1. Auditing: The Art and Science of Assurance Engagements
Chapter 15: Completing the Tests in the Sales and Collection Cycle: Accounts Receivable
Copyright © 2011 Pearson Canada Inc.

2. Chapter 15 Learning Objectives
Identify and describe the process for designing tests of details of balances for accounts receivable.
Explain when and why analytical review procedures are completed as part of the audit of sales and accounts receivable.
Describe the accounts receivable audit tests that would be completed for each audit assertion.
Describe the execution and evaluation of monetary unit sampling(MUS).
Copyright © 2011 Pearson Canada Inc.

3. Integration of Audit Risk Model and Types of Audit Tests
15-3
Copyright © 2011 Pearson Canada Inc.

4. Designing Tests of Details of Balances
15-4
Copyright © 2011 Pearson Canada Inc.

5. Effects of Inherent and Control Risks
15-5
Copyright © 2011 Pearson Canada Inc.

6. Materiality Considerations
Unless the organization is highly automated (e.g. with EDI, electronic data interchange), accounts receivable may be one of the largest amounts on the balance sheet.
Transactions throughout the year that build the sales and accounts receivable balances are also normally significant.
15-6
Copyright © 2011 Pearson Canada Inc.

7. Inherent Risk Considerations
Inherent risk tends to be moderate to low for all assertions except:
Realizable value (due to the judgment involved in assessing collectability) and
Cut-off for sales returns or allowances (in particular, warranty allowances or returns of goods on consignment may be difficult to estimate)
15-7
Copyright © 2011 Pearson Canada Inc.

8. Relationship Between Transaction-related and Balance-related Audit Objectives
Figure 15-3, p.501 shows how these audit assertions are related.
This helps in designing dual purpose tests that can validate internal controls as well as provide substantive assurance.
Pay special attention to occurrence/existence, completeness/existence.
15-8
Copyright © 2011 Pearson Canada Inc.

9. Analytical Procedures
Completed during three phases of the audit:
Planning (Phase I)
As part of substantive testing (Phase III)
As part of completing the audit engagement (Phase IV)
15-9
Copyright © 2011 Pearson Canada Inc.

10. Using Analytical Review to Target Detailed Tests
Helpful analyses could include comparing:
Sales by month
Sales returns and allowances
Individual customer balances
Bad debt expense to gross sales
Number of days in A/R
Aging categories
Allowance for uncollectible accounts
15-10
Copyright © 2011 Pearson Canada Inc.

11. Examples of Audit Procedures by Audit Objective (Assertion)
Detail tie-in: Add (foot) open-item file (sales, credit and cash receipts transactions) or the customer master file, and agree to the general ledger
Accuracy and existence: Confirm accounts receivable balances, performing alternative procedures for discrepancies and non-replies.
(Continued)
15-11
Copyright © 2011 Pearson Canada Inc.

12. Examples of Audit Procedures by Audit Objective (Assertion) (Continued)
Completeness: Agree a sample of customer details from the underlying information systems records (data files) to the accounts receivable trial balance.
Classification: Review the receivables listed on the aged trail balance for notes receivable or related party transactions.
(Continued)
15-12
Copyright © 2011 Pearson Canada Inc.

13. Examples of Audit Procedures by Audit Objective (Assertion) (Continued)
Cut-off: Select the last 40 sales transactions from the current year’s sales journal and the first 40 from the subsequent year’s, and trace each to the related shipping documents, checking for the date of actual shipment and ensuring the sales were recorded in the correct period.
(Continued)
15-13
Copyright © 2011 Pearson Canada Inc.

14. Examples of Audit Procedures by Audit Objective (Assertion) (Continued)
Valuation: Discuss with the credit manager the likelihood of collecting older accounts (identified by means of generalized audit software or by review of the aged accounts receivable trial balance). Examine subsequent cash receipts on these accounts and evaluate the collectability.
(Continued)
15-14
Copyright © 2011 Pearson Canada Inc.

15. Examples of Audit Procedures by Audit Objective (Assertion) (Continued)
Rights and obligations: Review the minutes of the board of directors’ meetings for any indication of pledged or factored accounts receivable.
(Continued)
15-15
Copyright © 2011 Pearson Canada Inc.

16. Examples of Audit Procedures by Audit Objective (Assertion) (Continued)
Presentation and disclosure: Enquire of management whether any receivables are pledged or factored.
15-16
Copyright © 2011 Pearson Canada Inc.

17. Discussion Problem 15-30, p. 534
A company is having collection problems
What would you do to investigate the causes?
15-17
Copyright © 2011 Pearson Canada Inc.

18. The Power of Confirmations
Useful for existence, accuracy and cutoff
A/R confirmations come in several forms:
Negative
Positive
Individual item
15-18
Copyright © 2011 Pearson Canada Inc.

19. Positive vs. Negative Confirmations
Positive confirmations
More reliable evidence
Possible to conduct follow up if not answered
Use when
Individual balances relatively large
Fewer debtors
Evidence or suspicion of fraud or serious error
(Continued)
15-19
Copyright © 2011 Pearson Canada Inc.

20. Positive vs. Negative Confirmations (Continued)
Failure to reply must be regarded as a correct response
Less expensive
Use when
Many homogenous balances
Small amounts owing
Internal controls strong
No evidence/suspicion of fraud or serious error
15-20
Copyright © 2011 Pearson Canada Inc.

21. Controlling and Managing the Confirmation Process
1. Controlling the sending of confirmations 2. Procedures for those accounts the client does not want confirmed 3. Handling returned confirmations 4. Timing of alternative procedures and second requests (All of the above illustrate components that affect the cost of this audit procedure.)
15-21
Copyright © 2011 Pearson Canada Inc.

22. 1. Controlling the Sending of Confirmations
The client may assist in preparing the confirmations, but the auditor must due the actual mailing, off the client premises.
If the client stuffs and stamps the envelopes, this must be supervised.
Return envelopes should bear the auditor’s address, not the client’s.
15-22
Copyright © 2011 Pearson Canada Inc.

23. 2. Procedures for those Accounts the Client does not want Confirmed
Where the client does not want to have an account confirmed that has been selected by the auditor, this account needs to be treated like a non-response.
This means that the auditor will apply alternative procedures to the amount.
15-23
Copyright © 2011 Pearson Canada Inc.

24. 3. Handling Returned Confirmations
Confirmations should be returned directly to the auditor’s offices.
Differences between the client’s records and the confirmation reply need to be assessed to determine whether the difference is an error.
15-24
Copyright © 2011 Pearson Canada Inc.

25. Types of Differences
Differences between the client records and the confirmation could be due to:
Payment already made by the client (a potential cut-off error or simply due to the postal service)
Goods were not received (a cut-off error, a potential credit note, or timing difference)
Goods were returned (requiring a credit note)
Amounts are in dispute (perhaps requiring an allowance)
15-25
Copyright © 2011 Pearson Canada Inc.

26. 4. Timing of alternative procedures and second requests
Second (or even third) requests can be sent if there is time.
Such follow-up requests also need to be carefully controlled by the auditor.
Alternative procedures are designed to provide adequate evidence with respect to existence, accuracy and cut-off.
15-26
Copyright © 2011 Pearson Canada Inc.

27. Discussion Question 15-26, p. 533
Confirmations have been returned with answers that do not match the records – what do you do?
15-27
Copyright © 2011 Pearson Canada Inc.

28. Nature of Alternative Procedures
Review of subsequent cash receipts
Examination of duplicate sales invoices
Examination of supporting shipping documentation
Review of correspondence between the client and the customer
15-28
Copyright © 2011 Pearson Canada Inc.

29. Sampling and Accounts Receivable
Sampling is used to select the transactions that will be tested.
For example, statistical sampling could be used to select accounts receivable for confirmation.
In addition, directed sampling (choosing high dollar amounts or old accounts) would be used.
15-29
Copyright © 2011 Pearson Canada Inc.

30. Discussion Problem 15-28, p. 534 Evaluate the sampling approach
Select the sample size
Evaluate results
15-30
Copyright © 2011 Pearson Canada Inc.