Accounts Receivable CAS 500 Audit evidence CAS 505

Accounts Receivable CAS 500 – Audit evidence CAS 505 – External confirmations CAS 530 – Audit sampling CAS 520 – Analytical procedures Accounts Receivable 1

Designing Tests of Details of Balances • Audit Risk Model • Thus need to consider – Inherent risk • the risk that the account, disclosure or financial statement note being is materially misstated – Control risk • the risk that the system of internal control will not prevent or detect materially misstated – Detection risk • risk that auditor's procedures will fail to detect errors – Audit risk • Acceptable audit risk - indicates the auditor’s willingness to accept that the financial statements may be materially misstated after the audit is completed an unqualified (clean) opinion was issued. Accounts Receivable 2

Types of Audit Tests and Audit Risk Model Sufficient Appropriate Audit Evidence Audit Risk = = Risk Assessment Procedures Inherent Risk + Procedures to understand internal control + x Control Risk Test of control + Remember the relationship of risk to the amount of evidence. x Analytical Procedures + Detection Risk Test of details Accounts Receivable 3

The Audit of Accounts Receivable Set materiality. Assess Audit Risk for A/R. Conduct analytical procedures for planning purposes Assess Control Risk for sales and collections cycle Identify assertions where substantive testing is insufficient, and/or there is risk of material misstatement e. g. Confirmations vs. Subsequent payments? e. g. Sample size will be affected by reliance on internal controls e. g. Monetary unit sampling could be used to select the actual items e. g. Low CR, could do substantive testing early The type of audit procedures? What is the sample size? Items to be selected? Timing – when to do the procedures? Design and perform test of control. Assess control risk Design and perform analytical procedures as substantive tests for accounts receivable balance Design tests of accounts receivable balance to satisfy balance-related audit objectives. Must consider IR for A/R. Materiality for A/R is allocated from planning materiality. Probably want a low audit risk for A/R as it is usually material. E. g. 5% Use last years assessed CR. If not available, estimate based on initial system review and discussions with client. Will eventually use the assessed materiality after testing. Some parts of an audit may require additional substantive testing beyond was is normal. This could be due to increased chance of material misstatement or due to the significance of the item, E. G. intercompany A/R. i. e. Related party T/A Design test for those controls on which the auditor will rely. You cannot assess CR without testing Tests of details can be reduced if CR is low. Analytical procedures are performed as additional persuasive evidence. Amount of testing is indirectly related to DR Accounts Receivable 4

Effects of Inherent and Control Risks High Inherent or Control Risk Greater chance of missing material misstatement Thus a lot of substantive testing Low Inherent or Control Risk Material misstatement will be caught by the system Thus substantive testing can be reduced, but not eliminated Accounts Receivable 5

Materiality Considerations • Accounts receivable may be one of the largest amounts on the balance sheet. • Sales and accounts receivable balances are normally significant. Accounts Receivable 6

Inherent Risk Considerations • Inherent risk tends to be moderate to low for all assertions – What are the risk associated with Accounts Receivable? – High risk areas: • Realizable value • Cut-off for sales returns or allowances Accounts Receivable 7

Balance-Related Audit Objectives • Help auditor decide appropriate audit evidence – Accounts receivable exist – Accounts receivable are owned have not been sold or discounted – There are no unrecorded accounts receivables – Stated at NRV – Accounts receivable are appropriately recorded and disclosed • Properly classified More specific than general audit objectives • Aged trial balance agrees with the general ledger • Accounts receivable are recorded in the correct period Accounts Receivable 8

Disclosure-Related Audit Objectives • Presentation and disclosure in the financial statements – Accounts receivable transactions actually occurred – Accounts receivable are amounts collectible by the client – Disclosures for accounts receivables are fully included – Accounts receivable in the financial statements are materially correct – Shown at amounts that are collectible – Correctly shown as current and long-term – Both financial and non-financial is clearly disclosed Accounts Receivable 9

Relationship Between Transaction-Related and Balance-Related Audit Objectives Accounts Receivable Balance Related Audit Objectives Class of Transactions Transaction-Related Audit Objectives Sales Occurrence Existence Rights and Obligations Completeness Accuracy Valuation Classification Detail Tie-In Cut-off X Completeness X Accuracy X X Posting & Summarization X Timing Cash Receipts X Occurrence Completeness Accuracy Classification Posting & Summarization X X X Timing X This helps in designing dual purpose tests that can validate internal controls as well as provide substantive assurance. Also show the test validates the transaction as well as the balance. Accounts Receivable 10

• Occurrence transaction-related audit objective for sales and the Existence balance-related audit objective – For sales, the audit objective occurrence shows that – For accounts receivable, the audit object of existence shows that – From the point of control risk • If auditor concludes that control risk over sales is low – Also, by performing accounts receivable confirmations Accounts Receivable 11

• Completeness transaction-related audit objective for cash receipts and the Existence balance-related audit objective – For cash receipts the audit objective completeness shows that – For accounts receivable the audit object shows that – From the point of control risk • If auditor concludes that control risk over cash receipts is low – Thus by performing subsequent payments Accounts Receivable 12

Analytical Procedures • Analytical procedures are important • But remember that analytical procedures are used during three main phases of the audit: 1. Planning 2. As part of substantive testing 3. As part of completing the audit engagement Accounts Receivable 13

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 • To what would these items be compared? • What is the auditor looking for? Accounts Receivable 14

The Audit Objective and the Audit Procedure • Existence and accuracy: – Confirm accounts receivable balances – performing alternative procedures for discrepancies and nonreplies. Accounts Receivable 15

• Rights and obligations: – Could also say the ownership of the asset – But what is done about pledged or factored accounts receivable? Accounts Receivable 16

• Valuation: – What is the important valuation account in relation to accounts receivable? – Thus pertinent procedures for valuation? Accounts Receivable 17

• Completeness: • Classification: Accounts Receivable 18

• Cut-off: – Select the last 40 sales transactions from the current year’s sales journal and the first 40 from the subsequent year’s • Detail tie-in: – Foot the customer master file • Presentation and disclosure: – Ensure full and complete disclosure in the financial statements Accounts Receivable 19

Accounts Receivable – Financial Statement Disclosure On the balance sheet: On the income statement: In the notes: Accounts Receivable 20

The Power of Confirmations • CAS 505 External Confirmations • A very important audit procedure – Mc. Kesson & Robbins 1937 • Useful for existence • A/R confirmations come in two forms: – Negative – Positive Accounts Receivable 21

Positive vs. Negative Confirmations • Positive confirmations – A more reliable form of evidence for A/R – if not answered • When are they used? – Individual balances are – And/or Accounts Receivable 22

ABC Company Letterhead ABC Company 1234 Main Street Winnipeg, Manitoba R 3 R 3 R 3 15 January, 201 Y • Note there are different forms of positive confirmation. An alternative is to have it sent by the auditor instead of the client. There is an example of this in the text on page 589. • As shown on this page, the auditor can show a list of invoices. To Whom it May Concern: This request is being sent to you to enable our independent auditors to confirm the correctness of our records. It is not a request for payment. Your prompt attention to this request will be appreciated. An stamped envelope is enclosed for your reply. Our records on December 31, 201 X showed an amount of $2, 987. 50 receivable from you. Please confirm whether this agrees with your records on that date by signing and returning this form directly to our auditors, CHAMBERS & FORD. An addressed envelope is enclosed for this purpose. If you find any difference please report details directly to our auditors in the space provided below. Sincerely, ………………… Jean Fellows, Controller Confirmation The balance receivable from us for $2, 987. 50 as of December 31, 201 X is correct except as noted below: ___________________________________________________________________________________________________________ ABC Company Date ……………………. By ……………………. . Accounts Receivable 23

• Negative confirmations – Failure to reply • Negative confirmation requires a response only if there is a discrepancy. • When are they used? Accounts Receivable 24

ABC Company Letterhead ABC Company 1234 Main Street Winnipeg, Manitoba R 3 R 3 R 3 15 January, 201 Y Again there are different forms of negative confirmation. An alternative is to have it sent by the auditor instead of the client. There is an example of this in the text on page 590 To Whom it May Concern: This request is being sent to you to enable our independent auditors to confirm the correctness of our records. It is not a request for payment. Our records on December 31, 201 X showed an amount of $2, 987. 50 receivable from you. If it does NOT agree with your records, please report any exceptions directly to our auditors, CHAMBERS & FORD. An addressed envelope is enclosed for this purpose. . Sincerely, ………………… Jean Fellows, Controller Differences ___________________________________________________________________________________________________________ ABC Company Date ……………………. By ……………………. . Accounts Receivable 25

Controlling and Managing the Confirmation Process Look at the following points: 1. 2. 3. 4. Controlling the sending of confirmations Procedures for those accounts the client does not want confirmed Handling returned confirmations Timing of alternative procedures and second requests • Auditor must also decide Accounts Receivable 26

1. Controlling the Sending of Confirmations • The client may assist in preparing the confirmations • If the client stuffs and stamps the envelopes • Return envelopes Accounts Receivable 27

2. Procedures for those Accounts the Client does not want Confirmed • If it has been selected by the auditor • The auditor will apply alternative procedures to the amount Accounts Receivable 28

3. Handling Returned Confirmations • Confirmations should be returned directly • Differences between the client’s records and the confirmation reply – need to determine if the difference is an error Accounts Receivable 29

Types of differences between client and customer • Differences between the client records and the confirmation could be due to: 1. Payment already made by the client • 2. A timing difference between client records and customer records Goods were not received • A timing difference for goods in transit 3. Goods were returned • 4. Could be a timing difference between customer and client for the return Amounts are in dispute Accounts Receivable 30

4. Timing of alternative procedures and second requests • Second requests can be sent • Control of such follow-up requests • Alternative procedures – designed to provide adequate evidence with respect to existence, accuracy and cut-off Accounts Receivable 31

Nature of Alternative Procedures • Review of subsequent cash receipts • Examination of duplicate sales invoices • Examination of shipping documentation • Review of correspondence between the client and the customer Accounts Receivable 32

Sampling and Accounts Receivable • Sampling is always used to determine which accounts receivable will be selected • Statistical sampling could be used to select accounts receivable for confirmation • Or directed sampling Accounts Receivable 33

Extending misstatements to the population – Point Estimate • • Assume that there are the following misstatements from the sample. The book value of the population is $596, 566. 00 Recorded Amount (a) Audited Amount (b) Misstatement (c) AAA 45, 689. 34 45, 896. 34 (207. 00) BBB 82, 391. 23 80, 291. 23 2, 100. 00 A 9987. 12 9887. 12 100. 00 B 3350. 75 3340. 75 10. 00 C 2167. 34 2267. 34 (100. 00) D 65. 43 64. 53 0. 90 E 775. 45 757. 45 18. 00 144, 426. 66 142, 504. 76 1921. 90 Total One can extend the misstatement to the population by using a point estimate. Point estimate = (Misstatement/Recorded Amount of Sample) x Book Value of the Population Point estimate = (1, 921. 90/144, 426. 66) x 596, 566. 00 = $7, 938. 56 As the Tolerable Misstatement = $40, 000, the population is not materially misstated. Accounts Receivable 34

Point Estimate – Multiple Strata • • Assume that there are the following misstatements from the sample, in two strata. High dollar values with a recorded value of $391, 756. 95 Low dollar values with a recorded value of $204, 809. 05 Thus the book value of the population is $596, 566. 00 Recorded Amount (a) Strata 1: Large dollar items. All items greater than or equal to $40, 000 Strata 2: Small dollar items. All items less than $40, 000 Audited Amount (b) Misstatement (c) AAA 45, 689. 34 45, 896. 34 (207. 00) BBB 82, 391. 23 80, 291. 23 2, 100. 00 Total 128, 080. 57 126, 210. 34 1893. 00 Point Estimate $5790. 07 A 9987. 12 9887. 12 100. 00 B 3350. 75 3340. 75 10. 00 C 2167. 34 2267. 34 (100. 00) D 65. 43 64. 53 0. 90 E 775. 45 757. 45 18. 00 16, 346. 09 16, 294. 42 28. 90 Total Point Estimate $362. 10 Total Point Estimate Strata 1 point estimate: (1, 893/128, 080. 57) x 391, 756. 95 = $5, 790. 07 $6152. 17 Strata 2 point estimate: (28. 90/16, 346. 09) x 204, 809. 05 = $362. 10 As materiality is $40, 000, the population is not materially misstated. Accounts Receivable 35

Example 2: Extending misstatements to the population • • • Commonly used with MUS Sample size is 40 and RIA is 10% There is no stratification. WHY? Recorded Amount (a) • Audited Amount (b) Misstatement (c) Misstatement Percentage c/a AAA 45, 689. 34 45, 896. 34 (207. 00) (0. 0045) BBB 82, 391. 23 80, 291. 23 2, 100. 00 0. 0255 A 9987. 12 9887. 12 100. 00 1. 0% B 3350. 75 3340. 75 10. 00 0. 3% C 2167. 34 2267. 34 (100. 00) D 65. 43 64. 53 0. 90 1. 4% E 775. 45 757. 45 18. 00 2. 3% (4. 6%) Here there are five overstatements and two understatement. Accounts Receivable 36

Sample size ACTUAL NUMBER OF DEVIATIONS FOUND 0 1 2 3 4 5 6 7 8 9 10 5 PERCENT RISK OF OVER RELIANCE (RIA or Beta Risk) 20 25 14. 0 11. 3 21. 7 17. 7 28. 3 23. 2 34. 4 28. 2 40. 2 33. 0 45. 6 37. 6 50. 8 42. 0 55. 9 46. 3 60. 7 50. 4 65. 4 54. 4 69. 9 58. 4 30 35 40 45 50 55 60 65 70 75 80 90 100 125 150 200 300 400 500 9. 6 8. 3 7. 3 6. 5 5. 9 5. 4 4. 9 4. 6 4. 2 4. 0 3. 7 3. 3 3. 0 2. 4 2. 0 1. 5 1. 0 0. 8 0. 6 14. 9 12. 9 11. 4 10. 2 9. 2 8. 4 7. 7 7. 1 6. 6 6. 2 5. 8 5. 2 4. 7 3. 8 3. 2 2. 4 1. 6 1. 2 1. 0 19. 6 17. 0 15. 0 13. 4 12. 1 11. 1 10. 2 9. 4 8. 8 8. 2 7. 7 6. 9 6. 2 5. 0 4. 2 3. 2 2. 1 1. 6 1. 3 23. 9 20. 7 18. 3 16. 4 14. 8 13. 5 12. 5 11. 5 10. 8 10. 1 9. 5 8. 4 7. 6 6. 1 5. 1 3. 9 2. 6 2. 0 1. 6 28. 0 24. 3 21. 5 19. 2 17. 4 15. 9 14. 7 13. 6 12. 7 11. 8 11. 1 9. 9 9. 0 7. 2 6. 0 4. 6 3. 1 2. 3 1. 9 31. 9 27. 8 24. 6 22. 0 19. 9 18. 2 16. 8 15. 5 14. 5 13. 6 12. 7 11. 4 10. 3 8. 3 6. 9 5. 2 3. 5 2. 7 2. 1 35. 8 31. 1 27. 5 24. 7 22. 4 20. 5 18. 8 17. 5 16. 3 15. 2 14. 3 12. 8 11. 5 9. 3 7. 8 5. 9 4. 0 3. 0 2. 4 39. 4 34. 4 30. 4 27. 3 24. 7 22. 6 20. 8 19. 3 18. 0 16. 9 15. 9 14. 2 12. 8 10. 3 8. 6 6. 5 4. 4 3. 3 2. 7 43. 0 37. 5 33. 3 29. 8 27. 1 24. 8 22. 8 21. 2 19. 7 18. 5 17. 4 15. 5 14. 0 11. 3 9. 5 7. 2 4. 8 3. 6 2. 9 46. 6 40. 6 36. 0 32. 4 29. 4 26. 9 24. 8 23. 0 21. 4 20. 1 18. 9 16. 9 15. 2 12. 3 10. 3 7. 8 5. 2 3. 9 3. 2 50. 0 43. 7 38. 8 34. 8 31. 6 28. 9 26. 7 24. 7 23. 1 21. 6 20. 3 18. 2 16. 4 13. 2 11. 1 8. 4 5. 6 4. 3 3. 4 Accounts Receivable 37

Sample size ACTUAL NUMBER OF DEVIATIONS FOUND 0 1 2 3 4 5 6 7 8 9 10 10 PERCENT RISK OF OVER RELIANCE (RIA or Beta Risk) 20 25 10. 9 8. 8 18. 1 14. 7 24. 5 20. 0 30. 5 24. 9 36. 1 29. 5 30 35 40 45 50 55 60 65 70 75 80 90 100 125 150 200 300 400 500 7. 4 12. 4 16. 8 21. 0 24. 9 6. 4 10. 7 14. 5 18. 2 21. 6 5. 6 9. 4 12. 8 16. 0 19. 0 5. 0 3. 8 8. 4 3. 4 11. 4 3. 2 14. 3 3. 0 17. 0 3. 0 4. 6 7. 6 10. 3 12. 9 15. 4 4. 2 6. 9 9. 4 11. 8 14. 1 3. 8 6. 4 8. 7 10. 8 12. 9 3. 5 5. 9 8. 0 10. 0 12. 0 3. 3 5. 5 7. 5 9. 3 11. 1 3. 1 5. 1 7. 0 8. 7 10. 4 2. 9 4. 8 6. 6 8. 2 9. 8 2. 6 4. 3 5. 9 7. 3 8. 7 2. 3 3. 9 5. 3 6. 6 7. 9 1. 9 3. 1 4. 3 5. 3 6. 3 1. 6 2. 6 3. 6 4. 4 5. 3 1. 2 2. 0 2. 7 3. 4 4. 0 0. 8 1. 3 1. 8 2. 3 2. 7 0. 6 1. 0 1. 4 1. 7 2. 0 0. 5 0. 8 1. 1 1. 4 1. 6 41. 5 34. 0 46. 8 38. 4 51. 9 42. 6 56. 8 46. 8 61. 6 50. 8 66. 2 54. 8 28. 8 24. 9 22. 0 19. 7 17. 8 16. 3 15. 0 13. 9 12. 1 11. 3 10. 1 9. 1 7. 3 6. 1 4. 6 3. 1 2. 4 1. 9 32. 5 28. 2 24. 9 22. 3 20. 2 18. 4 16. 9 15. 7 14. 6 13. 7 12. 8 11. 5 10. 3 8. 3 7. 0 5. 3 3. 5 2. 7 2. 1 36. 2 31. 4 27. 7 24. 8 22. 5 20. 5 18. 9 17. 5 16. 3 15. 2 14. 3 12. 8 11. 5 9. 3 7. 8 5. 9 3. 0 2. 4 39. 7 34. 5 30. 5 27. 3 24. 7 22. 6 20. 8 19. 3 18. 0 16. 8 15. 8 14. 1 12. 7 10. 2 8. 6 6. 5 4. 3 3. 3 2. 6 43. 2 37. 6 33. 2 29. 8 27. 0 24. 6 22. 7 21. 0 19. 6 18. 3 17. 2 15. 4 13. 9 11. 2 9. 4 7. 1 4. 7 3. 6 2. 9 46. 7 40. 6 35. 9 32. 2 29. 2 26. 7 24. 6 22. 8 21. 2 19. 8 18. 7 16. 7 15. 0 12. 1 10. 1 7. 6 5. 1 3. 9 3. 1 The Upper and Lower Bounds must be determined. What do these mean? Obtain the Precision Limits from this table – 10% RIA Accounts Receivable 38

With this example one has to consider that a large part of the population has not been examined, and there may be items that have misstatements. Thus they have been missed because they are not in the sample. This part of the population is not in the sample. Thus zero misstatements have been found here because these items have not been examined. The misstatements of the remaining part of the population are not known. Thus a misstatement assumption has to be made. E. g. they are 50% misstated. See next slide. Sample The misstatements of the sample, as percentages, are known. See previous slide 39. Accounts Receivable 39

Note in the following table, the conservative approach is to associate the lowest misstatement limit (2) portion with the highest misstatement unit error (4). The amount of error is thus maximized Overstatements Number of Misstatements (1) Upper Precision Limit Portion (2) Recorded Value (3) Misstatement Unit Error Assumption (4) Bound Portion 2 x 3 x 4 0 0. 056 596, 566 0. 500 $16, 704 1 0. 038 596, 566 0. 025 567 2 0. 034 596, 566 0. 023 467 3 0. 032 596, 566 0. 014 4 0. 030 596, 566 0. 010 179 5 0. 030 596. 566 0. 003 54 Overstatements Upper Precision Limit * 267 0. 220 Initial Misstatement Bound * These amounts come from the Example 2 slide. Only overstatements. $18, 238 Accounts Receivable 40

Understatements Number of Misstatements (1) Upper Precision Limit Portion (2) Recorded Value (3) Misstatement Unit Error Assumption (4) Bound Portion 2 x 3 x 4 0 0. 056 596, 566 0. 500 $16, 704 1 0. 038 596, 566 0. 046 1043 2 0. 034 596, 566 0. 005 101 Understatements Upper Precision Limit Initial Misstatement Bound 0. 128 $17, 848 Accounts Receivable 41

Offsetting Adjustments Number of Misstatements Misstatement Unit Error Assumption (a) Sample Size (b) Recorded Population (c) Point Estimate a(c/b) Initial Overstatement Bounds $18, 238 Understatement Misstatements 1 0. 046 40 596, 566 686 (686) 2 0. 005 40 596, 566 75 (75) Total 0. 051 40 596, 566 761 (761) Adjusted Overstatement Bound 17, 477 Initial Understatement Bound 17, 848 Overstatement Misstatements 1 0. 025 40 596, 566 373 (373) 2 0. 023 40 596, 566 343 (343) 3 0. 014 40 596, 566 209 (209) 4 0. 010 40 596, 566 149 (149) 5 0. 003 40 596, 566 45 (45) Total 0. 075 40 596, 566 1119 Adjusted Understatement Bound (1119) 16, 729 Since materiality is $40, 000, there is no material misstatement. Accounts Receivable 42

The Decision Rule for MUS If both the lower misstatement bound (LMB) and upper misstatement bound (UMB) fall between the understatement and overstatement tolerable misstatement amounts, accept the conclusions that the book value is not misstated by a material amount. Otherwise, conclude that the book value is misstated by a material amount. Tolerable misstatement ($40, 000) $40, 000 Reject No material misstatement IF $45, 708 ($16, 729) $17, 477 IF $49, 708 LMB UMB Since materiality is $40, 000, there is no material misstatement. Accounts Receivable 43

Decisions making (Check one box) • Accept population • Request client to adjust population • Expand audit test • Some other action. Specify Accounts Receivable 44

Problem DC 10 -1, Page 547 When Marge Simpson, PA, audited the Candle Company inventory, a random sample of inventory types was chosen for physical observation and price testing. The sample size was 80 different types of candles and candle-making inventory. The entire inventory contained 1, 740 types, and the amount in the inventory control account was $166, 000. Simpson had already decided that a misstatement of as much as $6, 000 in the account would not be material. The audit work revealed the following eight errors in the sample of 80. Book Value (a) Audit value Error Amount (b) % Misstatement b/a $600. 00 $622. 00 $(22. 00) (0. 037) 15. 50 14. 50 1. 00 0. 065 65. 25 31. 50 33. 75 0. 517 83. 44 53. 45 29. 99 0. 359 16. 78 15. 63 1. 15 0. 069 78. 33 12. 50 65. 83 0. 840 13. 33 14. 22 (0. 89) (0. 067) 93. 87 39. 87 54. 00 0. 575 $966. 50 $803. 67 $162. 83 Accounts Receivable 45

Assume the sample was chosen using Monetary Unit Sampling, and the sampling risk is 10%. Simpson also assumes that the Misstatement Assumption for zero misstatements is 50% for both over and under misstatements. Is the inventory materially misstated? Total Population = Sample Size = 166, 000. 00 80 ARACR = 10. 00% Upper Misstatement Unit Error Assumption 50. 00% Lower Misstatement Unit Error Assumption 50. 00% Materiality 6, 000 Accounts Receivable 46

Sample size ACTUAL NUMBER OF DEVIATIONS FOUND 0 1 2 3 4 5 6 7 8 9 10 10 PERCENT RISK OF OVER RELIANCE (RIA or Beta Risk) 20 25 10. 9 8. 8 18. 1 14. 7 30 35 40 45 50 55 60 65 70 75 80 90 100 125 150 200 300 400 500 7. 4 12. 4 6. 4 10. 7 5. 6 9. 4 5. 0 8. 4 4. 6 7. 6 4. 2 6. 9 3. 8 6. 4 3. 5 5. 9 3. 3 5. 5 3. 1 5. 1 2. 9 4. 8 1. 9 2. 6 4. 3 1. 8 2. 3 3. 9 1. 9 3. 1 1. 6 2. 6 1. 2 2. 0 0. 8 1. 3 0. 6 1. 0 0. 5 0. 8 24. 5 20. 0 30. 5 24. 9 36. 1 29. 5 41. 5 34. 0 46. 8 38. 4 51. 9 42. 6 56. 8 46. 8 61. 6 50. 8 66. 2 54. 8 16. 8 14. 5 12. 8 11. 4 10. 3 9. 4 8. 7 8. 0 7. 5 7. 0 6. 6 5. 9 1. 6 5. 3 4. 3 3. 6 2. 7 1. 8 1. 4 1. 1 21. 0 18. 2 16. 0 14. 3 12. 9 11. 8 10. 0 9. 3 8. 7 8. 2 7. 3 1. 6 6. 6 5. 3 4. 4 3. 4 2. 3 1. 7 1. 4 24. 9 21. 6 19. 0 17. 0 15. 4 14. 1 12. 9 12. 0 11. 1 10. 4 9. 8 8. 7 1. 5 7. 9 6. 3 5. 3 4. 0 2. 7 2. 0 1. 6 28. 8 24. 9 22. 0 19. 7 17. 8 16. 3 15. 0 13. 9 12. 1 11. 3 10. 1 1. 9 9. 1 7. 3 6. 1 4. 6 3. 1 2. 4 1. 9 32. 5 28. 2 24. 9 22. 3 20. 2 18. 4 16. 9 15. 7 14. 6 13. 7 12. 8 11. 5 10. 3 8. 3 7. 0 5. 3 3. 5 2. 7 2. 1 36. 2 31. 4 27. 7 24. 8 22. 5 20. 5 18. 9 17. 5 16. 3 15. 2 14. 3 12. 8 11. 5 9. 3 7. 8 5. 9 3. 0 2. 4 39. 7 34. 5 30. 5 27. 3 24. 7 22. 6 20. 8 19. 3 18. 0 16. 8 15. 8 14. 1 12. 7 10. 2 8. 6 6. 5 4. 3 3. 3 2. 6 43. 2 37. 6 33. 2 29. 8 27. 0 24. 6 22. 7 21. 0 19. 6 18. 3 17. 2 15. 4 13. 9 11. 2 9. 4 7. 1 4. 7 3. 6 2. 9 46. 7 40. 6 35. 9 32. 2 29. 2 26. 7 24. 6 22. 8 21. 2 19. 8 18. 7 16. 7 15. 0 12. 1 10. 1 7. 6 5. 1 3. 9 3. 1 The Upper and Lower Bounds must be determined. What do these mean? Obtain the Precision Limits from this table – 10% RIA Accounts Receivable 47

Overstatements Number of Misstatements (1) Upper Precision Limit Portion (2) Recorded Value (3) Misstatement Unit Error Assumption (4) Bound Portion 2 x 3 x 4 0 0. 029 166, 000 0. 500 $2, 407 1 0. 019 166, 000 0. 840 2649 2 0. 018 166, 000 0. 575 1718 3 0. 016 166, 000 0. 517 1373 4 0. 016 166, 000 0. 359 954 5 0. 015 166, 000 0. 069 172 6 0. 015 166, 000 0. 065 162 Overstatements Upper Precision Limit Initial Misstatement Bound 0. 128 $9, 435 Accounts Receivable 48

Understatements Number of Misstatements (1) Upper Precision Limit Portion (2) Recorded Value (3) Misstatement Unit Error Assumption (4) Bound Portion 2 x 3 x 4 0 0. 029 166, 000 0. 500 $2, 407 1 0. 019 166, 000 0. 067 211 2 0. 018 166, 000 0. 037 111 Understatements Upper Precision Limit Initial Misstatement Bound 0. 066 $2, 729 Accounts Receivable 49

Offsetting Adjustments Number of Misstatements Misstatement Unit Error Assumption (a) Sample Size (b) Recorded Population (c) Point Estimate a(c/b) Bounds Initial Overstatement Bound $9, 435 Understatement Misstatements 1 0. 067 80 166, 000 139 (139) 2 0. 037 80 166, 000 77 (77) Total 0. 104 80 166, 000 216 (216) Adjusted Overstatement Bound 9, 219 Initial Understatement Bound 2, 729 Overstatement Misstatements 1 0. 840 80 166, 000 1743 (1743) 2 0. 575 80 166, 000 1193 (1193) 3 0. 517 80 166, 000 1073 (1073) 4 0. 359 80 166, 000 745 (745) 5 0. 069 80 166, 000 143 (143) 6 0. 065 80 166, 000 135 (135) Total 2. 425 5032 (5032) Adjusted Understatement Bound -2303 As the Upper Bound is greater than the materiality of $6, 000, there may be a material misstatement Accounts Receivable 50

The Decision Rule Tolerable misstatement ($6, 000) $6, 000 Reject $2, 303 $9, 219 LMB UMB Problem Since materiality is $6, 000, there may be material misstatement. Accounts Receivable 51

Problem EP 11 -4, Page 609 Several accounts receivable confirmations have been returned with the notation “verification of supplier statements is no longer possible because our data processing system does not accumulate each supplier’s invoice”. Required: What alternative auditing procedures could be used to audit these accounts receivable? (© 2000, American Institute of CPAs. All rights reserved. Adapted by permission. ) Accounts Receivable 52

Problem EP 11 -5, Page 609 During the audit of the December 31, 20 X 5, financial statements, the auditor identifies cash amounts received after December 31, 20 X 5, and traces these amounts to the cash account in the general ledger and to the accounts receivable subledger balances at December 31, 20 X 5. Required: a)What kind of procedure is this? Which financial statement assertion does it provide evidence for? b)What records or documents would the auditor need to look at to identify cash amounts received after year-end? Accounts Receivable 53

Problem DC 11 -6, Page 613 The ABC Appliance Company, a manufacturer of small electrical appliances, deals exclusively with 20 distributors situated throughout the country. At December 31 (the balance sheet date), receivables from these distributors aggregated $875, 000. Total current assets were 1. 3 million. With respect to receivables, the auditors followed the procedures outlined below in the course of the annual audit of the financial statements. 1. 2. 3. 4. 5. Reviewed the system of internal control and found it to be exceptionally good. Reconciled the subsidiary ledger and control accounts at year-end. Aged the accounts – none were overdue. Examined detailed sales and collection transactions for February, July, and November. Received positive confirmations of year-end balances. Required: Criticize the completeness or incompleteness of the above program, giving reasons for your recommendations concerning the addition or omission of any procedures. Accounts Receivable 54

Problem DC 11 -9, Page 615 The auditor of a stock exchange brokerage company, Roller Securities Inc. , sends out negative confirmations of account details for a sample of about 50% of the stock brokerage’s customers, selected at random. Historically, 2 -5% of the confirmations have been returned, and the majority of the discrepancies reported have been understatements. Investigation of those discrepancies rarely indicates an error on Roller Securities Inc. ’s part. Usually, they are explained by transactions that are in progress or pending over the year-end, by late payments on the customer’s part, or by other mistakes in the customer’s own records. Required: a)Describe the inherent risks and the internal control risks that exist for customer accounts at Roller Securities Inc. b)Discuss the advantages and disadvantages of using negative confirmations to provide audit evidence about the assertions in this case. Comment on the persuasiveness of the evidence the negative confirmations provide. Do you think it can be sufficient to support the auditor’s opinion? Accounts Receivable 55

Problem DC 11 -10, Page 615 Parts Inc. sells electrical components to large department stores and also has a few cash sales to electricians. Sales invoices are prepared for all sales. Cash sales are recorded in the cash receipts journal, and cash is deposited to the bank each day. All sales to large stores are credit sales and are handled by sales clerks by telephone or email. The sales clerk takes the customer’s request, checks the authorized customer list for credit limits (if it is a credit sale), prepares the sales invoice, and sends one copy to the inventory control department, which sends the ordered goods to the shipping department. For cash sales, the inventory control clerk brings the items sold to the sales counter and the goods are given to the purchaser at the time of sale. For credit sales, the shipping clerk signs the inventory control copy of the sales invoice and then prepares a shipping invoice. A third copy of the sales invoice is forwarded to the accounting department so that a clerk can enter the sale into the sales journal. The shipping invoices are maintained in the shipping department in case a shipment needs to be checked. All goods are shipped FOB shipping point. Required: a)Design two audit procedures, in addition to sample selection, that will provide evidence of he occurrence/existence of sales. Identify the procedure (trace, compare, vouch, and so on) and the documents you are using, and explain why these procedures will show whether recorded sales are valid. b)Design two audit procedures that will provide evidence of the completeness of sales. Identify the procedure (trace compare, vouch, and so on) and the documents you are using, and explain why these procedures will show whether recorded sales are complete. (Adapted from External Auditing (AU 1), June 2011, with permission of Chartered Professional Accountants of Canada, Toronto, Canada) Accounts Receivable 56