SUFFICIENT APPROPRIATE AUDIT EVIDENCE AND TESTING THE SALES SYSTEM

<< Concept of Audit Evidence

Control Procedures over Sales and Debtors >>

Fundamentals of Auditing ACC 311

Lesson 23

SUFFICIENT APPROPRIATE AUDIT EVIDENCE

AND

TESTING THE SALES SYSTEM

Recap:

Audit evidence includes: the information contained in the accounting records underlying the financial

statements.

Audit evidence might include:

· Documents (invoices, credit notes, cash receipts)

· Accounting entries (write down to NRV, depreciation)

· Answers from the management (Provisions)

· Information from third parties (banks, debtors)

· Computations (depreciation, accruals, provisions)

· Observations (inventory count)

Sufficiency:

The measure of quantity of audit evidence.

The measure of quality i.e. relevance and reliability of audit evidence.

Appropriateness:

Key questions for the auditor to consider therefore will be:

1. Do I have enough evidence to reach a conclusion on this audit area?

2. Is the evidence that I have, reliable enough to, allow me to reach a conclusion on this area of the

audit?

Assertions in obtaining Audit Evidence

(a)

Assertions about classes of transactions and events for the period under audit;

Occurrence transactions and events that have been recorded have occurred and pertain

to the entity;

ii.

Completeness all transactions and events that should have been recorded have been

recorded (accruals & depreciation);

iii.

Accuracy amounts and other data relating to recorded transactions and events have been

recorded appropriately. (valuation and estimations)

iv.

Cutoff transactions and events have been recorded in the proper period.

Classification transactions and events have been recorded in the proper accounts.

Assertions about account balances at the period end.

(b)

Existence assets, liabilities, and equity interests exist;

ii.

Rights and obligations the entity holds or controls the rights to assets, and liabilities are

the obligations of the entity;

iii.

Completeness all assets, liabilities and equity interests that should have been recorded

have been recorded;

iv.

Valuation and allocation assets, liabilities, and equity interests are included in the financial

statements at appropriate amounts and any resulting valuation or allocation adjustments

are appropriately recorded.

Assertions about presentation and disclosure:

(c)

Occurrence and rights and obligations disclosed events, transactions and other matters

have occurred and pertain to the entity;

ii.

Completeness all disclosures that should have been included in the financial statements

have been included;

iii.

Classification and understandability financial information is appropriately presented and

described, and disclosures are clearly expressed;

iv.

Accuracy and valuation financial and other information are disclosed fairly and at

appropriate amounts.

Audit procedures for obtaining Audit Evidence

The auditor uses one or more types of audit procedures described below:

Fundamentals of Auditing ACC 311

(i)

Inspection of Records or Documents

It consists of examining records or documents whether internal or external, in paper form,

electronic form, or other media. Inspection provides evidence of varying degrees of reliability

depending on their nature and source and in the case of internal records, on effectiveness of

controls over their production.

(ii)

Inspection of Tangible Assets

It consists of physical examination of the assets. It may provide reliable audit evidence of their

existence cannot necessarily about other assertions.

(iii)

Inquiry

It means seeking information of knowledgeable persons throughout the entity or outside the entity.

Those may be formal written or informal oral. It provides an auditor with new information or

corroborative evidences. It may also bring to high information different from the one possessed by

the auditor. Certain oral inquiries might be got confirmed through written representations.

(iv)

Confirmations

It is a specific type of inquiry. It is the process of obtaining a representation of information or an

existing condition directly from a third party. Confirmations are sought from debtors, creditors,

bankers, legal advisors etc.

(v)

Recalculation

It consists of checking the mathematical accuracy of documents or records. It can be performed

through use of information technology.

(vi)

Re-performance

It is the auditor's independent execution of procedures or controls that were originally performed

as part of the entity's internal control, either manually or through the use of CAATs, for example,

reperforming the aging of accounts receivable.

(vii)

Analytical procedures

It consists of evaluations of financial information made by a study of plausible relationship among

both financial and non-financial data. It includes investigation of significant fluctuations found and

the relationship that are inconsistent.

TESTING THE SALES SYSTEM

Control Objectives

For many businesses, sales are made on credit and so objectives for the sales cycle includes control debtors

as well.

These control objectives include:

a) Customers' orders should be authorized, controlled and recorded in order to execute them

promptly

b) Goods shipped and work completed should be controlled to ensure that invoices are issued and

revenue recorded for all sales.

c) Goods returned and claims by customers (for example, in respect of damaged goods) should be

controlled in order to determine the liability for goods returned and claims received. .

d) Invoices and credits should be appropriately checked for accuracy and should be authorized before

being entered in the receivables' records.

e) Authorized customer transactions, and only those transactions, should be accurately entered in the

accounting records.

f) There should be procedures to ensure that sales invoices are subsequently paid by customers and

that doubtful amounts are identified in order to determine any provisions or write offs required

Control procedures over sales and debtors

There are a large number of controls that may be required in the sales cycle due to the importance of this

area in any business and the possible opportunities that exist for diverting sales and cash receipts away from

the business.

Typical control procedures at key stages of the sales cycle are:

1. Orders

2. Dispatch

3. Invoicing and credit notes

Fundamentals of Auditing ACC 311

4. Returns inwards

5. Receivables

6. Bad Debts

(a)

Orders

(i)

Existing customers should be allocated a credit limit and it should be ascertained whether this limit

is to be exceeded if the new order is accepted. If so the matter should be referred to credit control.

(ii)

Any new customer should be referred to the credit control department before the order is accepted.

(iii)

All orders received should be recorded on pre-numbered sales order documents so that a check can

be made that all orders have been dealt with -a completeness check.

(iv)

All orders should be authorized before any goods are dispatched.

(v)

The sales order document should be used to produce a dispatch note for the goods outwards

department. No goods may be dispatched without a dispatch note.

(b) Dispatch

(i)

Dispatch notes should be pre-numbered and a register kept of them to enable them to be matched

with relate to sales invoices and customer orders.

(ii)

Dispatch notes should be authorized before goods leave the company.

(iii)

Regular checks should be made to ensure that all dispatches have been invoiced.

(c) Invoicing and Credit Notes

(i)

Sales invoices should be authorized by a responsible official and matched with the authorized order

and dispatch note.

(ii)

All invoices and credit notes should be entered In daybook records, the sales ledger, and sales

ledger control account. Batch totals should be maintained for this purpose.

(iii)

Sales invoices and credit notes should be checked for prices. casts and calculations by a person

other than the one preparing the invoice.

(iv)

All invoices and credit notes should be serially pre-numbered and regular sequence checks should

be carried out.

(v)

Credit notes should be authorized by someone unconnected with dispatch or sales ledger functions.

(vi)

Copies of cancelled invoices should be retained.

(vii)

Any cancellation of an invoice should lead to a cancellation of the related dispatch note.

(viii)

Cancelled (and free of charge) invoices should be signed by a responsible official.

(ix)

Each invoice should distinguish between different types of sales and, if relevant, different rates of

VAT or sales tax. Any coding of invoices should be periodically checked independently

(d) Returns

(i)

Any goods returned by the customer should be checked for obvious damage and, when accepted. a

document should be raised.

(ii)

All goods returned should be used to prepare appropriate credit notes

(e) Receivables/Debtors

(i)

A receivables ledger control account should be prepared regularly and checked to individual sales

ledger balances by an Independent official.

(ii)

Receivables ledger personnel should be independent of dispatch and cash receipt functions.

(iii)

Statements should be sent regularly to customers.

(iv)

Formal procedures should exist for following up overdue debts which should be highlighted either

by the preparation of an aged list of balances or by the preparation of regular customer statements.

(v)

Letters should be sent to customers for collection of overdue debts. A policy should be in place for

the Institution of legal proceeds where appropriate.

f) Bad debts

(i)

The authority to write off a bad debt should be in writing. Appropriate adjustments should be

made to the sales ledger and the control account

Fundamentals of Auditing ACC 311

(ii)

The use of court action or the writing-off of a bad debt should be authorised by an official

independent of the cash receipt function.

Tests of Control

Tests of control should be designed to check that the control procedures are being applied and that

objectives are being achieved. Tests may be appropriate under the following broad headings.

(a) Carry out sequence test checks on invoices, credit notes, dispatch notes and orders. Ensure that all

items are included and that there are no omissions or duplications.

(b) Check the existence of evidence for authorization in respect of:

acceptance of the order (the creditworthiness check)

ii.

dispatch of goods

iii.

raising of the invoice or credit note

iv.

pricing and discounts

write-off of bad debts.

Check both that the relevant signature exists and that the control has been applied.

invoices, including pricing, and VAT and sales tax calculations

ii.

credit notes,

This is often done by means of a 'grid stamp' containing several signatures on the face of the document.

Ensure that the control has been applied by checking the accuracy of such invoices and credit notes.

(d) Check dispatch notes and goods returned notes to ensure that they are matched with invoices and

credit notes.

(e) Check that control account reconciliations have been performed and reviewed.

In all cases, tests should be performed on a sample basis.

Table of Contents: