Revenue Cycle Tests of Controls and Substantive Testing: IT Auditing, Hall, 3e

Chapter 9:
Revenue Cycle Tests of Controls

and Substantive Testing
IT Auditing, Hall, 3e
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Manual Procedures
Follow Figure 9-1

Obtaining & recording customers
orders
Document = SALES ORDER

One copy in Open Order File
Approving credit
One copy of sales order went to credit
dept.
Returned authorized copy triggers release
of sales order into system
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copied or duplicated,
3e
Manual Procedures
Processing shipping orders

4 copies of Sales Order to warehouse; packing slip,
shipping notice, stock release, file copy
Locate and pick goods using Stock Release; package
them with packing slip
Reconcile documents and goods, sign Shipping Notice,
prepare Bill of Lading multiple copies
Transfer custody of goods (packing slip inside) and 2
copies of Bill of Lading to carrier
Record shipment in shipping log
Send shipping notice to Billing Dept.

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Legacy System Procedures

Keypunch batch of shipping notices
Edit run program, correct any errors
Field checks
Limit tests
Range tests
Price times quantity extensions
Sort
run on batches by AR account number
Legacy systems store records in sequential manner,

usually tape
Next process is to post individual shipping notices to
appropriate individual AR accounts
AR
update & billing run [Figure 9-2]
Updates AR file becomes new AR file

Billing would be printing invoices to be mailed
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3e or printout
4
Sales
journal
file
Legacy System Procedures

Re-sort
by inventory item {why?}
Same reason; but this process is to update Inventory

Items
Inventory update run [Figure 9-3]
Reduce quantity on hand for items shipped, generate a
new Inventory file
Compare On Hand quantity with Reorder Point to
identify items needing replenishment; file or printout
Journal voucher for Cost of Goods Sold [DR] and
Inventory [CR]
Sort
journal entries by GL #
Run general ledger update
Management reports
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Batch Cash Receipts Systems With Direct

Access Files
See
Figure 9-4
Discrete events that naturally fit the batch
approach
Update Procedures
Mail Room
Receives checks and Remittance Advices.

Separates checks from Remittance Advices
Prepares a Remittance List multiple copies
Copy of Remittance List and checks go to Cash Receipts
Dept.
Remittance Advices and copy of Remittance List go to AR
Dept.
Last copy of Remittance List to Controllers Office
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Access Files
Cash receipts dept.

Reconciles checks and remittance list
Prepares deposit slip multiple copies
Using terminal/IS, creates a journal voucher of cash
received; Cash [DR] and AR [CR]
End of day, deposit cash and Deposit slips to the
bank
File copy of deposit slip

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Access Files
AR Dept.
Reconciles remittance advices and
remittance list
Prepares batch for transactions
based on remittance advice data to
update AR subsidiary ledger
Files remittance advices and
remittance list

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Access Files
DP Dept.
Accesses the two files created in cash receipts (journal
voucher) and AR (batch transaction file of CR)
Reconciles the files
Updates AR-SUB accounts
Updates GL (AR, Cash)
Creates a cash receipts journal
System produces transaction listing that is sent to AR
dept. where AR clerk will reconcile against the
remittance list of file there
More management reports

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Real-Time Sales Order Entry and Cash

Receipts
See
Figure 9-5
Sales procedures
Transactions are processed as they occur, separately
Credit check is performed online by the system
If approved, system checks availability of inventory
If available, system:
Transmits electronic stock release to warehouse dept
Transmits electronic packing slip to shipping dept
Updates inventory file records for depletion
Records sale in open sales order computer file

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Receipts
Warehouse procedures
Produces hard copy of stock release
Clerk picks goods, sends them with a copy of stock
release to shipping dept.
Shipping procedures
Reconciles goods, stock release, packing slip from
system.
Online, IS prepares Bill of Lading for shipment, and
shipping notice for DP Dept.
Select carrier and prepare goods for shipment, along
with packing slip and Bill of Lading
Stock release form is filed

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Receipts
Billing procedures
Record sales invoice and shipment in IS
Print invoice to be sent to customer
Update shipping log and sale invoice files
Delete shipment from open sales order file
Cash receipts procedures

Keypunch cash receipts using the remittance advice into
IS,matching it with the specific record in the sales invoice
file
Keypunch any credit memos using similar process
Generate a remittance file of posted transactions

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Features of Real-Time Processing

Events Database
Traditional accounting does not have to exist in per se (in

traditional form)
General Ledger can be derived at any time from a compilation from
the events database
Advantages
Greatly shortens the cash cycle of the firm

Can give a firm a competitive advantage (e.g., managing inventory
better)
Real-time editing permits the identification of many kinds of errors
as they occur, greatly reducing the efficiency and effectiveness of
business processes
Reduces the amount of paper documents
Electronic audit trails are possible in real-time computer-based
systems

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Point-of-Sale Systems
Point of sale systems are used extensively in retail

establishments.
Customers pick the inventory from the shelves and
take them to a cashier.
The clerk scans the universal product code (UPC).
The POS system is connected to an inventory file,
where the price and description are retrieved.
The inventory levels are updated and reorder needs
can immediately be detected.
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Hall, 3e
Point-of-Sale Systems
The system computes the amount due. Payment is

either cash, check, ATM or credit card in most cases.
No accounts receivables
If checks, ATM or credit cards are used, an on-line link
to receive approval is necessary.
At the end of the day or a cashiers shift, the money
and receipts in the drawer are reconciled to the
internal cash register tape or a printout from the
computers database.
Cash over and under must be recorded
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Hall, 3e
Point-of-Sale System
16
Hall, 3e
Management Assertions and Revenue Cycle

Audit Objectives
Existence / Occurrence
VERIFY AR balance represents amounts actually owed as of Balance Sheet date

Establish sales represents goods shipped and/or services rendered during period of
financials
Completeness
Determine all amounts owed organization are included in AR

VERIFY shipped goods, services rendered, and/or returns and allowances for period
are included in financials
Accuracy
VERIFY revenue transactions are accurately computed, based on correct prices and
quantities
Ensure AR subsidiary ledger, sales invoice file, remittance file are mathematically
correct .. And agree with GL accounts
Rights & Obligations
Determine organization has legal right to AR

VERIFY accounts sold or factored have been removed from AR
Valuation or Allocation
Determine AR balance stated in net realizable value

Establish allocation for uncollectible accounts is appropriate
Presentation and Disclosure
VERIFY AR and revenues for period are properly described and classified
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Input Controls
Purpose
Ensure creditworthiness of customers
Control techniques vary considerably between batch systems and
real-time systems
Credit authorization procedures
Credit worthiness of customer
Batch and manual systems use credit dept.
Real-time systems use programmed decision rules
Testing credit procedures

Verify effective procedures exist
Verify information is adequately communicated
Verify effectiveness of programmed decision rules (test data, ITF)
Verify that authority for making credit decisions is limited to authorized
credit personnel/procedures
Perform Substantive Tests of Detail
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Review
credit
policy
periodically
and revise as necessary
Input Controls
Data Validation Controls

To detect transcription errors in data as it is processed
Batch: after shipment of goods
Error logs
Error correction computer processes
Transaction resubmission procedures
Real-Time: Errors handled as they occur
Missing data checks presence of blank fields

Numeric-Alphabetic data checks correct form of data
Limit checks value does not exceed max for the field
Range checks data is within upper and lower limits
Validity checks compare actual values against known acceptable values
Check digit identify keystroke errors by testing internal validity
Testing Data Validation Controls
Verify controls exist and are functioning effectively

Validation of program logic can be difficult
If Controls over system development and maintenance are NOT weak, testing data
editing/programming logic more efficient than substantive tests of details (test data,
ITF)
Some assurance can be gained through the testing of error lists and error logs
(detected errors only)

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Input Controls
Batch controls
Manage high volumes of similar transactions

Purpose: Reconcile output produced by system with the original input
Controls continue through all computer (data) processes
Batch transmittal sheet:
Unique batch number
Batch date
Transaction code
Record count
Batch control total (amount)
Hast totals (e.g., account numbers)
Testing data validation controls

Failures of batch controls indicates data errors
Involves reviewing transmittal records of batches processed and
reconcile them to the batch control log (batch transmittal sheet)
Examine out-of-balance conditions and other errors to determine
cause of error
Review and reconcile transaction listings, error logs, etc.

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Process Controls
Computerized procedures for file updating
Restricting access to data
Techniques:
File update controls -- Run-to-run batch control data to monitor data

processing steps
Transaction code controls to process different transactions using
different programming logic (e.g., transaction types)
Sequence check controls sequential files, proper sorting of
transaction files required
Testing file update controls results in errors
Testing data that contains errors (incorrect transaction codes, out of
sequence)
Can be performed in ITF or test data
CAATTs requires careful planning
Single audit procedure can be devised that performs all tests in one
operation.
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Access Controls
Prevent and detect unauthorized and illegal access to

firms systems and/or assets
Warehouse security
Depositing cash daily
Use safe deposit box, night box, lock cash drawers and safes
Accounting records
Removal of an account from books
Unauthorized shipments of goods using blank sales orders
Removal of cash, covered by adjustments to cash account
Theft of products/inventory, covered by adjustments to inventory or cash
accounts
Testing access controls heart of accounting information integrity

Absence thereof allows manipulation of invoices (i.e., fraud)
Access controls are system-wide and application-specific
Learning.
AccessAllcontrols
areMay
dependent
oncopied
effective
controls in O/S,
networks,
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Rights Reserved.
notHall,
be scanned,
or duplicated,
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or posted to a publicly
website, in whole or in part.
andaccessible
databases
Physical Controls
Segregation
of duties
Rule 1: Transaction authorization separate from

transaction processing
Rule 2: Asset custody separate from record-keeping
tasks
Rule 3: Organization structured such that fraud requires
collusion between two or more people
Supervision
Necessary for employees who perform incompatible

functions
Compensates for inherent exposure from incompatible
functions
Can be supplement when duties are properly segregated
Prevention vs. detection of fraud and crime is objective:
supervision can be effective preventive control

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Physical Controls
Independent verification
Review the work of others at critical points in business processes
Purpose: Identify errors or possible fraud
Examples:
Shipping dept. verifies goods sent from warehouse dept. are correct in
type and quantity
Billing dept. reconciles shipping notice with sales notice to ensure
customers billed correctly
Testing physical controls
Review organizational structure for incompatible tasks

Tasks normally segregated in manual systems get consolidated in
DP systems.
Duties of design, maintenance, and operations for computers need
to be separated
Programmers should not be responsible for subsequent program
changes.
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Output Controls
PURPOSE: Information is not lost, misdirected, or corrupted; that the

system output processes function properly
Controls are designed to identify potential problems
Reconciling GL to subsidiary ledgers
Maintenance of the audit trail that is the primary way to trace the source
of detected errors
Details of transactions processed at intermediate points
AR change report
Transaction logs: permanent record of valid transactions
Transaction listings successfully posted transactions
Log of automatic transactions
Unique transaction identifiers
Error listings
Testing output controls

Reviewing summary reports for accuracy, completeness,timeliness, and
relevance for decisions
Trace sample transactions through audit trails; including transaction
listings, error logs, and logs of resubmitted records
ACL is very helpful in this process

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Substantive Tests of Revenue Cycle Accounts
PURPOSE: Determine the nature, timing, and extent of substantive tests

using auditors assessment of inherent risk, unmitigated control risk,
materiality considerations, and efficiency of the audit.
Concern: Overstatement or understatement of revenues?

Focus on large and unusual transactions, especially near period-end
Recognizing revenues from sales that did not occur
Recognizing revenues BEFORE they are realized
Failing to recognize cutoff points
Underestimating allowance for doubtful accounts
Shipping unsolicited products to customers, subsequently returned
Billings customers for products held by seller
Tests of controls and substantive tests
Credit limit logic may be effective but cut-off of AR may be error
Substantive testing of AR may give assurance about accuracy of total
AR but does not offer assurance about collectability

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Substantive Tests of Revenue Cycle

Accounts
Understanding
data
VERIFY data used in CAATTs (e.g., ACL) is accurate

VERIFY adequate setup of files from originals
(e.g., ACL and Profile command)
Relationships and data from [see Figure 9-10]:
Customer file
Sales Invoice file
Line item file
Inventory file
Shipping log file
File preparation procedures

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Substantive Tests of Revenue Cycle Accounts

Accuracy/completeness
assertion
Analytical review of account balances

Overall perspective for trends in sales, cash receipts, sales
returns, and AR
Provides first-level assurance that amounts are reasonably
stated and reasonably complete
If so, may reduce the extent of substantive testing
Review sales invoices for unusual trends and exceptions

Scanning data files using CAAT
(e.g., ACL and stratify and possibly filters - see Figure 9-11)
Reveals all errors or raises questions?
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Accounts
Accuracy/completeness assertion
Review sales invoice and shipping log files
Missing and duplicate transactions [see Table 9-2]
Questions/survey:
Are procedures in place to document and approve voided invoices?
How are gaps in sales invoice numbers communicated to
management?
What physical controls exist over access to sales invoice source
documents?
If applicable, are batch totals used to control batch transactions during
each processing step?
Are transaction listings reconciled and reviewed by management?
Review line item and inventory files for pricing accuracy

ACL allows auditor to compare prices on invoices with inventory using
JOIN [see example on page 413]
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TestingAllunmatched
records
(complement)

Accounts
Existence assertion
Confirmation of AR SAS #67
Not required if:
AR is immaterial
Assessed Control Risk is low
Confirmation process will be ineffective
CAATTs to use for this function?

Steps:
Select accounts to confirm
Consolidate invoices (not AR subsidiary) using CLASSIFY (filter) and SUMMARIZE
(amount) [see Tables 9-3 and 9-4]
Why?
JOIN the CUSTOMER file with the new consolidated invoice file
Prepare confirmation requests [see Figure 9-12]

Positive and Negative Confirmations (ACL, EXPORT)
Evaluating and controlling responses
Retain custody of the confirmation letters until mailed

The letters should be addressed to the auditor, not client org.
The replies should be mailed to the auditor, not client org.
Discrepancies should be investigated.
Non responses to POSITIVE confirmation should be investigated

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Accounts
Valuation/allocation
assertion
Corroborate or refute AR is stated at reasonable Net

Realizable Value
AGING AR
ACL, AGE [see Table 9-7]
Is allowance for doubtful accounts reasonable compared to prior

years and based on composition of AR portfolio
Confirmation process will be ineffective
Review past-due balances

Conference with credit manager to determine collectability
Determine if methods used to estimate allowance for doubtful
accounts is adequate, not the collectability of each account
Determine
if overall
allowance
is,ortherefore,
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31
Appendix:
Overview of Revenue Cycle
Activities and Documents
DFD of Sales Order Processing

System
Hall, 3e
33
Manual Sales Order Processing System
Hall, 3e
34
Manual Sales Order Processing System

(cont.)
Hall, 3e
35
Sales Order Processing
Begins with a customer placing an order

The sales department captures the essential details
on a sales order form.
The transaction is authorized by obtaining credit
approval by the credit department.
Sales information is released to:
Billing
Warehouse (stock release or picking ticket)
Shipping (packing slip and shipping notice)
36
Hall, 3e
The merchandise is picked from the Warehouse

and sent to Shipping.
Stock records are adjusted.
The merchandise, packing slip, and bill of lading
are prepared by Shipping and sent to the
customer.
Shipping reconciles the merchandise received
from the Warehouse with the sales information on
the packing slip.
Shipping information is sent to Billing. Billing
compiles and reconciles the relevant facts and
issues an invoice to the customer and updates the
sales journal. Information is transferred to:
Accounts Receivable (A/R)
Inventory Control
37
Hall, 3e
A/R records the information in the customers account

in the accounts receivable subsidiary ledger.
Inventory Control adjusts the inventory subsidiary

ledger.
Billing, A/R, and Inventory Control submits summary

information to the General Ledger dept., which then
reconciles this data and posts to the control accounts
in the G/L.
38
Hall, 3e
DFD of Sales Return Procedures
39
Hall, 3e
Sales Returns Procedures
40
Hall, 3e
Sales Return Journal Entry

G/L posts the following to control accounts:
InventoryControl
DR
Sales Returns and Allowances
DR
Cost of Goods Sold
CR
Accounts ReceivableControl
CR
41
Hall, 3e
DFD of Cash Receipts Procedure
42
Hall, 3e
Flowchart of Cash Receipts System
43
Hall, 3e
Cash Receipts Processes
Customer checks and remittance advices are

received in the Mail Room.
A mail room clerk prepares a cash prelist and sends the
prelist and the checks to Cash Receipts.
The cash prelist is also sent to A/R and the Controller.
Cash Receipts:
verifies the accuracy and completeness of the checks

updates the cash receipts journal
prepares a deposit slip
prepares a journal voucher to send to G/L
44
Hall, 3e
Cash Receipts Processes
A/R posts from the remittance advices to

the accounts receivable subsidiary
ledger.
Periodically, a summary of the postings is sent to
G/L.
G/L department:
reconciles the journal voucher from Cash Receipts
with the summaries from A/R
updates the general ledger control accounts
The Controller reconciles the bank

accounts.
45
Hall, 3e

Revenue Cycle Tests of Controls and Substantive Testing: IT Auditing, Hall, 3e

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Chapter 9:

Revenue Cycle Tests of Controls

Follow Figure 9-1

Document = SALES ORDER

2011 Cengage Learning. All Rights Reserved. May notHall,

Processing shipping orders

2011 Cengage Learning. All Rights Reserved. May notHall,

Legacy System Procedures

run on batches by AR account number

Legacy systems store records in sequential manner,

update & billing run [Figure 9-2]

Updates AR file becomes new AR file

Legacy System Procedures

by inventory item {why?}

Same reason; but this process is to update Inventory

Batch Cash Receipts Systems With Direct

Receives checks and Remittance Advices.

Batch Cash Receipts Systems With Direct

Cash receipts dept.

2011 Cengage Learning. All Rights Reserved. May notHall,

Batch Cash Receipts Systems With Direct

2011 Cengage Learning. All Rights Reserved. May notHall,

Batch Cash Receipts Systems With Direct

2011 Cengage Learning. All Rights Reserved. May notHall,

Real-Time Sales Order Entry and Cash

2011 Cengage Learning. All Rights Reserved. May notHall,

Real-Time Sales Order Entry and Cash

2011 Cengage Learning. All Rights Reserved. May notHall,

Real-Time Sales Order Entry and Cash

Cash receipts procedures

2011 Cengage Learning. All Rights Reserved. May notHall,

Features of Real-Time Processing

Traditional accounting does not have to exist in per se (in

Greatly shortens the cash cycle of the firm

2011 Cengage Learning. All Rights Reserved. May notHall,

Point of sale systems are used extensively in retail

The system computes the amount due. Payment is

Management Assertions and Revenue Cycle

VERIFY AR balance represents amounts actually owed as of Balance Sheet date

Determine all amounts owed organization are included in AR

Rights & Obligations

Determine organization has legal right to AR

Determine AR balance stated in net realizable value

Presentation and Disclosure

Testing credit procedures

Data Validation Controls

Real-Time: Errors handled as they occur

Missing data checks presence of blank fields

Testing Data Validation Controls

Verify controls exist and are functioning effectively

2011 Cengage Learning. All Rights Reserved. May notHall,

Manage high volumes of similar transactions

Testing data validation controls

2011 Cengage Learning. All Rights Reserved. May notHall,

File update controls -- Run-to-run batch control data to monitor data

Prevent and detect unauthorized and illegal access to

Testing access controls heart of accounting information integrity

Rule 1: Transaction authorization separate from

Necessary for employees who perform incompatible

2011 Cengage Learning. All Rights Reserved. May notHall,

Testing physical controls

Review organizational structure for incompatible tasks

PURPOSE: Information is not lost, misdirected, or corrupted; that the