Copyright © 2007 Pearson Education Canada 1 Chapter 14: Completing the Tests in the Sales and...

Copyright © 2007 Pearson Education Canada

1

Chapter 14: Completing the Tests in the Sales and Collection

Cycle: Accounts Receivable


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Chapter 14 objectives

Describe the process for designing tests of details of balances for accounts receivable

Explain the relationship between transaction-related and balance-related audit objectives

Discuss analytical procedures for accounts receivable

Link detailed audit tests to audit assertions Explain how sampling is used for tests of details


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Methodology for designing tests of details of balances for accounts

receivable


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Audit tests to be performed are based upon assessed risks


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Effects of inherent and control risks


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Materiality considerations

Unless the organization is highly automated (e.g. with EDI, electronic data interchange), accounts receivable may be one of the largest amounts on the balance sheet

Transactions throughout the year that build the sales and accounts receivable balances are also normally significant


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Inherent risk considerations

Inherent risk tends to be moderate to low for all assertions except: – Realizable value (due to the judgment

involved in assessing collectability) and– Cut-off for sales returns or allowances (in

particular, warranty allowances or returns of goods on consignment may be difficult to estimate)


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Figure 14-1 and figure 14-2

14-1: After procedures to obtain an understanding and tests of controls we do tests of details

14-2: Designing tests of details rests on the previous work that has been done in the cycle


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Consider the relationship between transaction-related and balance-related audit objectives

Figure 14-3 shows how these audit assertions are related

This helps in designing dual purpose tests that can validate internal controls as well as provide substantive assurance

Pay special attention to occurrence/existence, completeness/existence (p. 420)


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Analytical procedures

Completed during three phases of the audit:– Planning (Phase I)– As part of substantive testing (Phase III)– As part of completing the audit engagement

(Phase IV)


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Using analytical review to target detailed tests (see table 14-1)

Helpful analyses could include comparing:– Sales by month– Sales returns and allowances– Individual customer balances– Bad debt expense to gross sales– Number of days in A/R– Aging categories– Allowance for uncollectible accounts


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Examples of audit procedures by audit objective (assertion), Table 14-4

Detail tie-in: Add (foot) open-item file (sales, credit and cash receipts transactions) or the customer master file, and agree to the general ledger

Accuracy and existence: Confirm accounts receivable balances, performing alternative procedures for discrepancies and non-replies.


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Examples of audit procedures by audit objective (assertion), Table 14-4 (cont’d)

Completeness: Agree a sample of customer details from the underlying information systems records (data files) to the accounts receivable trial balance.

Classification: Review the receivables listed on the aged trail balance for notes receivable or related party transactions.


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Cut-off: Select the last 40 sales transactions from the current year’s sales journal and the first 40 from the subsequent year’s, and trace each to the related shipping documents, checking for the date of actual shipment and ensuring the sales were recorded in the correct period.


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Valuation: Discuss with the credit manager the likelihood of collecting older accounts (identified by means of generalized audit software or by review of the aged accounts receivable trial balance). Examine subsequent cash receipts on these accounts and evaluate the collectability.


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Rights and obligations: Review the minutes of the board of directors’ meetings for any indication of pledged or factored accounts receivable.

Presentation and disclosure: Enquire of management whether any receivables are pledged or factored.


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Practice problem 14-25 (p. 450)

A company is having collection problems

What would you do to investigate the causes?


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The power of confirmations

Useful for existence, accuracy and cutoff

A/R confirmations come in several forms:– Negative– Positive

• Individual item

• Balance owing


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Confirmations have been returned with answers that do not match the records – what do you do?


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Positive vs. negative confirmations

Positive confirmations– More reliable evidence– Possible to conduct follow up if not answered

Use When– Individual balances relatively large– Fewer debtors– Evidence or suspicion of fraud or serious error


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Positive vs. negative confirmations

Negative confirmations– Failure to reply must be regarded as a correct

response– Less expensive

Used When– Many homogenous balances– Small amounts owing– Internal controls strong– No evidence/suspicion of fraud or serious error


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Controlling and managing the confirmation process

1. Controlling the sending of confirmations 2. Procedures for those accounts the client

does not want confirmed 3. Handling returned confirmations 4. Timing of alternative procedures and

second requests (All of the above illustrate components that

affect the cost of this audit procedure.)


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1. Controlling the sending of confirmations

The client may assist in preparing the confirmations, but the auditor must due the actual mailing, off the client premises

If the client stuffs and stamps the envelopes, this must be supervised

Return envelopes should bear the auditor’s address, not the client’s


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2. Procedures for those accounts the client does not want confirmed

Where the client does not want to have an account confirmed that has been selected by the auditor, this account needs to be treated like a non-response

This means that the auditor will apply alternative procedures to the amount


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3. Handling returned confirmations

Confirmations should be returned directly to the auditor’s offices

Differences between the client’s records and the confirmation reply need to be assessed to determine whether the difference is an error


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Types of differences

Differences between the client records and the confirmation could be due to:– Payment already made by the client (a potential cut-

off error or simply due to the postal service)– Goods were not received (a cut-off error, a potential

credit note, or timing difference)– Goods were returned (requiring a credit note)– Amounts are in dispute (perhaps requiring an

allowance)


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4. Timing of alternative procedures and second requests

Second (or even third) requests can be sent if there is time

Such follow-up requests also need to be carefully controlled by the auditor

Alternative procedures are designed to provide adequate evidence with respect to existence, accuracy and cut-off


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Nature of alternative procedures

Review of subsequent cash receipts Examination of duplicate sales invoices Examination of supporting shipping

documentation Review of correspondence between the

client and the customer


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Sampling and accounts receivable

Sampling is used to select the transactions that will be tested

For example, statistical sampling could be used to select accounts receivable for confirmation

In addition, directed sampling (choosing high dollar amounts or old accounts) would be used


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Evaluate the sampling approach

Select the sample size Evaluate results

Copyright © 2007 Pearson Education Canada 1 Chapter 14: Completing the Tests in the Sales and...

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