Completing the Tests in theSales and Collection Cycle:Accounts Receivable Chapter 15
Accounts Receivable Balance-Related Audit Objectives Detail tie-in Accuracy Realizable value Existence Classification Rights and obligations Completeness Cutoff Presentation and disclosure
Methodology for Designing Tests ofBalances – Accounts Receivable Identify client business risks affecting accounts receivable. Set tolerable misstatement and assess inherent risk for accounts receivable. Assess control risk for sales and collection cycle.
Methodology for Designing Tests ofBalances – Accounts Receivable Design and perform tests of controls and substantive tests of transactions for sales and collection cycle. Design and perform analytical procedures for accounts receivable balance.
Methodology for Designing Tests ofBalances – Accounts Receivable Design tests of details of accounts receivable balance to satisfy balance-related audit objectives. Audit procedures Sample size Items to select Timing
Analytical Procedures for the Sales and Collection Cycle Compare Gross margin percentage with previous years Sales by month over time Sales returns and allowances as a percentage of gross sales with previous years by product line
Analytical Procedures for the Sales and Collection Cycle Compare Individual customer balances over a stated amount Bad debt expense as a percentage of gross sales Days that accounts receivable are outstanding with previous years
Analytical Procedures for the Sales and Collection Cycle Compare Aging category as a percentage of receivables Allowance for uncollectible accounts as a percentage of accounts receivable Charge-off of uncollectible accounts as a percentage of total accounts receivable with previous years
Designing Tests ofDetail of Balances Aged trial balance Recorded accounts receivable exist Existing accounts receivable are included Accounts receivable are accurate Accounts receivable are properly classified
Designing Tests ofDetail of Balances Cutoff for accounts receivable is correct Accounts receivable is stated at realizable value The client has rights to accounts receivable Accounts receivable presentation and disclosures are proper
Confirmation of A/R Balance • Primary audit procedure for testing existence, accuracy and cutoff • Addresses 5 of the 8 balance-related audit objectives (not classification, realizable value, and presentation & disclosure) • Expensive audit procedure – auditor and client time – but highly reliable evidence • Required procedure in normal circumstances
SAS 67 Exceptions to Sending A/R Confirmations 1. Accounts receivable are immaterial. 2. The auditor considers confirmations ineffective evidence because response rates will likely be inadequate or unreliable. 3. The combined level of inherent risk and control risk is low and other substantive evidence can be accumulated to provide sufficient evidence.
Type of Confirmation Positive confirmation – confirm the printed balance on the confirmation Blank confirmation form – requests customer to fill in balance amount on the confirmation Invoice confirmation – confirm one or more invoices Instead of the total balance Negative confirmation – respond only if balance is incorrect
Timing The most reliable evidence from confirmations is obtained when they are sent as close to the balance sheet date as possible, as opposed to confirming the accounts several months before year-end.
Sample Size Tolerable misstatement Inherent risk Control risk Achieved detection risk from other substantive tests Type of confirmation
Selection of Itemsfor Testing Stratification is desirable – based on dollar amount or length of time outstanding. But a sample is also needed for judging total population. When selecting a sample of accounts receivable for 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 from sending confirmation to certain customers, the auditor should consider the possibility that the client is attempting to conceal fictitious or known misstatements of accounts receivable.
Evaluating Returned Confirmations • Clean responses – no follow up required • Responses with disagreement – follow up with the client for reason. Reasons could be timing issues, customer can’t confirm (or won’t), or errors. Customer completes the confirmation weeks after the cutoff date and their system does not allow them to go back to the cutoff date to accurately confirm. • No response – send a second request, do follow up procedures – subsequent receipts testing
Subsequent Cash Receipts Evidence of the receipt of cash subsequent to the confirmation date includes examining remittance advices, entries in the cash receipts records, or perhaps even subsequent credits in the accounts receivable master files. If customer paid for the goods, then the sale must exist.
Duplicate Sales Invoices These are useful in verifying the actual issuance of a sales invoice and the actual date of the billing. If a sales invoice was issued to a customer, then the sale most likely exists.
Shipping Documents These are important in establishing whether the shipment was actually made and as a test of cutoff.
CorrespondenceWith the Client Usually, the auditor does not need to review correspondence as a part of alternative procedures, but correspondence can be used to disclose disputed and questionable receivables not uncovered by other means.
Drawing Conclusions Reevaluate internal control. Evaluate the qualitative nature of misstatements. Determine whether sufficient evidence was obtained.