Enhance your sales audit procedures for higher education

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hello and welcome to the session this is Professor Farhad and this session we're going to be looking at the sales cycle we're going to understand the internal control and look at the substantive testing for the sales cycle now bear in mind that we already introduced the sales cycle and the prior session so you can go to my auditing sales cycle playlist and look at the first recording as an introduction you have to understand what the sales cycle has and we went over this we went over this picture earlier and details now we're going to go ahead and look at first internal control how do we how do we how do we assess and understand internal control the first thing we have to do what comes to internal control is we have to understand internal control and specifically we are dealing with sales so we have to understand the internal control with sales and after we understand the internal control we have to assess the internal control and this is gonna help us plan the control risk because remember the audit risk model control risk times inherent risk times detection risk this is what we're trying to do assess the control risk then after we assess the control risk we may or may not rely test test control now what do I mean we may or may when we may or may not test control that means that if we're gonna rely on the control we will test them if you are not going to rely on the control we don't test them now if you are a publicly traded company which is an issuer company follow the PCAOB the Public Company Accounting Oversight Board you have to test internal control you don't have an option because you have to issue a report about internal control over financial reporting okay so all these steps one two and three I'm not going to go over these steps in this session and the reason is because I already went over these three steps and my internal control auditing procedures and specifically we obtain an understanding of internal control we assess internal control and we test internal control for specifically as a sample we looked at sales so you can go back and view those because notice I have 50 and 35 almost an hour of lecture to understand how to obtain understanding assessing and testing so we don't do it in the session it's already done then once after we obtained the understanding now what we are going to go ahead a for gonna test the control will test the control otherwise we're gonna move on to the next step which is substantive test this is when we actually do the substantive testing and in this session I'm gonna show you what substantive testing do we do when it comes to sales here here we determine the audit procedures the sample size the item to select and the timing when did when we do the substantive testing so once again understanding of control we already covered this you can go to my prior session assessing planned control risk we covered this also you could Lou you could look at the prior session now we're going to look at a few key control for sales although they might be covered in the internal control but I think they are a good review so what are some key control that are important for sale in other words you have to follow as a company when it comes to sales one is adequate separation of duties and I'm gonna obviously emphasize all of those proper authorization I'm just listing them adequate documents and record pre-numbered documents monthly statements and internal verification so those are key control for sales which is any company should have okay let's start with adequate separation of duties remember that's the most important internal control and here we're gonna be specifically discussing with since okay so proper segregation of duties help miss statement due to both errors in front so what are we what are we separating when it comes to sales well we're separating few things the first thing we do is we separate the sales so the people who are in sales and the cash receipts so the people that makes the sales should not receive the cash so those should be separate why because you could be record processing the sale and receiving the cash and hiding the cash and never recording the sale to the credit function in sales people who make sales should not be able to determine the credit of the if this customer is a credit worthy or not should be the function of someone else and we saw this in the prior session a lot of this is repeat but it's good when you reinforce that you understand that I explained it to you in a different perspective your understanding of the information will get better also internal verification any form of internal verification from the original data so whoever input something in the system should not also verify the data so if you processed sales and then sales goes to the account receivable well somebody should compare sales to account receivable to cash the person that do the verification should not be involved in the inputting of the data should be independent okay so for example the account receivable subledger whoever look at the accounts receivable subledger look at the sales and look at the cash receipts should not be any of the individuals that were involved in the account receivable subledger account their sales and cash receipts should be an independent party so simply put this is important control whoever does the verification should not be the same individual that inputted the information in the system right because if that's the same individual they would say here everything was good don't worry I looked into it well you input it you can't look into it somebody else should verify it so this is adequate internal control or adequate separation of duties when it comes to sales proper authorization is another important internal control when it comes to sales here we are concerned with three things we want to make sure that the credit must be properly authorized before a sales take place so before we make a sale we should approve the customer's credit make sure the customer is approval this is gonna prevent two things it's gonna prevent fictitious sales because fictitious sales mean were selling two o'clock to an actual client so fictitious sales on yourself to somebody doesn't exist and making sure we are selling the credit toward the customers why that's an issue that's an issue because down the road if we sell to not credit worthy customers we may not be able to collect the money so it's easy to sell if you want the sell just say I'm gonna sell to everyone on credit and your sales will go up but what happened you cannot collect so this is what we're concerned with when it comes to proper authorization another thing with proper authorization is Goods should be shipped only after proper authorization to prevent fictitious sales again no shipment should be made unless we have proper authorization in other words we only are shipping to people who actually exist ok err - obviously credit worthy but to people who actually exist so someone should approve the the sales before the sailors ship and what we're trying to accomplish here is prices including basic term freight and discount must be authorized this is make sure that we don't we don't understand we don't sell something for other than the prices that we want to sell them for so always we're going to have proper authorization on these three levels this way we are selling to legitimate customers we are charging them the proper amount and we are shipping only to legitimate customers so that's another good internal control proper authorization and the sales cycle another good internal control is adequate documents and record so remember that the records could be electronics or could be paper depending if you're using IT or if you're still using manual now if you would assume any would use a manual because we look at electronic system in the IT session you should have a pre numbered multi copy also pre numbered sales invoices at the time a customer order is received so once you have a more than one order that obviously multiple copy of the same order you can send one to the credit department wanted the shipping and obviously you could keep one for yourself and one you can build a customer for it so it's the same copy so we've not making a mistake so we're comparing the original copy and sending the original copy to the various departments now all these copies should be pre numbered so this way we are accounting only for one sale again pre-numbered document is important because it helped prevent the failure of the bill and the duplicate billing and recording so if they are pretty numbered we're not gonna build the customer twice because each customer will only have a unique number okay and once we are account for all our documents if something is missing you want to see why it's listening and we account for that therefore we don't fail to build a customer because we need to account for all our documents another good control for sales obviously is monthly statements when you send the monthly statements for the customer it encourage the customer to look at the statement and if there's anything wrong they will contact you also gonna help with accuracy it helps you with the accuracy again we talked about internal verification process that's important basically could be manual or computerized but remember remember when it comes to the internal verification process we have to have whoever does the verification should not be involved with the original data okay so this process could be computerized or it could be manual ok so computer program or independent personnel remember if the word independent personnel does the independent internal verification not that would not be individual or not the department that inputted the data ok and when we do this we'll do this for the 6 for the sales transaction of the 6 transaction related audit objective which we'll see in a moment ok so for example we include accounting 14 for the numerical sequence of prenumbered document checking the accuracy of the document preparation and review and report for unusual or incorrect item this is when we do the internal verification now the next thing we're going to look at is the management assertions when it comes to sales transaction and you're gonna see this those assertions again and again and again and again so we're gonna go through various cycles we're starting with the revenue cycle with the sales cycle with a look at the expenditure cycle we're gonna look at the payroll cycle and those assertions will appear again and again so make sure you know what the current completeness accuracy cutoff classification so on and so forth now those are for the sales we're gonna have 40 basically where they look and the income statement now but remember those who are also existed for the balance sheet would end for the disclosure and presentation so make sure you understand those the management assertion we're gonna look at each one of them as they relate to sales specifically now because we're dealing with sales starting with the occurrence what are we concerned with when it comes to occurrence we want to make sure they record that sales actually occur so so we're not selling to people that don't exist the sales that we are recording so when we debit accounts receivable when we credit sales we are record we are debiting account receiver for an actual customer we are not booking fictitious sales ok now remember intentional overstatement and we have intentional and unintentional if we made an unintentional statement that's easy to find why because we don't receive the cash for it so the auditor can see that no cash has been received for this customer or when we try to confirm it what can I see later on we'll try to confirm the account receivable the customer would say I did not receive anything but the problem is intentional overstatement of account receivable and sales when you do intentionally and you'll try to cover this this is where the problem is so what are we looking for when it comes to occurrence we're looking for sales included in the journal for which no shipment were made so this could be if we were looking for this this error this is could be an error or a fraud what does that mean it means we have sales so we recorded the sales so the sales exist okay we have no shipping document remember when we when do when do we record the sale after we ship it so we're going to be looking for sales that exists with no ship and document okay that's a problem means we are recording sales it could be prematurely what do how do we do this we're gonna do something called vouching just bear with me I'm gonna show you what our changes in a moment basically what we do in a nutshell we look at the sales journal and we go back we go back to the source document okay we look at the SIL sales journal and we go back to the source document to see if an actual sales occur if something is recorded it should have source documents such as shipping so we want to see if there is shipping then there's an actual sales order okay this is how we look for for for for occurrence we could be recording sales more than once now or it could be recording the same sales more than once this could be an error or this could be fraud could be we just made a mistake what do we do how do we look for this we look for duplicate sales number hopefully if we're using pre numbered invoices then we should be able to pick this up really easily the third thing we look at for occurrence is shipment made to non existing customers and recorded as sales this is simply fraud you don't make a mistake by shipping to not existing customers here if there is an issue like this would you look for it the first thing you look for is a is a breakdown in the internal control for this to happen for this to happen the person recording the sale is also authorizing the shipment so that should not be the case because whoever recorded the sale is the same person that's also preparing ship and document that should not be the case okay so there's any gif if the company does not have those separation of duties now we this could happen okay so what we do if if we suspect this we can be a customer information on sales invoice to Master File to make sure that whatever we're seeing on the invoice is for a customer that exists okay so this is how we look for this other techniques also we can do we can exempt shipping document customer order to make sure this is an actual sale to an actual client okay and the best thing to do is to examine cash receipts after year-end so if the customer debited account receivable credited sales for a non-existent client well that exists that client you get I have maybe 30 days to pay doorbell we want to make sure we want to see if that individual paid doorbell and obviously we're gonna have other methods we're gonna see when we look at account receivable how to confirm this but the best way is to look for cash receipts if the person paid their bill then they are a legitimate customer know if it dishes customer over will not send you a check right okay so this is why sometime we will receive for the cash payment to check for those non existing customer if we suspect someone now we have other steps to perform before we wait for the cash we're going to see this later on when we work with account receivable but this is how we test for occurrence that the SE of actually exists in its is it a legitimate sales let's put it this way is it a legitimate sale another thing we look forward when it comes to sales is completeness completeness is not really an issue when it comes to sales completeness means that you recorded all the sales that you that you that you process usually it's the opposite way okay this is less likely to be tested because the risk of overstatement of sales is more likely than understatement this could be the issue of the company trying to pay less taxes they would report less sales but here we are assuming we are dealing with issuers with large companies publicly traded companies so that's not really an issue but could also be an issue if let's assume in here one manager they reach their goal reach their sales goal so what they do since they reach their sales goal what they do is they defer some sales they don't record some sales until year two because they already reach their goal they're gonna get the bonus therefore what they do they without the last week of sales to recorded any air - that could be the case of course but not likely what I'm gonna assume it's not that's not likely so here we have to do here what we have to do is to learn about something called directional testing or that direction of test how do we test for completeness and how do we test for 4000 we're gonna look at this okay so remember the first thing we look at is occurrence the V if the transaction actually exists and we looked at last as completeness we're gonna have to do two tests one is call the tracing and one is called valchek okay and when we do tracing what we're doing the completeness so let's do the tracing first and see how tracing work then we'll discuss the the occurrence when we do the boundary let's look at the regular same how does the regular sale start and hopefully you know this from your intro to the sales cycle first the customer places in order then we ship the order we send the customer a duplicate invoice and we keep one for ourselves and once we ship the order we're going to record the sale and the sales journal here what we do is we debit let's assume there was a customer order of 50,000 this is the customer order we shipped 50,000 we build the customer 50,000 now we have an account receivable sales of 50,000 we put this in the in the sales journal we put this in the in a general ledger for the account receivable for the sales and also the account receivable is updated and the financial statements are updated so this is how it works this is this this is the sequence now what we do if we want to know if all if all if all transactions are recorded we just pick a customer board that we pick a customer order and we test for it we do what's called the completeness test and we want to make sure that the customer order made it all the way through the sales journal wasn't a sales journal we assume it's in the ledger and it's in the receivable so this is called the the test is called here is the completeness the completeness test or tracing so when we go from the beginning so this is the beginning of the process that we end of the process would for completeness we want to make sure that if we receive the customer order if we shipped it then we build for it and we recorded it in the account receivable this is how we test for completeness now when it comes to occurrence or vouching what kind of the opposite we're gonna start by looking at a transaction so we look at a transaction here we saw its account receivable twenty thousand sales twenty thousand for a customer so what we do now we want to make sure and this is for for a legitimate customer for a for a customer for an order that we actually receive so we pick up this account receivable and we say okay let's see if we have duplicate sales invoice let's see if we have ship and document let's see if we have a customer order now we're going backward to see if what we what we recorded is supported by actual documents now can the company manufacture of the document sure they can manufacture all these documents of course they can but this is our job as auditor to make sure as we're going through the process looking for stuff that doesn't make any sense this is for the occurrence test this is called vouching this is going the opposite way going from the end to the beginning of the process going from the end of the process to the beginning of the process this is how you test for vouching now on the CPA exam this is tested heavily so are you looking for completeness tracing or are you looking for vouching which is occurrence so make sure you notice another management assertion we have to be aware of when it comes to sales is accuracy basically what's accuracy sales are accurately recorded when we're recording the the proper dollar amount okay sales are actually recorded what is the auditor concerned with their concern with any problem with the quantity we're not recording the appropriate quantity or we may not be billing the appropriate amount which is the price so this is Q and this is P P is for price that could be the case okay or accurate recording the amount billed or if we if we if we have those correctly then when we build them proof will not build them for the proper amount if it's a computerized system if Q is correct P is correct and a computerized system the billing should be correct as well okay now how do we how does the auditor look for this how that does the auditor look for this we compare prices on duplicate sales invoices we proof price price list so look at the sales invoice look at the reproof driveless do they match hopefully they do recalculate extensions and footings and compare the details to the invoices with shipping records for description quantity and customer identification here we're looking at we we do the when we do the computation ourselves look at the invoice make sure everything is matching five units times the price times the tax total everything compared to the invoice compared to the ship and document make sure the description match hopefully everything is good now here I put dual cast what you do dual test means is when you're doing the internal control you may also kind of do the internal control and say if their accuracy is good you'd say I would less substantive testing this is a dual test basically it's for internal control as well as substantive testing another thing that we have to test another assertion we have to test is posting and summarization what is posting and summarization basically our sales transaction are correctly included in the master file and correctly summarized are we updating our sales ledger are we updating our account receivable ledger okay so sales journal must be correctly total and posted to the ledger if the financial statements are correct exactly if we if we if we if we recorded a sale we want to make sure that made it to the general ledger and from the general ledger to the financial statements of course here the general the and all that software allow for efficiency testing of the accuracy so for example we can do we can download the data take the data put it on our system add up all the transactions and then compare our total to their total to make sure everything was posted this is how we do it so it can be done fairly quickly with a software or we can download or date on to an excel sheet they have their total we compute the total and hopefully it will match okay posting and summarization differ from those other transactions later not objective because they include footing journals Master File record and ledger so what we're doing in this step as we're looking at all the journals all the entries a list of entries we're looking at numerous transactions were adding them all together okay and comparing them to each other think of the the journal to the master file to the ledger why am i emphasizing this because a lot of people confuse this with accuracy what aren't we doing an accuracy test here no let me show you at accuracies and this is where people get confused when an auditor can be in an amount on a duplicate sale invoice with either a sales journal or a master file entry this is when you're doing accuracy you're looking at one transaction and you're comparing to see if that specific transaction was recorded properly in the posting and summarization you're looking at a series of transaction you're looking at total footing means adding the journal adding a list of transaction adding the total sales comparing the total sales to the Master File record or the ledger this is the difference between the two don't confuse accuracy which is kind of sounds familiar leave the accuracies for one transaction posting and summarization is for a bunch of transaction another thing we need to be concerned of is classification well our sales are properly classified and this is this is not really a big problem in sales specially if you have a small company but it could be for other account we're going to see later when it comes to liabilities but the classification is not as important but we need to take a look to see with it what it looks like we want to make sure that transactions are charged to the correct general ledger account for example what cash and credit sales company personnel should not debit account receivable and credit cash okay for or credit sales for collection of receivables when we receive the cash when we receive the cash we should we debit cash if it's we debit cash if it's a cash sale and credit sales if we receive a payment for previous for a previous sales sales on account we debit cash we credit account receivable we cannot mix those for example for cash sales that credit account receivable and for cash received for previous sales that would care davit cash and credit account receivable or credit sales again so that's important another thing we need to be aware of is when we sell operating assets such as building or land so when we debit cash we need to credit we cannot credit sales we want to make sure the sales the sales account we inform for example with credit sales of land it's a different account and sales we wanna want we don't want to mix the sales of operating assets such as building and land with regular sales okay those are two different type of sales because when you sell the land or when you sell the building you also might have a gain or a loss you want to make sure you properly classify those transactions also for those companies that using more than one sales classification such as companies issuing segmented earning statements for example some companies what they do they for publicly traded companies they might have to do this where they have to separate their sales into for example four divisions the u.s. division or in the u.s. it might be the East Coast the West Coast Central and South East just just make this up okay so what you have to do is when you when you record a sale you wanna record it to the prior division also for this for this type of certian auditor commonly test sales for proper classification as part of the testing of accuracy so when we look at accuracy when we add up all the numbers we also see if it's properly classified say because what we do in that step we examine support and document to determine the proper classification of a given transaction and compare it with the actual amount to which it's charged when we look for accuracy when we when we do accuracy also we meet the classification because we're looking at the invoice and we're seeing what's happening the last but not not the least important assertion of sales is cut off and this is important in cut off sales cut off especially when it comes to account receivable what a sales cut off it means is the transaction recorded in the prior period prior period means what this says here one this is here too so what happened is we want to make sure that no sales in year two and early year two is move back to year one and no sales in year one its move it's moving forward to year two so when I make sure that those transactions don't happen the sales is recorded in the period period now how do we make sure that that's the case well we want to make sure that sales is built and recorded as soon as as soon as the shipment takes place to prevent unintentional and mission of transaction so especially at the end of the year we should have a policy for example the company policy as soon as we ship something we need to record it within maybe maybe 24 hours ok time to record the transaction are also less likely to contain misstatement because you're going to remember exactly what happened once again if the if the system is computerized then it's not an issue because once they scan the shipment the scanning of the shipment will update the record the sales record so this way it's recorded in the prior period there's no cutoff issue so when the order to do substantive tests of transaction procedure for accuracy also when they do accuracy they commonly compare the date on the selected bills of lading which is the shipping document or other shipping documents with the date on the related duplicate sales invoice the sales journal and the account receivable so when they also look for accuracy they look they're looking at the transaction is is look at the date and see compare the date to the shipping document to the sales journal and make sure it's reported in the prior in the proper period now if there is a significant differences basically what does that mean it means there's a lot of transaction that are shipped in January second but they are dated on you know December 29th and there are significant issues like this then there's a potential cutoff problem okay and this is this is this could be a serious issue so how do we test for this what happened the the the auditor would look at for example December the last week in December and the first week in January and they will test they will pass that data would look in January make sure that the shipments made in January belong were recalled in January the shipment made in December were recorded in December now here we have an issue of F or B shipping fo B destination we would look at this little bit more when we do the account receivable okay but this is basically the cutoff the last thing we need to look in this session is the sales returns and allowances how to test for sales returns and allowances the transaction related other objective are essentially the same for a credit memo as those with processing sales with two notable differences so so the audit objective are the same one is the sales returns and allowance may not be a material amount which is it's not as important okay so we can simply ignore them it's a small amount but remember this could be any area of fraud as weas as we stated in another session because the company may not be recording sales return in turn overstating their sales and the other issue we have to be concerned with is the occurrence as I just said if sales return is happening and sales allowance is happening we want to make sure if it's happening it's being recorded auditor usually emphasized testing record the transaction to uncover any theft of cash and the collection of account receivable that was and the next session we would look at we would look at the cash receipts which is also it's gonna be part of the sales because after we make a sale we receive the cash now in the next session we're gonna look at two things for cash receipts we can look at the test of control and we can look at the substantive testing so we're gonna do the same thing except in this session I did not look at the test of control because the test of control for sales was covered in another set in another session so I didn't want to repeat the same thing and I showed you what that other session is but in the next session we would look at the test of control for the cash receipts what are the proper internal control and how do we test the control for this and we look at what substantive testing they will we will have to undertake for the cash receipts if you have any questions any comments about this sessions by all means email me or see me in class once again if you're studying for your CPA exam study hard it's worth it