Auditing and Assurance Services: An Intergrated Approach, 9/e
Arens, Beasley, Elder

Part 3aVideo Transcript

Application of the Audit Process to the Sales and Collection Cycle (Tests of Controls)

ARENS: Hi, I'm Al Arens, co-author of Auditing and Assurance Services: An Integrated Approach. I would like to briefly introduce this segment.

There is an old adage: "don't go looking for trouble." It may be good advice when it comes from mothers, but it is not necessarily applicable in auditing. After all, there can be a real competitive advantage from conducting periodic audits of the risks that stem from every aspect of a business.

For example, what's the only thing more devastating to the corporate bottom-line than not making a huge potential sale? The answer: making a sale, but - because of a faulty credit decision - never collecting on the receivable.

Credit professionals can prevent this potential for loss by anticipating problems that could destroy the profit margin. In this segment, Hal Schaeffer and Mary Ludwig - two long-time observers of credit risk management - offer auditors some insights into the importance of the credit process.

SCHAEFFER: "A" is for analysis - that goes hand-in-hand with what I said earlier as far as taking financial information and looking at it from four different points of view. You're going to be looking at it from a common size analysis. You'll be looking at it from a trend analysis and industrial statistics, and doing comparisons on that. And, you'll also do ratio analysis where you will also convert numbers into corresponding ratios, and by doing trend analysis, you could see how each year compares to each other. You can also compare how they look against industrial numbers, which are supplied by firms such as Robert Morris and Associates.

Step "B," which is building a solid credit investigation. You want to compile all the information that you need, credit reports, trade references, bank references, etc., to make a sound business credit decision. This involves having access to different information, possibly the Internet as well, and doing a key search.

The next is "C" which is critical to putting this whole aspect together as looking at all the different aspects of outside factors and inside company factors that affect a credit decision. Things such as the margin that you have on your products. Other things such as, where is your customer? Are they local? Are they international? What type of product are you selling? Are you selling a commodity, versus a very exclusive, very hard to get piece of product. If that's the case, your selling tactics and your decision-making ability as far as credit is concerned, are totally different than if you have a basic commodity that anybody can supply.

And finally "D" is the... making the decision ultimately, and being prepared to be overridden by someone higher up that may take a different approach at whether they want to extend credit to that particular customer or not. If there's a need that the credit executive doesn't have available to them, then they may take and say, "Well this is the way we have to go forward with this piece of business." And if that's the case, you want to take an approach of being a team player. You want to make sure that you maximize your sales, minimize your risk. And by doing so, this time you may be taking a greater risk, but if you can watch over how it plays out, you can take it and turn around and minimize that risk.