AUDITING

CHAPTER 11
Accounts Receivable &
Cash Balances
By
David N. Ricchiute

TOPICS IN
REVENUE/RECEIPT
Relationship assertions & audit
CYCLE
procedures
Relationship audit risk, client strategies,
substantive tests
Substantive tests for assertions
Revenue recognition, earnings
manipulation, & channel stuffing
Audit sampling & accounts receivable
Computer-assisted audit techniques

GBW 8th ed. Ch. 11

ASSERTIONS &
OBJECTIVES
Management assertions:
Recorded receivables & cash
balances

Exist
Include all transactions
(completeness)
Represent rights of entity
Are valued appropriately
Are presented & disclosed properly

GBW 8th ed. Ch. 11

OBJECTIVES &
PROCEDURES:
Objective: determine whether all recorded
Existence/Occurrence
sales, receivables, cash balances
Procedures

Existence
Physical observation
Confirmation

Transactions occurred
Cutoff testing for proper period

GBW 8th ed. Ch. 11

OBJECTIVES &
PROCEDURES:
Completeness
Objective: determine whether all
receivables, sales, cash of period are
presented in financial statements
Procedures

Examine documents
Apply analytical procedures
Cutoff bank statements, bank
reconciliations, etc.

GBW 8th ed. Ch. 11

OBJECTIVES &
PROCEDURES:
Rights/Obligations
Objective: determine whether entity
has property rights to cash,
accounts receivable
Procedures

Examine documentation
Confirmations
Inquiries
GBW 8th ed. Ch. 11

OBJECTIVES &
PROCEDURES:
Valuation, Allocation

Objective: determine whether entity

has recorded items in correct
amounts, accounts, & time periods
Procedures

Confirm balances
Verify mathematical accuracy
Examine details of recording

GBW 8th ed. Ch. 11

OBJECTIVES &
PROCEDURES: Presentation,
Disclosure

Objective: determine whether

recorded transactions,
balances properly classified,
described, disclosed
Procedures

Compare presentation to GAAP

Annual updates of AICPA
guidelines
GBW 8th ed. Ch. 11

AUDIT RISK MODEL

AR = CR x IR x DR
Detection risk (DR): likelihood that
error could occur & not be detected
Based on

Control risk (CR)

Likelihood of material error

Inherent risk (IR)

Strategies & threats

GBW 8th ed. Ch. 11

DETECTION RISK
DR =

____AR___
IR x CR
Nature, extent, timing substantive
tests

10

Nature: more/less persuasive tests

Extent: larger/smaller samples
Timing: balance sheet date or interim
GBW 8th ed. Ch. 11

ASSERTIONS & PROCEDURES

Accounts Receivable, Sales-1
Valuation
Verify mathematical accuracy AR

11

Obtain aged trial balance

Foot trial balance
Compare total AR per trial balance to
general ledger

GBW 8th ed. Ch. 11

ASSERTIONS &
PROCEDURES
Accounts
Receivable,
Existence, rights,
valuation Sales-2
Confirm year-end accounts & notes
receivable with debtors

Positive: tell auditor if balance correct

Large balances, inaccuracies

Negative: tell auditor only if balance

incorrect
Control adequate, small balances

12

GBW 8th ed. Ch. 11

ASSERTIONS &
PROCEDURES
Accounts Receivable, Sales-3

Existence or occurrence, completeness

Test cutoff to determine whether
sales, receivables recorded in proper
period

13

FOB shipping point

FOB destination

GBW 8th ed. Ch. 11

ASSERTIONS &
PROCEDURES
Accounts
Receivable,
Sales-4
Valuation, rights
Review collectibility receivables
Determine adequacy allowance for
doubtful accounts

14

GBW 8th ed. Ch. 11

ASSERTIONS &
PROCEDURES
Accounts
Receivable,
Sales-5
Existence or occurrence,
completeness,
valuation
Perform analytical procedures for
reasonableness of sales, receivables
balances

15

Collections problems
Overstated sales
Understated sales

GBW 8th ed. Ch. 11

ASSERTIONS &
PROCEDURES
Accounts
Receivable,
Sales-6
Presentation & disclosure
Review financial statements to
determine

16

Accounts, notes receivable properly

classified, described
Disclosures adequate

GBW 8th ed. Ch. 11

TESTING CUTOFF
Sales, Receivables
At or around end each quarter, the former
President directed his subordinates to hold
IGIs books open, to backdate invoices,
shipping documents. This caused IGI to
record out-of-period sales & to overstate
revenue, net income end each quarter.
Procedures

17

Trace recorded sales to shipping documents

before, after end of period

GBW 8th ed. Ch. 11

ASSERTIONS &
PROCEDURES: Cash-1
Existence, rights, valuation
Confirm year end balances with all
banks

18

GBW 8th ed. Ch. 11

ASSERTIONS &
PROCEDURES: Cash-2
Valuation
Verify mathematical accuracy
recorded cash balances

19

Foot cash journals

Trace totals to general ledger, yearend bank reconciliations
Test cash on hand

GBW 8th ed. Ch. 11

ASSERTIONS &
PROCEDURES: Cash-3
Existence, completeness, valuation
Test cutoff

Obtain cutoff bank statement

Verify accuracy
Examine & trace to bank reconciliations & cash journals
Proof of cash

20

Reconcile recorded cash with bank confirmation

Examine interbank, intercompany transfers

GBW 8th ed. Ch. 11

ASSERTIONS &
PROCEDURES: Cash-4
Presentation & disclosure
Review financial statements to
determine

21

Cash balances properly classified,

described
Disclosures adequate

GBW 8th ed. Ch. 11

TESTING CUTOFF FOR

CASH
Reconcile internal documents

Cash journals
General ledger
Bank reconciliations

With external documents

22

Year-end bank statement

Cutoff bank statements
Bank confirmations

GBW 8th ed. Ch. 11

REVENUE RECOGNITION
& EARNINGS
MANIPULATION
Increasingly, I have become concerned
that the motivation to meet Wall Street
earnings expectations may be overriding
common sense business practices.

Arthur Levitt, Jr., The Numbers Game. Speech NYU, 1998.

23

GBW 8th ed. Ch. 11

REVENUE RECOGNITION
SAB 104
Criteria

24

Persuasive evidence of arrangement

exists
Delivery has occurred or services
rendered
Sellers price fixed or determinable
Collectibility reasonably assured

GBW 8th ed. Ch. 11

COMMON MEANS TO
MANIPULATE EARNINGS 1Method
Revenue Recognition
BillError
& hold
Cancelled orders
Conditional sales
Consignment
sales
Continuing
involvement
Improper cutoff

25

Shipments to 3rd party

warehouses Cancelled, duplicate
orders
Before contingencies resolved
Goods on consignment, trial
Seller involved after delivery,
e.g., installation
Before title, risk ownership
passed

GBW 8th ed. Ch. 11

COMMON MEANS TO
MANIPULATE EARNINGS 2Method
Revenue Recognition
Error

Kickback sales
Overstated
completion
Partial
shipments
Pre-invoicing
Premature
shipment
26

Inflated selling price for kickback

Inflated % completion on
construction projects
Not all goods ordered are
shipped
Goods still in production
Goods ordered but not
authorized for shipment

GBW 8th ed. Ch. 11

COMMON MEANS TO
MANIPULATE EARNINGS M
Revenue Recognition
3ethod

Error sales
Premature
Sham sales
Side agreements
Uncertain
performance
Uncertain
realization
Unauthorized
shipment
27

Goods ordered but not shipped

False shipments
To forestall completion earnings
process
Sellers performance uncertain
Collection uncertain, unlikely
Shipments not authorized

GBW 8th ed. Ch. 11

MANIPULATED EARNINGS
Channel Stuffing
Definition: incentives to induce
incremental demand
Examples

Bausch & Lomb

Told distributors to buy large amount of

inventory to maintain distributorship

B&L recognized extra $22 million

Sunbeam
Used price discounting to encourage

customers to hold 80 weeks of inventory

28

GBW 8th ed. Ch. 11

MANIPULATED EARNINGS
Asset Swaps
Definition: companies trading right
to use others asset
Examples

Global Crossing
Treated underseas cables as real estate
Recognized revenue by treating swap as

sale

29

GBW 8th ed. Ch. 11

MANIPULATED EARNINGS
Other
Improper expense capitalization

Chambers Development
Capitalized landfill expenses after

determining earnings necessary to meet

analysts expectations

MicroStrategy
Recognized revenue before all services

provided for software sales

30

GBW 8th ed. Ch. 11

AUDIT SAMPLING &

ACCOUNTS
Update
assessment
of
control
risk
RECEIVABLE

Planning confirmations & selecting plan

31

Identify population, sampling unit,

anticipated error
Estimate tolerable error & risk incorrect
acceptance
Calculate sample size
Choose sample selection method
Evaluate results
GBW 8th ed. Ch. 11

COMPUTER ASSISTED
TESTS: AR Accuracy
Foot, crossfoot recorded amounts
within master file
Total balances
Display/print exceptions

32

GBW 8th ed. Ch. 11

COMPUTER ASSISTED
TESTS: AR Aging
Trace individual balances from
master file to sales journal
Classify balances by invoice
dates/age
Display/print aged trial balances

33

GBW 8th ed. Ch. 11

COMPUTER ASSISTED
TESTS: AR Credit Balances
Scan master receivables file for net
credit balances
Display/print listing credit balance
accounts

34

GBW 8th ed. Ch. 11