rr chapter 16

©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 16 - 1

Completing the Testsin the Sales and Collection Cycle:Accounts Receivable

Chapter 16

©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 16 - 16 - 22

Learning Objective 1

Describe the methodology for

designing tests of details of

balances using the audit

risk model.


Accounts Receivable Balance-related Audit Objectives

1. Detail tie-in

7. Realizable value

5. Classification

4. Accuracy

2. Existence

8. Rights

3. Completeness

6. Cutoff


Identify client businessrisks affecting

accounts receivable

Methodology for Designing Testsof Details of Balances for A/R

Set tolerable misstatementand assess inherent riskfor accounts receivable

Assess control risk forsales and collection cycle

Phase I

Phase I

Phase I



Design and performtests of controls and

substantive testsof transactions

for the sales andcollection cycle

Phase II


Timing

Items to select

Sample size

Audit procedures


Design and performanalytical procedures

for accountsreceivable balance

Design tests ofdetails of accountsreceivable balance

to satisfybalance-relatedaudit objectives

Phase III

Phase III


Relationship Between Sales and Accounts Receivable

ACCOUNTS RECEIVABLEBALANCE-RELATEDAUDIT OBJECTIVES

Translation-relatedaudit objectives

Sales

Occurrence

Completeness

Accuracy

Posting andsummarization

Classification

Timing

De

tail

tie-

in

Ex

iste

nce

Co

mp

lete

ne

ss

Ac

cu

rac

y

Cla

ssif

ica

tio

n

Cu

toff

Re

aliz

able

val

ue

Rig

hts

××

×

×

×

×


Relationship Between Sales and Accounts Receivable

ACCOUNTS RECEIVABLEBALANCE-RELATEDAUDIT OBJECTIVES

Translation-relatedaudit objectivesCash receipts

Occurrence

Completeness

Accuracy

Posting andsummarization

Classification

Timing

De

tail

tie-

in

Ex

iste

nce

Co

mp

lete

ne

ss

Ac

cu

rac

y

Cla

ssif

ica

tio

n

Cu

toff

Re

aliz

able

val

ue

Rig

hts

××

×

×

×

×



Design and perform analytical

procedures for accounts in the

sales and collection cycle.


Analytical Procedures for the Sales and Collection Cycle

Gross margin percentage withprevious years

Sales by month over time Sales returns and allowances

as a percentage of gross saleswith previous years

Compare by product line:



Individual customer balances overa stated amount

Bad debt expense as a percentageof gross sales

Days that accounts receivableare outstanding

Compare with previous years:



Aging category as a percentageof receivables

Allowance for uncollectible accounts asa percentage of accounts receivable

Write-off of uncollectible accounts as apercentage of total accounts receivable

Compare with previous years:


Selected Comparative Information

SalesGross marginAccounts receivableBad debt expenseTotal current assetsTotal assetsNet earningsNumber of accounts receivableNumber of accts. rec. with balances over $100,000

144,328 39,845 20,197 3,323 51,027 61,367 5,681

258

37

9.0 9.6 7.3 (2.1)14.0 (7.0)21.9

16.7

15.6

132,421 36,350 18,827 3,394 44,779 66,021 4,659

221

32

7.0 7.014.1 7.3 6.6 8.039.0

5.7

6.7

123,737 33,961 16,505 3,162 41,989 61,147 3,351

209

30

12/31/07($000)

Percentchange2006-2007

12/31/06($000)

Percentchange2005-2006

12/31/05($000)


Analytical Procedures: Sales and Collection Cycle

Gross margin/net salesSales returns and allowances/ gross salesBad debt expense/net salesAllowance for uncollectible accounts/accounts receivableNumber of days receivables outstandingNet accounts receivable/ current assets

27.85%

0.90% 2.30%

6.10%

48.09

37.20%

27.70%

0.90% 2.60%

7.50%

47.96

32.50%

27.68%

0.90% 2.60%

6.40%

49.32

32.30%

12/31/0712/31/07 12/31/0612/31/06 12/31/0512/31/05


Design and Perform Tests of Details of A/R Balance (Phase III)

Planned detection risk for eachobjective is an auditor decision

Combining the factors that determineplanned detection risk is complex


Analytical Procedures for Gross Margin

20072007 20062006 20052005

HardwoodSoftwoodPlywood

36.323.940.3

32.422.050.1

36.420.344.2

32.522.154.3

36.020.545.4

32.322.355.6

Gross margin percentGross margin percent

GreatGreatWesternWestern IndustryIndustry





Design and perform tests of

details of balances for accounts

receivable.


Designing Tests of Detailof Balances

Accounts receivable are correctly added andagree with the Master File and the GeneralLedger (aged trial balance).

Recorded accounts receivable exist

Existing accounts receivable are included



Accounts receivable are accurate

Accounts receivable are properly classified

Cutoff for accounts receivable is correct



Accounts receivable is stated atrealizable value

The client has rights to accounts receivable

Accounts receivable presentation anddisclosure



Obtain and evaluate accounts

receivable confirmations.


Auditing Standards Requirements

1. Accounts receivable are immaterial.

2. The auditor considers confirmationsineffective evidence because responserates will likely be inadequate or unreliable.

3. The combined level of inherent risk andcontrol risk is low and other substantiveevidence can be accumulated to providesufficient evidence.


Type of Confirmation

Positive confirmation

Blank confirmation form

Invoice confirmation

Negative confirmation


Timing

The most reliable evidence from confirmationsis obtained when they are sent as close to thebalance sheet date as possible.


Sample Size

Tolerable misstatement

Inherent risk

Control risk

Achieved detection risk fromother substantive tests

Type of confirmation


Maintaining Control

After the items for confirmation have beenselected, the auditor must maintain controlof the confirmations until they are returnedfrom the customer.


Follow-up on Nonresponses

When positive confirmations are used,SAS 67 requires follow-up proceduresfor confirmations not returned by he customer.


Subsequent Cash Receipts

Evidence of the receipt of cash subsequentto the confirmation date includes examiningremittance advices, entries in the cashreceipts records, or perhaps evensubsequent credits in the accountsreceivable master file.


Duplicate Sales Invoices

These are useful in verifying the actualissuance of a sales invoice and theactual date of the billing.


Shipping Documents

These are important in establishingwhether the shipment was actuallymade and as a test of cutoff.


Analysis of Difference

Payment has already been made

Goods have not been received

The goods have been returned

Clerical errors and disputed accounts


Drawing Conclusions

Reevaluate internal control

Evaluate the qualitative nature ofmisstatements

Determine whether sufficient evidencewas obtained



Design audit procedures for the

audit of accounts receivable,

using an evidence planning

worksheet as a guide.


Source of Each Row in the Evidence Planning Worksheet Tolerable misstatement Acceptable audit risk Inherent risk Control risk Substantive tests of transactions results Analytical procedures Planned detection risk and planned audit evidence

©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 16 - 35

End of Chapter 16