Completing the Tests in the Sales and Collection Cycle: Accounts Receivable

1. Completing the Testsin the Sales and Collection Cycle:Accounts Receivable Chapter 16

2. Learning Objective 1 Describe the methodology for designing tests of details of balances using the audit risk model.

3. Accounts Receivable Balance-related Audit Objectives Detail tie-in Rights Existence A/R Audit Objectives Realizable value Completeness Cutoff Accuracy Classification

4. Methodology for Designing Testsof Details of Balances for A/R Phase I Assess control risk for sales and collection cycle Set tolerable misstatement and assess inherent risk for accounts receivable Identify client business risks affecting Accounts Receivable

5. Methodology for Designing Testsof Details of Balances for A/R Phase II Design and perform tests of controls and substantive tests of transactions for the sales and collection cycle

6. Methodology for Designing Testsof Details of Balances for A/R Phase III Design tests of details of accounts receivable balance to satisfy balance-related objectives Design and perform analytical procedures for accounts receivable Sample size Timing Items to select Audit procedures

7. Relationship Between Sales and Accounts Receivable ACCOUNTS RECEIVABLE BALANCE-RELATED AUDIT OBJECTIVES Existence Accuracy Cutoff Detail tie-in Completeness Classification Realizable value Rights Translation-related audit objectives Sales Occurrence × Completeness × Accuracy × Posting and summarization × Classification × Timing ×

8. Relationship Between Sales and Accounts Receivable ACCOUNTS RECEIVABLE BALANCE-RELATED AUDIT OBJECTIVES Detail tie-in Completeness Classification Realizable value Rights Existence Accuracy Cutoff Translation-related audit objectives Cash receipts Occurrence × Completeness × Accuracy × Posting and summarization × Classification × Timing ×

9. Learning Objective 2 Design and perform analytical procedures for accounts in the sales and collection cycle.

10. Analytical Procedures for the Sales and Collection Cycle Compare by product line: • Gross margin percentage with previous years • Sales by month over time • Sales returns and allowances as a percentage of gross sales with previous years

11. Analytical Procedures for the Sales and Collection Cycle Compare with previous years: • Individual customer balances over a stated amount • Bad debt expense as a percentage of gross sales • Days that accounts receivable are outstanding

12. Analytical Procedures for the Sales and Collection Cycle Compare with previous years: • Aging category as a percentage of receivables • Allowance for uncollectible accounts as • a percentage of accounts receivable • Write-off of uncollectible accounts as a • percentage of total accounts receivable

13. Selected Comparative Information 12/31/11 ($000) Percent change 2010-11 12/31/10 ($000) 12/31/09 ($000) Percent change 2009- 2010 Sales Gross margin Accounts receivable Bad debt expense Total current assets Total assets Net earnings Number of accounts receivable Number of accts. rec. with balances over $100,000 144,328 39,845 20,197 3,323 51,027 61,367 5,681 258 37 9.0 9.6 7.3 (2.1) 14.0 (7.0) 21.9 16.7 15.6 132,421 36,350 18,827 3,394 44,779 66,021 4,659 221 32 7.0 7.0 14.1 7.3 6.6 8.0 39.0 5.7 6.7 123,737 33,961 16,505 3,162 41,989 61,147 3,351 209 30

14. Analytical Procedures: Sales and Collection Cycle

15. Design and Perform Tests of Details of A/R Balance (Phase III) • Planned detection risk for each objective is an auditor decision • Combining the factors that determine • planned detection risk is complex

16. Learning Objective 3 Design and perform tests of details of balances for accounts receivable.

17. Designing Tests of Detailof Balances Accounts receivable are correctly added and agree with the Master File and the General Ledger (aged trial balance). • Recorded accounts receivable exist • Existing accounts receivable are included

18. Designing Tests of Detailof Balances • Accounts receivable are accurate • Accounts receivable are properly classified • Cutoff for accounts receivable is correct

19. Designing Tests of Detailof Balances • Accounts receivable is stated at • realizable value • The client has rights to accounts receivable • Accounts receivable presentation and • disclosure

20. Learning Objective 4 Obtain and evaluate accounts receivable confirmations.

21. Confirmation Requirements Auditing Standards International United States Required Except when: Confirmations not required Expected low response rate Alternate Procedures Low inherent & control risks

22. Type of Confirmation • Positive confirmation • Blank confirmation form • Invoice confirmation • Negative confirmation

23. Positive Confirmation

24. Negative Confirmation Requirements • Risk of material misstatement is low • Large number of small account balances • Expected low exception rate • Expect adequate consideration from • recipients

25. Negative Confirmation

26. Timing The most reliable evidence from confirmations is obtained when they are sent as close to the balance sheet date as possible.

27. Sampling Decisions Tolerable misstatement Inherent Risk Control Risk Sample Size factors Achieved Detection risk from other tests Type of Confirmation

28. Verifying Addresses and Maintaining Control The auditor should perform procedures to verify the addresses or email addresses used for confirmation. Auditors must be responsible for mailing the confirmations and maintaining control of the confirmations until they are returned from the customer.

29. Follow-up on Nonresponses When positive confirmations are used, AU 330 requires follow-up procedures for confirmations not returned by the customer. Alternate Procedures Duplicate sales invoices Shipping documents Subsequent cash receipts

30. Analysis of Differences • Payment-in-transit • Shipment-in-transit • The goods have been returned • Errors and disputes

31. Drawing Conclusions • Reevaluate internal control • Evaluate the qualitative nature of • misstatements • Determine whether sufficient evidence • was obtained

32. Learning Objective 5 Design audit procedures for the audit of accounts receivable, using an evidence planning worksheet as a guide.

33. Evidence Planning Worksheet

34. End of Chapter 16