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

2. Learning Objectives
Describe the methodology for designing tests of details of balances using the audit risk model.
Design and perform analytical procedures for accounts in the sales and collection cycle.
Design and perform tests of details of balances for accounts receivable.

3. Learning Objectives
Obtain and evaluate accounts receivable confirmations.
Design audit procedures for the audit of accounts receivable, using the evidence planning worksheet as a guide.

4. 1
Describe the methodology for designing tests of details of balances using the audit
risk model.

5. Accounts Receivable Balance-related Audit Objectives
Detail tie-in
Existence
Rights
A/R
Audit
Objectives
Completeness
Realizable value
In designing tests of details of balances for accounts receivable, auditors must satisfy each of the eight balance-related audit objectives first discussed in Chapter 6.
Accuracy
Cutoff
Classification

6. Methodology for Designing Tests of Details of Balances for Accounts Receivable
Phase I
Identify client business risks affecting Accounts Receivable
Set performance materiality and assess inherent risk for accounts receivable
Assess control risk for sales and collection cycle
Tests of accounts receivable are based on the auditor’s risk assessment procedures that provide an understanding of the client's business and industry.
Client business risks affecting accounts receivable are considered in the auditor’s evaluation of inherent risk and planned evidence for accounts receivable.
The auditor first decides the preliminary judgment about materiality for the entire financial statements and then allocates the preliminary judgment amount to each significant balance sheet account including accounts receivable.
The auditor is especially concerned with three aspects of internal controls:
Controls that prevent or detect embezzlements
Controls over cutoff
Controls related to the allowance for uncollectible accounts
The auditor must relate control risk for transaction related audit objectives to balance related audit objective in deciding planned detection risk and planned evidence for tests of details of balances.
Two relationships deserve special mention:
For sales, the occurrence transaction related objective affects the existence balance related objective.
The realizable value and rights objective as well as the presentation and disclosure related objectives are affected by assessed control risk for transactions. To assess control risk below the maximum for these objectives, the auditor must identify and test separate controls that support those objectives.

7. Methodology for Designing Tests of Details of Balances for Accounts Receivable
Phase II
Design and perform tests of controls and
substantive tests of transactions
for the sales and collection cycle
The results of the tests of controls determine whether assessed control risk for cash and cash receipts needs to be revised. Auditors use the results of the substantive tests of transactions to determine the extent to which planned detection risk is satisfied for each accounts receivable balance-related audit objective.

8. Design and perform analytical procedures for accounts receivable
Methodology for Designing Tests of Details of Balances for Accounts Receivable
Phase III
Design tests of details of accounts receivable balance to satisfy balance-related objectives
Design and perform analytical procedures for accounts receivable
Most analytical procedures performed during the detailed testing phase are done after the balance sheet date but before tests of details of balances. Auditors perform analytical procedures for the entire sales and collection cycle not just accounts receivable.
The appropriate tests of details of balances depend on the factors listed in the evidence planning worksheet.
Audit procedures
Sample
size
Items to select
Timing

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

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

11. 2
Design and perform analytical procedures for accounts in the sales and collection cycle.

12. 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
In addition to analytical procedures, auditors should also review accounts receivable for large and unusual amounts such as large balances, accounts that have been outstanding for a long time, receivables from affiliated companies, officers, directors, other related parties and credit balances.

13. 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

14. 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
Because analytical procedures are substantive tests, they reduce the extent to which the auditor needs to perform detailed tests of balances if the analytical procedure results are favorable.
Write-off of uncollectible accounts as a
percentage of total accounts receivable

15. Selected Comparative Information
12/31/13
($000)
Percent
change
12/31/12
($000)
Percent
change
2011-
2012
12/31/11
($000)
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
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
When analytical procedures in the sales and collection cycle uncover unusual fluctuations, the auditor should make additional inquiries of management. Management responses should be critically evaluated to determine whether they adequately explain the unusual fluctuations and whether they are supported by corroborating evidence.

16. Analytical Procedures: Sales and Collection Cycle

17. 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
The task of combining the factors that determine planned detection risk is complex because the measurement for each factor is imprecise and the appropriate weight given to each factor is highly subjective.
Planned evidence is the inverse of planned detection risk.

18. 3
Design and perform tests of details of balances for accounts receivable.

19. Designing Tests of Detail of Balances
Accounts receivable are correctly added and
agree with the Master File and the General
Ledger (aged trial balance).
Recorded accounts receivable exist
Confirmation of accounts receivable is the most important test of details of accounts receivable.
An aged trial balance lists the balances in the accounts receivable master file at the balance sheet date including individual customer balances outstanding and a breakdown of each balance by the time passed between the date of sale and the balance sheet date.
Confirmation of customer balances is the most important test of details of balances for determining the existence of recorded accounts receivable.
Existing accounts receivable are included

20. Designing Tests of Detail of Balances
Accounts receivable are accurate
Accounts receivable are properly classified
Cutoff for accounts receivable is correct
Confirmation of accounts selected from the trial balance is the most common test of details of balances for the accuracy of accounts receivable.
When customers do not respond to confirmation requests, auditors examine supporting documents in the same way for the existence objective.
Auditors can evaluate the classification of accounts receivable relatively easily by reviewing the aged trial balance for material receivables from affiliates officers or other related parties.
The objective of cutoff tests is to verify whether transactions near the end of the accounting period are recorded in the proper period.
Cutoff misstatements exist when current period transactions are recorded in the subsequent period or vice versa.

21. Designing Tests of Detail of Balances
Accounts receivable is stated at
realizable value
The client has rights to accounts receivable
Accounts receivable presentation and
disclosure
The realizable value of accounts receivable equals gross accounts receivable less the allowance for uncollectible accounts.
The client will estimate the allowance for uncollectible accounts, but the auditor must evaluate whether the clients allowance is reasonable considering all available facts.
Rights to accounts receivable are ordinarily not an audit problem. However, in some cases a portion of the receivable may have been pledged as collateral assigned to someone else factored or sold at a discount.
To uncover instances in which the client has limited rights to receivables, the auditor may review the minutes, discuss with the client, confirm with banks, examine debt contracts for evidence of accounts receivable pledged as collateral and examine correspondence files.
To evaluate the adequacy of the presentation and disclosure the auditor must have a thorough understanding of accounting standards and presentation and disclosure requirements.

22. Obtain and evaluate accounts receivable confirmations.4
Obtain and evaluate accounts receivable confirmations.

23. Confirmation Requirements
Auditing Standards
United States
International
Required Except when:
Confirmations not required
The lack of a requirement to confirm accounts receivable is one of the notable differences between requirements of US and international audit standards.
Expected low response rate
Alternate
Procedures
Low inherent & control risks

24. Type of Confirmation Positive confirmation Blank confirmation form
Invoice confirmation
Negative confirmation
A positive confirmation is a communication addressed to the debtor requesting the recipient to confirm directly whether the balance as stated on the confirmation is correct or incorrect.
A blank confirmation is a type of positive confirmation that does not state the amount on the confirmation but request the recipient to fill in the balance or furnish other information. These are considered more reliable than confirmations that include balance information.
An invoice confirmation is another type of positive confirmation in which an individual invoice is confirmed rather than the customer's entire balance.
A negative confirmation requests a response only when the debtor disagrees with the stated amount.

25. Positive Confirmation

26. Negative Confirmation Requirements
Risk of material misstatement is low
Large number of small account balances
Expected low exception rate
Expect adequate consideration from
recipients
Negatives can only be used when all of the above circumstances are present.
Most often used for audits of hospitals, retail stores, banks, and other industries where receivables are due from the general public.

27. Negative Confirmation

28. Timing The most reliable evidence from confirmations
is obtained when they are sent as close to the
balance sheet date as possible.
If the decision is made to confirm accounts receivable before year-end, the auditor typically prepares a roll-forward schedule that reconciles the accounts receivable balance at the confirmation date to accounts receivable at the balance sheet date.

29. Sampling Decisions Sample Size factors Performance materiality
Inherent Risk
Control Risk
Sample
Size factors
Achieved
Detection
risk from
other tests
Type of
Confirmation

30. Verifying Addresses and Maintaining Control
The auditor should perform procedures to
verify the addresses or 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.

31. Follow-up on Nonresponses
When positive confirmations are used,
Auditing standards require follow-up
Procedures for confirmations not
returned by the customer.
Alternate Procedures
Subsequent cash receipts
Duplicate sales invoices
Shipping documents

32. Analysis of Differences
Payment-in-transit
Shipment-in-transit
The goods have been returned
Errors and disputes
Customer has made a payment before the confirmation date, but the client has not received the payment in time.
Good were shipped prior to the confirmation date but have not been received by the customer prior to the confirmation date.
Failure to record a credit memo could be due to a failure to record a credit memo for goods returned.

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

34. 5
Design audit procedures for the audit of accounts receivable, using an evidence planning worksheet as a guide.

35. Evidence Planning Worksheet

36. Are there any questions?

37. Copyright
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