Bab 2_09-44

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CHAPTER 2

THEORITICAL FOUNDATION

2.1 Auditing

2.1.1 Definition of Auditing

The term auditing was derived from the word audire, which means to hear.

(Gill et al. 1999, p. 4). Moreover, according to Arens et al. (2006, p. 4), auditing

can be defined as:

The accumulation and evaluation of evidence about information to determine

and report on the degree of correspondence between the information and

established criteria.

Moreover, as stated in the Auditing and Assurance Services in Australia book by

Gay & Simnett (2007, p. 16), the definition of auditing according to American

Accounting Association (AAA) in A Statement of Basic Auditing Concept

(ASOBAC) is:

A systematic process of objectively obtaining and evaluating evidence

regarding assertions about economic actions and events to ascertain the degree

of correspondence between those assertions and established criteria and

communicating the results to interested users.

Therefore, auditing could be defined as the process to analyze certain objects and

collect the evidences to check whether there is degree of correspondence

between the objects and the established criteria. Besides, an audit should be

conducted by person who is competent and has adequate knowledge of auditing.

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2.1.2 Types of Audits

As discussed by Arens et al.(2006, p.14), generally, there are three types of

audits:

Financial Statement Audit The financial statement audit is performed to determine whether the

companys financial statements are created based on the valid accounting

standards. Moreover, according to Gill & Cosserat (1996, p. 4), the financial

statements audit is usually conducted by the external auditors who is

selected by the shareholders of the company. Furthermore, after performed

the audit, the auditor should report the findings to several parties including

the shareholders, creditors, regulatory agencies, and public.

Compliance Audit The compliance audit is performed by the auditor to evaluate whether

specific financial or operating activities of the company are suitable with

certain conditions, rules or regulations set by the specific authorized party.

For example, some companies establish the internal audit function which

responsible to perform the compliance audit based on criteria set by the

management. In addition, the auditor should report the findings of

compliance audit to the authority that create the criteria.

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Operational Audit According to Arens et al. (2006, p. 14), the operational audit is performed to

evaluate the effectiveness and efficiency of the operating procedures,

methods and activity in the company. Generally, the scope of operational

audit includes all activities of a department, branch or division. In addition,

the scope might also include the activities of a function that cross the

business unit lines such as data processing function.

In addition, based on Gay & Simnett (2007, p. 38-39), the auditor might also

perform the comprehensive audit, which is the integration of financial statement

audit, compliance audit, and the performance audits. Moreover, due to the

increasing use of technology in business, the auditor is required to perform the

information system audit. The objective of this type of audit is to evaluate the

companys internal control especially which related with the information

processing using the computer systems.

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2.2 Operational Audit

2.2.1 Definition of Operational Audit

According to Gay & Simnett (2007, p. 716), the term operational audit is also

referred as the value-for-money (VFM), performance audit or management audit.

The operational audit is performed to evaluate the effectiveness and efficiency of

the entitys operating activities.

Furthermore, as stated in Auditing and Assurance Services in Australia (Gay &

Simnett 2007, p. 716), the term efficiency and effectiveness are defined in AUS

806 as follow:

Based on AUS 806.04, the term efficiency is defined as the use of a given set of resource inputs to maximize the outputs.

Based on AUS 806.05, the term effectiveness is defined as the achievement of the objectives or other intended effects of activities.

In addition, another definition of effectiveness and efficiency, based on

BusinessDictionary.com is:

Effectiveness is defined as the degree to which objectives are achieved and the extent to which targeted problems are resolved. In other word,

effectiveness might be defined as doing the right thing.

(BusinessDictionary.com, WebFinance, Inc. 2008)

Efficiency is defined as comparison of what is actually produced or performed with what can be achieved with the same consumption of

resources (money, time, labor, etc.). In other word, efficiency might be

defined as doing the thing right.

(BusinessDictionary.com, WebFinance, Inc. 2008)

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Besides, according to Gay & Simnett (2007, p. 716), the operational audit might

also include the review of:

Use of human, financial, and other resources; Information systems, performance measures and monitoring arrangements; Procedures followed by audited bodies for remedying identified

deficiencies.

Furthermore, after perform the operational audit, the auditor usually create the

audit report regarding the findings and provide some recommendations for the

improvement of the units that had been evaluated.

2.2.2 Types of Operational Audit

According to Arens et al. (2006, p. 778), there are three types of operational

audit that are:

1. Functional Audit

The functional audit is performed to evaluate the effectiveness and

efficiencies of one function or more in an organization. For example, the

auditor perform the functional audit of procurement or purchasing division to

evaluate whether the purchasing staff had made right decision to buy the

goods which have good quality with lowest prices.

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2. Organizational Audit

The organizational audit is performed to evaluate the effectiveness and

efficiency of the organizations procedures or methods that are used by all

organizational units in the organization including the divisions, subsidiaries

or branches. Moreover, this type of audit is also including the evaluation

regarding the effectiveness and efficiency of interaction among the divisions.

3. Special Assignment

The special assignment is usually performed by the auditor based on the

demand of management. The management might ask the auditors to evaluate

certain aspect of the company which is vulnerable to fraud or the

ineffectiveness and inefficiency of the existing procedures.

2.2.3 Stages Performed in Operational Audit

According to Gay & Simnett (2007, p. 719), there are several stages that should

be performed by the auditor in conducting the operational audit. Those stages

are:

1. Planning Stage

In the planning stage, the auditor should perform observation about the

clients company in order to collect the information needed and identify the

specific area that need to be audited. In addition, the auditor should also

obtain good understanding about the business of clients company and the

industry where the business operated.

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2. Preliminary Study Stage

In this stage, the auditor should determine the main issues of the audit, the

scope of audit and the schedule of audit work. Moreover, in this stage, the

auditor should also collect the information regarding how the operating

activity supposed to run and how the control activities supposed to work.

(Gay & Simnett, 2007, p. 720).

Nevertheless, the auditor should perform the analysis about the control

environment and the control activities implemented in the company. The

aspects that should be analyzed for those controls are:

i. Control environment

The control environment indicate the actions, policies, and procedures

performed by the top level of management, board of directors, owner and

managers regarding the importance and implementation of internal

control in the company.

ii. Control Activities

The control activities are defined by Arens et al. (2006, p. 278) as the

policy and procedures implemented in the company that consists of:

1. Adequate separation of duties;

2. Proper authorization of transactions and activities;

3. Adequate documents and records;

4. Physical control over assets and records;

5. Independent checks on performance.

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Furthermore, there are several procedures that could be used to obtain

information in the preliminary study stage, including:

Interviewing (Inquiry)

The auditor could perform interview with responsible staffs to obtain

information in specific area of clients company. Moreover, it will be

better if the auditor use open-ended and uncritical question approach

hence it do not waste the time of both parties and the clear picture of

the companys condition can be obtained well.

Observation

The auditor could perform physical observation regarding how the

staffs perform daily business operating activities in the company.

Hence, the auditor can evaluate whether the staffs had performed their

duties according to applicable standards or not. Moreover, as discussed

by Gay & Simnett (2007, p. 721), the auditor might perform walk-

through of transactions technique.

In performing this technique the auditor review the re-performance of

some transactions related to daily business operations from the

beginning step to the end. The purpose is to collect the information

regarding how the clients company performs the operating activities,

the ability of staffs, and the weaknesses that occur in the companys

existing procedures.

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3. Implementation Stage

As stated by Gay & Simnett (2007, p. 721), in the implementation stage the

auditor should perform several actions including:

Create the audit programs that relate the audit objectives to audit

procedures

In creating the audit programs, the auditor must determine the scope of

audit and state the clear audit objectives of every audit tests that will be

performed. Hence, the auditor can collect sufficient appropriate

relevant evidences that could support the auditor in making the audit

opinion.

Collect sufficient appropriate audit evidences by performing the

audit tests needed

When the auditor want to evaluate the effectiveness of internal control

implemented in the companys operating procedures, the type of audit

test that should be performed is the tests of controls. Moreover, there

are some procedures of tests of controls that should be performed in

collecting the evidences. Those procedures are obtain the information

from clients staffs regarding the business operation by using internal

control questionnaire, observe the clients staffs when performing the

business operation procedures and examine the documents related with

the clients business operating activities.

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Forms the audit findings, conclusions and recommendations.

After performing the audit test needed, the auditor should analyze the

audit findings, reach the conclusions and create recommendations

needed to improve the current performance of the unit being audited.

4. Reporting Stage

After performed all audit programs stated in operational audit procedures, the

auditor must create the operational audit report. The report consists of the

objectives, scope and approach of the audit, the findings and

recommendations provided. (Gay & Simnett, 2007, p. 723).

2.3 Sales and Collection Cycle

2.3.1 Definition of Sales

Sales are defined as the delivery of goods and services to the customers who

have ordered it and collect some amount of money as the exchange of those

goods and services. In addition, the basic principle of sales is it can only be

recognized when the transaction is already realized, or can be quite easily

realized. In addition, the delivery of the goods or services should have taken

place for the sales recognition. (InvestorWords.com, 2008).

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However, according to Arens et al. (2006, p. 411), the definition of sales is not

only limited to the transfer of goods or services physically to the customers, but

it also include the transfer of ownership of those goods or services. Therefore,

sales might be defined as the ownership transfer of goods or services to the

customers who order it and then, the customers will pay some amount of money

as the exchange for the goods or services.

2.3.2 Sales Cycle

Based on Arens et al. (2006, p. 411), the sales cycle consist of several processes

which intent to deliver the goods and services including its ownership to the

customers. Those processes are:

1. Accept and process the customers orders;

2. Granting credit;

3. Shipping Goods;

4. Billing Customers;

5. Recording Sales.

Moreover, the further explanation of every process in sales cycle based on Arens

et al. (2006, p. 411) will be described as follows:

1. Accept and process the customers orders

The customer order could be defined as the request of customer to buy some

goods or services. The supplier who sell the goods or render the services

might accept the customer order in the written form or verbally through the

telephone.

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In addition, the supplier might also send the sales representatives to offer the

goods or services to the people and if the customers are willing to buy the

products or render the services, they could order it through the sales

representatives directly.

Furthermore, as stated by Gill & Cosserat (1996, p. 499), after received the

customer orders, the supplier will identify whether the customer who place

the order is listed in the existing approved customer list or not. If the

customer is already listed, the order will be proceed and the sales order will

be created. However, if the customer is not listed yet, the supervisor of sales

orders division should analyze the order and decided whether to accept or

reject the order.

After that, if the order from customer is accepted, the sales order will be

issued. According to Gill & Cosserat (1996, p. 499), the document serve the

function as the indicator for the start of transactions trail and it can also be

used as the evidence for the management. In addition, the document consists

of the description of the goods or services ordered, the quantity requested and

other information related to the goods or services. (Arens et al., 2006, p.

412).

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2. Granting Credit

Generally, the credit departments in most companies who provide credit sales

to the customers should check the credit limit of the customers before they

approve the new credit sales. As discussed by Gill & Cosserat (1996, p. 499),

the credit limit checking is performed by compare the total price of new order

with the existing authorized credit limit and the existing debt of the customer.

In addition, at the present day, when the technology grown fast, many

companies implement the computer program that could automatically

approve the credit sales or reject it. The computer program will approve the

new credit sales if the total price of new order plus the existing customers

debt is less than the authorized credit limit set by the company in the

computer master file. (Arens et al. 2006, p. 412)

3. Shipping goods

The next step that will be performed after the new credit order approved by

the company is preparing the goods ordered that will be delivered to

customers. However, the staff who will deliver the goods should show the

picking list and copy of sales order to the warehouse staffs as the proof to

take the goods.

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Moreover, the warehouse staff should prepare the packing list of the goods

being delivered that indicate the description of goods, quantity, freight

charges and other relevant information. However, if the sellers use the

forwarder or carrier service to deliver the goods for customers, they should

also prepare the bill of ladings. In addition the warehouse staff should also

create the shipping notice document that consist of the document indicate that

the goods have been delivered and the copy of sales order.

4. Billing the customers

After deliver the goods or inventory to the customers, the company will

generate sales invoices related to the goods and send it to bill the customers.

Moreover, as stated by Arens et al. (2006, p. 412), the main concern

regarding billing the customers is to ensure that all the goods shipped have

been billed at authorized prices and there is no duplicate billings sent to the

customers.

5. Recording Sales

The last step perform in sales cycle is recording the sales transactions. As

discussed by Gill & Cosserat (1996, p. 500), the recording transactions could

be performed either manually or using computer system. For the manual

recording system, the process is started by inputting the sales invoices to the

sales journal. After that, the invoices are posted to the accounts receivable

subsidiary ledger and the sales journal will be posted to the general ledger

accounts.

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On the other hand, if the recording of sales transactions is performed using

the computerized system, the staff does not need to input the sales invoices to

update the sales transaction file, accounts receivable master file, and general

ledger master files since the sales transactions file created in the previous

billing process could be used to update it automatically.

2.3.3 Definition of Collection

The definition of collection in relation with sales cycle is the action performed to

collect the payment as the exchange for the goods and services that had been

delivered to the customers. Some companies establish the collection department

as the separate function which responsible to collect the payment from the

customers.

In certain circumstances, the customers might not able to pay their debt or

runaway to avoid the debt. However, the companies have prepared the

anticipation action to face this problem by estimating the provision amount of

bad debt expenses or uncollectible debts.

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2.3.4 Collection Cycle

According to Arens et al. (2006, p. 414), the collection cycle consist of some

processes that are performed to collect the receivables from customers as the

exchange for goods and services delivered and recording the transaction of cash

receipt. Those processes are:

1. Accept the cash receipts

As discussed by Gill & Cosserat (1996, p. 508), the receiving process of cash

receipts might be performed through:

Over-the-counter receipts

The companies usually assign the collectors who will responsible to

collect the receivable from customers. Then, the collectors will submit

the cash collected to the cashier. After received the cash, the cashier will

give over-the-counter receipts which is usually generated from the cash

register or point-of-sale terminal. These devices are used to reduce the

possibility of theft toward cash.

2. Depositing the cash receipt

Arens et al. (2006, p. 414) stated that the main consideration of handle cash

receipts is all of the cash received in a day should be deposited in the bank at

the correct amount as stated in the remittance list. In addition, the cashier

should also record the cash receipts transactions that can be used to generate

the cash receipt journal and update the accounts receivables and general

ledger master files.

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3. Recording the cash receipt transaction

In this stage, the companys staffs who responsible to record the cash receipts

transaction should ensure that they had recorded valid transaction. Moreover,

according to Gill & Cosserat (1996, p. 509), the companies who use over-the-

counter receipts, usually record the transaction in general ledger by using the

data generated from the daily cash summary prepared by the cashier.

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2.4 Operational Audit on Sales and Collection Cycle

2.4.1 Stages Performed in Operational Audit on Sales Cycle

According to Arens et. al (2006, p. 416-417), the auditor should perform several

stages in conducting the operational audit on sales cycle. Those stages are:

1. Planning stage

The auditor should obtain the information regarding client companys sales

operations. Therefore, the auditor might use the information to assess the

risks that might be associated with the companys internal control of sales.

2. Preliminary study stage

In this stage, the auditor could assess the control risk associated with sales by

performing some procedures that are:

Identify the existing control of sales implemented by the company; Identify the sales transaction-related audit objectives, as stated by Arens

et. al (2006, p. 420-421):

i. Existence

Recorded sales are for shipments actually made to customers.

ii. Completeness

Existing sales transactions are recorded.

iii. Accuracy

Recorded sales are for the amount of goods shipped and are

correctly billed and recorded.

iv. Classification

Sales transactions are properly classified.

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v. Timing

Sales are recorded on the correct dates.

vi. Posting and Summarization

Sales transactions are properly included in the accounts

receivable master file and are correctly summarized.

Determine the key internal controls and weaknesses found in the clients company;

Correlate the weakness found with the objectives; Evaluate the control risk associated with every sales transaction related

audit objectives.

3. Implementation Stage

In this stage, the author should design the audit programs that consist of

several audit procedures including the types of audit tests that are needed to

be performed to obtain the evidences. For instance, the auditor will perform

the tests of control to verify the effectiveness of internal control implemented

in sales cycle of the company.

4. Reporting Stage

After perform all audit procedures, the auditor should create the audit report

that contains the summary of audit findings and it might also include the

recommendations needed to improve the business performance, especially the

sales cycle.

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2.4.2 Stages Performed in Operational Audit on Collection Cycle

The stages performed in operational audit on collection cycle are consists of:

1. Planning stage

The auditor should obtain the information regarding client companys

business operations on collection cycle. Therefore, the auditor might use the

information to assess the risks that are associated with companys internal

control of collection cycle.

2. Preliminary study stage

The auditor should obtain good understanding about the internal control of

collection cycle implemented in the clients company.

Identify the existing control of collection implemented by the company; Identify the collection of cash receipts transaction-related audit

objectives, as stated by Arens et. al (2006, p. 428-429):

i. Existence

Recorded cash receipts are for funds actually received by the

company.

ii. Completeness

Cash received is recorded in the cash receipts journal.

iii. Accuracy

Cash receipts are deposited and recorded at the amount received.

iv. Classification

Cash receipts transactions are properly classified.

v. Timing

Cash receipts are recorded on the correct dates.

vi. Posting and Summarization

Cash receipts are properly included in the accounts receivable

master file and are correctly summarized.

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Determine the key internal controls and weaknesses found in the clients company;

Correlate the weakness found with the objectives; Evaluate the control risk associated with every cash receipts transaction

related audit objectives.

3. Implementation Stage

In this stage, the author should design the audit programs that consist of

several audit procedures including the types of audit tests that are needed to

be performed to obtain the evidences. For instance, the auditor will perform

the tests of control to verify the effectiveness of internal control implemented

in the collection cycle of the company.

4. Reporting Stage

After perform all audit procedures and obtain the findings, the auditor should

create the audit report that contains the summary of the findings and it might

also include the recommendations needed to improve the business

performance, especially for the collection cycle.