Module 2 - Audit of Transaction Cycles PDF

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AUDITING AND ASSURANCE PRINCIPLES, CONCEPTS, AND APPLICATIONSMODULE 2: OVERVIEW OF THE TRANSACTION CYCLESI. Description This module discusses the different transaction cycles and the key controls for each transaction cycles.II. Objectives After completing the module, the students are expected to: ✓ ...

Description

MODULE 2: OVERVIEW OF THE TRANSACTION CYCLES I. Description This module discusses the different transaction cycles and the key controls for each transaction cycles. II. Objectives After completing the module, the students are expected to: ✓ Describe the different categories of the transaction cycles. ✓ Identify the forms and documentation used by the different departments ✓ Identify and describe the functions of the departments in each transaction cycles ✓ Identify the different possible controls in each transaction cycles. III. Duration Start: Week 2 End: Week 2 IV. Learning Contents A. TRANSACTION CYCLES Transaction cycles are the means through which an accounting system processed transactions of related activities such as sale of goods to customers, acquisition of merchandise and payment to vendors, production of finished products for sale, and payment to employees for services they had rendered. A Transaction is an agreement between two entities to exchange goods or services or any other event that can be measured in economic terms by an organization. Transaction Cycle Revenue and Receipt cycle Expenditure and Disbursement cycle

Human Resources and Payroll Production or Conversion Financing and Investing

• • • • • • • • •

Inclusion Sale of goods or services to customer Collection of cash Acquisition of goods and services Payment for the goods and services acquired Acquisition of services from employees Payment for the services acquired Production of entity’s product for sale Generation of capital funds from outside investors Investment of capital funds to other profitable activities

AUDITING AND ASSURANCE PRINCIPLES, CONCEPTS, AND APPLICATIONS Ms. Desiree D. Cemefrania, CPA

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B. REVENUE AND RECEIPT CYCLE Business Function: ✓ Resources are distributed to customers in exchange for promises of future payments. ✓ Customers pay cash for resources distributed to them. Affected Accounts: ✓ Sales ✓ Sales Returns and Allowances ✓ Sales Discount ✓ ✓ ✓ ✓

Accounts Receivables Allowance for Bad Debts Bad Debts Expense Cash

Departments Involved: Department Sales Department • • To manage and • improve the • entity’s sales • • • • • Credit Department • To minimize exposure to high-risk customers Warehouse (Inventory Control) • To control movement and monitor level and condition of inventories

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Activities Locates and encourages buyers Negotiates and deals with customers Accepts Customer orders Prepares S.O. and distributes them File retention copy Monitor the status of the order Reviews and grants customer request for returns. Sends out credit memo to the concerned departments. Receives S.O. from Sales Conduct Credit Investigation Approves Credit request Notify Sales for the approval/denial of credit request Forward S.O. to Warehouse Review approved S.O. Monitor the availability of inventories and update the Sales Dept. Notifies Sales Dept of the shipment Release goods to the courier Forwards documents to Billing dept.

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Controls Within Exclusive function to communicate with customer Maintenance of master list of customers and list of prices of products and services Complete documentation for new customers

Must be independent from Sales Maintain and update of list of approved customers

Monitoring of inventory levels to provide assurance of its availability when needed Report to Sales dept regarding inventory count

AUDITING AND ASSURANCE PRINCIPLES, CONCEPTS, AND APPLICATIONS Ms. Desiree D. Cemefrania, CPA

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Receiving department receives returned goods and prepares receiving report. • Compares received goods vs. credit memo • Compare S.O. and with approved inventories from Warehouse • Completes shipping documents (DR) and prepares for shipment • Notify Sales dept that goods have been shipped. • Forwards S.O. and D.R. to Billing Department ✓ Compares S.O., D.R. (Sales dept and shipping dept) ✓ Prepares Sales Invoice and send copies to customers and Accounting Dep. •

Shipping • To provide reasonable assurance that all shipments are authorized

Billing Department ✓ To provide reasonable assurance that all shipments are billed Accounting Dept. Inventory Accounting

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General Accounting

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Accounts Receivable

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Collection/ Receipt Cycle Mail Room

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Pre-numbered shipping documents for proper monitoring Report for completed shipped orders

✓ Pre-numbered Sales Invoice ✓ D.R. must be present to ensure that billed S.O. has been shipped.

To provide costing information of the goods sold. Updates inventory records Record sale and forward S.I. to A/R dept Updates SL related to customer accounts

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Treasury Department

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Receives the remittance advise and customer checks from customer Prepares summary of receipts Endorses the checks and remittance advise to Treasury Department Provides report to A/R dept. Updates cash records Prepared deposit slips for check received Prepares collection summary and send to AR and Gen. Accounting Deposit collection to the bank The Treasurer authorize the write-off of AR

AUDITING AND ASSURANCE PRINCIPLES, CONCEPTS, AND APPLICATIONS Ms. Desiree D. Cemefrania, CPA

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Accounting Departments: Accounts Receivables

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General Accounting

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Forms/Documents: Forms SALES ORDER (Order slip/customer order) DELIVERY RECEIPT (Bill of lading/ shipping document) SALES INVOICE (Billing statement) PAYMENT ADVICE (Remittance Advice) DAILY SUMMARY

Compares remittance advice (mail room) and cash summary from Treasury, updates Customer SL and prepare daily summary to be forwarded to General Accounting Review individual customer accounts Performs aging of receivables Recommend write-off of delinquent accounts Validates report from Treasury and Accounts Receivables and updates General Ledger.

Description Details of goods or services ordered

Initiated By: Sales Department

Describes the goods to be shipped and serves as a contract bet. courier and seller Details of the good/services sold, amount due and terms of payment Document informing the seller that the goods/service sold has been paid Summary of daily transactions of all the departments

Shipping Department

Billing Department

Customer

Different dept’s involved in the cycle

Given to: Customers Billing Department Shipping Customer Carrier Billing Department Customer Carrier Billing A/R Department

General Accounting A/R Department Treasury

CONTROLS: ✓ Initiating department approves the form. ✓ Initiating department is accountable for all the forms in their department, such as access to the forms and unused forms. ✓ If approved by the management through policies, forwarding of the form can be done also electronically. ✓ The initiating department must retain a copy of the forms for filing.

C. PURCHASE TO PAY (P2P)/ EXPENSE AND DISBURSEMENT CYCLE Business Function ✓ Resources are acquired from vendors in exchange for obligations to pay. AUDITING AND ASSURANCE PRINCIPLES, CONCEPTS, AND APPLICATIONS Ms. Desiree D. Cemefrania, CPA

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✓ The entity pays cash to vendors. Affected Accounts: ✓ ✓ ✓ ✓

Purchases Purchase Returns and Allowances Accounts Payables Cash

Departments: Department Requesting Department Purchasing/ Procurement • To meet the specific needs of the requesting dept at least possible cost Receiving Department • To provide reasonable assurance that received goods are based on approved P.O. Accounts Payable • To provide reasonable assurance that the payments will be made for shipments received Treasury Department

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Activities Prepares requisition slip Receives approved requisition slip Locates and negotiates with vendors Prepares Purchase Orders and sends out to vendors, user, receiving and AP Monitoring of the P.O.’s status and updates the requesting party Files P.O. until goods are received Upon receipt, counts and checks the goods’ condition Compares P.O. and shipping document Prepares receiving report to be forwarded to Purchasing and AP

Check and review P.R., P.O., receiving report and Vendor’s invoice • Prepares AP Voucher with complete attachments • Prepares daily summary to be forwarded to Treasury and General Accounting ✓ Reviews AP Vouchers ✓ Prepares Check Voucher and check and submit for signing ✓ Forwards checks and remittance advice to vendors •

Controls Within

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Exclusive function to communicate to the vendors Maintains list of authorized/accredited vendors Monitoring and comparing price

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Proper procedures to ensure that the receiving department will count and check the goods received

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AP Vouchers should be supported by complete attachments (P.R., P.O., Receiving docs)

✓ Check voucher must be stamped “paid”, “cancelled” and check number must be stated

AUDITING AND ASSURANCE PRINCIPLES, CONCEPTS, AND APPLICATIONS Ms. Desiree D. Cemefrania, CPA

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✓ Prepares Daily Summary to be forwarded to General Accounting

✓ Signatories should have assigned limit and/or cosignatories ✓ No checks should be issued with “Cash” payee

Forms/Documents Forms Requisition Slip (Purchase Request) Purchase Order

Description Contains the details of the user department’s request Describes the goods to be acquired

Initiated By: Requesting department Purchasing department

Shipping document

Describes the goods to be shipped. Serves as contract between seller and courier Described the goods to be received Describes the goods purchased Informing the seller that their invoice has been paid Summary of daily transactions of all the departments

Vendor

Receiving report Vendor’s invoice Remittance Advice Daily Summaries

Given to: Purchasing Vendor User Receiving dept Accounts Payable Receiving department

Receiving department Vendor

Purchasing Accounts Payable Accounts Payable

Treasury

Vendor

Accounts Payable Treasury

General Accounting

D. HUMAN RESOURCES AND PAYROLL CYCLE This cycle is part of the expenditure and disbursement cycle. This cycle covers the entity’s acquisition of services from its employees and personnel. Payroll includes different categories of employee benefits that could significantly affect major elements of financial statements and for most entities, significant amounts of resources is incurred. Types of Employee Benefits: ✓ ✓ ✓ ✓

Short-term Post-employment Other long-term benefits Retirement benefits

AUDITING AND ASSURANCE PRINCIPLES, CONCEPTS, AND APPLICATIONS Ms. Desiree D. Cemefrania, CPA

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Business Functions: ✓ Services are received from employees in exchanged for obligations to pay. ✓ Entity pays cash to employees Affected Accounts: ✓ ✓ ✓ ✓ ✓

Salaries and wages expense Salaries and wages payable Withholding taxes payable Inventories (for inventoriable salaries and wages) Cash

Departments Involved: Department User department • Ensures that time records prepared by the employees represent actual hours worked.

HR Department • To ensure that employees included in the payroll are rendering services to the entity

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Treasury Department

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Payroll Department • To provide reasonable assurance that payroll calculation is valid

Activities Monitors and approves daily time records

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Initiates, updates and maintains HR records Forwards payroll related information to Payroll department Determines terms of settlement in case of termination/resignation Monitors status of employment of employees Receives and reviews information from HR Considers update on pay rates and deductions Prepares payroll register Updates cumulative employee earnings per record Reviews payroll registered received Prepares check and facilitates signing

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Controls Within Appropriate review activities to ensure the truthfulness of the DTR information Use of reliable computer system in place of manual recording with exclusive access to users and proper approvals Access on employees’ files shall be limited to HR department only Limited employees’ information shall be shared to appropriate department

Appropriate level of management not part of the payroll department to conduct review for accuracy Assure adequate of segregation of duties internally and inter-department Separate bank accounts for payroll distribution

AUDITING AND ASSURANCE PRINCIPLES, CONCEPTS, AND APPLICATIONS Ms. Desiree D. Cemefrania, CPA

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Distributes payment to the employees • Prepares daily summary to be forwarded to General Accounting ✓ Records inventoriable costs to appropriate jobs or customer accounts and forwards daily summary to General Accounting ✓ Reviews daily summary received from different department and records related expenses •

Inventory Accounting

General Accounting

Forms/Documents: Forms HR Records (201 file) Daily Time Record (DTR)

Payroll Register Labor Cost Summary

Employee Earnings Record

Daily Summary

Description Contains all information related to the entity’s employees. Describes the number of hours worked by an employee for a particular pay period Shows all related payroll information Shows all capitalizable payroll information attributed to a particular job or customer order Cumulative YTD summary of earnings and deductions of every employee Summarizes transactions recorded during the day by different departments

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Regular audit with different intervals to be conducted to check existence of employees

Initiated By: HR Department

Given to: Payroll

User Department

Payroll

Payroll Payroll

Treasury General Accounting Inventory Accounting

Payroll

Accounts Payable

Payroll Inventory Treasury

General Accounting

E. PRODUCTION AND CONVERSION CYCLE Production and conversion cycle covers the production of entity’s product for sale. This is where materials, labor and overhead are converted into finished goods. The primary objective is the proper valuation of inventories. This encompasses the proper allocation of costs to each run made by the production department. This cycle uses inputs from disbursement and expenditure cycle and provides information to revenue and receipt cycle. Function Custody

Departments Assigned Production Department – physical custody of the

Control Procedures Physical count VS records

AUDITING AND ASSURANCE PRINCIPLES, CONCEPTS, AND APPLICATIONS Ms. Desiree D. Cemefrania, CPA

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materials documents Authorization

Recording

and

labor

Production Department – authorized to make normal production runs Special runs must be authorized by the BOD. Cost Accounting – records daily summary and forwarded to General Accounting.

If held by other parties, confirmation requests to custodians for verification Validation of the auditors whether the production runs are authorized with appropriate requests

Competency of the staffs must be evaluated Reconciliation to GL

F. FINACE AND INVESTMENT CYCLE This involves three (3) major categories: ✓ Investments ✓ Long-term Debts ✓ Shareholders’ Equity Processes involves the following: ✓ ✓ ✓ ✓

Accounting for investments Accounting for mergers Accounting for long term liabilities Accounting for equity transactions

FINANCE CYCLE Functions Custody

Authorization

Departments Assigned Corporate Secretary – unissued debt and equity certificates Board of Directors

Recording

General Accounting

Controls Frequent inquiries custodian

to

the

Review of the auditors by minutes of meetings Competency of the staffs must be evaluated Reconciliation to GL

INVESTMENT CYCLE Functions Custody

Departments Assigned Negotiable Instruments – Brokerage

Controls Auditor send out confirmation request to external custodian.

AUDITING AND ASSURANCE PRINCIPLES, CONCEPTS, AND APPLICATIONS Ms. Desiree D. Cemefrania, CPA

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Authorization

Titles to real estate accounts – within the entity’s safe or bank deposit box Board of Directors

Recording

General Accounting

If internally, auditor observes accounting for certificates held Review of the auditors by minutes of meetings Competency of the staffs must be evaluated Reconciliation to GL

V. References • Auditing and Assurance Concepts and Applications by Darrell Joe O. Asuncion, Mark Alyson B. Ngina and Raymund Francis A. Escala •

Auditing and Assurance, Concepts and Applications by Ma. Elenita Balatbat Cabrera and Gilbert Anthony B. Cabrera

AUDITING AND ASSURANCE PRINCIPLES, CONCEPTS, AND APPLICATIONS Ms. Desiree D. Cemefrania, CPA

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