CHAPTER 4
TRANSACTION CYCLES
REVENUE AND
RECEIPT
CATEGORIES OF TRANSACTION CYCLES
CATEGORY INCLUSION
Revenue and receipt Sale of goods or services to customers
Collection of cash
Expenditure and disbursement Acquisition of goods and services
Payment for the goods and services
acquired
Human resources and payroll Acquisition of services from
employees
Payment for the services acquired
Production or conversion Production of entity’s product for sale
Financing and investing Generation of capital funds from
outside investors
Investment of capital funds to other
profitable activities
CATEGORIES OF TRANSACTION CYCLES
REVENUE AND RECEIPT CYCLE / ORDER TO CASH (OTC)
Business functions Resources are distributed to customers in exchange for promises of future payments
Customers pay cash
Accounts affected Sales, sales returns, allowances and discount
Receivable, allowance for bad debts, bad debts expense
Cash
Departments involved Revenue
Sales or customer order
Credit
Inventory control or warehouse
Shipping
Billing
Accounting (inventory, receivable and general)
Receipt
Mail room or receptionist
Treasury
Accounting (receivable and general_
CATEGORIES OF TRANSACTION CYCLES
Forms or documents received, initiated and processed
Form Description Initiated by: Distributed to:
Sales order (customer Details of goods ordered Sales department • Customers
order) (qty, prices and payment • Credit
terms • Shipping
• Billing
Shipping docs (bill of Describes the goods to Shipping department • Carrier
lading or DR) be shipped and serves as • Customers
contract between the • Biling
entity and carrier
Sales invoice Describes the goods sold, Billing department • Customers
amount due and terms • Accounting
Remittance advice Document sent by a Customer thru the mail • General accounting
customer to a seller room department • Receivable
detailing the invoices department
being paid
Daily summaries Summarizes transactions Receivable (for sales) • General accounting
recorded during the day Treasury (for collection) • Treasury and
by the different Mail room receivable
departments
Figure 5.1 Internal Control Flowchart for Processing Sales
TEST OF CONTROLS OVER SALES AND
RECEIVABLES
ASSERTIONS
General Specific
1. Existence or occurrence 1. Recorded sales are for shipments actually made to
customers
2. Completeness 2. All sales transactions that occurred are
recorded
3. Rights and Obligations 3. Sales recorded represent only sales
transactions
4. Valuation or allocation 4. Sales are correctly billed and recorded
5. Presentation and disclosure 5. Sales and accounts receivable are recorded
to result in presentation and disclosure in
accordance with PAS / PFRS
TESTS OF CONTROLS OVER SALES AND RECEIVABLES
A. EXISTENCE AND OCCURRENCE: Recorded sales are for
shipments actually made to customers
Controls Test of Controls
1. Recording of sales is supported by customer 1. To test this control, the auditor examines
orders, sales orders approved by the credit dept approved customer order, sales order, shipping
and approved an executed shipping document and copy of sales invoice for sample
documents entries in the sales journal. The documents
should bear the required approval, such that of the
credit manager’s approval. The description,
quantity of goods shipped, name, address and
other details regarding the transactions should be
shipment
2. A clerk independent of accounts receivable 2. The auditor can observe whether a clerk
prepares and mails monthly statements to independent of the accounts receivable
customers for all trade accounts receivable and bookkeeper prepares and mails monthly
follows up on any complaints. statements and follows up any complaints. He
can also examine files on complaints received for
selected months.
TESTS OF CONTROLS OVER SALES AND RECEIVABLES
B. COMPLETENESS : All sales transactions that occurred are
recorded
Controls Test of Controls
3. Prenumbered shipping documents are 3. The auditor can observe client performing
accounted for to determine that all sales the procedure or select a sample of
invoice is prepared for all shipments shipping orders and examine the invoice
that bills the sale. The presence of a sales
invoice indicates that the shipment was
billed
4. Pre-numbered sales invoices are 4. The auditor can observe the clerk recording
accounted for to determine that all sales sales if he or she is accounting for the
are recorded numerical sequence of invoices and
determines why any missing invoices have
not been processed. The auditor can also
select a sample of sales invoice copies to
trace into the sales journal.
5. Procedures to ensure timely recording if 5. The auditor should inquire how
sales and proper cut-off are established procedures are being followed and inspect
report on the last shipments that the shipping
clerk sends to the billing clerk. Proper cut-off
also provide evidence about the existence of
transactions.
TESTS OF CONTROLS OVER SALES AND RECEIVABLES
C. RIGHTS AND OBLIGTIONS : Sales recorded represent only sales
transactions
Controls Test of Controls
6. Clerk should check sales orders and sales 6. The auditor should observe that the control
invoices for terms to determine that is being observed.
transaction is a sale rather than a consign-
ment
D. VALUATION OR ALLOCATION : Sales are correctly billed and
recorded
Controls Test of Controls
7. For all goods shipped, goods are counted and 7. The auditor observes that the control is
and descriptions and quantities are compared being performed and examines a sample
to quantities and descriptions on sales orders of shipping orders for the signature on the
and shipping documents prior to shipping shipping documents that indicates that the
counting and comparison occurred.
TESTS OF CONTROLS OVER SALES AND RECEIVABLES
D. VALUATION OR ALLOCATION : Sales are correctly billed and
recorded
Controls Test of Controls
8. Customer credit is approved by a responsible 8. The auditor examines a sample of sales order
official prior to merchandise shipment. for credit approval prior to shipment
Although approval of credit prior to
shipment does not guarantee absence of
uncollectible accounts, the procedure
reduces the likelihood of the account beco-
ming uncollectible
9. Sales are checked for: 5. To test these controls, the auditor performs the
a) Proper pricing following:
b) Mathematical accuracy a) Inquiry about the updating and use of price
c) Terms of price lists
b) Examine a sample of invoice copies to
determine that they contain a signature
indicating that the price, mathematical
accuracy and terms have been checked.
TESTS OF CONTROLS OVER SALES AND RECEIVABLES
D. VALUATION OR ALLOCATION : Sales are correctly billed and
recorded
Controls Test of Controls
10. The accounts receivable subsidiary ledger is 10. To test this control, the auditor observes
balanced to the general ledger control that is being performed. The auditor may
account regularly. The absence of this also foot the accounts receivable subsidiary
control results in the possibility of careless ledger and compare the total with the
recordkeeping and omission of posting of balance appearing in the general ledger
sales or payments control account.
E,. PRESENTATION AND DISCLOSURE : Sales and accounts receivable are recorded to result in presentation and
disclosure in accordance with PAS/PFRS
Controls Test of Controls
11. Sales must be properly classified to generate 11. The auditor can test this control by deter-
accurate segment reporting. Entities may mining that the invoice copy contains the
require a second person to independently signature that indicates approval of account
review or check the account coding on classification used.
invoices
AUDIT PROGRAM FOR TEST OF CONTROLS OVER SALES TRANSATIONS
WP Done
Audit Procedures Ref By Date
1. For sample of entries in the sales journals ,
a. Compare data in the sales journal to approved customer order,
sales order, shipping document, and copy of sales invoice for:
a.1 customer order number
a.2 invoice number
a.3 customer name
a.4 date
a.5 description of goods
a.6 quantity
a.7 price
a.8 invoice amount
a.9 terms
b. Determine credit approval
c. Determine that signature are on invoices indicating independent
checking for
c.1. proper pricing
c.2. mathematical accuracy
c.3 terms
2. For a sample of shipping documents, examine signature indicating that for goods shipped,
goods are counted, quantities and description on sales orders and shipping documents prior to
shipping, and the
transactions are recorded in the sales journal.
AUDIT PROGRAM FOR TEST OF CONTROLS OVER SALES TRANSATIONS
WP Done
Audit Procedures Ref By Date
3. Discuss the procedures followed with the person (independent of the bookkeeper)
who mails to customers monthly statements for all trade accounts receivable and
follows u p on any complaints. Review the clients correspondence files reflecting
resolution of these items.
4. Observe the procedures followed to ensure a proper cut-off of sales at year-end.
5. Observe that the accounts receivable subsidiary ledger is balanced to the general
ledger control account regularly
6. Examine evidenced of accounting for the sequence of sales orders, shipping
documents, and sales invoices.
SUBSTANTIVE TEST OF SALES TRANSACTIONS
ASSERTIONS AUDIT OBJECTIVES AUDIT PROCEDURES
I. Occurrence and Validity A. To determine that recorded sales are authorized 1. Review the sales journal, general ledger
II. Rights and Obligations and are for shipments actually made to non- and accounts receivable master file or
fictitious customers. trial balance for large or unusual items.
2. Trace sales journal entries to copies of
sales orders, sales invoices and shipping
documents.
3. Trace shipping documents to entry of
shipments perpetual inventory records
4. Compare prices on sales invoices with
authorized price lists or properly
executed contracts.
III. Completeness B. To determine that existing sales transactions are 5. Trace shipping documents to resultant
recorded on a timely basis sales invoices and entry into sales
journal and accounts receivable master
file.
6. Compare dates of recorded sales
transactions with dates on shipping
records or perform sales cutoff tests.
IV. Valuation or Allocation C. To determine that recorded sales are for 7. Recomputed information on sales invoices
the amount of goods shipped and are 8. Trace entries in sales journal to sales
correctly billed and recorded invoices
9. Trace details on sales invoices to shipping
documents, price tests and customer’s
orders.
AUDIT PROGRAM FOR TEST OF CONTROLS OVER SALES ADJUSTMENTS
WP Done
Audit Procedures Ref By Date
1. Account for credit memoranda
2. Prove the footings of credit memorandum register
3. Trace the postings of credit memorandum to the general ledger
4. Review credit memoranda for approval
5. Check credit memoranda concerning returned goods for (a) arithmetical accuracy;
(b) quantities returned (by reference to receiving records); and (c) unit prices (by
references to the original invoice or record of the selling price
6. Inspect credit files in support of accounts written off as uncollectible
Substantive tests for sales returns and allowances
1) Review the use and authorization of credit memoranda
* use of pre-numbered CMs and signed by an officer
2) Review credits for returned merchandise if supported by receiving report on
the returned shipment
3) Verify prices, extensions, and footings and trace postings from the sales
return journal or other accounting records to the customers accounts in the
subsidiary ledger.
AUDIT PROGRAM FOR TEST OF CONTROLS OVER CASH RECEIPT TRANSACTIONS
WP Done
Audit Procedures Ref By Date
1. Compare remittances or other details of cash receipts with entries in the cash
receipts book
2. Compare recorded receipts with individual deposits as shown by bank
statements
3. Compare composition of authenticated duplicated deposit slips with the
recorded receipts
4. Compare the recorded receipts with an independent record prepared before
receipts are transmitted to the cashier
5. Test of cash discounts and other allowances or credits
6. Test posting to the general ledger to the customers’ ledger and to other
subsidiary ledger
7. Review cash receipts for unusual transactions
2. For a sample of shipping documents, examine signature indicating that for goods shipped,
goods are counted, quantities and description on sales orders and shipping documents prior to
shipping, and the
transactions are recorded in the sales journal.
EXPENDITURE AND
DISBURSEMENTS
DOCUMENT USED IN THE EXPENDITURE CYCLE
DOCUMENTS AUDIT SIGNIFICANCE
Purchase Requisition Provides evidence that the purchasing dept was authorized to
initiate a purchase
Purchase Order Indicates authorization to procure goods and services. Contains the
signature of the employee who authorized a purchase
Receiving Report Provides evidence that goods were received
Vendor’s invoice Provides evidence about a purchase of goods or services
Debit Memo Indicates a reduction in the amount owed to a vendor because of returned
goods or an allowance granted
Voucher Formal means of recording and controlling acquisitions for each payment.
Check Provides evidence about payments that an entity has made.
Vendor’s statement Determines that all transactions recorded on the statement have been
recorded in the books.
AUDIT PROGRAM FOR TEST OF CONTROLS: ACQUISITION
TRANSACTIONS
WP Done
Audit Procedures Ref By Date
1. For sample of purchases, examine the related purchase requisition and purchase order
2. For a sample of purchases, trace the transactions to the voucher register and the perpetual
inventory records maintained in stores
3. Check vendor invoice for mathematical accuracy
4. Trace posting from the voucher register to the general ledger
AUDIT PROGRAM FOR TEST OF CONTROLS: CASH DISBURSEMENTS
WP Done
Audit Procedures Ref By Date
1. Prove the arithmetical accuracy of the cash disbursements record and trace postings to the general
ledger
2. Compare paid bank checks with the cash disbursement records
3. Account for all checks
4. Reconcile recorded disbursements with bank statement
5. Examine supporting documents
6. Review cash disbursements records for unusual items