ch14 70 360

Chapter 14: Completing the Tests
in the Sales and Collection

Cycle: Accounts Receivable
1
Copyright © 2007 Pearson Education Canada
Chapter 14 objectives
 Describe the process for designing tests of details
of balances for accounts receivable
 Explain the relationship between transaction-
related and balance-related audit objectives
 Discuss analytical procedures for accounts
receivable
 Link detailed audit tests to audit assertions
 Explain how sampling is used for tests of details
14-2
Methodology for designing tests of
details of balances for accounts
receivable
14-3
Audit tests to be performed are
based upon assessed risks
14-4
Effects of inherent and control risks
14-5
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
14-6
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)
14-7
Figure 14-1 and figure 14-2
 14-1: After procedures to obtain an
understanding and tests of controls we do
tests of details
 14-2: Designing tests of details rests on the
previous work that has been done in the
cycle
14-8
Consider the relationship between transaction-
related and balance-related audit objectives
 Figure 14-3 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 (p. 420)
14-9
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)
14-10
Using analytical review to target detailed tests
(see table 14-1)
 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
14-11
Examples of audit procedures by audit
objective (assertion), Table 14-4
 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.
14-12
objective (assertion), Table 14-4 (cont’d)
 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.
14-13
 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.
14-14
 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.
14-15
 Rights and obligations: Review the

minutes of the board of directors’ meetings
for any indication of pledged or factored
accounts receivable.
 Presentation and disclosure: Enquire of
management whether any receivables are
pledged or factored.
14-16
Practice problem 14-25 (p. 450)
 A company is having
collection problems
 What would you do to
investigate the
causes?
14-17
The power of confirmations
 Useful for existence,
accuracy and cutoff
 A/R confirmations
come in several
forms:
– Negative
– Positive
• Individual item
• Balance owing
14-18
 Confirmations have
been returned with
answers that do not
match the records –
what do you do?
14-19
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
14-20
Positive vs. negative confirmations
 Negative confirmations
– Failure to reply must be regarded as a correct
response
– Less expensive
 Used When
– Many homogenous balances
– Small amounts owing
– Internal controls strong
– No evidence/suspicion of fraud or serious error
14-21
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.)
14-22
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
14-23
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
14-24
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
14-25
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)
14-26
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
14-27
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
14-28
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
14-29
 Evaluate the sampling
approach
 Select the sample size
 Evaluate results
14-30

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Chapter 14: Completing the Tests

in the Sales and Collection

 Figure 14-3 shows how these audit

 Helpful analyses could include comparing:

 Detail tie-in: Add (foot) open-item file

 Completeness: Agree a sample of customer

 Cut-off: Select the last 40 sales

 Valuation: Discuss with the credit manager

 Rights and obligations: Review the

 Confirmations should be returned directly

 Sampling is used to select the transactions

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