revenue & receipts cycle - test of controls

Chapter 10: Revenue and receipts cycle 10/51 10.7.1.2 Timing of tests of controls The auditor needs to gain evidence that the controls on which he intends to place reliance were operating effectively throughout the financial year under audit, so tests of controls may be carried out at different stages throughout the year during interim visits to the client. (For some large audit clients such as a bank, testing controls may be an ongoing process.) However, on most audits, to satisfy himself that controls were operating effectively throughout the year, the auditor will rely on the audit trail created for the transaction. For example: The auditor could choose a selection of sales transactions from throughout the year and inspect the sup- porting documentation to see that it consists of an order from an approved customer, a corresponding internal sales order, a despatch note and an invoice, all of which tie up with the description of goods, quantities, dates and document numbers, and which reveal the signatures of employees involved in the process. This of course does not prove that the sale was approved before it was made or that checking of prices, calculations, etc., did actually take place, but, combined with other evidence the auditor will seek, such as whether the debtor paid the amount reflected on the invoice, strong pervasive evidence that the controls were functioning at that time will have been gathered. If, however, other evidence reveals that there are des- patch notes for which there are no invoices, or that there are large numbers of credit notes subsequently being issued because incorrect goods are being sent to customers, or incorrect prices are being charged, the auditor gains evidence that the controls (are) were not effective. This is likely to increase the substantive tests that will need to be carried out. 10.7.1.3 Nature of tests of controls As pointed out earlier in the section, the auditor uses an assortment of procedures when conducting tests of controls. Controls in this cycle will vary from company to company and the auditor will need to select a suitable mix of procedures to achieve his overall objective of determining whether the controls implement- ed were (are) effective. The following procedures are examples of tests of controls that could be carried out: Inspection • A sample of recorded sales could be selected and the supporting internal sales order inspected for a valid authorising signature. The inspection of a signed picking slip and despatch note signed by the customer provides some evidence that the sale did actually occur. The best evidence that the sale occurred would be obtained by inspecting the cash receipts journal/bank statement and customer’s remittance advice and matching the recorded sale to the corresponding receipt from the customer. Of course the customer may not have paid, in which case the amount should appear in the debtors masterfile. • A sample of credit notes issued to customers could be inspected for an authorising signature and the detail on the supporting documentation, for example, a customer returns note could be inspected and matched to the credit note. • The log of masterfile amendments and supporting documentation could be inspected to confirm that appropriate procedures are carried out in respect of evaluating the creditworthiness of new customers before credit is extended, and that the limits and terms granted are approved. • A sample of daily till sales reconciliation schedules (cash reconciled to till rolls) could be inspected and compared to bank deposit slips to determine whether cash sales are banked timeously and intact. In a computerised system, the appropriate way of testing programme (automated) controls may be for the firm’s computer audit division to conduct system-orientated CAATs. For example, the computer auditor may attempt to process an order: • using an invalid customer number • leaving out a customer order reference number • inserting an invalid product code • (or process an order) that will result in the customer’s credit limit being exceeded. Inquiry • Inquire of the despatch clerk as to what happens if goods are transferred from the warehouse to the despatch area for delivery without a picking slip. • Inquire of the invoicing clerk as to what procedures he actually follows to ensure that all despatches/ deliveries of goods result in invoices being made out. 10/52 Auditing Notes for South African Students • Inquire of the credit manager as to what use he makes of daily reports that are generated on the system, of credit notes and other adjustments processed against the debtors masterfile. • Inquire of the financial accountant as to whether and how sales to related parties (e.g. companies within the same group) are identified. Note: Questions put to employees should be expressed in a way that requires more than a “yes” or “no” response. In this way the auditor will learn more about the effectiveness of the control and may be provided with information he least expected. Observation • Observe the despatch clerk counting and checking goods against the picking slip/despatch note before packing items into boxes for delivery. • Observe the procedures undertaken at the counter when a cash sale is made, for example, if the sale has been rung up. • Observe whether gate control personnel actually check goods leaving the premises (being delivered) against the delivery note/invoice. Note: Observation is not a very convincing procedure as the employee is likely to do what he is supposed to do because he knows that the auditor is watching! Observation would always be matched with other procedures. For example: In addition to observing the despatch clerk counting and checking, the auditor might ask the despatch clerk how he resolves a situation where the physical goods for despatch do not agree with the picking slip. With regard to the testing of controls over the accuracy and completeness of processing and recording of sales transactions and receipts from debtors promptly and in the correct accounts, the auditor takes into consideration that modern software is very fast, efficient and reliable. It is more likely that, instead of re- performing numerous calculations and tracing postings through the system, the auditor will concentrate his tests of controls on the effectiveness of the authorisation/approval of transactions and the effectiveness of controls over reviewing and reconciling the results of processing, for example, logs, day-end reports, list- ings, etc. This is perfectly acceptable because if the client is using up-to-date, well-supported reputable software, the auditor is most likely to assess the risk of material misstatement arising out of inaccurate or incomplete processing and recording (accuracy and classification, cut-off and completeness) as low. 10.7.2 Substantive procedures 10.7.2.1 Nature of substantive procedures In auditing the cycle so far, the auditor will have carried out procedures to: • identify and assess the risk of material misstatement, and • gather audit evidence about the operating effectiveness of the controls (tests of controls). The auditor is now required to conduct substantive tests that, as we have seen, are designed to detect material misstatement at the assertion level. Substantive tests consist of: • tests of detail of classes of transactions, account balances and disclosures, and • substantive analytical procedures. The difference between tests of detail and analytical procedures is that the former consists of auditing the detail of the transactions, account balance or disclosure whilst the latter provide more general or overall evidence. The types of procedure (tests of detail) carried out will still be those listed in point 5.3 with the obvious exception of analytical procedures. For example, in carrying out a test of detail to determine whether transactions in a sample of sales invoices have been allocated to the correct accounting period at the financial year-end (cut-off), the auditor would inspect the description of the goods sold, cross-referencing dates and customer signature on the supporting documentation (e.g. internal sales order, picking slip) in detail to confirm that the sale was made prior to year-end. When conducting substantive analytical procedures, the auditor does not consider the detail but rather the overall picture. He will compare totals of transactions and balances on accounts period to period, or consider changes in the making up of totals or balances to other periods or industry norms, etc., with the intention of identifying any strange or unusual fluctuations. For example, as a “completeness of sales” test, the auditor may compare the total of sales month to month for the current year and to the previous year,

objective

timing of test of controls

examples of timing of controls

nature of controls

examples of nature of controls