Completing the Tests in the Sales and Collection

Completing the Tests in the Sales and Collection Cycle: Accounts Receivable Chapter 16 © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 1

Learning Objective 1 Describe the methodology for designing tests of details of balances using the audit risk model. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 2

Accounts Receivable Balancerelated Audit Objectives 1. Detail tie-in 5. Classification 2. Existence 6. Cutoff 3. Completeness 7. Realizable value 4. Accuracy 8. Rights © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 3

Methodology for Designing Tests of Details of Balances for A/R Identify client business risks affecting accounts receivable Phase I Set tolerable misstatement and assess inherent risk Phase I for accounts receivable Assess control risk for Phase I sales and collection cycle © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 4

Methodology for Designing Tests of Details of Balances for A/R Design and perform tests of controls and substantive tests Phase II of transactions for the sales and collection cycle © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 5

Methodology for Designing Tests of Details of Balances for A/R Design and perform analytical procedures Phase III for accounts receivable balance Design tests of Audit procedures details of accounts Sample size receivable balance to satisfy Items to select balance-related Timing audit objectives © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Phase III 16 - 6

Occurrence Completeness Accuracy Posting and summarization Classification Timing × × Rights Realizable value Cutoff Classification Accuracy Sales Completeness Translation-related audit objectives Existence ACCOUNTS RECEIVABLE BALANCE-RELATED AUDIT OBJECTIVES Detail tie-in Relationship Between Sales and Accounts Receivable × × © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley × × 16 - 7

Occurrence Completeness Accuracy Posting and summarization Classification Timing × Rights Realizable value Cutoff Classification Accuracy Cash receipts Completeness Translation-related audit objectives Existence ACCOUNTS RECEIVABLE BALANCE-RELATED AUDIT OBJECTIVES Detail tie-in Relationship Between Sales and Accounts Receivable × × × © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley × × 16 - 8

Learning Objective 2 Design and perform analytical procedures for accounts in the sales and collection cycle. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 9

Analytical Procedures for the Sales and Collection Cycle Compare by product line: Ø Gross margin percentage with previous years Ø Sales by month over time Ø Sales returns and allowances as a percentage of gross sales with previous years © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 10

Analytical Procedures for the Sales and Collection Cycle Compare with previous years: Ø Individual customer balances over a stated amount Ø Bad debt expense as a percentage of gross sales Ø Days that accounts receivable are outstanding © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 11

Analytical Procedures for the Sales and Collection Cycle Compare with previous years: Ø Aging category as a percentage of receivables Ø Allowance for uncollectible accounts as a percentage of accounts receivable Ø Write-off of uncollectible accounts as a percentage of total accounts receivable © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 12

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 Percent change 12/31/09 2008 - 12/31/08 2007($000) 2009 ($000) 2008 12/31/07 ($000) 144, 328 39, 845 20, 197 3, 323 51, 027 61, 367 5, 681 9. 0 9. 6 7. 3 (2. 1) 14. 0 (7. 0) 21. 9 132, 421 36, 350 18, 827 3, 394 44, 779 66, 021 4, 659 7. 0 14. 1 7. 3 6. 6 8. 0 39. 0 123, 737 33, 961 16, 505 3, 162 41, 989 61, 147 3, 351 258 16. 7 221 5. 7 209 37 15. 6 32 6. 7 30 © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 13

Analytical Procedures: Sales and Collection Cycle 12/31/09 12/31/08 12/31/07 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% 27. 70% 27. 68% 0. 90% 2. 30% 0. 90% 2. 60% 6. 10% 7. 50% 6. 40% 48. 09 47. 96 49. 32 37. 20% 32. 50% 32. 30% © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 14

Design and Perform Tests of Details of A/R Balance (Phase III) Ø Planned detection risk for each objective is an auditor decision Ø Combining the factors that determine planned detection risk is complex © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 15

Learning Objective 3 Design and perform tests of details of balances for accounts receivable. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 16

Designing Tests of Detail of Balances Accounts receivable are correctly added and agree with the Master File and the General Ledger (aged trial balance). Ø Recorded accounts receivable exist Ø Existing accounts receivable are included © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 17

Designing Tests of Detail of Balances Ø Accounts receivable are accurate Ø Accounts receivable are properly classified Ø Cutoff for accounts receivable is correct © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 18

Designing Tests of Detail of Balances Ø Accounts receivable is stated at realizable value Ø The client has rights to accounts receivable Ø Accounts receivable presentation and disclosure © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 19

Learning Objective 4 Obtain and evaluate accounts receivable confirmations. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 20

Confirmations Are Required, Except When: 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. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 21

Type of Confirmation Ø Positive confirmation Ø Blank confirmation form Ø Invoice confirmation Ø Negative confirmation © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 22

Timing The most reliable evidence from confirmations is obtained when they are sent as close to the balance sheet date as possible. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 23

Sample Size Ø Tolerable misstatement Ø Inherent risk Ø Control risk Ø Achieved detection risk from other substantive tests Ø Type of confirmation © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 24

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. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 25

Follow-up on Nonresponses When positive confirmations are used, AU 330 requires follow-up procedures for confirmations not returned by the customer. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 26

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. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 27

Duplicate Sales Invoices These are useful in verifying the actual issuance of a sales invoice and the actual date of the billing. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 28

Shipping Documents These are important in establishing whether the shipment was actually made and as a test of cutoff. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 29

Analysis of Difference Ø Payment has already been made Ø Goods have not been received Ø The goods have been returned Ø Clerical errors and disputed accounts © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 30

Drawing Conclusions Ø Reevaluate internal control Ø Evaluate the qualitative nature of misstatements Ø Determine whether sufficient evidence was obtained © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 31

Learning Objective 5 Design audit procedures for the audit of accounts receivable, using an evidence planning worksheet as a guide. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 32

Source of Each Row in the Evidence Planning Worksheet Tolerable misstatement Ø Acceptable audit risk Ø Inherent risk Ø Control risk Ø Substantive tests of transactions results Ø Analytical procedures Ø Planned detection risk and planned audit evidence Ø © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 33

End of Chapter 16 © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 16 - 34