auditing chapter 11 accounts receivable & cash balances by david n. ricchiute
TRANSCRIPT
AUDITINGCHAPTER 11
Accounts Receivable & Cash Balances ByDavid N. Ricchiute
GBW 8th ed. Ch. 112
TOPICS INREVENUE/RECEIPT CYCLE
Relationship assertions & audit proceduresRelationship audit risk, client strategies, substantive testsSubstantive tests for assertionsRevenue recognition, earnings manipulation, & channel stuffing Audit sampling & accounts receivableComputer-assisted audit techniques
GBW 8th ed. Ch. 113
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. 114
OBJECTIVES & PROCEDURES: Existence/Occurrence
Objective: determine whether all recorded sales, receivables, cash balances
Procedures Existence
Physical observation Confirmation
Transactions occurred Cutoff testing for proper period
GBW 8th ed. Ch. 115
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. 116
OBJECTIVES & PROCEDURES: Rights/Obligations
Objective: determine whether entity has property rights to cash, accounts receivable
Procedures Examine documentation Confirmations Inquiries
GBW 8th ed. Ch. 117
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. 118
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. 119
AUDIT RISK MODEL
AR = CR x IR x DRDetection risk (DR): likelihood that error could occur & not be detectedBased on Control risk (CR)
Likelihood of material error Inherent risk (IR)
Strategies & threats
GBW 8th ed. Ch. 1110
DETECTION RISK
DR = ____AR___ IR x CR
Nature, extent, timing substantive tests Nature: more/less persuasive tests Extent: larger/smaller samples Timing: balance sheet date or interim
GBW 8th ed. Ch. 1111
ASSERTIONS & PROCEDURESAccounts Receivable, Sales-1
ValuationVerify mathematical accuracy AR Obtain aged trial balance Foot trial balance Compare total AR per trial balance to
general ledger
GBW 8th ed. Ch. 1112
ASSERTIONS & PROCEDURESAccounts Receivable, Sales-2
Existence, rights, valuationConfirm 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
GBW 8th ed. Ch. 1113
ASSERTIONS & PROCEDURESAccounts Receivable, Sales-3
Existence or occurrence, completenessTest cutoff to determine whether sales, receivables recorded in proper period FOB shipping point FOB destination
GBW 8th ed. Ch. 1114
ASSERTIONS & PROCEDURESAccounts Receivable, Sales-4
Valuation, rightsReview collectibility receivablesDetermine adequacy allowance for doubtful accounts
GBW 8th ed. Ch. 1115
ASSERTIONS & PROCEDURESAccounts Receivable, Sales-5
Existence or occurrence, completeness, valuationPerform analytical procedures for reasonableness of sales, receivables balances Collections problems Overstated sales Understated sales
GBW 8th ed. Ch. 1116
ASSERTIONS & PROCEDURESAccounts Receivable, Sales-6
Presentation & disclosureReview financial statements to determine Accounts, notes receivable properly
classified, described Disclosures adequate
GBW 8th ed. Ch. 1117
TESTING CUTOFF Sales, Receivables
At or around end each quarter, the former President directed his subordinates to hold IGI’s 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 Trace recorded sales to shipping documents
before, after end of period
GBW 8th ed. Ch. 1118
ASSERTIONS & PROCEDURES: Cash-1
Existence, rights, valuationConfirm year end balances with all banks
GBW 8th ed. Ch. 1119
ASSERTIONS & PROCEDURES: Cash-2
ValuationVerify mathematical accuracy recorded cash balances Foot cash journals Trace totals to general ledger, year-
end bank reconciliations Test cash on hand
GBW 8th ed. Ch. 1120
ASSERTIONS & PROCEDURES: Cash-3
Existence, completeness, valuationTest cutoff Obtain cutoff bank statement
Verify accuracy Examine & trace to bank reconciliations & cash
journals Proof of cash
Reconcile recorded cash with bank confirmation Examine interbank, intercompany transfers
GBW 8th ed. Ch. 1121
ASSERTIONS & PROCEDURES: Cash-4
Presentation & disclosureReview financial statements to determine Cash balances properly classified,
described Disclosures adequate
GBW 8th ed. Ch. 1122
TESTING CUTOFF FOR CASH
Reconcile internal documents Cash journals General ledger Bank reconciliations
With external documents Year-end bank statement Cutoff bank statements Bank confirmations
GBW 8th ed. Ch. 1123
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.
GBW 8th ed. Ch. 1124
REVENUE RECOGNITIONSAB 104
Criteria Persuasive evidence of arrangement
exists Delivery has occurred or services
rendered Seller’s price fixed or determinable Collectibility reasonably assured
GBW 8th ed. Ch. 1125
COMMON MEANS TO MANIPULATE EARNINGS - 1
Method Revenue Recognition ErrorBill & hold
Cancelled ordersConditional salesConsignment salesContinuing involvementImproper cutoff
Shipments to 3rd party warehouses Cancelled, duplicate orders Before contingencies resolvedGoods on consignment, trialSeller involved after delivery, e.g., installationBefore title, risk ownership passed
GBW 8th ed. Ch. 1126
COMMON MEANS TO MANIPULATE EARNINGS - 2
Method Revenue Recognition Error
Kickback salesOverstated completionPartial shipmentsPre-invoicingPremature shipment
Inflated selling price for kickbackInflated % completion on construction projectsNot all goods ordered are shippedGoods still in productionGoods ordered but not authorized for shipment
GBW 8th ed. Ch. 1127
COMMON MEANS TO MANIPULATE EARNINGS - 3Method Revenue Recognition
ErrorPremature salesSham salesSide agreements
Uncertain performanceUncertain realizationUnauthorized shipment
Goods ordered but not shippedFalse shipmentsTo forestall completion earnings processSeller’s performance uncertainCollection uncertain, unlikely
Shipments not authorized
GBW 8th ed. Ch. 1128
MANIPULATED EARNINGSChannel Stuffing
Definition: incentives to induce incremental demandExamples 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
GBW 8th ed. Ch. 1129
MANIPULATED EARNINGSAsset Swaps
Definition: companies trading right to use others assetExamples Global Crossing
Treated underseas cables as real estate Recognized revenue by treating swap as
sale
GBW 8th ed. Ch. 1130
MANIPULATED EARNINGSOther
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
GBW 8th ed. Ch. 1131
AUDIT SAMPLING & ACCOUNTS RECEIVABLE
Update assessment of control riskPlanning confirmations & selecting plan 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. 1132
COMPUTER ASSISTED TESTS: AR Accuracy
Foot, crossfoot recorded amounts within master fileTotal balancesDisplay/print exceptions
GBW 8th ed. Ch. 1133
COMPUTER ASSISTED TESTS: AR Aging
Trace individual balances from master file to sales journalClassify balances by invoice dates/ageDisplay/print aged trial balances
GBW 8th ed. Ch. 1134
COMPUTER ASSISTED TESTS: AR Credit Balances
Scan master receivables file for net credit balancesDisplay/print listing credit balance accounts