Chapter 16

Completing the Tests in the

Sales and Collection Cycle:
Accounts Receivable

Chapter 16 is a key chapter because it builds on Chapters 14 and 15. It is also

the first chapter where tests of details of balances are applied.
The following are the topics we cover:

 Chapter opening vignette

 Methodology for designing tests of details of balances
 Designing tests of details of balances
 Confirmation of accounts receivable
 Developing tests of details audit program
 Review

Chapter Opening Vignette – “When More Isn’t Better”

This vignette makes one essential point: the quality of evidence is more
important than the quantity of evidence. In fact, low quality cannot be compensated
for by high quantity. Confirmations are used to illustrate this point and can be
discussed here. Other types of evidence can also be discussed: e.g., internal vs.
external documentation and the value of client representations.

Methodology for Designing Tests of Details of Balances (page 520)

Before covering the methodology for designing tests of details of balances, we

spend quite a bit of time reviewing key concepts.

 Examine the summary of the audit process in Figure 13-9 (page 424) to
review how tests of controls and substantive tests of transactions (Chapter
14) and audit sampling for tests of controls and substantive tests of
transactions (Chapter 15) tie into Chapter 16. It is also useful to do the
same with Figure 13-7 (page 417).

(See Figures 13-9 and 13-7)

 Review Figure 13-2 (page 404) to describe the role of analytical

procedures and tests of details of balances in the audit of the sales and
collection cycle.

(See Figure 13-2)

We cover the methodology for designing tests of details of balances by using

Figure 16-1 (Page 520) as a frame of reference. We discuss the following steps:

(See Figure 16-1)

16-1
  Identify client business risks
 Set tolerable misstatement and assess inherent risk
 Assess control risk – We use Figure 16-2 (page 523) to describe the
relationship between transaction-related and balance related audit
objectives for the sales and collection cycle

(See Figure 16-2)

 Design and perform tests of controls and substantive test of transactions
 Design and perform analytical procedures – Table 16-1 (page 524) can be
used to illustrate analytical procedures for the sales and collection cycle. We
also use Tables 16-2 and 16-3 (page 525) to highlight practical applications
of analytical procedures for the sales and collection cycle using data for
Hillsburg Hardware.
(See Tables 16-1, 16-2, and 16-3)
 Design tests of details of balances
Designing Tests of Details of Balances (page 526)

We ask students to identify the physical starting point for performing tests of the
year-end balance in accounts receivable and explain why the aged trial balance is
the logical starting point. It is important that students know what an aged trial
balance looks like (Figure 16-3, page 527), and where it comes from. T-14-1 is
useful to show where the aged trial balance fits into the accounting system.
(See Figure 16-3)

(See T-14-1)
The balance-related audit objectives first developed in Chapter 6 should be
reviewed at this point. Our emphasis is on why there are objectives (types of
misstatements), why they are different from transaction-related audit objectives, and
how they are used.
T-16-1 summarizes balance-related audit objectives and T-16-2 compares balance-
related audit objectives to transaction-related audit objectives.
(See T-16-1 and T-16-2)

Next, we require students to close their books and go over the balance-related
audit objectives on T-16-3.

(See T-16-3)
We require students to do the following in class:

1. Convert the general objectives to specific objectives for accounts in the

sales and collection cycle.
2. Identify procedures to satisfy the objectives.
3. Identify factors that would affect the procedures, sample size, and items to
select.

16-2
16-3
 Our experience is that they need a lot of guidance in doing this, and it is
somewhat time-consuming, but productive. We believe that two objectives deserve
special attention:

 Realizable value – We refer students to the analysis of the allowance for

uncollectible accounts in Figure 16-4 (page 531). We first note that the
analysis depends on an accurate aging, and note that the aged accounts
receivable balances in Figure 16-4 come from the aged trial balance in
Figure 16-3 (page 527). We then ask students to describe how an auditor
should assess the appropriate loss percentage to apply to each aged
accounts receivable category. We emphasize the need to consider recent
trends in establishing loss percentages.

(See Figures 16-3 and 16-4)

 Cutoff – Students in our classes have problems in this area. We emphasize

cutoff for sales. We point out that cutoff misstatements are the most
frequent type of misstatements that auditors will find. Problem 16-27 is a
good one for this material. Often we make up our own example on T-16-4.

(See T-16-4)

Problems 16-23, 16-24 and 16-26 are excellent reviews of accounts receivable
balance-related audit objectives. Problem 16-25 is useful to help students distinguish
among tests of controls, substantive tests of transactions, analytical procedures, and
tests of details of balances.

Confirmation of Accounts Receivable (page 532)

We find it sufficient to cover several Review Questions after the definition of

confirmation is reviewed.

(See T-16-5)

16-10 – Type of confirmations (positives versus negatives)

16-11 – Timing
16-12 – Sample size
16-13 – Items to select

Multiple Choice Question 16-21 and Problem 16-33 (alternative procedures) are also
useful at this point. Problem 16-31 can be used to illustrate timing differences and
other errors and differences that an auditor may need to resolve when using
balance confirmations.

16-4
Developing Tests of Details Audit Program (page 538)

We use the Hillsburg Hardware Co. to illustrate how auditors develop detailed
audit program steps for tests of details. Refer students especially to Table 16-4
(page 540) and Table 16-5 (page 541) and remind them:

 Figure 16-7 (page 539) is useful for understanding the decision process
that the in-charge auditor followed.

(See Figure 16-7)

 The procedures were developed from a unique set of facts (see Figure 16-
7). If the facts change, the procedures are likely to change.
 The sample size and items to select are included in the audit program.
They were decided on a judgment basis considering the relevant factors in
the engagement.
 Notice that confirmation (Procedure 10 in Table 16-5) is used to satisfy
multiple objectives.

The procedures in Table 16-5 are those in Table 16-4 (design format) converted to
a performance format. We trace one or two procedures in class from Table 16-4 to
Table 16-5 to make sure that students understand how this is done. The reasons for
the differences between a design and a performance format should be emphasized.

(See Tables 16-4 and 16-5)

Review

Any of Problems 16-23, 16-24, 16-25, or 16-26 are useful to review types of
tests and balance-related audit objectives. Problem 16-32 is useful for practice in
developing an audit program. Case 16-34 is especially useful for identifying audit
risks and summarizing the trade-off between tests of controls, substantive tests of
transactions, analytical procedures, and tests of details of balances. Problem 16-36
can be used to illustrate the performance of selected procedures using ACL.
If you used the Pinnacle Manufacturing Case in earlier chapters, it is important
that you finish it by using Case 16-35, which is the final part.

16-5
 CHAPTER 16
CROSS-REFERENCE OF LEARNING OBJECTIVES AND PROBLEM MATERIAL

Multiple Discussion
Review Choice Questions ACL Problem
Learning Objectives Questions Questions and Problems and Cases
16-1 Describe the methodology for designing tests of 16-1, 16-2, 16-34
details of balances using the audit risk model. 16-17

16-2 Design and perform analytical procedures for 16-3 16-20 16-29, 16-32 16-35
accounts in the sales and collection cycle.
16-5

16-3 Design and perform tests of details of balances for 16-4, 16-5, 16-22 16-23, 16-24, 16-34, 16-35,
accounts receivable. 16-6, 16-7, 16-25, 16-26, 16-36
16-8, 16-18, 16-27, 16-29,
16-19 16-32

16-4 Obtain and evaluate accounts receivable 16-9, 16-10, 16-21 16-28, 16-30, 16-34, 16-35
confirmations. 16-11, 16-12, 16-31, 16-32,
16-13, 16-14, 16-33
16-15, 16-16

16-5 Design audit procedures for the audit of accounts 16-32 16-34
receivable, using an evidence planning worksheet
as a guide.
 BALANCE-RELATED AUDIT OBJECTIVES

 Details in the trial balance agree with related

master file amounts, foot to the total in the trial
balance, and agree to the total in the general
ledger.

 Amounts in the trial balance exist.

 Existing amounts are included in the trial balance.

 Amounts in the trial balance are accurate.

 Amounts in the trial balance are properly

classified.

 Transactions near the balance sheet date are

recorded in the proper period.

 Amounts in the trial balance are stated at

realizable value.

 The client has rights to the assets in the trial

balance.

T-16-1
 COMPARISON OF
TRANSACTION-RELATED AUDIT OBJECTIVES
AND BALANCE-RELATED AUDIT OBJECTIVES
TRANSACTION-RELATED
AUDIT OBJECTIVES
Transactions are properly
included in the master file and
are correctly summarized.
Recorded transactions exist.
Existing transactions are
recorded.
Transactions are accurately
stated.
Transactions are properly
classified.
Transactions are recorded on
the correct dates.
Not applicable.
Not applicable.
BALANCE-RELATED
AUDIT OBJECTIVES
Details in the trial balance agree
with related master file
amounts, foot to the total in the
trial balance, and agree to the
total in the general ledger.
Amounts in the trial balance
exist.
Existing amounts are included
in the trial balance.
Amounts in the trial balance are
accurate.
Amounts in the trial balance are
properly classified.
Transactions near the balance
sheet date are recorded in the
proper period.
Amounts in the trial balance are
stated at realizable value.
The client has rights to assets in
the trial balance.
T-16-2
 BALANCE-RELATED AUDIT OBJECTIVES
FOR TESTS OF DETAILS OF BALANCES

GENERAL BALANCE- SPECIFIC BALANCE-

RELATED AUDIT RELATED AUDIT
OBJECTIVES OBJECTIVES

Detail tie-in

Existence

Completeness

Accuracy

Classification

Cutoff

Realizable value

Rights

T-16-3
 SALES CUTOFF

Assume physical inventory was taken on 12-31-09.

Client says that the last shipment made was on
shipping document 11639. Shipping documents are
issued in numerical sequence. Year-end field work
starts 2-6-10.

REQUIRED:

A. What should the auditor do during the

physical count to test for sales cutoff?

B. What information should the auditor retain

with respect to sales cutoff, and where
should it be kept between 12-31-09 and 2-6-
10?

C. On 2-6-10, what sales cutoff procedures

should be performed?

T-16-4
CHARACTERISTICS OF A CONFIRMATION

1. Receipt

2. Usually written, but may be oral

3. Independent third party

4. Requested by auditor

QUESTION:

In what ways may positive or negative

confirmations fail to meet these
characteristics?

T-16-5