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Marwan El Rashedy 0122-162-68-24

Sales Returns and Allowances
Transaction-related audit objectives are essentially the same for credit memos as those for
processing sales, with two notable differences (1 of 2):
1. Materiality. Sales returns and allowances are often so immaterial that auditors can ignore
them.
2. Emphasis on the occurrence objective. Auditors usually emphasize testing recorded
transactions to uncover any theft of cash in the collection of accounts receivable that was
covered up by fictitious sales returns or allowances.

Methodology for Designing Tests of Controls and Substantive Tests of Transactions

for Cash Receipts
An essential part of the auditor’s responsibility in auditing cash receipts is to identify deficiencies
in internal control that increase the likelihood of fraud. Audit procedures that are designed
primarily for the discovery of fraud include:
1. Determine whether cash received was recorded.
The most difficult type of cash embezzlement for auditors to detect is when it occurs before the
cash is recorded in the cash receipts journal or other cash listing, especially if the sale and cash
receipt are recorded together. For example, if a grocery store clerk takes cash and intentionally
fails to record the sale and receipt of cash on the cash register, it is extremely difficult to discover
the theft.
2. Prepare proof of cash receipts.
Proof of cash receipts may not be able to check whether all cash receipts have been deposited. It
is a procedure to test whether all recorded cash receipts have been deposited in the bank
account. In this test, the total cash receipts recorded in the cash receipts journal for a period of
time, such as a month, are reconciled to the actual deposits made to the bank during the same
time. The procedure is not useful to discover cash receipts that have not been recorded in the
journals or time lags in making deposits, unrecorded loans, bank loans deposited directly into the
bank account, and similar misstatements.

3. Test to discover lapping of accounts receivable.

Lapping is the postponement of entries for the collection of receivables to conceal an existing
cash shortage. The fraud is perpetrated by someone who records cash in the cash receipts journal
and then enters them into the computer system. The person defers recording the cash receipts
from one customer and covers the shortage with receipts from another customer. These in turn
are covered by the receipts from a third customer a few days later. The employee must either
continue to cover the shortage through lapping, replace the stolen money, or find another way to
conceal the shortage.

Audit Tests for Uncollectible Accounts

The auditor’s primary concern here is the possibility of client personnel covering up an
embezzlement by writing off accounts receivable that have already been collected. The major
control for preventing this fraud is proper authorization of the write-off of uncollectible accounts.
Realizable value of accounts receivable is often a significant concern for the auditor.
Dr. Marwan El Rashedy 0122-162-68-24
There are two other controls to address this:
1. The preparation of a periodic aged accounts receivable trial balance for review and follow-
up by appropriate management personnel.
2. A policy of writing off uncollectible accounts when they are no longer likely to be collected.
What audit procedures are most likely to be used to verify accounts receivable written off as
uncollectible? State the purpose of each of these procedures.
The audit procedures most likely to be used to verify accounts receivable charged off as
uncollectible and the purpose of each procedure are as follows:
 Examine approvals by the appropriate persons of individual accounts charged off. The
purpose is to determine that charge-offs are approved.
 Examine correspondence in client’s files that indicates the un-collectibility of the accounts
for a selected number of write-offs. The purpose is to determine that the account appears
to be uncollectible.
 Examine credit records as an indication of the un-collectibility of an account. The purpose is
the same as the previous procedure.
 Consider the reason for the charge-off compared to the company policy for writing off
uncollectible accounts. The purpose is to determine whether or not company policy is being
followed.

Effect of Results of Tests of Controls and Substantive Tests of Transactions

The results of the tests of controls and substantive tests of transactions have a significant effect
on the remainder of the audit, especially on substantive tests of details of balances.

If the test results are unsatisfactory, it is necessary to:

Do additional substantive testing of sales, sales returns and allowances, write-off of
uncollectible accounts, and processing cash receipts.
The most significant effect of the results of the tests of controls and substantive tests of
transactions in the sales and collection cycle is:
Confirmation of accounts receivable. The type of confirmation, the size of the sample, and the
timing of the test are all affected.

……………………………………………………End of the Chapter……………………………………....

Dr. Marwan El Rashedy 0122-162-68-24

Solution
1. a. Substantive test of transactions
b. Sales are recorded on the correct dates. (Timing)
c. Inspection (documentation)

2. a. Test of control
b. Sales transactions are correctly included in the accounts receivable master file and
are correctly summarized. (Posting and summarization)
c. Inspection

3. a. Substantive test of transactions

b. Recorded sales are correctly billed and recorded. (Accuracy)
c. Reperformance

4. a. Test of control
b. (1) Recorded sales are for shipments actually made to nonfictitious customers.
(Occurrence)
(2) Recorded sales are for the amount of goods shipped and are correctly billed
and recorded. (Accuracy)

Dr. Marwan El Rashedy 0122-162-68-24

 (3) Sales transactions are correctly included in the accounts receivable master file
and are correctly summarized. (Posting and summarization)
(4) Cash received is recorded in the cash receipts journal. (Completeness)
(5) Cash receipts are deposited and recorded at the amounts received. (Accuracy)
(6) Cash receipts are correctly included in the accounts receivable master file and
are correctly summarized. (Posting and summarization)
c. Observation or inspection

5. a. Test of control
b. Recorded sales returns are for returns from existing customers. (Occurrence)
c. Inspection

6. a. Substantive test of transactions

b. (1) Cash received is recorded in the cash receipts journal.
(Completeness)
(2) Cash receipts are recorded on the correct dates (Timing) & correct amounts
(Accuracy)
c. Inspection

7. a. Substantive test of transactions

b. Recorded cash receipts are for funds actually received by the company.
(Occurrence)
c. Inspection

Dr. Marwan El Rashedy 0122-162-68-24

Solution
1. a. Test of control
b. Recorded sales are correctly billed and recorded. (Accuracy)
c. Recompute prices and extensions on sales invoices.

2. a. Test of control
b. Recorded sales are correctly billed and recorded. (Accuracy)
c. Recompute prices and sales discounts on sales invoices based on the sales discount
report or agreement with customers.

3. a. Substantive test of transactions

b. Recorded sales are for shipments actually made to nonficticious customers.
(Occurrence)
c. Not applicable

4. a. Substantive test of transactions

b. Sales transactions are correctly are correctly summarized. (Posting and
summarization)
c. Not applicable

5. a. Substantive test of transactions

b. Recorded sales are for shipments actually made to nonficticious customers.
(Occurrence)
c. Not applicable

6. a. Test of control
b. Cash received is recorded in the cash receipts journal. (Completeness)
c. Obtain prelisting of cash receipts and trace amounts to the cash receipts journal,
testing for names, amounts, and dates and compare the prelisting with the
duplicate deposit slip.

7. a. Test of control
b. (1) Cash receipts are deposited and recorded at the amounts received. (Accuracy)
(2) Recorded cash receipts are for funds actually received by the company.
(Occurrence)
c. Prepare proof of cash receipts.

8. a. Substantive test of transactions

b. Cash receipts transactions are correctly classified. (Classification)
c. Not applicable

9. a. Test of control
b. Recorded sales are for shipments actually made to nonficticious customers.
(Occurrence)
c. Trace sales journal entries to supporting documents, including duplicate sale
invoice, bill of lading, sales order, and customer order.

Dr. Marwan El Rashedy 0122-162-68-24