copyright © 2007 pearson education canada 1 chapter 14: completing the tests in the sales and...
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Copyright © 2007 Pearson Education Canada
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Chapter 14: Completing the Tests in the Sales and Collection
Cycle: Accounts Receivable
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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
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Methodology for designing tests of details of balances for accounts
receivable
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Audit tests to be performed are based upon assessed risks
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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
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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)
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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
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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)
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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)
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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
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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.
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Examples of audit procedures by audit 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.
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Examples of audit procedures by audit objective (assertion), Table 14-4 (cont’d)
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.
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Examples of audit procedures by audit objective (assertion), Table 14-4 (cont’d)
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.
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Examples of audit procedures by audit objective (assertion), Table 14-4 (cont’d)
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.
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Practice problem 14-25 (p. 450)
A company is having collection problems
What would you do to investigate the causes?
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The power of confirmations
Useful for existence, accuracy and cutoff
A/R confirmations come in several forms:– Negative– Positive
• Individual item
• Balance owing
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Practice problem 14-24 (p. 450)
Confirmations have been returned with answers that do not match the records – what do you do?
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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
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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
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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.)
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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
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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
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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
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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)
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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
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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
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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