“Auditing standards require the auditor to obtain an understanding of the entity and its environment as a basis
for assessing the risks of material misstatements. Business models differ
across organizations and industries leading to unique business processes needed
to account for transactions. While the core business functions for the sales
and collection cycle discussed in this chapter are generally relevant to all
organizations, the underlying business processes and related documents and
records are often unique to each organization. Below are four descriptions of
different businesses.

1. The Starbucks Coffee Company sells regular and specialty coffees and teas in over 15,000 stores spanning
more than 50 countries. Customers use cash, debit or credit cards, and pre-paid
Starbucks cards to purchase individual drinks that are served to them within
minutes.
2. Amazon.com is one of the worlds
largest online retailers of all kinds of products. While consumers can find a
wide variety of products available at Amazon.com, the company is known for its
huge selection of new and used books that can be purchased on its Web site.
3. Most people have a personal
physician who provides medical care when needed, including annual physicals and
other medical services. Patients make appointments to be seen by their
physician, who examines the patient and prescribes treatments and medications
when needed. Insured patients often pay a co-payment with the balance paid by
the insurance company.
4. The majority of universities
generate a significant portion of their revenue from tuition. Universities bill
students in advance for classes that will be taken in an upcoming term. For
full-time students, most universities charge a set tuition amount after
students enroll in a minimum number of courses per term.

Required
Analyze each of the above
independent business scenarios to answer each of the following questions:
a. Using the eight business
functions for the sales and collection cycle illustrated in Table 14-1 on page
441 as a guide, briefly describe the underlying business processes related to
each of the eight functions for the sales and cash collections for the above
independent scenarios.
b. What documents or other source
evidence would you use to test the occurrence transaction-related audit
objective for sales for each of the four scenarios?
c. For which of the four scenarios
would the sales returns and allowances business function not be applicable?
d. For which of the four scenarios
would the write-off of uncollectible accounts and bad debt expense business
functions not be applicable?

SOLUTION

(a)

Business Function

Starbucks

Amazon

Physician Practice

University

Processing customer orders

Baristas receive orders
from customers at the cash register.

Customers shop and process
orders online via the Amazon.com Web site.

Physicians provide medical
treatments based on the physicians diagnosis while patient is at the office.

University registrars have
records of enrolled students. Students are billed in advance of a semester based
on whether they are full-time or part-time students.

Granting
credit

No credit approval is
required for cash sales. Debit or credit card sales are verified by swiping
of card, which verifies transaction. Large debit or credit card sales require
online credit approval from credit card company.

Customers make purchases
via debit or credit cards. The Amazon system verifies credit worthiness with
credit card company before completing sales order.

Before services are
provided, patients must present documentation of health insurance coverage.
Physician practices generally are aware of insurance coverage for specific
health plans. For those patients without health insurance, somepractices
require prepayment of services and they often require patients to sign legal
documents indicating their obligation to pay.

Many universities do not
grant credit for tuition. Rather, students seek credit from outside sources
(e.g., student loans) and remit the cash to the university. If tuition is not
paid by a certain date in the early part of a semester, the student is no
longer allowed to take classes.

Shipping goods

Goods are delivered to
customer on site just after order is placed.

Goods are shipped after
the online sale is processed. Shipment is made via third-party shippers
(e.g., FedEx, UPS, etc.).

Medical services are
provided to the patient at the physicians office. No shipment of goods is
required.

There is no shipment of
goods. Universities deliver classes onsite or online.

Billing customers and
recording sales

All sales are entered in
the cash register upon ordering.

The Amazon online sales
system captures the salesorder at the point of ordering and customer
debit or credit card transactions are approved before order is complete;
payment is processed by Amazon from credit card companies, generally daily.
No separatebilling by Amazon is required.

Co-payments are collected
from patient upon exiting the physicians offices. Physician practices bill
insurance companies for services provided. Any non-covered services are later
billed to the patient.

Tuition is billed in
advance of providing access to classes. Tuition is recorded as a receivable
when billed and the revenue is recorded once the courses are delivered.

Processing and recording
cash receipts

Cash is collected as order
is placed and cash is entered
in the cash register drawer. Subsequently, cash in drawer is reconciled to
records generated by the cash register.

Cash is received
electronically from customer bank accounts for debit card transactions and
from credit card company electronic funds transfer (EFT) transactions.

A cashier at the
physicians office collects any co-payments or other amountsas patient exits the physicians
office. Payments from insurance companies
are sent to the physicians offices for processing.

Tuition payments are
typically received at the universitys cashiers office or by mail via a bank
lockbox.

Processing and recording
sales returns and discounts

Returns or discounts are
recorded using the cash register. Most likely, larger returns or discounts
must be approved by the store manager.

Customers must ship
merchandise for return back to specified Amazon distribution center for
processing. Discounts are applied electronically by the Amazon online sales
system at the point of customer ordering.

Generally, pre-negotiated
discounts associated with health insurance are processed at the point of
checkout. However, other discounts may be required by the insurance company,
which would be processed later by the physicians billing office.

Any tuition waivers or
scholarships provided by the university are processed as part of the billing
process as approved by the registrars office.

Writing off uncollectible
accounts

The only uncollectible
accounts relate to purchases made with an invalid credit card.

The only uncollectible
accounts relate to purchases made with an invalid credit card.

Because of the
complexities surrounding health insurance coverage and because of the number
of individuals without health insurance, there is a high likelihood that
patient receivables may not be fully collectible. Physician practices closely
monitor uncollectible accounts and periodically write-off those deemed
uncollectible. Many are turned over to collection agencies for processing.

If tuition is not paid in
full, the student generally is unable to complete courses. Most universities
require payment in full before acertain point in the semester. When tuition
is unpaid, the student is no longer able
to take the course. While some private universities may set up longer-term
receivables, most universities require the student to obtain loans from
non-university sources; thus, they often do not maintain large long-term
receivable balances. Write-off of tuition receivables would be approved by
the universitys billing office.

Providing for bad debts

Because most sales are
made with cash or debit card, the only provision for bad debts relates to
sales paid by credit cards that are not valid.

Because most sales are
made with debit or credit card, the only provision for bad debts relates to
sales paid by invalid debit or credit cards.

Because of the high
likelihood of uncollectible patient receivables, the provision for bad debts
Is likely to be a material account.

The universitys
accounting function would be required to record an estimate of likely bad
debts associated with unpaid tuition.

b.

Transaction Objective

Starbucks

Amazon

Physician Practice

University

Occurrence of sales

The auditor would likely
reconcile sales records generated by the cash register system to cash
deposited at the bank to obtain evidence that recorded sales occurred. If
sales are overstated, no cash would have been received from customers for
those invalid sales. So, cash deposited would be less than sales in that
situation.

The auditor may perform
analytical procedures that examine the relationship between sales recorded
and inventory usages.

The auditor could inspect
documentation from the Amazon distribution centers that goods were shipped
for a sample of sales transactions recorded.

The auditor could also
examine subsequent electronic fund transfers from banks and credit card
companies for sales orders processed.

The auditor could select a
sample of patient revenue transactions recorded and verify that there was
documentation of medical procedures performed in the patients medical
records.

The auditor could select a
sample of tuition revenue transactions and verify payment was received from
the student for the amounts billed. The auditor could also verify records in
the registrars office that the student is enrolled and course grades were
issued for the semester paid.

c. Physician
offices and universities would generally not have salesreturn
activities. While Starbucks may receive returns for some merchandise in
their stores (e.g., coffee mugs), they would likely not process a high volume
of returns for drinks, which are usually consumed shortly after purchase.

d. Starbucks
and Amazon most likely would not have a large volume of write-offs of
uncollectible accounts given they generally acceptpayment in cash and debit or
credit cards, which are processed daily by bank and credit companies.Auditing standards require the
auditor to obtain an understanding of the entity and its environment as a basis
for assessing the risks of material misstatements. Business models differ
across organizations and industries leading to unique business processes needed
to account for transactions. While the core business functions for the sales
and collection cycle discussed in this chapter are generally relevant to all
organizations, the underlying business processes and related documents and
records are often unique to each organization. Below are four descriptions of
different businesses. 1. The Starbucks Coffee Company
sells regular and specialty coffees and teas in over 15,000 stores spanning
more than 50 countries. Customers use cash, debit or credit cards, and pre-paid
Starbucks cards to purchase individual drinks that are served to them within
minutes.2. Amazon.com is one of the worlds
largest online retailers of all kinds of products. While consumers can find a
wide variety of products available at Amazon.com, the company is known for its
huge selection of new and used books that can be purchased on its Web site.3. Most people have a personal
physician who provides medical care when needed, including annual physicals and
other medical services. Patients make appointments to be seen by their
physician, who examines the patient and prescribes treatments and medications
when needed. Insured patients often pay a co-payment with the balance paid by
the insurance company.4. The majority of universities
generate a significant portion of their revenue from tuition. Universities bill
students in advance for classes that will be taken in an upcoming term. For
full-time students, most universities charge a set tuition amount after
students enroll in a minimum number of courses per term.Required Analyze each of the above
independent business scenarios to answer each of the following questions:a. Using the eight business
functions for the sales and collection cycle illustrated in Table 14-1 on page
441 as a guide, briefly describe the underlying business processes related to
each of the eight functions for the sales and cash collections for the above
independent scenarios.b. What documents or other source
evidence would you use to test the occurrence transaction-related audit
objective for sales for each of the four scenarios?c. For which of the four scenarios
would the sales returns and allowances business function not be applicable?d. For which of the four scenarios
would the write-off of uncollectible accounts and bad debt expense business
functions not be applicable?SOLUTION(a)Business Function
Starbucks
AmazonPhysician Practice
UniversityProcessing customer ordersBaristas receive orders
from customers at the cash register.Customers shop and process
orders online via the Amazon.com Web site.Physicians provide medical
treatments based on the physicians diagnosis while patient is at the office.University registrars have
records of enrolled students. Students are billed in advance of a semester based
on whether they are full-time or part-time students.Granting
creditNo credit approval is
required for cash sales. Debit or credit card sales are verified by swiping
of card, which verifies transaction. Large debit or credit card sales require
online credit approval from credit card company.Customers make purchases
via debit or credit cards. The Amazon system verifies credit worthiness with
credit card company before completing sales order.Before services are
provided, patients must present documentation of health insurance coverage.
Physician practices generally are aware of insurance coverage for specific
health plans. For those patients without health insurance, somepractices
require prepayment of services and they often require patients to sign legal
documents indicating their obligation to pay.Many universities do not
grant credit for tuition. Rather, students seek credit from outside sources
(e.g., student loans) and remit the cash to the university. If tuition is not
paid by a certain date in the early part of a semester, the student is no
longer allowed to take classes.Shipping goodsGoods are delivered to
customer on site just after order is placed.Goods are shipped after
the online sale is processed. Shipment is made via third-party shippers
(e.g., FedEx, UPS, etc.).Medical services are
provided to the patient at the physicians office. No shipment of goods is
required.There is no shipment of
goods. Universities deliver classes onsite or online.Billing customers and
recording salesAll sales are entered in
the cash register upon ordering.The Amazon online sales
system captures the salesorder at the point of ordering and customer
debit or credit card transactions are approved before order is complete;
payment is processed by Amazon from credit card companies, generally daily.
No separatebilling by Amazon is required.Co-payments are collected
from patient upon exiting the physicians offices. Physician practices bill
insurance companies for services provided. Any non-covered services are later
billed to the patient.Tuition is billed in
advance of providing access to classes. Tuition is recorded as a receivable
when billed and the revenue is recorded once the courses are delivered.Processing and recording
cash receiptsCash is collected as order
is placed and cash is entered
in the cash register drawer. Subsequently, cash in drawer is reconciled to
records generated by the cash register.Cash is received
electronically from customer bank accounts for debit card transactions and
from credit card company electronic funds transfer (EFT) transactions. A cashier at the
physicians office collects any co-payments or other amountsas patient exits the physicians
office. Payments from insurance companies
are sent to the physicians offices for processing.Tuition payments are
typically received at the universitys cashiers office or by mail via a bank
lockbox.Processing and recording
sales returns and discountsReturns or discounts are
recorded using the cash register. Most likely, larger returns or discounts
must be approved by the store manager.Customers must ship
merchandise for return back to specified Amazon distribution center for
processing. Discounts are applied electronically by the Amazon online sales
system at the point of customer ordering.Generally, pre-negotiated
discounts associated with health insurance are processed at the point of
checkout. However, other discounts may be required by the insurance company,
which would be processed later by the physicians billing office.Any tuition waivers or
scholarships provided by the university are processed as part of the billing
process as approved by the registrars office.Writing off uncollectible
accountsThe only uncollectible
accounts relate to purchases made with an invalid credit card.The only uncollectible
accounts relate to purchases made with an invalid credit card.Because of the
complexities surrounding health insurance coverage and because of the number
of individuals without health insurance, there is a high likelihood that
patient receivables may not be fully collectible. Physician practices closely
monitor uncollectible accounts and periodically write-off those deemed
uncollectible. Many are turned over to collection agencies for processing.If tuition is not paid in
full, the student generally is unable to complete courses. Most universities
require payment in full before acertain point in the semester. When tuition
is unpaid, the student is no longer able
to take the course. While some private universities may set up longer-term
receivables, most universities require the student to obtain loans from
non-university sources; thus, they often do not maintain large long-term
receivable balances. Write-off of tuition receivables would be approved by
the universitys billing office.Providing for bad debtsBecause most sales are
made with cash or debit card, the only provision for bad debts relates to
sales paid by credit cards that are not valid.Because most sales are
made with debit or credit card, the only provision for bad debts relates to
sales paid by invalid debit or credit cards.Because of the high
likelihood of uncollectible patient receivables, the provision for bad debts
Is likely to be a material account.The universitys
accounting function would be required to record an estimate of likely bad
debts associated with unpaid tuition.b.Transaction ObjectiveStarbucksAmazonPhysician PracticeUniversityOccurrence of salesThe auditor would likely
reconcile sales records generated by the cash register system to cash
deposited at the bank to obtain evidence that recorded sales occurred. If
sales are overstated, no cash would have been received from customers for
those invalid sales. So, cash deposited would be less than sales in that
situation.The auditor may perform
analytical procedures that examine the relationship between sales recorded
and inventory usages. The auditor could inspect
documentation from the Amazon distribution centers that goods were shipped
for a sample of sales transactions recorded.The auditor could also
examine subsequent electronic fund transfers from banks and credit card
companies for sales orders processed.The auditor could select a
sample of patient revenue transactions recorded and verify that there was
documentation of medical procedures performed in the patients medical
records.The auditor could select a
sample of tuition revenue transactions and verify payment was received from
the student for the amounts billed. The auditor could also verify records in
the registrars office that the student is enrolled and course grades were
issued for the semester paid.c. Physician
offices and universities would generally not have salesreturn
activities. While Starbucks may receive returns for some merchandise in
their stores (e.g., coffee mugs), they would likely not process a high volume
of returns for drinks, which are usually consumed shortly after purchase.d. Starbucks
and Amazon most likely would not have a large volume of write-offs of
uncollectible accounts given they generally acceptpayment in cash and debit or
credit cards, which are processed daily by bank and credit companies.”