Sources of Accounts Receivable
-Claims against customers from sale of goods
-Loans to officers or employees
-Loans to subsidiaries
-Claims against various other refunds
-Claims for tax refunds
-Advances to suppliers
How are accounts receivable shown on the balance sheet?
net realizable value
Sources of Notes Receivable
-Written promises to pay certain amounts at future dates
-Notes for substantial amounts
-Installment note or contract can allow seller to hold lien on goods
Examples of Notes Receivable
-Sale of industrial machinery, farm equipment
-Issuance of capital stock
-Loans to officers, employees
Audit Risk associated with accounts receivable
-Many incidences of fraud have involved overstatement of receivables and revenue
-Revenue recognition may be based on complex accounting rules
-Receivables and revenues are usually subject to valuation using significant accounting estimates
Objectives for the audit of receivables and revenues
-Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to receivables and revenues.
-Obtain an understanding of internal control over receivables and revenues.
-Assess the risks of material misst
Assess the risks of material misstatement and design tests of controls and substantive procedures that:
-Substantiate the existence of receivables and the occurrence of revenue transactions
-Establish the completeness of receivables and revenue transactions
-Verify the cutoff of revenue transactions
-Determine that the client has rights to recorded receivab
Internal Control over A/R and Revenue
-Control Environment
-Risk Assessment
*Risk of misstatement of revenue
-Control Activities
*Division of duties
Control Environment
-Important because of risk of intentional misstatement of revenue
-Independence of audit committee
-Management establish tone at the top
Commitment to competence
-Management's philosophy and operating style
-Human resource policies and practices
Control Activities: Division of Duties
(1) Prepare sales order (2) Approve credit
(3) Issue merchandise from stock
(4) Shipment (5) Billing (6) invoice verification (7) Maintenance of control accounts(8) Maintenance of customers' ledgers (9) Approval of sales returns and allowances (10) Author
Documents in the revenue cycle
Customer purchase order
Sales order
Bill of lading
Invoice
Control listing
Credit memo
Control: segregation of duties over sales and collection of receivables
Typical Test: Observe and make inquires about the performance of various functions
existence and occurrence
completeness
rights and obligations
valuation and accuracy
Control: Match sales invoices with shipping documents, purchase orders, and sales orders
Typical test: select a sample of sales invoices and compare details of shipping documents purchase orders, and sales orders.
existence and occurrence
cutoff
rights and obligations
valuation and accuracy
Control: Review of the clerical accuracy of sales invoices by a second person.
Typical test: select a sample of sales invoices and examine them for evidence of second-person review.
valuation and accuracy
Control: Obtain credit approval of sales prior to shipment
Typical test: make inquires about credit policies; select sample of sales transactions and examine for evidence of credit approval
existence and occurrence
valuation and accuracy
Control: mail monthly statements to customers to follow up on errors reported
Typical Test: observe and make inquires about the mailing of statements and review evidence of follow-up
existence and occurrence
completeness
rights and obligations
valuation and accuracy
Control: Reconcile bank accounts monthly
Typical Test: Review a sample of bank reconciliations performed during the year
existence and occurrence
rights and obligations
valuation and accuracy
Control: Use control listing to control cash collections
Typical Test: observe, make inquires about the process, and reconcile selected listings to the bank and accounting records
existence and occurrence
completeness
rights and obligations
valuation and accuracy
Control: Use budgets and analyze variances from actual amounts
Typical Test: examine budgets and evidence of follow up on variances
existence and occurrence
completeness
rights and obligations
valuation and accuracy
Control: Use pre-numbered shipping and billing documents and account for the sequence
Typical Test: Observe and make inquires about the use of pre numbered documents and inspect evidence of accounting for the sequence
completeness
cutoff
Control: Use credit memoranda for authorization of adjustments to sales and receivables
Typical Control: select a sample of credits to customers' accounts and inspect credit memoranda and other supporting documents
completeness
valuation and accuracy
Control: Use a chart of accounts and independent review of account classifications
Typical Control: Inspect the chart of accounts and evidence of the review of account classifications
presentation and disclosure
Revenue cycle controls
*Segregation of duties--sales and collections
*Matching of sales invoices and shipping documents
*Clerical accuracy checks on invoices
*Credit approval for sales transactions
*Mailing of monthly statementsReconciliation of bank accounts
*Use of control li
Internal Controls over Notes Receivable
-The custodian of notes receivable should not have access to cash or to the general accounting records
-The acceptance and renewal of notes be authorized in writing by a responsible official who does not have custody of notes
-The write-off of defaulted n
Audit Documentation Needed
Lead schedules for receivables and net revenue and
Working papers
Working Papers
Aged trial balance of A/R
Analyses of other accounts receivable
Analysis of notes receivable and related interest
Analysis of allowance for doubtful accounts and notes
Comparative analyses of revenue
Documentation of internal control
Risk analyses and aud
Receivables Audit Steps
A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to receivables and revenue.
B. Obtain an understanding of internal control over receivables and revenue.
C. Assess the risks of material
Examples of tests of controls:
a. Examine significant aspects of a sample of sales transactions.
b. Compare a sample of shipping documents to related sales invoices.
c. Review the use and authorization of credit memoranda.
d. Reconcile selected cash register tapes and sales tickets wit
procedures�substantive procedures for receivables and revenue.
1. Obtain an aged trial balance of trade accounts receivable and analyses of other accounts receivable and reconcile to ledgers.
2. Obtain analyses of notes receivable and related interest.
3. Inspect notes on hand and confirm those with holders.
4. Confi
Substantive Procedure: obtain aged listing of receivables and reconcile to ledgers. Obtain analyses of notes receivable and related interest
valuation and accuracy
Substantive Procedures: inspect notes on hand and confirm those not on hand
existence, occurrence, and rights
Substantive Procedures: confirm receivables with debtors
existence, occurrence, and rights, valuation and accuracy
Substantive Procedures: review the year end cutoff of sales transactions
existence, occurrence, and rights
Completeness
Cutoff
Substantive Procedures: perform analytical procedures.
Review significant year end sales contracts
existence, occurrence, and rights
Completeness
Valuation and accuracy
Substantial Procedure: verify interest earned on notes receivable
existence, occurrence, and rights
completeness
Substantive Procedure: evaluate the property of the client's accounting for transactions. Evaluate accounting estimates related to revenues
valuation and accuracy
Substantive Procedure: Determine adequacy of allowance for uncollectible accounts
valuation
Substantive Procedure: Ascertain the existence of pledged receivables. Investigate receivables from related parties
presentation and disclosure
Substantive Procedure: Evaluate the business purpose of significant and unusual sales transactions
valuation and accuracy
presentation and disclosure
Substantive Procedure: Evaluate financial statement presentation and disclosure
presentation and disclosure
Details on Understanding the Client Business
The types of products and services sold.
The classes and categories of the client's customers.
Whether the business is affected by seasonal or cyclical demand.
Typical marketing policies for the client and its industry.
Policies regarding pricing, sales r
Fraud Risk Related to Receivables and Revenues
Understand controls established by management to control risk
Determine controls have been implemented
Respond to risk
Has overall effect on audit
Design of audit procedures
Performing procedures to address risk of material misstatement due to management
Receivables should be confirmed, unless:
-Accounts receivable are immaterial,
-The use of confirmations would be ineffective, or
-The auditors' combined assessment of inherent and control risk is low, and audit risk can be reduced to acceptably low level with substantive tests
Types of Confirmations
Positive
Negative
Positive Confirmations
request addressed to the debtor asking for a reply
-Blank forms - leave amount blank
Negative Confirmations
ask debtor to advise the auditors only if the balance shown is incorrect
-Low level of assessed risk of material misstatement
-Large number of small balances
Steps in the Confirmation Process
(1) Develop audit objectives (2) choose appropriate confirmation for (3) determine the timing and extent (4) identify the information to be confirmed (5) select the accounts for confirmation (6) prepare and mail the requests (7) send 2nd requests for posi
Criteria for Revenue Recognition
-Persuasive evidence of an arrangement exists
-Delivery has occurred or services have been rendered
-The seller's price to the buyer is fixed or determinable
-Collectibility is reasonably assured
Potential Revenue Recognition Problems
-Sales with unusual right to return
-Side agreements
-Franchise fees
-Bill and hold transactions
-Sales using notes with unusual interest rates
-Percentage-of-completion method of revenue recognition
-Multiple element agreements
Allowance for Doubtful Accounts
Significant estimate made by management
Best evidence of collectability is subsequent payment
Analyze payments subsequent to balance sheet date
Document the subsequent payments inspected
Develop estimate and evaluate reasonableness of management estimate
-Compare the details of the aging of accounts receivable to prior years' aging.
-Investigate the credit ratings for delinquent and unusually large accounts.
-Review confirmation exceptions for an indication of amounts in dispute or other clues as to possi
To Identify Related Parties Auditors Should
-Proxy and other filings with SEC or other regulatory agencies
-conflict-of-interest statements by management
-Transactions with unusual terms
-Accounting records for unusual balances or transactions particularly near year-end