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

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

Accounts Receivable Balance-Related Audit Objectives Detail tie-in Existence Completeness Accuracy Classification Cutoff Realizable value Rights Presentation and disclosure

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

Methodology for Designing Tests of 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.

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

Relationship Between Sales and Accounts Receivable and disclosure Presentation Detail tie-in Existence Completeness Accuracy Classification Cutoff Realizable value Rights Accounts receivable balance-related audit objectives Translation-related audit objectives Sales Timing Posting/Summary ×

Relationship Between Sales and Accounts Receivable and disclosure Presentation Detail tie-in Existence Completeness Accuracy Classification Cutoff Realizable value Rights Accounts receivable balance-related audit objectives Translation-related audit objectives Cash receipts Timing Posting/Summary ×

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

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

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

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 Charge-off of uncollectible accounts as a percentage of total accounts receivable

Selected Comparative Information 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 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 12/31/04 ($000) Percent change 2003- 2004 12/31/03 2002- 2003 12/31/02

Analytical Procedures: Sales and Collection Cycle Gross margin/net sales Sales returns and allowances/ gross sales Bad debt expense/net sales Allowance for uncollectible accounts/accounts receivable Number of days receivables outstanding Net accounts receivable/ current assets 27.85% 0.90% 2.30% 6.10% 48.09 37.20% 27.70% 2.60% 7.50% 47.96 32.50% 27.68% 6.40% 49.32 32.30% 12/31/04 12/31/03 12/31/02

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.

Analytical Procedures for Gross Margin Hardwood Softwood Plywood 36.3 23.9 40.3 2005 2004 2003 32.4 22.0 50.1 36.4 20.3 44.2 32.5 22.1 54.3 36.0 20.5 45.4 32.3 22.3 55.6 Gross margin percent Great Western Industry

Learning Objective 3 Design and perform tests of details of balances for accounts receivable for each balance- related audit objective.

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 Existing accounts receivable are included

Designing Tests of Detail of Balances Accounts receivable are accurate Accounts receivable are properly classified Cutoff for accounts receivable is correct

Designing Tests of Detail of Balances Accounts receivable is stated at realizable value The client has rights to accounts receivable Accounts receivable presentation and disclosures are proper

Learning Objective 4 Obtain and evaluate accounts receivable confirmations.

AICPA Requirements 1. Accounts receivable are immaterial. 2. The auditor considers confirmations ineffective evidence because response rates will likely be inadequate or unreliable. 3. The combined level of inherent risk and control risk is low and other substantive evidence can be accumulated to provide sufficient evidence.

Type of Confirmation Positive confirmation Blank confirmation form Invoice confirmation Negative confirmation

Timing The most reliable evidence from confirmations is obtained when they are sent as close to the balance sheet date as possible, as opposed to confirming the accounts several months before year-end.

Sample Size Tolerable misstatement Inherent risk Control risk Achieved detection risk from other substantive tests Type of confirmation

Selection of the Items for Testing When selecting a sample of accounts receivable for confirmation, the auditor should be careful to avoid being influenced by the client.

Selection of Items for Testing If a client tries to discourage the auditor from sending confirmations to certain customers, the auditor should consider the possibility that the client is attempting to conceal fictitious or known misstatements of accounts receivable.

Maintaining Control After the items for confirmation have been selected, the auditor must maintain control of the confirmations until they are returned from the customer.

Follow-up on Nonresponses When positive confirmations are used, SAS 67 requires follow-up procedures for confirmations not returned by he customer. Alternative procedures

Subsequent Cash Receipts Evidence of the receipt of cash subsequent to the confirmation date includes examining remittance advices, entries in the cash receipts records, or perhaps even subsequent credits in the accounts receivable master file.

Duplicate Sales Invoices These are useful in verifying the actual issuance of a sales invoice and the actual date of the billing.

Shipping Documents These are important in establishing whether the shipment was actually made and as a test of cutoff.

Correspondence With the Client Usually, the auditor does not need to review correspondence as a part of alternative procedures, but correspondence can be used to disclose disputed and questionable receivables not uncovered by other means.

Analysis of Difference Payment has already been made Goods have not been received The goods have been returned Clerical errors and disputed accounts

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

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

Source of Each Row in the Evidence Planning Worksheet Tolerable misstatement Acceptable audit risk Inherent risk Control risk Substantive tests of transactions results Analytical procedures Planned detection risk and planned audit evidence