L EARNING O UTCOMES 1.Understand the financial statement assertions that are applicable to the account balances, classes of transactions and events in the Revenue and Receipts cycle. 2.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”).
Performed to obtain audit evidence of: The suitability of the design of the accounting and internal control system The effective operation of the system throughout the period of reliance. Tests of ControlsSubstantive Procedures Performed to obtain evidence to detect material misstatements in the financial statements Conclude on the Control Objectives Conclude on the Management Assertions Consist of: Tests of detail of transactions, balances and disclosures; Analytical procedures AUDIT APPROACH
A SSERTIONS Transactions and events Sales & Returns (Revenue) Receipts Occurrence Accuracy Completeness Cut-off Classification Account balances Trade receivables Bank & Cash Existence Rights Valuation Completeness Assertions applicable to R&R cycle Presentation and disclosure: RO4 only
D IRECTION OF T ESTING Ex Val Occ Acc COMPLETENESSCOMPLETENESS AFS TB GL DL SJ Supp Doc
A CCOUNTING A SPECTS AN 10/55 Recognition criteria for revenue – IAS 18 o When can a sales transaction be recognised as revenue? Allowance for doubtful debts o Uncollectable debts: expensed rather than sale adjust o What is a reasonable allowance?
1. Fraudulent financial reporting (i.e. fraudulently manipulating the figures in the financial records. Result: Over- or understatement) Risk Under/overstated Assertion affected Creating fictitious sales ? ? Not recording all sales ? ? Not allowing for all bad debts ? ? Recognize sale before delivery ? ? F RAUD RISKS 2. Misappropriation of assets (theft, embezzlement, unauthorized use of assets etc.). Applies to cash and inventory. Examples?
Inspection Observation Enquiry Reperformance Recalculation Analytical Procedures Other: External confirmation A UDIT P ROCEDURES [Audit verb][Party/Process/Doc][Objective/evidence] Inspect the delivery note for proof of the customer’s signature
L EARNING O UTCOMES 1.Understand 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.
Trade Receivables (“debtors”) = account balance, therefore assertions 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 the entity included in account balance? I NTRODUCTION
Dr Trade Receivables Cr Opening balance R Receipts R Sales R Cr Adjustments R Closing balance R R Opening balance R Consider the general ledger control account Assume allowance for doubtful debts at year-end: R To which figure to apply account balance assertions?
I NTRODUCTION Trade debtors closing balances at 31 Dec 2012: ABC DistributorsR DEF RetailersR GHI CorporationR JKL WholesalersR MNO TradingR Grand total (debtors sub-ledger)R Consider the debtors list Above shows the “assets” underlying the account balance
S UBSTANTIVE P ROCEDURES - E XISTENCE Risk: 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 receipts Audit procedures: ? Risk: 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 receipts Audit procedures: ?
D EBTORS C ONFIRMATIONS S UBSTANTIVE P ROCEDURES - E XISTENCE Choose positive vs. negative confirmations Auditor has control of confirmation process Select sample from financial records Mailing of confirmation letters to debtors Monitor repliesFollow up disagreements and no replies Determine possible misstatement of account balance (under/over)? Timing of confirmations?
E XAMPLE : D EBTORS C ONFIRMATION Debtor Silver CCReferenceR Amount per XYZ (Pty) Ltd age analysis at year end Invoice IN Customer alleges 5% discount for early payment of invoice IN2678 not taken into account by XYZ (1 250) Total owing per ABC Distributors Audit client name: XYZ (Pty) Ltd Customer (debtor) name: ABC Distributors Year end: 31 December 2012 Audit procedures to audit the difference?
S UBSTANTIVE P ROCEDURES - E XISTENCE Subsequent receipts testing Alternative to debtor confirmations Agree year end balances to “subsequent receipts”: payments received from debtors after year end. Example: Silver CC year end balance (31 Dec 2012): R relates to 1 invoice only: #IN2678 paid on 23 January 2013 How does receipt confirm existence of debtor Silver CC?
S UBSTANTIVE P ROCEDURES - RIGHTS Risk: 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: ? Risk: 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: ?
S UBSTANTIVE P ROCEDURES - V ALUATION Gross amount Gross amount = add Credit sales less Receipts +/- Adjustments Posted to Debtors sub-ledger Posted to GL control account Sales journal Cash rec. jnl Sales returns jnl Auditor to reconcile GL to sub-ledger/list - Reconciling items? Unusual entries? o Credit balances? o Cast! o Procedures on foreign debtors (RO) TB - AFS
Allowance for doubtful debts S UBSTANTIVE P ROCEDURES - V ALUATION 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 bad debts Audit procedures: ? 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 bad debts Audit procedures: ?
Why? if all credit sales posted to sub-ledger, then… S UBSTANTIVE P ROCEDURES -C OMPLETENESS Entails completeness of debtors (assets), not sales per sé Unlikely to confirm completeness with confirmations. However, completeness testing here relies on completeness and cut-off of revenue. (Refer to lecture on audit of Sales). If recorded in incorrect period, then… Debtor accounts are created (raised) in sub-ledger (“financial records”) if all sales posted.
Comparisons 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. Comparisons 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. S UBSTANTIVE P ROCEDURES - A NALYTICAL P ROCEDURES
S UBSTANTIVE P ROCEDURES - R OLL F ORWARD Roll-forward scheduleAmountExplanation Balance 30 Nov 2012 xxxxx Confirmed with debtors + Sales xxxxx - Receipts(xxxxx) Roll-forward testing (sample selections) +/- Adjustments xxxxx Closing balance 31 Dec 2012xxxxx Not confirmed with debtors, but indirectly audited 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. Primarily to address the existence and valuation assertions.
S UBSTANTIVE P ROCEDURES - R OLL F ORWARD Audit procedures for roll-forward Prepare or obtain a client prepared roll forward schedule (see preceding slide) Reperform the mathematical accuracy of the schedule Agree, by inspection, the opening balance to the debtors listing for 30 Nov 2012 Agree, 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.
S UBSTANTIVE P ROCEDURES - R OLL F ORWARD 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: o Compare the balance at 31 Dec 2012 to the balance at 31 Dec o Compare December sales and receipts with prior months. o Obtain explanations for any unusual differences.