0:00:08.000,0:00:16.066.In this video, we are going to get our hands.a.little bit dirty and look at a transactional.cycle.and walk through how we would audit it..0:00:16.066,0:00:20.066.My hope is to expose you to how a.transactional cycle actually works,.0:00:20.066,0:00:25.033.and then discuss some of the audit procedures.we would use to nail down our assessment of.control risk..0:00:25.033,0:00:29.066.In our next lesson, we will discuss substantive.procedures....0:00:29.066,0:00:33.033.that are necessary to reduce detection risk.sufficiently to achieve our designed level.of audit.assurance..0:00:33.033,0:00:38.066.For this video, we are going to use the sales.cycle, which is typically comprised of the.following accounts:.0:00:38.066,0:00:45.066.Sales, returns, bad debt and allowances,.receivables, cash receipts, and commodity.tax.collection..0:00:45.066,0:00:51.000.Let’s first describe the sales cycle from.cradle.to grave..I want to make note of three things..0:00:51.000,0:00:57.033.1..Understand the types of documents and.journals..This is to build up your vocabulary.0:00:57.033,0:01:05.066.2..Understand how the process works- that is.how dollars find their way through the.accounting systems....0:01:05.066,0:01:07.066.onto a set of financial statements..0:01:07.066,0:01:14.000.3..Understand how internal controls are overlaid.on processes to ensure integrity of the system..0:01:14.000,0:01:19.066.So let's get started..Sales often start with a.request for product..0:01:19.066,0:01:24.000.In a retail store, the customer brings their.desired purchase to the checkout register..0:01:24.000,0:01:27.033.In our hotel, a customer makes a reservation..0:01:27.033,0:01:32.033.In a manufacturing business, a customer will.submit a sales order..0:01:32.033,0:01:38.033.For cash based businesses, such as our.retailer, authorizing credit is not all that.important..0:01:38.033,0:01:44.000.But for our hotel and manufacturer, we need.to.confirm credit worthiness before accepting.the.order..0:01:44.000,0:01:48.000.If we plan on extending credit to these.customers,.0:01:48.000,0:01:54.033.this process becomes all the more important,.otherwise a credit card number would often.do.the trick..0:01:54.033,0:02:00.033.The next activity is to actually ship the.goods, or.deliver the services, to our customer..0:02:00.033,0:02:03.066.This isn’t an issue for a retailer..0:02:03.066,0:02:08.000.For our hotel, we are delivering a service,.so it.too isn’t much of an issue..0:02:08.000,0:02:15.033.However, for our manufacturer, we are going.to.have to pick the order and load it onto a.truck for.delivery..0:02:15.033,0:02:17.066.The documents you may find here include:.0:02:17.066,0:02:22.000.A picking slip which gives instructions to.the.warehouse staff as to what the customer has.ordered..0:02:22.000,0:02:27.033.A bill of lading from the carrier documenting.what.has been been loaded onto the truck..0:02:27.033,0:02:30.033.Once product is shipped, it needs to be.invoiced..0:02:30.033,0:02:36.066.The billing department will prepare a customer.invoice with the quantity shipped at the price.agreed to..0:02:36.066,0:02:40.066.At this point, the data starts getting recorded.in.journals and ledgers..0:02:40.066,0:02:49.066.The sales journal will summarize the sales.activity as we have now achieved revenue.recognition- that’s the credit side of the.entry..0:02:49.066,0:02:55.066.The debit goes to our accounts receivable.subledger to track the customer’s balance.outstanding..0:02:55.066,0:02:59.066.At month end, we may send the customer an.account statement,.0:02:59.066,0:03:06.000.which will summarize activity in their account,.including their purchases less returns and.remittances..0:03:06.000,0:03:13.033.For reporting purposes, you will see.management review what is called an aged trial.balance of accounts receivable..0:03:13.033,0:03:17.033.This document lists both the balance.outstanding from each customer,.0:03:17.033,0:03:27.033.and how old the balance is, often grouping.balances into current (under 30 days), 30-60.days, 60-90 days, and over 90 days-.0:03:27.033,0:03:33.033.a very helpful report for managers to use.to.manage working capital!.0:03:33.033,0:03:37.033.At some point, the customer will remit payment..0:03:37.033,0:03:42.066.They may send cash (unlikely), a check, or.an.electronic fund transfer..0:03:42.066,0:03:46.033.Cash or equivalents get deposited at the bank..0:03:46.033,0:03:51.033.A lock box is an arrangement whereby.remittances are sent directly to a bank for.deposit..0:03:51.033,0:03:58.000.The collection of cash gets recorded in a.cash.journal which debits cash and credits the.receivable subledger..0:03:58.000,0:04:03.000.Now if a customer returns product, a credit.memo may be issued..0:04:03.000,0:04:08.066.In the accounting system this too relieves.the.customer account, with an offsetting debit.to.inventory..0:04:08.066,0:04:15.000.Bad debts arise when customers don’t pay.us..The allowance is a provision for anticipated.bad.debt..0:04:15.000,0:04:21.066.A write off is applied against the provision.once.the company loses all hope of collecting the.account from the customer..0:04:21.066,0:04:26.066.Now to finish off our story, subledgers and.journals roll into the general ledger,.0:04:26.066,0:04:31.033.either on a transaction-by-transaction basis,.or.often on a batch basis..0:04:31.033,0:04:37.000.A batch basis simply means that transactions.are aggregated [by batch] and posted as single.entry in the G/L..0:04:37.000,0:04:42.000.The general ledger balances at the end of.the.period become your trial balance..0:04:42.000,0:04:47.000.Your trial balance will then get grouped,.matching up like accounts for reporting.purposes..0:04:47.000,0:04:51.066.And the grouped trial balance will enable.you to.draft your income statement and balance sheet..0:04:51.066,0:04:58.066.From there, you can draft the rest of your.financial statements..This is your financial.reporting process..0:04:58.066,0:05:03.066.And I emphasize process because we have not.yet talked about controls whatsoever..0:05:03.066,0:05:04.066.Don’t get these confused..0:05:04.066,0:05:11.000.Let’s go back and talk about controls that.overlay the sales process..0:05:11.000,0:05:17.066.We have already spent a lot of time talking.about internal controls in earlier lessons.so I’ll.try to keep this discussion brief,.0:05:17.066,0:05:21.000.but hopefully, you will begin seeing the pieces.falling into place..0:05:21.000,0:05:27.000.The starting point for all cycles will be.to.consider entity level controls and general.computer controls..0:05:27.000,0:05:34.066.For example, if you have a highly driven sales.organization with significant emphasis placed.on.growing sales,.0:05:34.066,0:05:36.033.this may lead to a management bias..0:05:36.033,0:05:40.066.This could motivate sales people to conjure.up.sales,.0:05:40.066,0:05:42.066.or the credit people to accept less creditworthy.customers..0:05:42.066,0:05:51.033.So always remember to consider the control.environment before you get into the details.as.this has a pervasive effect..0:05:51.033,0:05:57.066.At the customer order stage, we will want.to.have some controls over ensuring that the.order.is input accurately..0:05:57.066,0:06:03.033.Remember those annoying red text warnings.you get on websites when you miss completing.a field..0:06:03.033,0:06:07.066.That’s an input control, which helps to.cover off.the accuracy assertion..0:06:07.066,0:06:13.066.In our retailer, we will want to have other.controls.such as a bar code scanners that do the same.sort of thing..0:06:13.066,0:06:20.033.For our manufacturer, credit approval is a.key.control as this prevents us from taking on.customers that lack creditworthiness..0:06:20.033,0:06:24.033.This control helps with our valuation assertion..0:06:24.033,0:06:29.033.In the warehouse, the shipping documents will.be tracked and ideally serially numbered..0:06:29.033,0:06:38.000.If these documents are tracked and compared.to.sales invoices- either manually or electronically,.this helps ensure completeness of sales..0:06:38.000,0:06:44.000.Occurrence is validated by ensuring that only.those orders that are actually shipped get.recorded as sales..0:06:44.000,0:06:48.066.So if an order is say backordered, it should.not.show up in the sales journal..0:06:48.066,0:06:56.066.Segregation of duties is an important control.which prevents any self review bias as well.as.protects the organization from theft..0:06:56.066,0:07:01.033.Those handling the cash remittances should.not.be the same as those maintaining the.subledger..0:07:01.033,0:07:05.000.Those handling the invoicing should not have.custody of the assets..0:07:05.000,0:07:12.000.Management’s review of the aged receivable.listing helps ensure that the allowance and.bad.debts have been adequately considered-.0:07:12.000,0:07:15.066.this is your valuation of receivable assertion..0:07:15.066,0:07:19.033.The customer statements act as a control of.sorts..0:07:19.033,0:07:27.033.Not all company’s send customer statements,.but for those who do, one added advantage.is.that if a customer notices something is amiss-.0:07:27.033,0:07:32.066.like a payment has not been applied to their.account or they are being charged for something.they didn’t order-.0:07:32.066,0:07:34.066.rest assured that they will call you..0:07:34.066,0:07:39.066.So this helps to ensure both occurrence of.sales.and existence of accounts receivable..0:07:39.066,0:07:43.000.The issuance of credit notes and the write.off of.bad debts is important from a control stand.point,.0:07:43.000,0:07:49.000.so again, segregation and authorization controls.must be in place..0:07:49.000,0:07:55.000.I think I’ve given you enough examples so.that.you begin to understand how controls are.overlaid on the sales process.0:07:55.000,0:07:58.033.to achieve management’s assertions, and.our.audit objectives..0:07:58.033,0:08:05.000.A well designed system of internal controls.will.have a mix of preventative and detective.controls,.0:08:05.000,0:08:08.000.which may be manually or electronically.performed..0:08:08.000,0:08:14.033.Our role as auditors will be to identify the.controls which best address each of our.objectives..0:08:14.033,0:08:19.033.For argument sake, let’s just focus on the.existence and valuation of accounts receivable..0:08:19.033,0:08:25.066.We can go through our internal control.documentation and identify key controls that.address those particular control objectives..0:08:25.066,0:08:33.000.Maybe our bad debt allowance is system.generated based on the aging of the receivables,.in which case we will want to rely....0:08:33.000,0:08:39.066.on the system’s ability to age receivables.properly and would identify a processing control.in the application..0:08:39.066,0:08:43.033.For the existence assertion, the customer.statements may be the key control..0:08:43.033,0:08:48.066.But how do we know that someone is not just.pulling out the statements going to fictitious.customers before they are mailed..0:08:48.066,0:08:56.000.Well, in this case, we would need to ensure.adequate segregation of duties and would.identify that as a key control..0:08:56.000,0:09:02.033.Perhaps that control, in and of itself is.not.enough for us to reach our warm happy place..0:09:02.033,0:09:07.033.Maybe we need to identify the controls over.ensuring all shipments get invoiced as our.key.control..0:09:07.033,0:09:10.000.Does that make you feel better now?.0:09:10.000,0:09:16.000.It’s a judgement call as to how many controls.and which controls you identify as key controls..0:09:16.000,0:09:17.000.Do you remember what happens next?.0:09:17.000,0:09:22.033.That’s right, you need to assess control.risk.which again is based on your judgement..0:09:22.033,0:09:29.033.We will just pretend that this client has.a well.thought out and implemented system of internal.controls and for this reason,.0:09:29.033,0:09:31.000.we will assess control risk as low..0:09:31.000,0:09:36.066.If we had weaknesses, we would have to assess.control risk for those audit objectives differently,.0:09:36.066,0:09:40.066.and tailor our audit approach accordingly..0:09:40.066,0:09:43.000.Most of this stuff happens during audit planning.stage..0:09:43.000,0:09:47.000.Now we get to either the interim fieldwork.or.yearend fieldwork..0:09:47.000,0:09:48.000.What happens now?.0:09:48.000,0:09:51.000.That’s right, we have to test the controls.to.support our reliance..0:09:51.000,0:09:56.066.For our system aging control, we could test.the.control in a variety of ways..0:09:56.066,0:10:00.033.We might manually reperform the aging analysis.ourselves..0:10:00.033,0:10:06.033.Or we could process some dummy invoices with.different dates to test the aging algorithm.in the.system..0:10:06.033,0:10:11.066.To test segregation of duties, we could observe.the tasks being performed..0:10:11.066,0:10:15.066.We could make inquiries about the performance.of these tasks throughout the period..0:10:15.066,0:10:24.066.Again, these kind of feel like weak sources.of.evidence to me in and of themselves, so we.should also look at a second key control to.test..0:10:24.066,0:10:30.000.We were going to test to ensure all receivables.actually existed by vouching them back to.the.shipping documents..0:10:30.000,0:10:34.066.So here, the test of control might be to take.a.sample of sales invoices,.0:10:34.066,0:10:40.033.and ensuring that shipping documents are.attached signifying that the person who enters.the sales.0:10:40.033,0:10:44.033.has only entered sales only when they had.appropriate shipping evidence..0:10:44.033,0:10:47.033.If our finding support our beliefs about control.risk,.0:10:47.033,0:10:49.066.then we will move on to perform our substantive.work..0:10:49.066,0:10:56.000.Otherwise, we may need to return to the audit.plan and recalibrate our audit approach for.any.surprise deficiencies noted..0:10:56.000,0:11:03.000.Now, keep in mind, I’ve just picked out.a small.sample of some of the work that an auditor.would actually perform for illustrative purposes..0:11:03.000,0:11:10.066.In fact, while the amount of work performed.is a.matter of auditor judgement, it is likely.that if.you want to achieve a low control risk....0:11:10.066,0:11:15.033.assessment, you will need to make damn sure.the controls are effectively working throughout.the period..0:11:15.033,0:11:22.033.But hopefully, this is enough to give you.an idea.as to what this looks like and then when you.get.the opportunity,.0:11:22.033,0:11:29.033.you can apply this same thinking to all the.audit.objectives of interest for the sales cycle.and for.other cycles..0:11:29.033,0:11:38.033.So before we go, let me just show you one.form.out of the CICA Professional Enagement Manual.that could be used to document these findings..0:12:51.066,0:12:53.033.So until next time,.0:12:53.033,0:12:55.033.don’t stop until you get to the top and.when you.get to .the top, don’t stop..
