Chapter 14 - Sales and Collection Cycle

What are the 5 major classes of transactions in the Sales and Collection Cycle?

1. Sales (cash and credit sales) ; 2. Cash receipts ; 3. Sales returns and allowances ; 4. Write-off of uncollectible accounts ; 5. Estimate of bad debt expense.

What are the 8 key business functions in the Sales and Collection Cycle?

1. Processing customer orders ; 2. Granting credit ; 3. Shipping goods ; 4. Billing customers & recording sales ; 5. Processing & recording cash receipts ; 6. Processing returns & allowances ; 7. Writing off uncollectible accounts ; 8. Providing for bad debts.

What are the key documents used in the billing and recording function of the sales cycle?

1. Sales Order (customer order details) ; 2. Shipping Document / Bill of Lading (shipping contract) ; 3. Sales Invoice (bill sent to customer) ; 4. Sales Journal & A/R Master File.

Why is credit approval required BEFORE goods are shipped in the sales cycle?

Prevents shipping goods to customers who represent an unacceptably high credit/bad debt risk, protecting the Valuation/Allocation assertion of Accounts Receivable.

What is a Bill of Lading and why is it crucial evidence for sales OCCURRENCE?

A shipping document signed by the carrier when goods are shipped. It proves that goods were physically shipped before revenue was billed and recorded (testing Occurrence).

What is the difference between Vouching and Tracing in the sales cycle?

Vouching: Moving backward from Sales Journal -> Shipping Document to test OCCURRENCE (no fictitious sales). Tracing: Moving forward from Shipping Document -> Sales Journal to test COMPLETENESS (no unrecorded sales).

What is the primary audit objective tested by Vouching recorded sales to shipping documents?

Occurrence (verifying that recorded sales represent actual shipments and not fictitious revenue).

What is the primary audit objective tested by Tracing shipping documents to the sales journal?

Completeness (verifying that all actual goods shipped were properly billed and recorded in the sales journal).

What are the 6 transaction-related audit objectives applied to sales transactions?

1. Occurrence ; 2. Completeness ; 3. Accuracy ; 4. Cutoff ; 5. Classification ; 6. Posting & Summarization.

What internal control prevents recording fictitious sales transactions?

Requiring a signed Bill of Lading and approved Sales Order to be attached to every Duplicate Sales Invoice before entry into the Sales Journal.

What internal control prevents unrecorded sales shipments (completeness risk)?

Using sequentially prenumbered Shipping Documents and performing periodic independent accounting for all document numbers.

What is Lapping in cash receipts, and what internal control prevents it?

Lapping is stealing cash receipts and covering it by applying later customer payments to the stolen account. Prevented by mandatory employee vacations and separating cash handling from A/R posting.

What is a Proof of Cash receipts, and when is it used by auditors?

A 4-column reconciliation matching total cash receipts recorded in the cash receipts journal to actual bank deposits for a period; used when control risk over cash is high.

What is Sales Cutoff testing and why is year-end cutoff critical?

Verifying sales transactions are recorded in the period goods were shipped. Prevents premature revenue recognition (recording next year's sales this year) or unrecorded sales.

How do sales returns and allowances differ from sales transactions in audit risk?

Returns and allowances are often immaterial, but carry high risk of fraud cover-up (concealing stolen cash). All returns require independent receiving reports and credit memo approvals.

What key document authorizes the write-off of an uncollectible account receivable?

An approved Credit Memo or Write-Off Authorization form signed by a designated executive independent of cash handling and credit approval.

[Case Study: Classic City Narrative] In the Classic City case (,880 Bulldog hoodie order), why was matching the sales invoice to the bill of lading essential?

To verify Occurrence (that goods were actually shipped before billing) and Cutoff (ensuring sales were recorded in the correct accounting period).

[Case Study: Blue Ridge Medical] In Blue Ridge Medical (8,600 ECG monitor order), if shipping occurs on Dec 31 FOB Destination and arrives Jan 3, when should revenue be recorded?

On Jan 3 (when control and title transfer to the buyer upon delivery). Recording revenue on Dec 31 is a premature revenue recognition / cutoff error.

[Case Study: Unqualified Opinion] In the Unqualified Opinion case, the client recorded a 80,000 sales invoice on Dec 31 for goods that remained in the warehouse at midnight, included those goods in the Dec 31 physical inventory count, and shipped them Jan 2 (where control transfers on shipping). What 3 auditing errors/risks occurred?

1. Overstated Revenue & A/R on Dec 31 (Occurrence/Cutoff error) ; 2. Double-counting asset (included in inventory AND billed as sold) ; 3. Material misstatement requiring an audit adjustment.