©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Completing the Tests in the Sales and Collection Cycle: Accounts Receivable Chapter 12

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 1 Describe the methodology for designing tests of details of balances using the audit risk model.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Accounts Receivable Balance- Related Audit Objectives Detail tie-in Completeness ClassificationExistence Accuracy Cutoff Realizable value Rights and obligations Presentation and disclosure

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Methodology for Designing Tests of Balances – Accounts Receivable 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.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Methodology for Designing Tests of Balances – Accounts Receivable Design and perform tests of controls and substantive tests of transactions for sales and collection cycle. Design and perform analytical procedures for accounts receivable balance.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Methodology for Designing Tests of Balances – Accounts Receivable Design tests of details of accounts receivable balance to satisfy balance-related audit objectives. Audit procedures Sample size Items to select Timing

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Relationship Between Sales and Accounts Receivable Existence Completeness Accuracy Classification Timing Presentation and disclosure × Detail tie-in ExistenceCompletenessAccuracyClassificationCutoff Realizable value Rights Posting/Summary Accounts Receivable Balance-Related Audit Objectives Translation-Related Audit Objectives Sales × × × × ×

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Relationship Between Sales and Accounts Receivable Existence Completeness Accuracy Classification Timing Presentation and disclosure Detail tie-in ExistenceCompletenessAccuracyClassificationCutoff Realizable value Rights Posting/Summary Accounts Receivable Balance-Related Audit Objectives Translation-Related Audit Objectives Cash receipts × × × × × ×

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 2 Design and perform analytical procedures for accounts in the sales and collection cycle.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for the Sales and Collection Cycle Gross margin percentage with previous years Sales by month over time Sales returns and allowances as a percentage of gross sales with previous years

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for the Sales and Collection Cycle Individual customer balances over a stated amount Bad debt expense as a percentage of gross sales Days that accounts receivable are outstanding

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for the Sales and Collection Cycle 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

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Selected Comparative Information Percent 2002Change2001Change2000 (000) 02-01(000) 00-01(000) Sales Gross margin Accounts receivable Bad debt expense 3.3(2.9) Total assets 61.4(7.0) Net earnings Number of accounts receivable

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures Sales and Collection Cycle Gross margin/net sales27.8%27.7%27.5% Sales R&A/gross sales.9%.9%.8% Bad debt expense/net sales 2.3% 2.6% 2.4% Allowance for uncollectible accounts/accounts receivable 6.1% 8.2% 8.4% Number of days receivables outstanding Net accounts receivable/ current assets37.2%38.6%36.0%

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Design and Perform Tests of Details of A/R Balance (Phase III) Planned detection risk for each objective is an auditor’s decision. Combining the factors that determine planned detection risk is complex.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for Gross Margin Gross Margin Percent Client Industry Client Industry Hardwood Softwood Plywood

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 3 Design and perform tests of details of balances for accounts receivable for each balance- related audit objective.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Designing Tests of Detail of Balances Aged trial balance Recorded accounts receivable exist Existing accounts receivable are included Accounts receivable are accurate Accounts receivable are properly classified

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Designing Tests of Detail of Balances Cutoff for accounts receivable is correct Accounts receivable is stated at realizable value The client has rights to accounts receivable Accounts receivable presentation and disclosures are proper

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 4 Obtain and evaluate accounts receivable confirmations.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley 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.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Type of Confirmation Positive confirmation Blank confirmation form Invoice confirmation Negative confirmation

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley 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.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Sample Size Tolerable misstatement Inherent risk Control risk Achieved detection risk from other substantive tests Type of confirmation

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Selection of Items for Testing When selecting a sample of accounts receivable for confirmation, the auditor should be careful to avoid being influenced by the client.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Selection of Items for Testing If a client tries to discourage the auditor from sending confirmation to certain customers, the auditor should consider the possibility that the client is attempting to conceal fictitious or known misstatements of accounts receivable.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley 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 files.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Duplicate Sales Invoices These are useful in verifying the actual issuance of a sales invoice and the actual date of the billing.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Shipping Documents These are important in establishing whether the shipment was actually made and as a test of cutoff.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley 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.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analysis of Difference Payment has already been made Goods have not been received The goods have been returned Clerical errors and disputed accounts

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Drawing Conclusions Reevaluate internal control. Evaluate the qualitative nature of misstatements. Determine whether sufficient evidence was obtained.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 5 Design audit procedures for the audit of accounts receivable, using an evidence planning worksheet as a guide.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Source of Each Row in the Evidence Planning Worksheet Tolerable misstatement Acceptable audit risk Inherent risk Control risk Substantive tests of transactions results Planned detection risk and planned audit evidence

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Developing Tests of Details Audit Program The development of audit program procedures for tests of details in the sales and collection cycle is based on the results of the analytical procedures, tests of controls, and substantive tests of transactions.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley End of Chapter 12