Auditing & Ethics Issues
Tutorial 11
Tutorial 11: The Audit of Sales and Receipts Cycle 1
Review the lecture notes and reading materials, ask in the tutorial if you do not understand.
Part I Multiple Choice and Short Questions
1. Tracing bills of lading which is one type of shipping documents to sales invoices will provide evidence that
a. recorded sales were shipped
b. invoiced sales were shipped
c. shipments to customers were invoiced
d. shipments to customers were recorded as sales
2. Which of the following might be detected by an auditor’s review of the client’s sales cut-off?
a. excessive goods returned for credit
b. unrecorded sales
c. excessive sales discount
d. inflated sales for the year
3. An auditor is testing sales transactions. One step is to trace a sample of debit entries from the accounts receivable subsidiary ledger back to the supporting sales invoices. What would the auditor intend to establish by this step?
a. sales invoices represent bona fide sales
b. all sales have been recorded
c. all sales invoices have been properly posted to customer accounts
d. debit entries in the accounts receivable subsidiary ledger are properly supported by sales invoices
4. Which of the following audit procedures is most effective in testing on sales for understatement?
a. check the aging accounts receivable
b. send confirmation letters to trade debtors
c. trace samples of recorded sales from general ledger to initial sales order
d. trace samples of initial sales orders through summaries to recorded general ledger sales
5. An auditor examines a sample of copies of June and July sales invoices for the initials of the person who verified the quantitative data. This is an example of a
a. test of control
b. substantive test
c. cut-off test
d. analytical procedure
6. What are the internal control objectives for sales?
7. Name the major types of internal control activities.
Part II Long Questions
1. ABC Ltd. adopts the following procedures in its sales system:
Sales Department:
Orders are received by the two sales assistants through telephone or post. The two sales assistants will prepare the sales orders from the information obtained and then send them to stores.
Stores:
After receiving the sales orders, the store clerk will check against the bin card for the availability of goods. The store clerk then prepares a 2-part delivery note. The original of the delivery note will be sent to the customer together with the goods. The store clerk will then send the copy of delivery note and the sales order to the accounts department.
Accounts Department:
Within the accounts department, there are two accounts clerks who prepare the invoices, receive cheques and update the books of account. Based on the details of sales order and delivery note, the accounts clerk prepares a 2-part sales invoice. Original of the sales invoice will be sent to the customer. The copy of the sales invoice will be used to write up the sales day book and the sales ledger. The sales invoices together with the sales orders and delivery notes are filed in alphabetical order of customer name.
When the mail for incoming cheques is opened, a cheque list is made out of it. Such cheque list is used to update the sales ledger and the cash book. The cheque list is filed in date order.
Required:
a. Briefly describe the internal control objectives of sales system.
b. Identify FOUR weaknesses in the system described above and of each stating you recommendations
2. Due to a car accident, the Financial controller of Milka Ltd. has been in hospital for four months. His absence from office has significant impact on the company, and the internal controls have not functioned properly. The reported results show that there was no change in sales as compared with prior year but the current year’s gross profit margin decreased from 20% to 10% whereas bad debts increased from $100,000 to $6,000,0000.
The following narrative notes on the sales and cash receipts systems are found in the current year audit file:
SALES
Prenumbered Customer Order is raised by the Order Clerk upon receipt of written purchase order from the customers. The Customer Order is then passed to the Credit Control Clerk to check for outstanding balance. The Credit Control Clerk records the outstanding balance and initials on the Customer Order, thereafter the Customer Order will be returned to the Order Clerk for further ordering process. If it is a new customer, the Credit Control Clerk will simply mark nil on the Customer Order. As Milka Ltd. is a distributor, all sales are credit terms.
The Customer Order reaches the shipping department where the Shipping Clerk will prepare a prenumbered delivery note which consists of five copies. Copy 1 of the Delivery Note is passed to the Accounts department, copy 2 is filed in the shipping department, and copy 3 is sent to the warehouse for packing. Copy 4 and 5 are taken by the driver when delivering the goods ordered. Copy 5 will be retained by the customer. During the packing process, one warehouse clerk performs the packing, while the Driver is only responsible to deliver the goods to the customers.
The Driver after delivery, returns copy 4 to the warehouse clerk who will pass copy 4 to the Accounts Department for the preparation of sales invoice. An accounts clerk will key in the necessary data except for the unit selling price into the computer for automatic generation of sales invoice. The automation involves the extract of unit selling price from the Unit selling Price master file for the calculation for sales value. Whenever there is a change in the price list, the Accounts clerk will update the Unit Selling Price Master File according to the memo approved by both the Sales Manager and Sales Director, thereafter the memo will be filed by the Accounts clerk. A sales invoice of 2 copies is generated by the computer with a sequential number assigned for each sales invoice. One copy of the sales invoice is kept by the Accounts department for posting to accounting records, another copy is mailed to customers by the Mailing Clerk.
Cash Receipt
On a monthly basis, Accounts department generates an ageing report of outstanding debtors for the review of the Financial controller, who will inform the sales manger to take follow-up actions, but it is noted that ageing reports for the last four months are still in the in-tray of the Financial Controller untouched. Cheques and cash collected are banked-in every Friday afternoon by the Accounts Clerk, who is responsible for the preparation of bank statement and posting of entries to debtors ledger. Incoming mails are opened and recorded in an incoming mail log book by the Mailing Clerk.
Required:
Identify eight internal control weaknesses of the sales and cash receipt cycles and make recommendations for improvement.
(December 2 001, HKAAT)
3. In the audit of Belmont Manufacturing Co Ltd’s accounts for the year ended 31 December 2001, the following data are extracted from the accounting records.
Sales Invoice No / Date of Sales Invoice / Goods Dispatched Notes (GDN) No. / Date of GDN / Invoice AmountS0920 / 27 December 2001 / D2193 / 27 December 2001 / $30,000
S0921 / 29 December 2001 / D2198 / 3 January 2002 / $20,000
S0922 / 30 December 2001 / D2195 / 29 December 2001 / $40,000
S0923 / 30 December 2001 / D2196 / 31 December 2001 / $15,000
S0924 / 31 December 2001 / D2200 / 8 January 2002 / $14,000
S0925 / 2 January 2002 / D2201 / 8 January 2002 / $32,000
S0926 / 2 January 2002 / D2192 / 27 December 2001 / $50,000
S0927 / 3 January 2002 / D2194 / 28 December 2001 / $24,000
S0928 / 4 January 2002 / D2199 / 6 January 2002 / $18,000
S0929 / 5 January 2002 / D2197 / 31 December 2001 / $60,000
Note: All the sales invoices are on FOB origin terms, i.e. the title passes to the buyer when the goods are shipped
Note II: The sales journal is updated according to the date of sales invoice.
Belmont Manufacturing Co Ltd. recorded all the sales with invoice issued on or before 31 December 2001 as sales for the year ended 31 December 2001. It is Belmont’s pricing policy to fix its selling price as cost plus 25%
Required:
(a) Briefly explain the term “cut-off test”
(b) When and why do the auditors have to obtain:
(i) the number of the last GDN on or before the year-end, and
(ii) the number of the first GDN after the year end?
How would the auditors make use of these data?
(c) Classify each of the sales invoices from S0920 to S0929 into the correct accounting year. You are required to state the basis of your classification in general.
(d) Based on the cut-off error identified in (c), quantify the impact of the profit of Belmont for the year ended 31 December 2001.
(December 2003 HKAAT)
Part III Revision Questions
Question 2, page 133 of Chapter 12, Teresa Ho
Question 6, Dec 1996, HKAAT paper 6 – Auditing
AEI-TE-L11 2003 Page 1 of 5
Auditing & Ethics Issues
Tutorial 11
Tutorial Exercise – answer
Tutorial 11: The Audit of Sales and Cash Receipts Cycle 1
Part I Multiple Choice and Short Questions
1. c
2. b
3. d
4. d
5. a
6. authorization, completeness, validity, valuation, classification and cut-off
7. sales ordering, credit controls, goods delivery, billing, cash receipts and recording
Part II Long Questions
a. Internal control objectives of sales system
1. Recorded sales are for delivery made to nonfictitious customers
2. All existing sales transactions are recorded
3. Recorded sales are for the amount of goods shipped and are correctly billed and recorded
4. Sales transactions are properly classified
5. Sales are recorded in the correct period
b.
Weaknesses / Recommendations1. / There are no controls over the completeness of sales order / Sales order forms should be prenumbered and two additional copies should be produced, one kept in the sales department and one sent directly to accounts department
2. / In preparing sales invoices, there is no proof of delivery obtained from customers / Sales invoices should be prepared based on delivery notes and acknowledgement of receipt of goods from customers
3, / There is no segregation of duties within the accounts departments / Each person in the accounts department should be allocated with specific tasks to ensure that all duties are evenly allocated and have adequate segregation of duties
4. / There is no creditworthiness check / A credit procedure should be implemented. Each customer is given a maximum credit limit. Before accepting an order the credit limit should be checked.
5. / There is no controls over the completeness of sales invoicing / The sales invoices should be prenumbered
6. / There is no independent control over cash receipts / The post should be opened independently of the accounts department and a separate list of cheques received should be made
2.
Weakness / Recommendations1. Credit control functions not properly carried out, as the ordering process will be continued without regard to the outstanding balance / Credit control clerk should compare the outstanding balance with the authorised credit limit and reject the orders with outstanding balances in excess of credit limit. If the sales team would like to make sales in excess of the authorised credit limit, special approval from appropriate personnel must be evidence.
2. No authorized limit has been set for new customer / Every customer must have an authorised credit limit. The Credit committee should review the financial status and assess the credit of every potential customer before executing any purchase order placed by the new customer
3. There is no independent checking on the quantity and details of goods packed for delivery. / Another staff in the warehouse should be responsible for checking the goods packed for delivery to ensure the goods delivered match the goods ordered
4. There is no procedure to ensure accuracy of the information in the Unit Selling Price Master File. Any incorrect data in the Unit Selling price Master File could result in incorrect pricing for billing purpose. / Any updating to the Unit Selling Price Master File must be checked by a staff independent from the one who performs the input
5. The accuracy and correctness of the sales invoices have not been reviewed and approved by an authorized person before mailing to the customers / Sales invoices should be checked by another clerk to ensure the sales invoices are properly prepared and the sales invoices should be signed by an authorised person as evidence of approval
6. The company does not have a back-up system to ensure that the internal control procedures function properly in case of an absence. This results in no follow-up action being taken on outstanding debtor balances / During the absence of the Financial Controller, a copy of the ageing report on outstanding debtors should be distributed to the Sales Manager for follow-up action. As an alternative, the role of the Financial Controller should be backed-up by a designated person in case of the absence of the Financial Controller
7. It is easy for a misappropriation of cash by the accounts clerk on cash received from customers / The company should inform all the customers that they should only settle the balance either through cheque payment or direct credit to the company’s bank account
8. Cash and cheques collected are not banked-in promptly / All cash and cheques collected must be promptly banked-in so as to reduce any risk of lost of cheques or misappropriation of cash
9. There is inadequate segregation of duties because the preparation of bank reconciliation statement, keeping of debtors ledger and bank-in cash and cheques collected, are all performed by the Accounts Clerk. / Bank reconciliation statement should be prepared by a staff independent from the duties of keeping of debtors ledger and the bank-in of cash and cheques collected. Furthermore, there should be segregation of duties between the bookkeeping and custodian functions
10. Incoming mails are opened and recorded solely by the Mailing clerk, so incoming cheques and cash may easily be misappropriated / Incoming mails should be opened by the Mailing Clerk in the presence of another staff.
3.(a)