Completing The Tests in The Sales and Collection Cycle: Accounts Receivable

Completing the Tests
in the Sales and

Collection Cycle:
Accounts Receivable
Chapter 16
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 1

Learning Objective 1
Describe the methodology for

designing tests of details of
balances using the audit
risk model.

Accounts Receivable Balance-
Related Audit Objectives
Detail tie-in Existence Completeness
Accuracy Classification Cutoff
Realizable Presentation
Rights
value and disclosure

Methodology for Designing Tests
of Details of Balances for A/R
Phase I
Identify client business risks affecting accounts

receivable.
Set tolerable misstatement and assess inherent

risk for accounts receivable.
Assess control risk for sales and collection cycle.

Phase II
Design and perform tests of controls and

substantive tests of transactions for the
sales and collection cycle.

Phase III
Design and perform analytical procedures for

accounts receivable balance.
Design tests of details of accounts receivable

balance to satisfy balance-related audit objectives.
Audit Sample Items to

Timing
procedures size select
Relationship Between Sales and
Accounts Receivable
Accounts receivable balance-related audit objectives
and disclosure
Completeness
Classification
Presentation
Detail tie-in
Realizable
Existence
Accuracy
Rights
Translation-related
Cutoff
value
audit objectives
Sales
Existence
Completeness
Accuracy
Classification
Timing
Posting/Summary
Relationship Between Sales and
Accounts Receivable
Accounts receivable balance-related audit objectives
and disclosure
Completeness
Classification
Presentation
Detail tie-in
Realizable
Existence
Accuracy
Rights
Translation-related
Cutoff
value
audit objectives
Cash receipts
Existence
Completeness
Accuracy
Classification
Timing
Posting/Summary
Design and perform analytical

procedures for accounts in the
sales and collection cycle.

Analytical Procedures for the
Sales and Collection Cycle
Gross margin percentage with previous years
Sales by month over time
Sales returns and allowances as a percentage of

gross sales with previous years

Individual customer balances over a stated amount
Bad debt expense as a percentage of gross sales
Days that accounts receivable are outstanding

Aging category as a percentage of receivables
Allowance for uncollectible accounts as a

percentage of accounts receivable
Charge-off of uncollectible accounts as a

percentage of total accounts receivable

Selected Comparative Information
Percent Percent
change change
12/31/04 2003- 12/31/03 2002- 12/31/02
($000) 2004 ($000) 2003 ($000)
Sales 144,328 9.0 132,421 7.0 123,737
Gross margin 39,845 9.6 36,350 7.0 33,961
Accounts receivable 20,197 7.3 18,827 14.1 16,505
Bad debt expense 3,323 (2.1) 3,394 7.3 3,162
Total current assets 51,027 14.0 44,779 6.6 41,989
Total assets 61,367 (7.0) 66,021 8.0 61,147
Net earnings 5,681 21.9 4,659 39.0 3,351
Number of accounts
receivable 258 16.7 221 5.7 209
Number of accts. rec. with
balances over $100,000 37 15.6 32 6.7 30

Analytical Procedures: Sales and
Collection Cycle
12/31/04 12/31/03 12/31/02
Gross margin/net sales 27.85% 27.70% 27.68%
Sales returns and allowances/
gross sales 0.90% 0.90% 0.90%
Bad debt expense/net sales 2.30% 2.60% 2.60%
Allowance for uncollectible
accounts/accounts receivable 6.10% 7.50% 6.40%
Number of days receivables
outstanding 48.09 47.96 49.32
Net accounts receivable/
current assets 37.20% 32.50% 32.30%

Design and Perform Tests of
Details of A/R Balance (Phase III)
Planned detection risk for each objective

is an auditor decision.
Combining the factors that determine

planned detection risk is complex.

Analytical Procedures for Gross
Margin
Gross margin percent
2005 2004 2003
Great Great Great
Western Industry Western Industry Western Industry
Hardwood 36.3 32.4 36.4 32.5 36.0 32.3

Softwood 23.9 22.0 20.3 22.1 20.5 22.3
Plywood 40.3 50.1 44.2 54.3 45.4 55.6

Design and perform tests of

details of balances for accounts
receivable for each balance-
related audit objective.

Designing Tests of Detail
of Balances
Accounts receivable are correctly added and

agree with the Master File and the General
Ledger (aged trial balance).
Recorded accounts receivable exist
Existing accounts receivable are included

of Balances
Accounts receivable are accurate
Accounts receivable are properly classified
Cutoff for accounts receivable is correct

of Balances
Accounts receivable is stated at realizable value
The client has rights to accounts receivable
Accounts receivable presentation and

disclosures are proper

Obtain and evaluate accounts

receivable confirmations.

AICPA Requirements
1. Accounts receivable are immaterial.
2. The auditor considers confirmations

ineffective evidence because response
rates will likely be inadequate or unreliable.
3. The combined level of inherent risk and

control risk is low and other substantive
evidence can be accumulated to provide
sufficient evidence.

Type of Confirmation
Positive confirmation
Blank confirmation form
Invoice confirmation
Negative confirmation

Timing
The most reliable evidence from confirmations

is obtained when they are sent as close to the
balance sheet date as possible, as opposed
to confirming the accounts several months
before year-end.

Sample Size
Tolerable misstatement
Inherent risk
Control risk
Achieved detection risk from

other substantive tests
Type of confirmation

Selection of the Items for Testing
When selecting a sample of accounts receivable

for confirmation, the auditor should be careful
to avoid being influenced by the client.

Selection of Items for Testing
If a client tries to discourage the auditor from

sending confirmations to certain customers,
the auditor should consider the possibility
that the client is attempting to conceal
fictitious or known misstatements
of accounts receivable.

Maintaining Control
After the items for confirmation have been

selected, the auditor must maintain control
of the confirmations until they are returned
from the customer.

Follow-up on Nonresponses
When positive confirmations are used,

SAS 67 requires follow-up procedures
for confirmations not returned by
he customer.

Subsequent Cash Receipts
Evidence of the receipt of cash subsequent

to the confirmation date includes examining
remittance advices, entries in the cash
receipts records, or perhaps even
subsequent credits in the accounts
receivable master file.

Duplicate Sales Invoices
These are useful in verifying the actual

issuance of a sales invoice and the
actual date of the billing.

Shipping Documents
These are important in establishing

whether the shipment was actually
made and as a test of cutoff.

Correspondence With the Client
Usually, the auditor does not need to review

correspondence as a part of alternative
procedures, but correspondence can
be used to disclose disputed and
questionable receivables not
uncovered by other means.

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 of

misstatements.
Determine whether sufficient evidence

was 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

End of Chapter 16

Completing The Tests in The Sales and Collection Cycle: Accounts Receivable

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Completing the Tests

in the Sales and

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 1

Describe the methodology for

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 2

Detail tie-in Existence Completeness

Accuracy Classification Cutoff

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 3

Identify client business risks affecting accounts

Set tolerable misstatement and assess inherent

Assess control risk for sales and collection cycle.

Design and perform tests of controls and

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 5

Design and perform analytical procedures for

Design tests of details of accounts receivable

Audit Sample Items to

Design and perform analytical

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 9

Gross margin percentage with previous years

Sales by month over time

Sales returns and allowances as a percentage of

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 10

Individual customer balances over a stated amount

Bad debt expense as a percentage of gross sales

Days that accounts receivable are outstanding

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 11

Aging category as a percentage of receivables

Allowance for uncollectible accounts as a

Charge-off of uncollectible accounts as a

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 12

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 13

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 14

Planned detection risk for each objective

Combining the factors that determine

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 15

Hardwood 36.3 32.4 36.4 32.5 36.0 32.3

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 16

Design and perform tests of

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 17

Accounts receivable are correctly added and

Recorded accounts receivable exist

Existing accounts receivable are included

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 18

Accounts receivable are accurate

Accounts receivable are properly classified

Cutoff for accounts receivable is correct

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 19

Accounts receivable is stated at realizable value

The client has rights to accounts receivable

Accounts receivable presentation and

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 20

Obtain and evaluate accounts

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 21

2. The auditor considers confirmations

3. The combined level of inherent risk and

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 22

Blank confirmation form

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 23

The most reliable evidence from confirmations

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 24

Achieved detection risk from

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 25

When selecting a sample of accounts receivable