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Chapter 16Completing the Tests in the Sales and
Collection Cycle: Accounts Receivable(See Phase III in Figure 16-1 on page 485)
Now is the time to test the details
of balances.
Presentation Outline
I. Analytical Procedures
II. Designing Tests of Details of Balances
III. Confirmation of Accounts Receivable
IV. Sample Audit Program
I. Analytical Procedures for Accounts Receivable
A. Analytical Procedures Defined
B. Account Receivables that Deserve Special Attention
C. Some Typical Analytical Procedures
A. Analytical Procedures Defined
When analytical procedures in the sales and collection
cycle uncover unusual fluctuations, the auditor should make additional
inquiries of client management.
Client responses should be critically evaluated to
determine their adequacy and whether they are supported by other
corroborative evidence.
B. Account Receivables that Deserve Special Attention
Large balances may be overstated.
Accounts that have been outstanding for a long period of
time may not be collectible. Receivables from affiliated companies, officers, directors, and other related parties may
need separate disclosure. Significant credit balances may
need to be reclassified as a liability.
C. Some Typical Analytical ProceduresAnalytical Procedure Possible MisstatementCompare gross margin
percentage with previous years (by product line).
Overstatement or understatement of sales and
accounts receivable.
Compare sales returns and allowances as a percentage of
gross sales with previous years (by product line).
Overstatement or understatement of sales
returns and allowances and accounts receivable.
Compare bad debt expense as a percentage of gross sales with
previous years
Uncollectible accounts receivable that have not been
provided for.
Compare allowance for uncollectible accounts as a
percentage of accounts receivable with previous years.
Overstatement or understatement of allowance for uncollectible accounts and
bad debt expense.
II. Designing Tests of Details of Balances
A. Tie-in of Aged Trial Balance
B. Existence of Accounts Receivable
C. Completeness of Accounts Receivable
D. Accuracy of Accounts Receivable
E. Proper Classification of Account Receivable
F. Correct Cutoff of Sales and Receivables
G. Realizable Value
H. Client Rights to Accounts Receivable
I. Presentation and Disclosure of Accounts Receivable
A. Tie-in of Aged Trial Balance
Most tests of accounts receivable and the allowance for uncollectible accounts are
based on the aged trial balance (See Figure 16-3 on
page 491) The aged trial balance should
be tied into the control account on the general ledger
before other tests begin, in order to ensure that the total
population is being tested.
B. Existence of Accounts Receivable
When customers do not respond to confirmations,
auditors also examine supporting documents to verify the shipment of the
goods and evidence of subsequent cash receipts to determine if accounts were
collected.These additional audit
procedures are not as imperative when customers respond to confirmations.
C. Completeness of Accounts Receivable
The understatement of sales and accounts receivable is best
uncovered by substantive tests of
transactions for shipments made but not recorded, and by
analytical procedures.
D. Accuracy of Accounts Receivable
Confirmation of individual customer accounts is the
most common test of details for balances for
accounts receivable.Supporting documentation
for shipments and cash receipts can also be examined to support individual entries to customer accounts.
E. Proper Classification of Accounts Receivable
The aged trial balance can be reviewed for material
receivables from affiliates, officers, directors, and
other related parties. Such balances often require
segregation from accounts receivable and disclosure.
Significant credit balances in accounts receivable
should be reclassified as accounts payable.
F. Correct Cutoff of Sales and Receivables
Sales cutoff – the proper cutoff of sales can be easily verified when a client uses sequential prenumbered shipping
documents.Sales returns and allowances cutoff – most companies
record sales returns and allowances in the period they occur, assuming that they occur in fairly constant amounts over
time.Cash receipts cutoff – auditor may check to see if client is
holding the cash receipts book open, by tracing recorded cash receipts to subsequent period bank deposits on the
bank statement. A delay of several days could indicate a cutoff misstatement.
G. Realizable Value
GAAP requires that accounts receivable be stated at the
amount that will ultimately be collected (total A/R less allowance for doubtful
accounts). A common method of
evaluation is to examine noncurrent accounts on the
aged trial balance. The collectibility of more current accounts must also be
assessed.
H. Client Rights to Accounts Receivable
A portion of the receivables may have been pledged as collateral, assigned to someone else, or sold at a discount.
Customer confirmations will not uncover this since customers are often unaware of the arrangements.
A review of the minutes, discussions with the client, confirmation with banks, and the examination of debt
contracts may uncover such arrangements.
I. Presentation and Disclosure of Accounts ReceivableReceivables from officers
and affiliated companies must be segregated from accounts receivable from customers if the amounts
are material.Account receivable
footnote disclosure includes information about the pledging, discounting, factoring, assignment of accounts receivable, and amounts due from related
parties.
III. Confirmation of Accounts Receivable
A. The Confirmation Requirement
B. Types of Confirmations
C. The Acceptability of Negative Confirmations
D. Follow-up of Nonresponses to Positive Confirmations
E. Analysis of Differences
F. Factors Affecting Sample Size
A. The Confirmation Requirement
Accounts receivable are immaterial
Auditor considers confirmations to be ineffective evidence
because response rates will likely be inadequate.
The combined level of inherent risk and control
risk is low and other substantive evidence can
be accumulated to provide sufficient evidence.
Although auditing standards require confirmation of
accounts receivable, there are three
situations where they are deemed
unnecessary.
B. Types of Confirmations
Positive ConfirmationsRecipient is requested to
reply to the auditor whether the balance of the
account is correct or incorrect
More reliable than negative confirmations.
See Figure 16-5 on page 498.
Negative ConfirmationsRecipient is requested to
reply to the auditor only if the balance is incorrect.
The uncertainty associated with no response makes them less reliable than positive confirmation.
See Figure 16-6 on page 499.
Note: It is also common to use a combination of confirmations,sending the positives to accounts with large balances and the
negatives to those with small balances.
C. The Acceptability of Negative Confirmations
All three of the following conditions must be met
before an auditor can use negative confirmations:
Accounts receivable is made up of a large number of small
accounts. Combined assessed control
risk and inherent risk is low. Recipients of the
confirmations are likely to give them adequate
consideration.
D. Follow-up of Nonresponses to Positive Confirmations
Failure of customers to respond to initial confirmations often results in 2nd and possibly even 3rd confirmations being sent. When positive confirmations are used, SAS 67 requires follow-up
procedures for unreturned confirmations. Alternative procedures include:
Examination for subsequent cash receipt of the receivable. This approach is generally considered to be the best alternative
procedure. Verifying the issuance of the sales invoice and date of billing. Examination of shipping documents to determine if an actual
shipment occurred. Examining correspondence of disputed amounts between the
client and their customer.
Note: In some cases auditors will assume that nonresponses are 100percent overstatement amounts.
E. Analysis of Differences
Payment has already been made – customer has made a payment before the confirmation date, but the client has not received the
payment in time for recording before the confirmation date. Goods have not been received – client records the sale at the date
of shipment and the customer records the acquisition when the goods are received.
Goods have been returned – client’s failure to record a credit memo could result from timing differences or the improper
recording of sales returns and allowances. Clerical errors and disputed amounts – customer states that there
is an error in the price charged for the goods, the goods are damaged, the proper quantity of the goods was not received, etc.
Note: The analysis of differences is important because even immaterial errors may add up to a considerable amount when
combined with other misstatements.
F. Factors Affecting Sample Size
Tolerable misstatementInherent riskControl risk
Achieved detection risk from other proceduresType of confirmation (negative form requires
more confirmations)
IV. Sample Audit Program
See Table 16-5 on page 504 for an Illustration of an Audit Program for Tests of Details of Balances for the Sales and
Collection Cycle.
Summary
Analytical Procedures and Accounts Receivable Needing Special AttentionThe 9 Test of Balances AssertionsPositive and Negative ConfirmationAlternative Procedures for Lack of
Customer Responses to Positive Confirmation.