moreover, the disclosure committee should review the estimates if the aggregated adjustments are material to the financial statements.

3) Determining uncollectible accounts


As there is a possibility that a customers write-off can inappropriately used to conceal fraud, for example a cash misappropriation and concealed by writing the write-off against the allowance for uncollectible accounts, a company may need a good internal controls over the write-off of uncollectible accounts, which include:

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o Authorization of all write-offs of uncollectible accounts by treasurers office and supported by documentation, such as correspondence with the customer or collection agencies. o Appropriate review of journal entries to ensure the appropriateness of the transaction. In addition, management should establish controls over accounting estimates such as the provision for bad debt expense. Management should ordinarily establish a process for monitoring aging and the collectability of receivables. Hindsight should be used to evaluate the adequacy of prior provisions for bad debt expense compared with subsequent receivables that go bad. It is essential that the data used to develop a provision for bad debt expense should be reliable. In addition, a qualified and independent disclosure committee should review the allowance on a regular basis. These controls are necessary to determine the adequacy of the allowance.

Other Controls in the Revenue Cycle


It is also important to control balances and disclosures. The primary account balance in the revenue cycle is accounts receivable. If the good controls exist over credit sales, cash receipts, and sales adjustments, the accounts receivable balance should also be controlled as it is the product of recording these transactions. Most companies control completeness, existence, and valuation of receivables at historical cost by sending monthly statements to customers. Moreover, controls over the rights and obligations assertion relate to whether the company has legal claim to receivables. A company normally gives up claims to receivables when it sells the receivables or it pledges receivables as collateral. These transactions may not exist in many entities. However, if entity sells its receivables, it should keep a documentary record of receivables that have been sold. This record should be compared with monthly statements sent by a bank or factoring company. This provides an independent check on the accuracy of the companys records. Finally, management should establish controls over the occurrence and rights and obligations and disclosures, the completeness of disclosures, the classification and understandability of disclosures and the accuracy and valuation of information included in disclosures. Public Companies normally accomplish this task through workings of a disclosure committee that is independent of the CFO or controller who prepares the

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disclosures, and includes individuals who are knowledgeable about GAAP and transactions and disclosures relevant to the revenue cycle. If management uses spreadsheets to summarize disclosures, such as sales by geographic region or product line, or receivables classified as trade, related parties, or from employees, standard controls over the use of spreadsheets should be in place.

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Tests of Controls in Revenue Cycle


Most auditors plan to test controls that are effectively designed in the revenue cycle because of the high volume of routine transactions in this cycle. Public company auditors test controls to support opinion on internal controls. Private company auditors will test controls that appear to be effective because of the audit efficiencies that exist with this strategy. If the auditor plans to assess control risk as low for revenue cycle assertions covered by computer controls, he or she will usually have to: Test the effectiveness of general controls Use computer-assisted audit techniques (CAATs) to evaluate the effectiveness of programmed controls Test the effectiveness of procedures to follow up on exceptions identified by programmed controls For example, the auditor might use test data to determine whether expected results appear on exception reports when he or she submits: A missing or invalid customer code An invalid product code An order that exceeds a customers credit limit Transactions reporting shipments in quantities different from the amount ordered (both over and under) Prices, vendor numbers, or other information on sales invoices that do not match information on the sales order Invoice quantities that do not match quantities on shipping documents

The auditor might also used generalized audit software or a utility program to perform sequence checks and print lists of sales orders, shipping documents, or sales invoices whose numbers are missing in designated computer files.

1) Tests of Controls Related to Sales


Department Order & Credit Control Procedures 1. Prepare prenumbered Tests of Controls 1. Observe the credit

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sales order. 2. Perform credit check (authorization). 3. Approve credit for returns. 4. Follow up on old or past-due accounts. 5. Initiate write-offs, which should be approved by the treasurer. 1. Receive approved sales order from credit dept (must have approved sales order before release of goods from warehouse). 2. Pull inventory from warehouse and release to Warehouse & Shipping shipping. 3. Perform independent check of goods received from warehouse and approved sales orders in shipping department. 4. Prepare prenumbered bill of lading. 1. Receive approved sales order from credit dept (must have approved sales Billings and Account Receivables order before release of goods from warehouse). 2. Pull inventory from warehouse and release to shipping.
2.

procedure for new customers. From a population of approved sales orders (and returns), select a sample and inspect documents for evidence of credit check.

1. Observe warehouse personnel filling sales orders (existence). 2. Observe physical controls over inventory. 3. Observe evidence of independent checks (existence). 4. Inspect a sample of prenumbered shipping documents and: Agree to sales order Account for prenumbering

1. Vouch a sample of sales invoices (select approved sales orders from the sales journal) to shipping documents and approved sales orders. 2. Trace a sample of

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3. Perform independent check of goods received from warehouse and approved sales orders in shipping department. 4. Prepare prenumbered bill of lading. 5. Match shipping documents and sales orders before preparing invoice. 6. Periodically account for all prenumbered shipping documents. 7. Perform independent check of sales order pricing. 8. Prepare prenumbered sales invoice, batch and total invoices. 9. Update A/R master file. Agree input to invoice batch totals. 10. Print sales journal. 11. Print sales summary. Agree to invoice batch totals (independent check). 12. Mail monthly customer statements. 1. Receive sales summary. 2. Perform independent check Accounting of invoice batch totals and sales summary. 3. Review sales account

shipping documents (selection from prenumbered shipping documents) to sales invoice, sales journal, and A/R master file. 3. Observe and reperform procedures for a sample period. 4. Reperform pricing check: From a sample of sales invoices, check pricing with master price list. 5. Observe mailing process.

1. Observe and reperform the accounting process 2. Inspect customer exception file and

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classifications. 4. Post to general ledger. 5. Follow-up customer exceptions (independent check).

disposition.

2) Tests of Controls Related to Collection


Department Mailroom Control Procedure 1. Separate checks and remittance advices. 2. Stamp restrictive endorsement on checks. 3. Prepare prelisting of checks received. 4. Forward checks to Cashier. 5. Forward remittance advices to A/R. 6. Forward prelisting to Accounting, Cashier, and Accounts Receivable. Cashier 1. Receive checks and prepare deposit. 2. Prepare daily cash summary (copy to A/R and Accounting). 3. Deliver checks to bank. 4. File validated deposit slip. 1. Observe preparation of cash summary 2. Inspect deposit slip and compare to cash summary. Test of Control 1. Inspect checks prior to deposit for endorsement. 2. Observe preparation of prelisting

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Accounts Receivable

1. Match remittance advices and check deposit summary. 2. Update A/R master file. 3. Print CR journal/Updated A/R master file. 4. Print CR summary (copy to Accounting).

Observe procedures in preparing the accounts receivables file

Accounting

1. Independent check: Compare the cash summary (Cashier), the prelisting of checks (Mailroom), and the CR summary (A/R). 2. Post to general ledger 3. Prepare bank reconciliation

1. Inspect evidence of independent check 2. Reperform independent check for selected dates 3. Inspect bank reconciliation

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Substantive Test of Accounts Receivable


Accounts receivable represent the primary balance in the revenue cycle. Receivables include amounts due from customers, employees, and affiliates on open accounts, notes, and loans, and accrued interest on such balances. The main consideration is directed at gross receivables due from customers on credit sales transactions and the related contra account, the allowance for uncollectable accounts. In general, the sales that are most likely to represent potential misstatements are the uncollected sales. Thus, the auditor must (1) determine the acceptable level of detection risk for each significant related assertion and (2) design substantive tests to respond those risks.

Determining Detection Risk


For a specified level of audit risk, tests of details risk is inversely related to the assessed levels of inherent risk, analytical procedures risk, and control risk. Therefore, factors pertaining to these assessments must be considered in determining the acceptable level of tests of details risk for each accounts receivable assertion.

1) Existence and Occurrence


The existence and occurrence assertion for sales and accounts receivable represents a significant inherent risk because of the potential for revenue recognition problems. As a result, inherent risk is assessed at the maximum for this assertion. The combined control risk assessment for accounts receivable is a function of internal controls over the occurrence related to credit sales (low) and the completeness of cash receipts (low) and sales adjustment transactions (low). A common internal control over the occurrence of sales would be having the computer match sales invoice information with bill of lading and packing slip information input during the shipment of goods. Since the existence of accounts receivable represents significant inherent risk, the auditor should not plan to obtain substantial assurance from analytical procedures. I f the auditor simply compares current year with the prior year, without obtaining information about the underlying business activity, analytical procedures risk should probably be high. As a result, the appropriate level of detection risk for test of details is moderate.

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2) Completeness
The auditor might assess inherent risk for the completeness assertion as moderate. In most cases there is a greater risk of overstatement of receivables and sales than of understatement of receivables and sales. When considering the combined control risk assessment for the completeness of receivables, the auditor should evaluate the completeness assertion related to credit sales (low in this example) with the existence and occurrence assertion for cash receipts (low) and for sales adjustments (moderate). In this example, the conservative combined control risk assessment would be moderate. Internal controls over the completeness of sales would usually include daily follow up on items shipped that had not resulted in sales invoices. Controls over the occurrence of cash receipts would include comparison of recorded cash receipts with the underlying prelisting of cash. Finally, controls over the occurrence of sales returns would include matching of credit memo information with underlying receiving reports. Analytical procedures related to the completeness of sales and receivables would involve a comparison of sales to the underlying physical business such as a comparison of sales to capacity, sales to production levels, development of total assets or sales to fixed assets. If these tests show that all sales appear to be recorded, the auditor can reduce the extensiveness of other substantive tests. In this example the auditor assesses test of details risk very high. The auditor might assess the information about the completeness of sales obtained from sending confirmations, and perform cutoff tests on the recording of sales transactions at the end of the year.

3) Rights and Obligations


The assessment of inherent risk for the rights and obligations assertions depends on the entitys performance. Entities with strong operating cash flows rarely need to sell or factor receivables. Entities with weak operating cash flows are more likely sell their receivables or pledge them as collateral. If receivables have been factored, it is common to keep records of receivables that have been sold and to compare those records with monthly statements from the factoring company. Analytical procedures are not particularly effective at identifying the sale of rights to receivables, so the auditor usually plans to obtain most assurance from substantive tests of details. Auditors often use generalized audit software to scan the cash receipts journal for large cash receipts. Receivables are usually sold in larger batches, and this might 39

provide evidence of selling receivables. If inquiry or other evidence shows that the company has sold receivables, the auditor will confirm the sale or pledging of receivable with the entity to which the receivables with customers because they rarely know if their receivables have been sold.

4) Valuation and Allocation


The assessment of inherent risk for the valuation and allocation assertion is often set at high or maximum for accounts receivable because of the subjective nature of the allowance for doubtful accounts. Controls over the valuation and allocation assertion with respect to historical cost involve the controls over valuation of sales, cash receipts, and sales adjustments. These might include computer comparison of prices on sales invoices with the master price list, comparison of recorded cash receipts with the cash prelist, or comparison of prices on credit memos with sales invoice prices. Controls over the allowance for doubtful accounts include control over the granting of credit, comparison of balances plus orders to credit limits, the follow up on past due receivables, controls over the accuracy of receivables aging, an dthe quality of work of a disclosure committee that reviews the allowance for doubtful accounts. Control risk might be set at moderate because of the complex nature of the work of the disclosure committee in evaluating the adequacy of the allowance. Analytical procedures usually involve computing the entitys accounts receivable turn days. This is a rather blunt tool for careful analysis of valuation issues, so analytical procedures risk is often set at high or maximum. In this example, tets of details risk is set at very low as a result of subjectivity of the assertion.

5) Presentation and Disclosure


In developing preliminary audit strategy for the presentation and disclosures assertion the auditor will usually plan a primarily substantive approach. Inherent risk associated with disclosures is often set at high or maximum. The disclosures related to receivables are often not complex, so it is appropriate to set inherent risk as high. Controls usually involve the work of a disclosure committee. Because analytical procedures are rarely effective for testing disclosures, the auditor will usually place significant emphasis on tests of details of disclosures.

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Designing Substantive Tests


1) Initial Procedures
Initial procedures are the starting point for every audit test to obtain an understanding of the business and industry. It is important to understand the entitys policies regarding revenue recognition, as well as the entitys underlying economic drivers that impact total revenues and gross margin. An important initial procedure for verifying accounts receivable and the related allowance account is by using several audit procedures, as follows. Tracing the current periods beginning balances to the ending audited balances in the prior years working paper. Next, the auditor should review any significant entries that are unusual in nature or amount, in which they are required special investigation. In addition, a listing of all customer balances, called an accounts receivable trial balance, can be obtained through audit software. The total of accounts receivable trial balance should be compared with (1) the total of the subsidiary ledger or master file and (2) the general ledger control account.

2) Analytical Procedures
Through analytical procedures, the goal of auditor is to develop expectations of the accounts receivable balance, of the relationship of accounts receivable to sales, and of the entitys gross margins. Several analytical procedures that can be performed to provide evidence about accounts receivable are already presented in the introductory section.

3) Test of Details of Transactions


Test of Details of Transactions may be performed during interim work along with tests of controls, in the form of dual-purpose tests. The audit procedures to perform Test of Details of Transactions are described below. Vouch Revenue Transaction Vouching is an audit procedure to inspect documents and records from the accounting records (ledger) to sources of document. This test is performed to

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detect overstatements in the accounting records (testing the existence or occurrence of assertions). For example: the auditors select a debit in customers accounts and then vouch it to supporting documents, such as sales invoices, and matching documents. Trace Revenue Transaction Tracing is an audit procedure to inspect documents and records from the sources of document to accounting records (ledger). This test is performed to detect understatements in the accounting records (testing the completeness of assertions). For example: the auditors select a sample of sales order or bills of lading and trace the transaction to the sales journal and general ledger. Perform Cutoff Tests for Sales and Sales Returns The sales cutoff test is designed to obtain reasonable assurance that (1) sales and accounts receivable are recorded in the correct accounting period (the transactions occurred) and (2) the corresponding entries for inventories and cost of goods sold are made in the same period. For example: if January sales are recorded in December, there is a misstatement of the existence or occurrence assertions. Conversely, if December sales are not recorded until January, there is a misstatement of the completeness assertions. Meanwhile, sales return cutoff test is directed toward the possibility that returns made prior to year-end are not recorded until after year-end, resulting in the overstatement of receivables and sales. Perform Cutoff Tests for Cash Receipts The cash receipts cutoff test is designed to obtain reasonable assurance that cash receipts are recorded in the accounting period in which received. A proper cutoff at the balance sheet date is essential to the correct presentation of both cash and accounts receivable. In addition, personal observation or a review of documentation can provide evidence concerning the promptness of the cutoff.

4) Test of Details of Balances


Two primary sets of procedures in this category of substantive tests are: (1) confirmation of receivables and the related follow up procedures and (2) procedures for evaluating the adequacy of the allowance for uncollectable accounts.

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Confirm Receivables Confirmation of accounts receivable involves direct written communication between individual customers and the auditor. This substantive test is used extensively by the auditor. The confirmation of receivables is a generally accepted auditing procedure. AU 330, The Confirmation Process (SAS 67), states that there is an presumption that the auditor will request the confirmation of receivables during an audit unless: Accounts receivable are immaterial to the financial statements. The use of confirmations would be ineffective as an audit procedure. The auditors combined assessment of inherent risk and control risk is low and that assessment, in conjunction with evidence expected to be provided by analytical procedures or other substantive tests of details, is sufficient to reduce audit risk to an acceptably low level for the applicable financial statement assertions. In many situations, both confirmation of accounts receivable and other substantive tests of details are necessary to reduce audit risk to an acceptably low level of the applicable financial statement assertions. Forms of Confirmation There are 3 forms of confirmation request: The positive confirmation, which requires the customers to respond whether or not the balance shown is correct. The negative confirmation, which requires the customers to respond only when the balance shown is incorrect. The blank confirmation, which requires the customers to fill in the balance.

Timing and Extent of Requests The timing of requests can be divided into two categories as follows. When the applicable detection risk is low or using primarily substantive approach, the auditor usually requests confirmation of receivables as of the balance sheet date. On the other hand, when the auditor follows a lower assessed level of control risk approach, the confirmation date may be one or two months earlier. The extent of request will depend on the types of confirmation request. Negative confirmation request requires larger sample sizes than the positive request. Controlling the Requests

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This means that the auditor must control every step in the confirmation process. For instance: Ascertaining that the amount, name, and address agree with the data in customers account. Maintaining custody of the confirmations until they are mailed. Using the firms oqn return address envelopes for the confirmations. Personally depositing the request in the mail. Insisting that the returns be sent directly to the auditor.

Summarizing and Evaluating Results The auditors working papers should contain a summary of the results from confirming accounts receivable. The summary should provide, as minimum: The number and dollar value of confirmations sent and response received The proportion of the population total covered by the sample The relationship between the audited and the book values of items included in the sample. Applicability to Assertions The confirmation of accounts receivables is the primary source of evidence in meeting the existence or occurrence assertion and also providing evidence concerning the rights and obligations assertion. In addition, when a customers response indicates agreement with the book balance, there is evidence that the balance is complete.

5) Test of Details of Accounting Estimates


The most important accounting estimate involved in the revenue cycle is the allowance for doubtful accounts. The allowance for uncollectable accounts is an accounting estimate made by management to estimate prospectively receivables that will not be collected in the future. Audit tests of this accounting estimate include: Using generalized audit software to foot and crossfoot the aged trial balance of accounts receivable and agreeing the total to the general ledger balance. Testing the aging amounts shown in the aging categories on the aged trial balance. Considering evidence concerning the collectability of past-due amounts.

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Identifying customers with past-due balances, and calculating credit histories for customers with past-due balances. Evaluating prior estimates of uncollectable accounts with the subsequent experience and the benefit of hindsight.

Alternatively, the aging of a customers balance can be tested by vouching the amounts shown in each aging category to the subsidiary ledger or master file.

6) Test of Details of Disclosures


The auditor must be knowledgeable about the statement presentation and disclosure requirements for accounts receivable and sales under GAAP. The requirements include proper identification and classification for receivables. For example: GAAP requires proper classification of receivables as current and noncurrent, and disclosures concerning the pledging, assigning, or factoring of receivables. Disclosures may be required regarding significant customers or sales by significant lines of business. Those evidences should be obtainable by inquiring of management and reviewing minutes of board of directors meetings and loan agreements.

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References:
Boynton, W. C., & Johnson, R. N. (2006). Modern Auditing 8th edition. NJ: John Wiley & Sons. Garcia, Bien (2013). Test of Control Related to Revenue Cycle. Retrieved from http://www.scribd.com/doc/134930364/Tests-of-Controls-Related-to-theRevenue-Cycle Remittance advice. Retrieved from http://en.wikipedia.org/wiki/

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