Audit of the

Revenue Cycle
(Sales & Collection)

Accounting Department
Auditing II Faculty of Economics
Padjadjaran University
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Learning Objective 1

Describe the nature of the revenue

cycle and the transaction classes
involved and identify transaction
and account balance audit objective
for the revenue cycle

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Audit Objective

The overall audit objective in the audit of

the revenue cycle is to evaluate whether
the account balances affected by the cycle
are fairly presented in accordance with
generally accepted accounting principles

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Nature
An entity’s revenue cycle consists of
activities related to the exchange of goods
and services with customers and to the
collection of the revenue in cash

Revenue transaction
 Sales (cash & credit)
 Cash receipts
 Sales return & allowances
 Provision for bad debts
 Write-off of uncollectible accounts
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Accounts in the Revenue Cycle

Sales Cash in Bank

Cash
sales
Accounts Receivable Cash Discounts
Sales on Taken
account Beginning Cash receipts
balance

Sales on Sales returns Sales Returns

account and allowances and Allowances

Ending Charge-off of
balance uncollectible Allowance for
accounts Uncollectible

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Accounts in the Revenue Cycle
Allowance for
Accounts Receivable Uncollectible Accounts
Beginning Cash receipts Charge-off of Beginning
balance uncollectible balance
accounts
Sales on Sales returns Estimate of
account and allowances bad debt
expense
Ending Charge-off of
balance uncollectible Ending
accounts balance
Bad Debt
Expense

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Learning Objective 2

Describe the business functions

and the related documents and
records in the revenue cycle.

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Business Functions

• The revenue cycle involve the decisions and

processes necessary for the transfer of the
ownership of goods and services to customers
after they are made available for sale.
• It begins with a request by a customer and
ends with the conversion of goods or service
into an account receivable, and ultimately
into cash.

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 Sales Transaction
Accounts Business functions Documents and records

 Sales  Processing customer  Customer order

 Accounts orders  Sales order
receivable  Granting credit  Customer order or sales
order
 Shipping goods  Shipping document
 Billing customers  Sales invoice
and recording sales  Sales transaction file
 Sales journal or listing
 Accounts receivable
master file
 Accounts receivable
trial balance
 Monthly statements
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 Cash Receipts Transaction
Accounts Business functions Documents and records

 Cash in bank  Processing and Remittance advice

(debits from recording cash  Prelisting of cash
cash receipts) receipts receipts
 Accounts  Cash receipts
receivable transaction file
 Cash receipts journal or
listing

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 Sales Returns and Allowances
Transaction
Accounts Business functions Documents and records

 Sales returns  Processing and  Credit memo

and recording sales  Sales and returns and
allowances returns and allowances journal
 Accounts allowances
receivable

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 Charge-off of Uncollectible
Accounts Transaction
Accounts Business functions Documents and records

 Accounts  Charging off  Uncollectible account

receivable uncollectible authorization form
 Allowance for accounts  General journal
uncollectible receivable
accounts

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 Bad Debt Expense Transaction

Accounts Business functions Documents and records

 Bad debt  Providing for bad  General journal

expense debts
 Allowance for
uncollectible
accounts

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Processing Customer Orders

Customer Order:
A request for merchandise by a customer

Sales Order:
A document describing the goods ordered
by a customer

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Granting Credit

Before goods are shipped, a properly

authorized person must approve credit
to the customer for sales on account.

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Shipping Goods

This is the first point in the cycle

where company assets are given up.

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Billing Customers and Recording
Sales
Billing is the means by which the customer is
informed of the amount due for the goods ordered

Internal controls :
Making sure that all shipments
made have been billed
No shipment has been billed
more than once
Each shipment is billed for
the proper amount
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Billing Customers and Recording
Sales
Sales invoice

Sales transaction file

Sales journal or listing

Accounts receivable master file

Accounts receivable trial balance

Monthly statement

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Processing and Recording Cash
Receipts
Remittance advice

Prelisting of cash receipts

Cash receipts transaction file

Cash receipts journal or listing

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Processing and Recording Sales
Returns and Allowances

Credit memo

Sales returns and allowances journal

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Charging Off Uncollectible
Accounts Receivable

Uncollectible account authorization form

This is a document used internally to

indicate authority to write an account
receivable off as uncollectible.

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Providing for Bad Debts

This provision represents a residual,

resulting from management’s
end-of-period adjustment of the
allowance for uncollectible accounts.

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Learning Objective 3

Understand how e-commerce

activities affect the sales
and collection cycle.

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Effect of E-Commerce on the
Sales and Collection Cycle

The Internet and other developing

technologies allow companies to
develop new business models.

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Effect of E-Commerce on the
Sales and Collection Cycle

Business-to-business (B2B)

Business-to-consumer (B2C)

Management’s assertions for sales and

collection activities remain the same.

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Effect of E-Commerce on the
Sales and Collection Cycle

Auditors should obtain an understanding

of the design and operation of key internal
controls over e-commerce revenues.

Evidence for e-commerce activities is

likely to be in electronic form.

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Learning Objective 4

Understand internal control,

and design and perform tests
of controls and substantive
tests of transactions for sales.

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 Methodology for Designing
Controls and Substantive Tests
of Sales Transactions for Sales
Understand internal Design tests of controls and
control – sales. substantive tests of transactions
for sales to meet transaction
-related audit objectives.
Assess planned
control risk – sales. Audit procedures
Sample size
Determine extent of Items to select
testing controls. Timing
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Understand Internal Control –
Sales

Study the client’s flowcharts, prepare

an internal control questionnaire, and
perform walk-through tests of sales.

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Assess Planned Control Risk –
Sales

1. Framework for assessing control risk

2. Identify key internal controls and deficiencies

3. Associate controls and deficiencies with the

objectives

4. Assess control risk for each objective

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Assess Planned Control Risk –
Sales

Adequate separation
of duties
Proper authorization
Adequate documents
and records
Prenumbered
documents
Monthly statements
Internal verification
procedures

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Determine Extent of Testing
Controls

Audits of public
companies

Audits of nonpublic
companies

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Transaction-Related Audit
Objectives for Sales
Existence:
Recorded sales are for shipments actually made.

Completeness:
Existing sales transactions are recorded.

Accuracy:
Recorded sales are for the amount shipped.

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Transaction-Related Audit
Objectives for Sales
Classification:
Sales transactions are properly classified.

Timing:
Sales are recorded on the correct dates.

Posting and summarization:

Sales transactions are properly included
in the accounts receivable master file.
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 Direction of Tests for Sales

Duplicate Accounts
Customer Shipping Sales General
order document
sales
journal journal = receivable
invoice master file

Completeness Existence
start start

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Summary of Methodology for
Sales

Transaction-related audit objectives (Column 1)

Key existing controls (Column 2)
Tests of control (Column 3)
Deficiencies (Column 4)
Substantive tests of transactions (Column 5)

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Learning Objective 5

Apply the methodology for

controls over sales transactions
to controls over sales returns
and allowances.

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Sales Returns and Allowances

The transaction-related audit objectives and

client’s methods of controlling misstatements
are essentially the same for processing credit
memos as those described for sales.

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Sales Returns and Allowances

There are, however, two important differences.

Emphasis on
Materiality
objectives

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Learning Objective 6

Understand internal control, and

design and perform tests of
controls and substantive tests
of transactions for cash receipts.

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Tests of Controls and Substantive
Tests of Transactions for Cash
Receipts

 Determine whether cash received was recorded.

 Prepare proof of cash receipts.
 Test to discover lapping of accounts receivable.

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Learning Objective 7

Apply the methodology for

controls over the sales and
collection cycle to write-offs
of uncollectible accounts
receivable.

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Audit Tests for Uncollectible
Accounts
Existence of recorded write-offs is the most
important transaction-related audit objective.

What is a major concern in testing accounts

charged off as uncollectible?

– covering up a defalcation by charging off

accounts receivable that have been collected

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Additional Internal Controls Over
Account Balances
Realizable value

Credit approval

Aged accounts receivable trial balance

Charging off uncollectibles

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Additional Internal Controls Over
Account Balances

Rights and obligations

Presentation and disclosure

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Effect of Results of Controls and
Substantive Tests of Transactions
The parts of the audit most affected by the
tests for the sales and collection cycle are:

Accounts receivable Cash

Bad debt expense Allowance for

doubtful accounts

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Types of Audit Tests for the Sales
and Collection Cycle
Accounts Cash in
Sales Receivable Bank
Sales Cash receipts
transactions transactions
Audited by Audited by
TOC, STOT, and AP TOC, STOT, and AP

Ending Ending
balance balance
Audited by AP and TDB

TOC + STOT + AP + TDB

= Sufficient competent evidence per GAAS
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End

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