Completing the Tests

in the Sales and

Collection Cycle:
Accounts Receivable
Chapter 16
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

16 - 1

Learning Objective 1
Describe the methodology for
designing tests of details of
balances using the audit
risk model.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Accounts Receivable BalanceRelated Audit Objectives

Detail
Detailtie-in
tie-in

Existence
Existence

Completeness
Completeness

Accuracy
Accuracy

Classification
Classification

Cutoff
Cutoff

Realizable
Realizable
value
value

Rights
Rights

Presentation
Presentation
and
anddisclosure
disclosure

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Methodology for Designing Tests

of Details of Balances for A/R
Phase
PhaseII
Identify
Identifyclient
clientbusiness
businessrisks
risksaffecting
affectingaccounts
accounts
receivable.
receivable.
Set
Settolerable
tolerablemisstatement
misstatementand
andassess
assessinherent
inherent
risk
riskfor
foraccounts
accountsreceivable.
receivable.
Assess
Assesscontrol
controlrisk
riskfor
forsales
salesand
andcollection
collectioncycle.
cycle.
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Methodology for Designing Tests

of Details of Balances for A/R
Phase
PhaseIIII
Design
Designand
andperform
performtests
testsof
ofcontrols
controlsand
and
substantive
substantivetests
testsof
oftransactions
transactionsfor
forthe
the
sales
salesand
andcollection
collectioncycle.
cycle.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Methodology for Designing Tests

of Details of Balances for A/R
Phase
PhaseIII
III
Design
Designand
andperform
performanalytical
analyticalprocedures
proceduresfor
for
accounts
accountsreceivable
receivablebalance.
balance.
Design
Designtests
testsof
ofdetails
detailsof
ofaccounts
accountsreceivable
receivable
balance
balanceto
tosatisfy
satisfybalance-related
balance-relatedaudit
auditobjectives.
objectives.
Audit
Audit
procedures
procedures

Sample
Sample
size
size

Items
Itemsto
to
select
select

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

Timing
Timing
16 - 6

Relationship Between Sales and

Accounts Receivable

Existence
Completeness
Accuracy
Classification
Timing
Posting/Summary

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

Presentation
and disclosure

Rights

Realizable
value

Cutoff

Classification

Accuracy

Completeness

Sales

Existence

Translation-related
audit objectives

Detail tie-in

Accounts receivable balance-related audit objectives

16 - 7

Relationship Between Sales and

Accounts Receivable

Existence
Completeness
Accuracy
Classification
Timing
Posting/Summary

Presentation
and disclosure

Rights

Realizable
value

Cutoff

Classification

Accuracy

Completeness

Cash receipts

Existence

Translation-related
audit objectives

Detail tie-in

Accounts receivable balance-related audit objectives

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Learning Objective 2

Design and perform analytical

procedures for accounts in the
sales and collection cycle.

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Analytical Procedures for the

Sales and Collection Cycle
Gross
Grossmargin
marginpercentage
percentagewith
withprevious
previousyears
years
Sales
Salesby
bymonth
monthover
overtime
time
Sales
Salesreturns
returnsand
andallowances
allowancesas
asaapercentage
percentageof
of
gross
grosssales
saleswith
withprevious
previousyears
years

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Analytical Procedures for the

Sales and Collection Cycle
Individual
Individualcustomer
customerbalances
balancesover
overaastated
statedamount
amount
Bad
Baddebt
debtexpense
expenseas
asaapercentage
percentageof
ofgross
grosssales
sales
Days
Daysthat
thataccounts
accountsreceivable
receivableare
areoutstanding
outstanding

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Analytical Procedures for the

Sales and Collection Cycle
Aging
Agingcategory
categoryas
asaapercentage
percentageof
ofreceivables
receivables
Allowance
Allowancefor
foruncollectible
uncollectibleaccounts
accountsas
asaa
percentage
percentageof
ofaccounts
accountsreceivable
receivable
Charge-off
Charge-offof
ofuncollectible
uncollectibleaccounts
accountsas
asaa
percentage
percentageof
oftotal
totalaccounts
accountsreceivable
receivable
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Selected Comparative Information

Percent
change
12/31/04 2003- 12/31/03
($000)
2004
($000)

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
20022003

12/31/02
($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
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

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Analytical Procedures: Sales and

Collection Cycle
12/31/04 12/31/03 12/31/02
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%

0.90%
2.60%

6.10%

7.50%

6.40%

48.09

47.96

49.32

37.20%

32.50%

32.30%

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Design and Perform Tests of

Details of A/R Balance (Phase III)
Planned
Planneddetection
detectionrisk
riskfor
foreach
eachobjective
objective
isisan
anauditor
auditordecision.
decision.
Combining
Combiningthe
thefactors
factorsthat
thatdetermine
determine
planned
planneddetection
detectionrisk
riskisiscomplex.
complex.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Analytical Procedures for Gross

Margin
Gross margin percent
2005

2004

2003

Great
Great
Great
Western Industry Western Industry Western Industry

Hardwood
Softwood
Plywood

36.3
23.9
40.3

32.4
22.0
50.1

36.4
20.3
44.2

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

32.5
22.1
54.3

36.0
20.5
45.4

32.3
22.3
55.6

16 - 16

Learning Objective 3
Design and perform tests of
details of balances for accounts
receivable for each balancerelated audit objective.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

16 - 17

Designing Tests of Detail

of Balances
Accounts
Accountsreceivable
receivableare
arecorrectly
correctlyadded
addedand
and
agree
agreewith
withthe
theMaster
MasterFile
Fileand
andthe
theGeneral
General
Ledger
Ledger((aged
agedtrial
trialbalance
balance).).
Recorded
Recordedaccounts
accountsreceivable
receivableexist
exist
Existing
Existingaccounts
accountsreceivable
receivableare
areincluded
included
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Designing Tests of Detail

of Balances
Accounts
Accountsreceivable
receivableare
areaccurate
accurate
Accounts
Accountsreceivable
receivableare
areproperly
properlyclassified
classified
Cutoff
Cutofffor
foraccounts
accountsreceivable
receivableisiscorrect
correct

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Designing Tests of Detail

of Balances
Accounts
Accountsreceivable
receivableisisstated
statedat
atrealizable
realizablevalue
value
The
Theclient
clienthas
hasrights
rightsto
toaccounts
accountsreceivable
receivable
Accounts
Accountsreceivable
receivablepresentation
presentationand
and
disclosures
disclosuresare
areproper
proper

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

16 - 20

Learning Objective 4

Obtain and evaluate accounts

receivable confirmations.

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AICPA Requirements
1.
1.Accounts
Accountsreceivable
receivableare
areimmaterial.
immaterial.
2.
2.The
Theauditor
auditorconsiders
considersconfirmations
confirmations
ineffective
ineffectiveevidence
evidencebecause
becauseresponse
response
rates
rateswill
willlikely
likelybe
beinadequate
inadequateor
orunreliable.
unreliable.
3.
3.The
Thecombined
combinedlevel
levelof
ofinherent
inherentrisk
riskand
and
control
controlrisk
riskisislow
lowand
andother
othersubstantive
substantive
evidence
evidencecan
canbe
beaccumulated
accumulatedto
toprovide
provide
sufficient
sufficientevidence.
evidence.
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Type of Confirmation
Positive
Positiveconfirmation
confirmation
Blank
Blankconfirmation
confirmationform
form
Invoice
Invoiceconfirmation
confirmation
Negative
Negativeconfirmation
confirmation
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Timing

The
Themost
mostreliable
reliableevidence
evidencefrom
fromconfirmations
confirmations
isisobtained
obtainedwhen
whenthey
theyare
aresent
sentas
asclose
closeto
tothe
the
balance
balancesheet
sheetdate
dateas
aspossible,
possible,as
asopposed
opposed
to
toconfirming
confirmingthe
theaccounts
accountsseveral
severalmonths
months
before
beforeyear-end.
year-end.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Sample Size
Tolerable
Tolerablemisstatement
misstatement
Inherent
Inherentrisk
risk
Control
Controlrisk
risk
Achieved
Achieveddetection
detectionrisk
riskfrom
from
other
othersubstantive
substantivetests
tests
Type
Typeof
ofconfirmation
confirmation
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Selection of the Items for Testing

When
Whenselecting
selectingaasample
sampleof
ofaccounts
accountsreceivable
receivable
for
forconfirmation,
confirmation,the
theauditor
auditorshould
shouldbe
becareful
careful
to
toavoid
avoidbeing
beinginfluenced
influencedby
bythe
theclient.
client.

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Selection of Items for Testing

IfIfaaclient
clienttries
triesto
todiscourage
discouragethe
theauditor
auditorfrom
from
sending
sendingconfirmations
confirmationsto
tocertain
certaincustomers,
customers,
the
theauditor
auditorshould
shouldconsider
considerthe
thepossibility
possibility
that
thatthe
theclient
clientisisattempting
attemptingto
toconceal
conceal
fictitious
fictitiousor
orknown
knownmisstatements
misstatements
of
ofaccounts
accountsreceivable.
receivable.

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Maintaining Control
After
Afterthe
theitems
itemsfor
forconfirmation
confirmationhave
havebeen
been
selected,
selected,the
theauditor
auditormust
mustmaintain
maintaincontrol
control
of
ofthe
theconfirmations
confirmationsuntil
untilthey
theyare
arereturned
returned
from
fromthe
thecustomer.
customer.

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Follow-up on Nonresponses
When
Whenpositive
positiveconfirmations
confirmationsare
areused,
used,
SAS
SAS67
67requires
requiresfollow-up
follow-upprocedures
procedures
for
forconfirmations
confirmationsnot
notreturned
returnedby
by
he
hecustomer.
customer.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Subsequent Cash Receipts

Evidence
Evidenceof
ofthe
thereceipt
receiptof
ofcash
cashsubsequent
subsequent
to
tothe
theconfirmation
confirmationdate
dateincludes
includesexamining
examining
remittance
remittanceadvices,
advices,entries
entriesininthe
thecash
cash
receipts
receiptsrecords,
records,or
orperhaps
perhapseven
even
subsequent
subsequentcredits
creditsininthe
theaccounts
accounts
receivable
receivablemaster
masterfile.
file.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Duplicate Sales Invoices

These
Theseare
areuseful
usefulininverifying
verifyingthe
theactual
actual
issuance
issuanceof
ofaasales
salesinvoice
invoiceand
andthe
the
actual
actualdate
dateof
ofthe
thebilling.
billing.

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Shipping Documents
These
Theseare
areimportant
importantininestablishing
establishing
whether
whetherthe
theshipment
shipmentwas
wasactually
actually
made
madeand
andas
asaatest
testof
ofcutoff.
cutoff.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Correspondence With the Client

Usually,
Usually,the
theauditor
auditordoes
doesnot
notneed
needto
toreview
review
correspondence
correspondenceas
asaapart
partof
ofalternative
alternative
procedures,
procedures,but
butcorrespondence
correspondencecan
can
be
beused
usedto
todisclose
disclosedisputed
disputedand
and
questionable
questionablereceivables
receivablesnot
not
uncovered
uncoveredby
byother
othermeans.
means.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Analysis of Difference
Payment
Paymenthas
hasalready
alreadybeen
beenmade
made
Goods
Goodshave
havenot
notbeen
beenreceived
received
The
Thegoods
goodshave
havebeen
beenreturned
returned
Clerical
Clericalerrors
errorsand
anddisputed
disputedaccounts
accounts

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Drawing Conclusions
Reevaluate
Reevaluateinternal
internalcontrol.
control.
Evaluate
Evaluatethe
thequalitative
qualitativenature
natureof
of
misstatements.
misstatements.
Determine
Determinewhether
whethersufficient
sufficientevidence
evidence
was
wasobtained.
obtained.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Learning Objective 5
Design audit procedures for the
audit of accounts receivable,
using an evidence planning
worksheet as a guide.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Source of Each Row in the

Evidence Planning Worksheet
Tolerable misstatement
Tolerable misstatement
Acceptable audit risk

Acceptable audit risk

Inherent risk
Inherent risk
Control risk
Control risk
Substantive tests of
Substantive tests of
transactions
transactionsresults
results
Analytical procedures
Analytical procedures
Planned detection risk and
Planned detection risk and
planned
plannedaudit
auditevidence
evidence
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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End of Chapter 16

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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