CHAPTER THREE

RECEIVABLE AND SALES

AUDIT
BY: Birhanu F. (MA. in Public Financial Management) 1
 Introduction
• The overall objective of the audit of accounts receivable and
sales is to determine if they are fairly presented in the
context of the financial statements as a whole.
• The sales account is closely tied to accounts receivable;
therefore, evidence supporting accounts receivable tends to
support sales.
For example, having determined that an account receivable is
valid, the auditor has thereby supported the validity of the
sale.
BY: Birhanu F. (MA. in Public Financial Management) 2
3.1 Meaning, Sources and Nature of Receivables
Receivables are all money claims against individuals, organizations
or other debtors.
They are acquired by business enterprises in various types of
transactions, common being the sale of goods (merchandise) or
services on a credit basis.
Accounts and Notes receivables originating from sales transactions
are called Trade Receivables.
Receivables are shown on the balance sheet at their net realizable
value (I.e. A/R balanceless Allowance for uncollectible accounts).
BY: Birhanu F. (MA. in Public Financial Management) 3
Sources of Receivables: Accounts receivable/Notes receivable include the
business organization’s:
Claims against customers from sale of goods and services
Loans given to officers or employees
Loans given to subsidiaries
Claims for tax refunds
Claims against various other refunds
Advances to suppliers
Sources of Notes Receivable
Written promises to pay certain amounts at future dates
Notes for substantial amounts
Sale of industrial machinery, farm equipment, Issuance of capital stock, Loans
to officers, employees BY: Birhanu F. (MA. in Public Financial Management) 4
Audit Risk: Audit risk is significant in A/R, N/R or
Sales accounts because:
Many incidences of fraud have involved
overstatement of receivables and revenue.
Revenue recognition may be based on complex
accounting rules.
Receivables and revenues are usually subject to
valuation using significant accounting estimates.

BY: Birhanu F. (MA. in Public Financial Management) 5

3.2 Internal Control over Receivables/Sales
The internal controls with regard to accounts receivable include the
following:
A) Appropriate segregation of responsibilities
1. Persons handling cash receipts do not have access to the accounts
receivable records.
2. The billing function should be separated from the handling of cash
receipts.
3. Any special discount concessions to customers should be approved
by a responsible supervisor.
4. The credit function should be separated from the handling of cash
receipts and the record keeping function.
BY: Birhanu F. (MA. in Public Financial Management) 6
5. The A/R ledger clerk recording sales and cash collections
should be someone other than the general bookkeeper.
6. Persons having the authority to originate non-cash credits
to receivables should not have access to cash.
B. Documentation approvals and records
1. Sales invoices should be sequentially numbered and
procedures should be established to account for the use of the
invoice forms.
2. Credit memos should also be sequentially numbered and
controlled in the same manner as are sales invoices.
BY: Birhanu F. (MA. in Public Financial Management) 7
3. Sequentially numbered remittance advice forms should be
prepared when cash is received by the company. Formal procedures
should be established for carrying out the billing function.
4. A/R records should indicate both control account and a
subsidiary ledger.
5. Formal procedures should be established for authorizing and
approving the acceptance of notes receivable.
C. Safeguarding Assets and records
1. The accounts receivable records should be stored in a safe or
vault designed to protect those records from damage or alteration
when they are not being used.
BY: Birhanu F. (MA. in Public Financial Management) 8
INTERNAL CONTROL OF SALES AND RECEIVABLES

• The objectives of internal controls over receivables are to ensure:

a.All goods dispatched/Shipped are invoiced.
b.Invoicing is at correct price and discount.
c.Goods are only dispatched on credit to approved customers.
d.Invoices are recorded and related to subsequent cash receipts.
e.Receivables are controlled and bad debts pursued.
f. Credit notes approved.
 An important part of the controls would be to ensure that the
cashier does not have access to the sales ledger, and the sales
ledger clerk does not have access to cash received.
BY: Birhanu F. (MA. in Public Financial Management) 9
• Control procedures, over sales and receivables
include the following.
A. Orders.
- The orders should be checked against the customer’s account.
- All orders received should be recorded on pre- numbered sales
order documents.
- All orders should be authorized before goods are dispatched.
B. Dispatch.
- Dispatch notes should be pre-numbered and a register kept
of them to relate to sales invoices and orders.
- Goods dispatch notes should be authorized as goods leave.
BY: Birhanu F. (MA. in Public Financial Management) 10
C. Invoicing
- Sales invoices should be authorized by a responsible official.
- Sales invoices should be checked for prices and calculations by a person other
than the one preparing the invoice.
- All invoices should be pre-numbered consecutively.
- Copies of cancelled invoices should be retained/booked.
d. Receivables.
- A receivable ledger control account should be prepared and checked to individual sales
ledger balances.
- Receivables ledger personnel should be independent of dispatch and cash receipt
functions.
- Statements should be sent regularly
BY: Birhanuto customers.
F. (MA. in Public Financial Management) 11
E. Bad debts.
- The authority to write off a bad debt should be given in
writing and adjustments made to the accounts receivable
ledger.
- The use of court action or write-off of a bad debt should
be authorized by an official independent of the cash receipts
function.

BY: Birhanu F. (MA. in Public Financial Management) 12

 Revenue cycle and relevant control
The account data in the revenue system include sales or
other trade revenues, sales returns and allowances, sales
discounts, the allowance for doubtful accounts, bad debts
expense, receivables and cash receipts from cash sales and
collection accounts. Because of the perceived inclination
of management to overstate assets, the auditor is most
concerned with verifying that the receivables element of
the system and the offsetting credits to sales are not
overstated. BY: Birhanu F. (MA. in Public Financial Management) 13
 A data flow diagram for sales order application system.
Data flow key
8 1.Order
2.Sales order
7 3.Approved sales
Credit Finished Shipping
Goods order
4.Shipping order
2 3 4 5 5.Packing slip
9 6.Billing memo
Customer 7.shipping advice
1 Sales
order 6
8.shipment
11
9.shipping advice
Billing A/R
10.invoice
10 13 Details
11.posting memo
12.journal voucher
12 Customer
Data 13.Control total.
G/L
Datta flow key
BY: Birhanu F. (MA. in Public Financial Management) 14
 T h e a b o v e f u n c ti o n s w i ll b e s h o w n w it h a fl o w d i a g r a m b el o w .
Data flow key
2 1.remittance advices
Cash receipts 1
G/L 2.control total
3.sales return memo
Customer data Customers 4.sales return advice
12
Accounts 5.credit memo
D et ail s 13 14
receivable
11 6.write off memo
Receiving 8 9 Internal audit 7.write off advice
7 5
8.aged trial balance
3
Credit manager 4 Billing
9.journal voucher
10.control total
11.worthless account list
6
12.statements
Treasurer 13.total write offs
14.write off confirmation
15.write off memo
15
D at a fl o w k e y
BY: Birhanu F. (MA. in Public Financial Management) 15
3.3. Objectives for the Audit of Receivables and Revenue
1. Use the understanding of the client and its environment to consider
inherent risk, including fraud risks, related to receivables and
revenues.
2. Obtain an understanding of internal control over receivables and
revenues.
3. Assess the risks of material misstatement and design tests of
controls and substantive procedures that:
A. Substantiate the existence of receivables and the occurrence of
revenue transactions.
B.Establish the completeness of receivables and revenue transactions.
BY: Birhanu F. (MA. in Public Financial Management) 16
C. Verify the cutoff of revenue transactions.
D. Determine that the client has rights to recorded receivables.
E. Establish the proper valuation of receivables and the accuracy of
revenue transactions.
F. Determine that the presentation and disclosure of receivables and
revenue are appropriate.

BY: Birhanu F. (MA. in Public Financial Management) 17

 Assertion Transaction class Account balance
Category Audit objective Audit objective
  Recorded sales transactions represent goods Accounts receivable include all
Existence or shipped during the period. Recorded cash amounts owed by the customers
Occurrence receipts transactions represent cash received exists at the balance sheet date.
during the period.

  All sales, cash receipts sales adjustments that Accounts receivable include all
Completeness occurred during the period have been claims on customers at the balance
recorded. sheet date.
  The entity has rights to the receivables and Accounts receivable at the balance
Rights and cash resulting from sales transactions. sheet date represents legal claims of
Obligations the entity.
Valuation All sales, cash receipts and sales adjustments Accounts receivable represent gross
transactions are correctly journalized, claims, On customers at the balance
summarized, and posted. sheet date. The allowance for
uncollectible accounts represent a
reasonable estimate.
BY: Birhanu F. (MA. in Public Financial Management) 18
Presentation The details of sales, cash receipts and sales Accounts receivables are properly
3.4 Audit Program for Receivable/Sales (Receivables Audit Steps)
(I) Internal Control considerations- Tests of Controls
Perform following tests of controls.
a. Examine significant aspects of a sample of sales transactions.
b. Compare a sample of shipping documents to related sales
invoices.
c. Review the use and authorization of credit memoranda.
d. Reconcile selected cash register tapes and sales tickets with sales
journals.
e. Test IT application controls.
f. Examine evidence of review and approval of revenue estimates.
BY: Birhanu F. (MA. in Public Financial Management) 19
(II)Substantive Audit Procedures for Receivable/Sales
Perform following major Substantive procedures for receivables and
revenue.
1. Obtain an aged trial balance of trade accounts receivable and
analyses of other accounts receivable and reconcile to ledgers.
2. Obtain analyses of notes receivable and related interest. (Accuracy)
3. Inspect notes on hand and confirm those with holders(existence, occurrence
& right)

4. Confirm receivables with debtors.(existence, occurrence . right& Valuation)

5. Review the year-end cutoff of sales transactions. (existence, occurrence,
right& completeness)

BY: Birhanu F. (MA. in Public Financial Management) 20

6. Perform analytical procedures for accounts receivable, notes
receivable, and revenue. (Existence, occurrence, right, completeness& valuation)
7. Review significant year-end sales contracts for unusual
terms. (Existence, occurrence, right, completeness& valuation)
8. Test the valuation of notes receivable, computation of
interest income, interest receivable, and amortization of
discount or premium. ( )
9. Evaluate the propriety of the client’s accounting methods for
receivables and revenue. (valuation)
BY: Birhanu F. (MA. in Public Financial Management) 21
10. Evaluate accounting estimates related to revenue recognition.
(valuation)

11. Determine the adequacy of the client’s allowance for uncollectible

accounts. (Valuation)
12. Ascertain whether any receivables have been pledged. (Presentation)
13. Investigate any transactions with or receivables from related parties.
(Presentation &disclosure)

14. Evaluate the business purpose of significant and unusual sales

transactions. (Presentation &disclosure)
15. Evaluate financial statement presentation and disclosures of
receivables and revenue. BY: Birhanu F. (MA. in Public Financial Management) 22
BY: Birhanu F. (MA. in Public Financial Management) 23
Importance and Assertions for the Audit of Cash and Bank
Balances
Importance of the audit of cash and bank balances
The audit of cash is considered an important part of an audit mainly
due to two reasons:
(a)  Almost all business transactions will be ultimately settled
through the cash accounts, the audit of cash accounts also assists in
the verification of other asset and liability accounts as well as
revenue and expenses.
(b)   Cash is the highly liquid asset in a company and it is an area of
high inherent risk since there is a relatively high risk of
misappropriation. BY: Birhanu F. (MA. in Public Financial Management) 24