3 LearningOutcomesUnderstand the financial statement assertions that are applicable to the account balances, classes of transactions and events in the Revenue and Receipts cycle.Apply the direction of testing correctly to a particular assertion.3. Understand the fraud risks applicable to the revenue and receipts cycle, including risks of material misstatement.4. Understand the audit procedures available to the auditor for substantive testing (“auditor’s toolbox”).
4 AUDIT APPROACH Tests of Controls Substantive Procedures Performed to obtain audit evidence of:The suitability of the design of the accounting and internal control systemThe effective operation of the system throughout the period of reliance.Performed to obtain evidence to detect material misstatements in the financial statementsConsist of:Tests of detail of transactions, balances and disclosures;Analytical proceduresConclude on the Control ObjectivesConclude on the Management Assertions
5 Transactions and events AssertionsAssertions applicable to R&R cycleAccount balancesTrade receivablesBank & CashExistenceRightsValuationCompletenessTransactions and eventsSales & Returns (Revenue)ReceiptsOccurrenceAccuracyCompletenessCut-offClassificationPresentation and disclosure: RO4 only
6 Direction of Testing AFS C OMP Ex Val TB L E Occ T ENE Acc GL S DL SJ Supp Doc
7 Accounting Aspects Recognition criteria for revenue – IAS 18 AN 10/55Recognition criteria for revenue – IAS 18When can a sales transaction be recognised as revenue?Allowance for doubtful debtsUncollectable debts: expensed rather than sale adjustWhat is a reasonable allowance?
8 Fraud risks1. Fraudulent financial reporting (i.e. fraudulently manipulating the figures in the financial records. Result: Over- or understatement)Risk Under/overstated Assertion affectedCreating fictitious sales ? ?Not recording all sales ? ?Not allowing for all bad debts ? ?Recognize sale before delivery ? ?2. Misappropriation of assets (theft, embezzlement, unauthorized use of assets etc.). Applies to cash and inventory. Examples?
9 [Objective/evidence] AuditProceduresInspectionObservationEnquiryReperformanceRecalculationAnalytical ProceduresOther: External confirmation[Audit verb][Party/Process/Doc][Objective/evidence]Inspect the delivery note for proof of thecustomer’s signature
12 LearningOutcomesUnderstand and explain the financial statement assertions that are applicable to trade receivables.2. Understand the important accounting aspects applicable to trade receivable.3. Describe the substantive audit procedures necessary to audit the assertions relevant to the trade receivables account balance.4. Describe the substantive audit procedures to audit a roll-forward schedule i.t.o. debtors.
13 IntroductionTrade Receivables (“debtors”) = account balance, thereforeassertions applicable:Existence: underlying debtors (asset) making up the balance genuine?Valuation: account balance included at appropriate carrying value? (after proper allowance for doubtful debts)Rights: underlying debtors (assets) belong to the entity?Completeness: all debtors (assets) that belong to theentity included in account balance?
14 Dr Trade Receivables Cr IntroductionConsider the general ledger control accountDr Trade Receivables CrOpening balanceRReceiptsRSalesRCr AdjustmentsRClosing balanceRRRRAssume allowance for doubtful debts at year-end: R17 000To which figure to apply account balance assertions?
15 Introduction Trade debtors closing balances at 31 Dec 2012: Consider the debtors listTrade debtors closing balances at 31 Dec 2012:ABC DistributorsRDEF RetailersRGHI CorporationRJKL WholesalersRMNO TradingRGrand total (debtors sub-ledger)RAbove shows the “assets” underlying the account balance
16 Substantive Procedures - ExistenceRisk: Debtor balances in financial records are fictitious as there are no actual debtors “behind the balance”.Audit evidence: - Confirm balance directly with debtor- Verify post year-end receiptsAudit procedures: ?
17 Determine possible misstatement of account balance (under/over)? Substantive Procedures- ExistenceDebtors ConfirmationsSelect sample from financial recordsChoose positive vs. negative confirmationsAuditor has control of confirmation processMailing of confirmation letters to debtorsMonitor repliesFollow up disagreements and no repliesTiming of confirmations?Determine possible misstatement of account balance (under/over)?
18 Example: Debtors Confirmation Audit client name: XYZ (Pty) LtdCustomer (debtor) name: ABC DistributorsYear end: 31 December 2012Debtor Silver CCReferenceRAmount per XYZ (Pty) Ltd age analysis at year endInvoice IN267820 000Customer alleges 5% discount for early payment of invoice IN2678 not taken into account by XYZ(1 250)Total owing per ABC Distributors18 750Audit procedures to audit the difference?
19 - Existence Subsequent receipts testing Substantive Procedures Alternative to debtor confirmationsAgree year end balances to “subsequent receipts”:payments received from debtors after year end.Example:Silver CC year end balance (31 Dec 2012): R18 750relates to 1 invoice only: #IN2678paid on 23 January 2013How does receipt confirm existence of debtor Silver CC?sample of debtors on the year end debtors list is selectedPayments received after year-end are identified (CRJ)Receipts are then traced (agreed by inspection) to debtor’s remittances to identify which invoices the payment is in respect ofThese invoices and matching delivery notes are then inspected to confirm thatdated prior to the year-endincluded at year-end in the sales journal and debtors ledger
20 Substantive Procedures - RIGHTSRisk: The audit client does not own the underlying assets (trade debtors) making up the account balance disclosed in the AFS.Audit evidence: no debtors ceded, encumbered, factored.Audit procedures: ?
22 - Valuation Substantive Procedures Allowance for doubtful debts Risk: Trade receivables over/understated due to allowance being under/overstated.Audit evidence: Allowance reasonable Consistent with prior year- In-line with accounting policy/IFRS- Correctly calculated- Authorised senior management- Incl. all potentially irrecoverable debt- Amount in relation to prior year actual baddebtsAudit procedures: ?
23 -Completeness Substantive Procedures Entails completeness of debtors (assets), not sales per séUnlikely to confirm completeness with confirmations.However, completeness testing here relies on completeness and cut-off of revenue. (Refer to lecture on audit of Sales).Why? if all credit sales posted to sub-ledger, then…If recorded in incorrect period, then…Debtor accounts are created (raised) in sub-ledger (“financial records”)if all sales posted.
24 -Analytical Procedures Substantive Procedures-Analytical ProceduresComparisons and ratio calculations to determine risk areas (“assertions most at risk of misstatement”).Usually precedes testing of assertions.Unexpected differences (e.g. between current and prior year) can be followed up/specific procedures performed thereon.
25 - Roll Forward Substantive Procedures Roll-forward schedule Amount For various reasons (e.g. time constraints at year end), auditor decides/is compelled to confirm balances before year end.Problem then: sufficient appropriate audit evidence not obtained for year end balance.Solution: perform “roll-forward” process as per table below.Roll-forward scheduleAmountExplanationBalance 30 Nov 2012xxxxxConfirmed with debtors+ SalesReceipts(xxxxx)Roll-forward testing (sample selections)+/- AdjustmentsClosing balance 31 Dec 2012Not confirmed with debtors, but indirectly auditedPrimarily to address the existence and valuation assertions.
26 - Roll Forward Audit procedures for roll-forward Substantive Procedures- Roll ForwardAudit procedures for roll-forwardPrepare or obtain a client prepared roll forward schedule (see preceding slide)Reperform the mathematical accuracy of the scheduleAgree, by inspection, the opening balance to the debtors listing for 30 Nov 2012Agree, by inspection, the closing balance per the roll forward schedule to the debtors control account in the general ledger and grand total in the sub-ledger. Ensure the correct transaction totals have been brought across to schedule by inspection of the books of prime entry (e.g. sales journal/ cash book).Note and obtain explanations for any unusual journal adjustments reflected in the roll forward schedule.Inspect supporting documentation for all material transactions.
27 - Roll Forward Substantive Procedures Audit procedures for roll-forward (continued…)Ensure system of internal controls remained effective for the month of December by performing relevant tests of control. Inspect the debtors control account for post year-end adjustments and inspect supporting documentation for any material/large/unusual adjustments that may relate to the current financial period transactions.Perform year end cut-off tests or cross reference to work papers i.r.o sales and receipts cut-off tests.Perform the following analytical procedures: Compare the balance at 31 Dec 2012 to the balance at 31 Dec 2011.Compare December sales and receipts with prior months.Obtain explanations for any unusual differences.