Auditing sales and revenue - part 1

Summary

In this video series, Amanda introduces accounting transaction cycles from an audit perspective, focusing on sales and cash receipts. She outlines the typical sales process, inherent risks, and control activities in different firms. Amanda also discusses how to test controls and perform substantive procedures. The series is designed to help students understand transaction processes in-depth and is broken into multiple parts for comprehensive coverage.

Takeaways

• 📈 The series will cover various accounting transaction cycles such as sales, purchasing, payroll, and long-term liabilities from an audit perspective.
• 🔍 It will analyze typical processes, inherent risks, and common control activities in different firms.
• 📝 The video on sales is divided into two parts: the first focuses on the sales process and inherent risks, while the second will discuss control testing and substantive procedures.
• 🛒 The sales process varies between retail and wholesale environments, with different payment, delivery, and salesperson remuneration methods impacting the process.
• 💼 Salespeople's compensation, such as commissions and bonuses, can increase the risk of material misstatement in sales and revenue recognition.
• 💻 Barcode scanning and price lists are examples of control activities that help ensure the accuracy and classification of sales transactions.
• 📊 The recognition of revenue is a critical accounting issue, with revenue only recognized once goods have been delivered to the customer.
• ✅ Assertions related to sales include occurrence, accuracy, classification, completeness, and cutoff, each with potential risks that auditors must consider.
• 🔑 Control activities are integral to the sales process, such as credit limit checks, order picking, and delivery confirmations, which auditors will assess.
• 🔍 The next video will delve into how to test control activities and gather substantive evidence to ensure the integrity of the sales process and financial reporting.

Q & A

What is the main focus of the new series on 'Amanda Loves to Audit'?

The new series focuses on accounting transaction cycles from an audit perspective, covering various cycles such as sales and cash receipts, purchasing and accounts payable, payroll, property, plant, equipment, and long-term liabilities.

What are the key components analyzed in each transaction cycle?

For each transaction cycle, the series analyzes the typical process, inherent and accounting risks, common control activities, how to test those controls, and substantive procedures.

Why is the series divided into multiple videos?

The series is divided into multiple videos because the depth of analysis for each transaction cycle is extensive and would be too long for a single video.

How does the sales process differ between retail and wholesale environments?

In retail, the process often involves customers selecting items, barcode scanning, payment processing, and receipt generation. In wholesale, it involves order placement, credit limit checks, warehouse processing, delivery, and obtaining customer signatures upon delivery.

What are the common inherent risks and accounting risks of material misstatement in the sales process?

Common inherent risks include issues with revenue recognition, particularly around the timing of when goods are considered delivered. Accounting risks involve overstatement of sales due to bonuses or sales targets, accuracy of pricing, correct classification in journal entries, and ensuring completeness of sales records.

What is the importance of barcode scanning in the retail sales process from an audit perspective?

Barcode scanning serves as an internal control in the retail sales process, ensuring that the correct price is applied to the item and that the total is accurately calculated, reducing the risk of misstatement.

How does the payment method affect the sales process and what controls are associated with it?

Payment methods such as cash and credit cards require different processes and controls. Cash payments involve receiving the exact amount and giving change, while credit card payments involve charging the card and updating the accounting system. Controls include ensuring accurate recording of transactions and safeguarding against fraud.

What is the significance of delivery in the wholesale sales process from an audit perspective?

Delivery is significant as revenue recognition in wholesale often occurs upon delivery. Audits must ensure that journal entries correctly reflect the delivery and that customer signatures or electronic confirmations are obtained as proof of delivery.

Why is the recognition of revenue a critical accounting issue in the sales process?

The recognition of revenue is critical because it must align with accounting standards, which typically require goods to be delivered before revenue can be recognized. Misalignment can lead to overstating revenue and misrepresenting the financial position of the company.

What are the different assertions related to the sales account that need to be considered in an audit?

The assertions related to the sales account include occurrence, which ensures that all sales have occurred; accuracy, ensuring the correct amount is recorded; classification, that sales are correctly categorized in financial statements; completeness, that all sales are recorded; and cutoff, ensuring that sales are recorded in the correct accounting period.

Outlines

00:00

📚 Introduction to Accounting Transaction Cycles Audit Series

Amanda introduces a new series on auditing from the perspective of accounting transaction cycles. The series will cover various cycles such as sales, purchasing, payroll, and long-term liabilities. Amanda plans to analyze typical processes, inherent risks, control activities, and substantive procedures within different firms. The series is a response to requests for in-depth analysis of transaction processes, aiming to aid students and professionals in understanding auditing standards. The first topic, sales, will be explored in two parts: the sales process and its inherent risks in part one, and control and substantive testing in part two.

05:02

🛒 Delving into the Sales Process and Its Controls

Amanda discusses the sales process, focusing on the product type, payment methods, and delivery logistics. She emphasizes the importance of understanding whether the entity sells goods or services, the payment terms, and the delivery process. Amanda also highlights the significance of sales personnel and their compensation, which can impact the risk of material misstatement. The paragraph concludes with a flowchart illustrating a typical retail sales process, including barcode scanning, price calculation, and payment processing, all of which serve as internal controls.

10:03

📊 Flowcharting the Sales Process in Retail and Wholesale

Amanda contrasts the sales processes in retail and wholesale environments. In retail, the process involves customer selection, barcode scanning, payment, and receipt generation. For wholesale, the process starts with an online order, includes a credit limit check, and continues with warehouse operations like order processing, item collection, and delivery. Amanda also mentions the need for a customer signature upon delivery, which updates the system and triggers journal entries for revenue recognition. The paragraph provides a detailed flowchart for each scenario, highlighting the steps and controls involved.

15:04

💼 Accounting Issues and Revenue Recognition in Sales

Amanda addresses accounting issues related to the sales process, particularly the recognition of revenue. She explains that revenue can only be recognized upon delivery, not at the point of order placement. This affects the accuracy of financial reporting, especially regarding the cutoff assertion. Amanda also discusses the risks associated with sales accounts, such as overstatement due to bonuses or commissions, and the importance of accurate pricing and journal entries. The paragraph concludes with a discussion of the potential for understatement of sales and the implications for revenue recognition.

20:05

🔍 Upcoming: Testing Controls and Gathering Substantive Evidence

In the concluding paragraph, Amanda outlines the plan for the next video in the series, which will focus on testing control activities and gathering substantive evidence. She summarizes the key points covered in the current video, including the sales process, controls, and potential accounting issues. Amanda invites viewers to engage with the content by liking, subscribing, and visiting her website for more resources on auditing. She expresses her appreciation for the viewers' time and looks forward to continuing the series.

Keywords

💡Transaction Cycles

Transaction cycles refer to the sequence of procedures and processes that a business follows to manage and record its financial transactions. In the context of the video, transaction cycles such as sales, purchasing, payroll, and property management are analyzed to understand the typical processes and inherent risks associated with them. The video aims to explore these cycles from an auditing perspective to identify control activities and potential risks.

💡Inherent Risks

Inherent risks are the potential for material misstatement of financial statements that could arise from errors or fraud. The video discusses how to identify these risks within different transaction cycles and how they can affect the accuracy and reliability of financial reporting. For instance, in sales, the risk of overstatement due to sales targets or commissions is highlighted.

💡Control Activities

Control activities are the actions taken by a company to ensure that its financial processes are carried out effectively and that risks are mitigated. The video provides examples such as barcode scanning in retail sales to control the accuracy of sales transactions, and credit limit checks in wholesale environments to control who receives credit.

💡Substantive Procedures

Substantive procedures are audit procedures performed to detect material misstatements at the assertion level. The video mentions that after identifying control activities, the next step is to look at substantive tests to gather evidence about the accuracy of the financial statements. These procedures are crucial for auditors to provide assurance on the financial statements.

💡Point of Sale (POS)

Point of Sale (POS) refers to the place where a retail transaction is completed. In the video, it is mentioned as a key component in the retail sales process where the customer selects an item, it is barcode scanned, and the total is calculated. The POS system is integral to recording sales transactions and updating the accounting system.

💡Accounts Receivable

Accounts receivable represents the money owed by customers who have purchased goods or services on credit. The video discusses how the process of managing accounts receivable, including credit checks and payment terms, is critical in both retail and wholesale environments. It also ties into the discussion of inherent risks, such as the potential for overstatement due to credit sales.

💡Sales Commissions

Sales commissions are payments made to sales personnel based on their sales performance. The video points out that commissions can increase the risk of material misstatement as salespeople might be incentivized to manipulate sales figures to meet targets or earn higher commissions. This is a key consideration in the sales transaction cycle.

💡Barcode Scanning

Barcode scanning is a method of capturing product information, such as price and description, by scanning a barcode at the point of sale. The video uses this as an example of a control activity in retail sales to ensure that the correct price is charged and recorded, which is crucial for the accuracy of sales transactions.

💡Journal Entries

Journal entries are the initial records in the accounting system that document financial transactions. The video explains that journal entries are made to record sales transactions, such as debiting accounts receivable and crediting sales revenue upon delivery of goods. These entries are essential for the integrity of financial reporting.

💡Audit Assertions

Audit assertions are representations by management about the financial statements that auditors evaluate for accuracy. The video discusses how assertions like occurrence, accuracy, classification, completeness, and cutoff relate to the sales account. For example, the occurrence assertion ensures that recorded sales have actually occurred, which is crucial for preventing the overstatement of revenue.

Highlights

Introduction to a new series on accounting transaction cycles from an audit perspective.

Analysis of traditional processes in various transaction cycles like sales, purchasing, payroll, and long-term liabilities.

Identification of inherent and accounting risks associated with different transaction cycles.

Discussion on common control activities and how to test those controls.

Explanation of substantive procedures that can be used in auditing.

The decision to split the sales video into two parts due to the complexity of the topic.

Exploration of the typical sales process in different types of companies.

Consideration of product types and how they affect the sales process.

Discussion on payment methods and their impact on the sales process.

Importance of understanding delivery methods in the sales process.

Analysis of how sales personnel are compensated and its implications for the sales process.

Mapping out a flow diagram of a typical sales process in a retail environment.

Identification of internal controls within the retail sales process.

Flowchart example of a wholesale sales process, including order placement and credit limit checks.

Discussion on the importance of recognizing revenue at the correct time in the sales process.

Analysis of potential accounting issues related to the sales process, such as revenue recognition and cut-off.

Explanation of the assertions related to the sales account and the associated risks.

Preview of the next video in the series, which will cover testing control activities and gathering substantive evidence.

Invitation for viewers to engage with the content by subscribing and accessing additional resources on the Amanda Loves to Audit website.

Transcripts

what's up audit fans welcome to amanda

loves to audit

and the launch of my new series on

accounting

transaction cycles from an audit

perspective so what are we going to look

at in this series

well for a range of different

transaction cycles like

sales and cash receipts purchasing and

accounts payable

payroll property plan equipment long

term liabilities

we're going to analyze what a

traditional or typical process

looks like in a range of different firms

then we're going to look at the sorts of

inherent and accounting risks

that are going to arise we're going to

try and identify common control

activities how you test those controls

and different

sorts of substantive procedures you

could use

why am i doing this well i've had lots

of requests

for analyzing transaction processes in

depth

and helping students develop some

examples

like my series on auditing standards

this is a really big

undertaking so this is not something

that's going to happen in just a couple

of weeks

it's going to take quite a long time to

get through all the videos

but i look forward to making them and

sharing them with you so without further

ado

let's get into it

[Music]

so my video on sales is going to be

broken into

two parts the first part is going to be

about the process

what should we expect to see in a

regular sales process

in different types of companies then

we're going to look at the common

inherent risks and accounting potential

accounting

risks of material misstatement we'll

also identify the control

activities in today's video however

in part two of this video we're going to

look at

the types of tests of internal controls

that we can do over the control

activities that we identify

and also the type of substantive tests

now why have i broken it into

two videos well it'd just be too long

for one specific video so make sure

you've got yourself a snack

a cup of tea and i'm going to start

drawing on my tablet right now

so let's try and understand that process

related to sales and we need to find out

you know

what exactly is happening so there are

so the sorts of things that you're going

to want to ask or you're going to want

to find

out are about what sort of product

does the entity sell is it something big

is it something small

is it a good so i guess there's some

issues there we want to find out if it's

a good

or if it's a service we need to find

out if it's a what i call a one stage

item

which means you buy it you take it away

straight then and there

or is it multi-staged

so that might mean that you buy

something that has a number of different

components maybe it needs delivery later

so we need to think about what is the

product and how do they sell it how is

it sold

to the customer so once you've figured

out the product

then you need to think about the payment

all right so how do people pay is it a

retail

operation where it's cash

and credit cards so that's likely to be

retail

or is it more wholesale

where people are likely to purchase

on credit or on account and that on

credit or on account

is that accounts receivable process

that a lot of wholesalers manufacturers

will use

because remember there are different

processes if we do have credit

then there are going to be questions

about exactly

who receives credit and what is the

approval process so do we need to look

at bank

statements do we give everybody a

generic approval process or

some sort of generic uh you know

everybody gets 50 000

worth of credit straight away and then

you also need to think about

payment terms so when it comes to

payment terms it might be that you have

to pay within 30 days within 60 days

do you get a discount if you pay early

so payment is really

important now the next thing we need to

consider

is also going to be delivery

how do customers actually receive their

goods

is it that they take it with them

oops can't spell their

take it with them or

is there delivery now when you have

delivery you need to think about

two specific things number one who does

the delivery is it the client

with their own trucks um or delivery

service

or do they contract

some sort of career company or delivery

company

now this is all important because if

they deliver it themselves

then how do we account for those costs

if it's a courier company then when it

comes time to audit expenses we know we

need to look for those

doing the audit the next thing

that i typically think about when i'm

analyzing a sales process

is the sales people so who are how are

sales made are sales made online

are they made with sales people if

they're made with sales people

then we want to ask questions about

how are they paid or remunerated

because if they're paid with a salary so

they get a fixed amount per year

or an hourly wage

then we don't need to think about

whether their pay

affects sales however

if they also receive some commissions

we know this increases our risk of

material misstatement and i'll explain

more on that later

and then the last one do they receive

some sort of bonus again bonuses

are going to impact how

they might manipulate sales accounts

receivable or cash

to meet particular bonus targets it

increases the risk

so when we're thinking about a sales

process how is the sale made

i forgot to add up here is it a good or

a service

is it something that perhaps is

delivered online as well

so we need to think about the product

the payment the delivery

and the sales people to be able to

understand the process because remember

retail is going to be different from

wholesale so next up let's map

out a quick flow diagram or flow chart

of what a process might look like i'm

going to switch to a slightly smaller

pen because we're going to need to fit

quite a lot here on the page

so imagine we've got a start point okay

now here

let's talk about sales in a retail

environment so let's say

sales

retail here okay so in a retail

situation you have your customer comes

in

they pick up the item it needs to be

purchased

so what sort of process what might we

see

well customer

selects item oh i'm not going to run out

i'm going to run out of room here

so they've selected the item it needs to

be

barcode scanned all right so

scan barcode

of the item now when you scan that

barcode

that's going to bring in a control

activity and the barcode acts as a

control activity itself so you're going

to have

some sort of computer price list all

right so you're going to scan all your

items

then the system is going to calculate

the total for the sale

all right so it's going to add

everything up that also acts as an

internal control process

now here i'm going to add a payment

process

so payment type

and let's say if it's cash then

they are received cash

and give change all right and that's

probably

at some point going to update

my accounting system right we don't some

sort of point of sale system

so they're going to have to enter the

cash and receive the change

now if it's a credit card

there'll be a process here

to charge the credit card so regardless

of which payment method we have there's

going to be a process to generate a

receipt

all right so we have to generate

a receipt i'm going to shift this flow

chart up a little bit so i can keep

writing the receipt's going to come from

that accounting system

if we charge the credit card that's

information is going into the accounting

system as well i've got some lines

crossing over here it's not exactly the

neatest flowchart

that's going to give us a little

document receipt

and that's going to go to the customer

okay so in this process let me try and

show it all on one page here i'm going

to highlight the activities

where there is an internal control okay

so scanning the barcode that's an

internal control

we've got the price list acts as an

internal control

the system automatically calculates the

total sales

that's a control that we have to

generate a receipt and then it updates

the accounting

that's going to be a control as well now

if you think about your supermarket

there might also be some process where

you have to deactivate an rfid

tracker on an item if it's an electronic

store

or you're selling something quite

expensive but this is the sort of

process that you might see

in some sort of sales environment now

also i didn't add up here

that prior to when the customer scans

the item

there might also be a step depending on

the business

about the sales person

scans their id all right that could be

in there as an extra control to make

sure that you know exactly who is

selling

or who is using the cash register at

that specific time

so that's an example for retail let's

look at an example

for a wholesale environment

all right so let's say in a wholesale

environment the customer places an order

via the website okay so let's say here

order via the website

okay so they've placed an order into our

system

let's say this is the point of sale

or the web system so pause or a web

system

then what happens typically is that

there will need to be let's not do that

as a square

let's do a credit limit check

so we need to figure out for

how much they owe do they still have

money to be able to

spend on account so if they've

exceeded the limit we're going to need

to send something

denying the order

if they have cash to spare

so they are within the limit

then we can order

or process the sale

okay so there's going to be need some

sort of process there

now processing the sale means that now

we need to organize something happening

in our warehouse i'm going to draw a

line here

because this is in the warehouse so

we're going to process the sale

by entering the details here or

print the order details

so from this system they're going to

print the order details

and generally they generate something

called

a pick list or a pack list so that says

for these this order here are the five

items that need to be collected off the

shelves

that are going into this transaction so

there's going to be a manual process

where somebody has to go off and

collect the order items

all right and then as i collect them

hopefully they're marking them off

the pick list at the same time

so what needs to happen is once they've

collected all the items

let's write this here items

match the pick list

all right if no

then they need to go back and they need

to figure out what am i missing

but if they have all the items yes

they can probably box everything up

attach label

to the box so there has to be some sort

of label

that's generated so that it knows where

to go for delivery

and then probably in the system the mark

the order

is ready for delivery

all right so in

the accounting system somewhere all the

delivery or the inventory management

system

we have to mark that as an order ready

for delivery

then we have to go out and deliver the

item so i'm going to run out of room

here so i'm going to do delivery

down here so imagine they have their own

delivery drivers in-house

so the driver

is going to

deliver the item now typically when you

receive a delivery you also need to have

a signature so

they're going to need to obtain

customer signature now that could be oh

i've got that as a manual process there

let me just make that an online process

because it could be signing on a tablet

which again is going to update that

system to say that the item is delivered

now once it's delivered then

automatically

what should happen is also

some journal entries

okay so we should automatically have

journal entries and that journal entry

would be to go

debit accounts receivable credit

sales and we know that that has to

happen there because that's the delivery

point so that's the accounting standard

rules

and then there will be a process later

where at the end of the month you say to

the customer

here is what you owe and here is what is

to be collected

now i just realized back in our examples

for

our retail entity we didn't talk about

where journal entries

would be made so generally we would make

the journal entry after we generate the

receipt

there would also be a process to create

the automatic

journal there and so that's going to be

debit cash

or money owed from the credit card

credit sales revenue

so that's pretty much the process that

we expect to see

so what we need to do next is think

about our

accounting issues

okay and i mentioned one of those

briefly before and the first one

is recognition of revenue so remember

that the goods

cannot be recognized as revenue until

they've been delivered to the customer

so a lot of businesses will say they can

recognize the revenue as soon as they've

given the parcel over to australia post

for example

but technically they don't earn that

revenue until the article has been

delivered

so we know that we have an issue around

the recognition of revenue

and in terms of assertions

that's going to affect our cutoff

assertion recognizing revenue

in the correct period now if there are

sales commissions

we know that actually let's take this to

from an assertion perspective let's look

at our assertions

occurrence accuracy

accuracy couldn't spell it there for a

minute

classification

completeness oops

and cut off

okay so these are our assertions

relating to the sales account because

this is a transaction account

we need to think about what are the

risks associated with this specific

account

so we're more worried about

overstatement of accounts

like sales because people are more

likely to

overstate revenue so we're worried about

occurrence

could there be any reason for there to

be fake sales or overstatement of sales

and that is most likely related to

bonuses or commissions

i can't write here today

or sales targets so that's going to be a

big one

accuracy is have we charged our

customers the correct amount

so this is often going to be related to

barcodes

and scanning and price lists

is there any way that people can

override the price

if there is a price override who

approves it is there a manager

classification is going to be our

journal entry so that's going to be

related to

do we have any risk in how the journal

entries are processed

set up for the specific account so how

is the accounting system set up

what are the default journal entries are

those journal entries correct

completeness is we're worried about

understatement of sales that's

unlikely everywhere unless you're trying

to receive a government supplement for

low business performance at the moment

so

when would a company be likely to

understate

sales so we have to investigate whether

there are any

issues about the entity or the

environment that would encourage

understatement

and then cut off and cut off is one of

those ones that is typically

related to delivery we can have mistakes

or companies potentially recognizing

sales

when the order is placed

not when the goods are delivered and

that's a really common one if you're

trying to bring sales into this period

alternatively companies might be trying

to push sales into the next period

if they've already reached their sales

targets so we need to look at our

accounting process and go to the client

interview them find out the process

and see if there are any indications

that we might have issues related

to these assertions so that's the end of

our first video in this series i've

talked about

sales i've talked about the sorts of

controls that we might want to see

and i've talked about the potential

accounting issues

what we're going to do in our next video

in this series is actually look at the

process

of how do i test those control

activities

and then also how do i gather

substantive evidence

of course if you thought the video was

useful i'd love for you to give me a

thumbs up

please consider subscribing to make sure

that you get all the videos in the

series

and check out all of my other work on

auditing

and my webpage on amanda loves to

audit.com there's lots of resources

there to help students

and to help you brush up on your audit

knowledge thanks for watching and i'll

see you next time