©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 1

Completing the Tests in theSales and Collection Cycle:

Accounts Receivable

Chapter 16

Learning Objective 1

Describe the methodology

for designing tests of details

of balances using the

audit risk model.

Accounts Receivable Balance-Related Audit Objectives

Detail tie-in

Completeness

ClassificationExistence

Accuracy

Cutoff

Realizablevalue

Rights andobligations

Methodology for Designing Tests of

Balances – Accounts Receivable

Identify client business risksaffecting sales and collection

cycle and set audit risk (ch. 8).

Set tolerable misstatement for A/R and assess inherent risk for sales and collection cycle (ch. 9).Potential FR – improper rev recognition (ch. 11)

Assess control risk for salesand collection cycle (ch. 10).

Methodology for Designing Tests of

Balances – Accounts Receivable

Design and perform tests ofcontrols and substantive testsof transactions for sales and

collection cycle (ch. 14 and 15).

Design and perform analyticalprocedures for sales and collection

cycle balances (e.g., sales, BDE) (ch. 8 and 16).

Methodology for Designing Tests of

Balances – Accounts Receivable

Design tests of details ofaccounts receivable balance

to satisfy balance-relatedaudit objectives.

Audit procedures/staffingSample size/budget

Items to selectTiming

Relationship Between Sales and Accounts Receivable: dr. A/R (inc), cr. Sales (inc)

OccurrenceCompletenessAccuracyClassificationTiming

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Posting/Summary

Accounts ReceivableBalance-Related

Audit Objectives →

Transaction-RelatedAudit Objectives

Sales ↓

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Relationship Between Collections and Accounts Receivable: dr. cash (inc), cr. A/R (dec)

OccurrenceCompletenessAccuracyClassificationTiming

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Posting/Summary

Accounts ReceivableBalance-RelatedAudit Objectives

Transaction-RelatedAudit Objectives

Cash receipts

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Say what???

Recording a cash receipt that did not occur (cash – occurrence violation) violates completeness objective for A/R – there is an open A/R not in the accounting records (A/R reduced with false j/e).

Failure to record a cash receipt (cash – completeness violation) means violation of existence for A/R – A/R should be reduced – does not exist.

Learning Objective 2

Design and perform analytical

procedures for accounts in the

sales and collection cycle.

Analytical Procedures for the Sales and Collection Cycle

Gross margin percentage with previous years

Sales by month over time

Sales returns and allowances as a percentageof gross sales with previous years

Sales growth vs. related NFM growth

Analytical Procedures for the Sales and Collection Cycle

Individual customer A/R balances over a stated amount

Bad debt expense as a percentage of gross sales

Days that accounts receivable are outstanding

Analytical Procedures for the Sales and Collection Cycle

Aging category as a percentage of receivables

Allowance for uncollectible accountsas a percentage of accounts receivable

Charge-off of uncollectible accountsas a percentage of total accounts receivable

Selected Comparative Information

Percent Percent2008 Change 2007 Change 2006

(000) 08-07 (000) 07-06 (000)Sales 144.3 9.4 132.0 6.5 124.0Gross margin 39.8 9.3 36.4 7.1 34.0Accounts receivable 20.2 7.4 18.8 13.9 16.5Bad debt expense 3.3 (2.9) 3.4 9.7 3.1Total assets 61.4 (7.0) 66.0 8.0 61.1Net earnings 5.7 21.3 4.7 38.2 3.4Number of accounts receivable 258 16.7 221 5.7 209

Analytical ProceduresSales and Collection Cycle

2008 2007 2006Gross margin/net sales 27.8% 27.7% 27.5%Sales R&A/gross sales .9% .9% .8%Bad debt expense/net sales 2.3% 2.6% 2.4%Allowance for uncollectible accounts/accounts receivable 6.1% 8.2% 8.4%Number of days receivables outstanding 51.5 52.3 51.2Net accounts receivable/ current assets 37.2% 38.6% 36.0%

Analytical Procedures for Gross Margin: Sales – CGS / Sales

Gross Margin Percent 2008 2007

Client Industry Client IndustryHardwood 36.3 32.4 36.4 32.5Softwood 23.9 22.0 20.3 22.1Plywood 40.3 50.1 44.2 54.3

Learning Objective 3

Design and perform tests of

details of balances for accounts

receivable for each balance-

related audit objective.

Design and Perform Tests of Details

of A/R Balance (Phase III)

Planned detection risk for eachobjective is an auditor’s decision.

Combining the factors that determineplanned detection risk and reacting to DR is complex.

Research – better at assessment than response

Designing Tests ofDetail of Balances

Aged A/R master file / subsidiary ledger (realizable value): BDE and Allowance

Recorded accounts receivable exist (confirm)

Existing accounts receivable are included(completeness) – Less of a concern – covered w/

Sales (cash) ToT of completeness (existence).Accounts receivable are accurate (confirm and ToT)

Accounts receivable are properly classified – reclassify notes receivable, credits

Designing Tests ofDetail of Balances

Cutoff for accounts receivable is correct – ToT (timing)

The client has rights to accounts receivable: factoring? discussions, BOD minutes

Extra: Accounts receivable and Sales presentation and disclosures are proper – SOX: exec loans, more than

5%, Rev Recognition policy

Learning Objective 4

Obtain and evaluate accounts

receivable confirmations.

AICPA Requirements: When confirmation NOT required

1. Accounts receivable are immaterial. OR

2. The auditor considers confirmationsineffective evidence because responserates will likely be inadequate or unreliable. OR

3. The combined level of inherent risk andcontrol risk is low (DR high) and other

substantive evidence can be accumulated to provide sufficient evidence (ToT and AP).

MUST DOCUMENT – story time

Type of Confirmation

Positive confirmation: non responses must be followed up.

Positive confirmation: non responses must be followed up.

Negative confirmation: all: (1) many small balances (coverage) (B2C) AND(2) IR and CR are low AND (3) high response rate to

positive confirms in PY

Negative confirmation: all: (1) many small balances (coverage) (B2C) AND(2) IR and CR are low AND (3) high response rate to

positive confirms in PY

Timing

The most reliable evidence fromconfirmations is obtained when

they are sent as close to the balancesheet date as possible, as opposedto confirming the accounts several

months before year-end.Consider earnings release dates in

light of risks – can you get it done??SEC / LAFs : 90 → 60 days

Sample Size (firm specific)

Tolerable misstatement - indirect

Inherent risk - direct

Control risk - direct

Assurance re: objectives fromother substantive tests (ToT, AP) - indirectType of confirmation – more with negative

Dollar A/R balance – Not “large” so typicallypart of process - direct

Selection of Itemsfor Testing

When selecting a sample of accounts receivablefor confirmation, the auditor should be careful

to avoid being influenced by the client.

Selection of Itemsfor Testing

If a client tries to discourage the auditor fromsending confirmation to certain customers,the auditor should consider the possibility

that the client is attempting to concealfictitious or known misstatements of

accounts receivable.Scope limitation???? Disclaimer of opinion???

Parmalat and cash confirms, Satyam

Subsequent Cash Receipts

Follow up: Evidence of the receipt of cash subsequentto the confirmation date includes examining

remittance advices, entries in the cash receiptsrecords, or perhaps even subsequent credits in

the accounts receivable master files.

Monday Morning QB: Evaluate 12/31 balance withPost 12/31 info

Duplicate Sales Invoices

These are useful in verifyingthe actual issuance of a salesinvoice and the actual date

of the billing: Cutoff

Shipping Documents

These are important in establishingwhether the shipment was actually

made (existence and completeness) and as a test of cutoff.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 31

End of Chapter 16