When engaged in auditing a public firm, such as Apollo Shoe Inc. , an auditor must determine when to trust in the company’s internal controls and when to ascertain auxiliary testing methods are obligatory to analyze control risks. The sales and collection cycle is rather a substantial fraction of the audit because this unique segment employs a multitude of documentation and records ranging anywhere from customer and sales orders, shipping documents, credit memos, and general journal entries; therefore, a working comprehension of the diverse paperwork is indispensable.
Before auditors can assess control risk and design tests of controls and substantive tests of transactions, they need to understand the business functions and documents and records in a business” (Arens, Elderly, & Beasley, 2012, p. 443). Test of Controls Taking a glimpse into the Apollo Shoes Inc. the organization appears to have implemented control systems that coincide with the following business functions essential to the sales and collection cycle:
(1) processing customer orders,
(2) granting credit,
(3) shipping goods,
(4) billing customers and recording sales, and
(5) processing and recording cash receipts (Arens, Elderly, & Beasley, 2012).
However with regard to
(a) processing and recording sales returns and allowances,
(b) writing off uncollectible accounts receivable, and
(c) providing for bad debts (Arens, Elderly, & Beasley, 2012), these business functions are absent from the Apollo Shoes work paper control systems and these deficiencies require identification. For instance there appear to have been some discrepancies discovered in the sales and accounts receivable area and Darlene Wardlaw indicated that some sales transactions were missing the bill of lading, which signifies sales were improperly recorded.
Tests of controls an be devised to authenticate its value, if the internal control is to have copy 1 of the bill of lading attached to the shipment and copy 2 remitted with invoice copy 4 to the accounts receivable department, the test of control is to designate a shipping employee to initial the bill of lading once generated with pre-number (Louwers & Reynolds, 2007). The follow-up to this would occur when the accounts receivable (“A/R”) department received copy 2 (with the initials). A spreadsheet could then be generated that would capture the pre-numbered bill of lading and the employee initialing the statement.
In the event that a bill of lading arrived in the A/R department without proper endorsement, these could then be flagged and researched for accuracy. Substantive Tests of Transactions The auditor reviewing Apollo Shoes Inc conducted substantive tests upon the sales and collection cycle. These tests involved evaluating sales records to determine shipments made were to consumers rather than fictitious (occurrence), making sure sales transactions were recorded (completeness), and verifying whether or not sales recorded on invoice records were for the goods actually shipped, were accurately billed and notated (accuracy).
When examining the accounting and control procedures manual developed by Apollo Shoes, there is a correlation between the internal controls to that of the financial assertions. For instance, sales invoices are issued in numerical sequence, verified by an accounts receivable clerk to determine if all invoices have been received and if any are missing they are tracked down, and then further examined to agree on whether the items shipped agree with the items billed for proper quantity, price, and other sales order terms as applicable. Analytical Procedures Analytical procedures use comparisons and relationships to assess whether account balances or other data appear reasonable relative to the auditor’s expectations” (Arens, Elderly & Beasley, 2012, p. 223).
The auditor’s analysis of the sales and collection cycle revealed that a portion of the 120 sales transactions retrieved for sampling had “no credit approval” even though Apollo Shoes company policy indicates that these sales orders are forwarded to the credit manager to evaluate and approve. If not approved, then the customer is expected to pay up front. In the event the ales order is denied credit approval, there ought to be a record clarifying those order numbers that are credit and those that are paid in advance. This would provide a checks and balance system while also supplying traceability. Personnel and Payroll Cycles The personnel and payroll cycle includes the hiring of employees, recording hours worked, withholding and, recording of taxes, distributing payment for work performed, and properly documenting the termination of employees. Payroll can be a significant expense for a company and without proper internal controls can be vulnerable to fraud.
Some common types of the fraud within the payroll cycle consist of ghost employees, claiming unworked hours, and pay rate alteration. The objective of a payroll audit is to determine if the current balances in the audit period are fairly stated and in accordance with accounting principles. According Arens, Elder, and Beasley, “Tests of controls and substantive tests of transactions procedures are the most important means of verifying account balances in the payroll and personnel cycle” (2012, p. 664).
An auditor obtains an understanding of the internal controls in place and assesses control risk by testing of controls and performing substantive testing. Personnel and Payroll Tests of Controls After becoming familiar with the Apollo Shoes personnel and payroll cycle, the auditor begins testing the controls. Apollo Shoes payroll department keeps the individual employee records that will be reviewed as the first test of control. The personnel department is responsible for approving new hires, terminations, and hourly rate changes.
The auditor will review the completion and approval on the “payroll change” documents. The auditor will observe the process for which hourly employees stamp timecards to determine the likelihood that employees could stamp cards for another employee. Apollo Shoes payroll clerk produces “take-home sheets” used to calculate gross pay and deductions that will be reviewed and determine if the second clerk has verified the calculations. The auditor will account for a sequence of checks and determine if the checks not claimed are secured properly.
Substantive Tests of Controls After completing the tests of controls an auditor will begin to conduct substantive tests of transactions. The first test is verifying the payroll departments records with the cancelled checks to confirm the payments made are to existing current employees. Next the auditors will reconcile the payroll bank account with the payroll register. Auditors will re-compute the gross and net pay from the “take-home sheets” to ensure the calculations are correct.
The timecards are evaluated for the proper approval and verified that the hours processed for payment match the timecards. The auditors will trace the payroll journal to the master file to ensure transactions are recording correctly. The auditor will compare the vouchers stamped PAID, kept by accounts payable, to canceled checks for authentic endorsement. Analytical Procedures Analytical procedures are used to evaluate and compare financial information and help identify risks if balances have an unusual or unexpected change.
The first analytical procedure performed for the payroll cycle is a comparison of the payroll expense account balance with previous year. The administrative wages expense increase for Apollo Shoes by approximately 600,000, which is associated with the 10% increase in officer salaries in 2007. Another analytical procedure is comparing the direct labor and sales of previous years. In this case, Apollo Shoes had a decrease in sales by approximately 900,000 but an increase in warehouse salaries by almost 2%, which is not very significant.
Last the payroll tax expense is compared to the prior period, which contained no significant changes. The auditor did come across a significant increase in Federal Payroll Taxes Payable account which will be further evaluated. Acquisition and payment cycle The acquisition of goods and services includes the acquisition of items such as raw materials, supplies, utilities, repairs, maintenance, research, and development. Inventory, cost of goods sold, accounts payable, and expenses are the major accounts affected.
Tests of controls
The business functions for the acquisition and payment cycle are
(1) processing purchase orders,
(2) receiving goods and services,
(3) recognizing the liability, and
(4) processing and recording cash disbursements (Arens, Elder & Beasley, 2012).
Apollo has systems in place to purchase items via an approved vendor list, including procedures to assure the accuracy of items ordered through the receiving department and receipt of proper notification and documentation to the accounts payable department.
Part of performing Apollo’s risk assessment would include procedures such as studying their flowcharts, reviewing the internal control questionnaires, and walkthrough tests for acquisition and cash disbursement transactions (Arens, Elder & Beasley, 2012). The assessed plan control risk would examine each business function such as the authorization of purchases, separation of the custody of the received goods and authorization of payments to vendors as indicated in Apollo’s accounting and control system manual. Upon identifying key internal controls and deficiencies, control risk is assessed.
Substantive tests of transactions
The auditor would perform substantive tests on the purchase authorizations, timely recording, and payment authorizations. The auditor would also perform tests of controls to determine that Apollo’s controls are operating effectively. Substantive tests of transactions for acquisitions to be performed for management assertions are examining recorded acquisitions to be certain they are for goods and services received (occurrence), examining existing acquisitions are recorded (completeness), and acquisitions are accurately recorded (accuracy).
An example between the linking of internal controls to the financial statement assertions, as described in Apollo’s accounting and control systems manual, are the verification of pre-numbered requisitions completed and sent to purchasing, the verification of the quantity and price of goods ordered, proper authorizations and the matching of vendor invoice, purchase order, and receiving reports. Analytical procedures Apollo Shoes established company policies for the counting of inventory. The auditor’s inventory test counts on Apollo’s count sheets should be tied to the inventory warehouse report.
Then the inventory warehouse report should be tied to Apollo’s inventory status report prepared by management. In addition, a sample number of unit costs from recent invoices should be tied to the inventory status report. If the numbers agree then the inventory status report should be tied to the inventory lead schedule following by the trial balance. Obsolete or defective inventory should be examined. The trial balance indicated a reserve for inventory obsolescence of $867,000 and had decreased significantly from the prior year. After the inventory count the auditor should trace obsolete or damaged inventory to Apollo’s inventory records.
The auditor should compare Apollo’s analytics to their past performance, industry results, and auditor’s expectations. Conclusion In this paper the subject explained is the sales and collection, payroll and personnel, and acquisition and payments cycles for Apollo Shoes. It offered a better understanding of the various objectives related to the test of controls processes as well as identified the key internal controls used by Apollo Shoes, Inc. Through this paper it is learned why it is important to design tests of controls, substantive tests of transactions, and analytical procedures.
Cite this essay
Sales and Collection Cycle. (2020, Jun 02). Retrieved from https://studymoose.com/sales-collection-cycle-new-essay