Substantive Tests of Receivables and Sales

Audit objectives for Receivables and Sales Balances

Existence: Sales and Accounts Receivable are for shipments made to customers

1. Confirm accounts receivable and perform procedures for confirmations not returned.

2. Perform analytical procedures to test sales and accounts receivable.

Completeness: Sales transactions that occurred and existing receivables are recorded.

1. Perform a test of sales cutoff.

Obligations/Rights: Accounts receivable are owned by the client

1. Review minutes of the board of directors’ meetings, inquire of the client personnel, read
contracts and agreements, and confirm with lenders any indications that accounts have
been assigned, sold, or pledged.

Valuation: Accounts Receivable are properly valued.

1. Verify mathematical accuracy of the accounts receivable aging schedule and trace it to the
accounts receivable subsidiary ledger.

2. Test the adequacy of the allowance for uncollectible accounts.

Presentation and Disclosure: Sales and accounts receivable are properly presented and disclosed in
accordance with GAAP.

1. Review financial statements and perform analytical procedures to determine whether

accounts are classified and disclosed in accordance with GAAP.

Audit objectives for Sales Transactions

Occurrence: Recorded sales are for shipments actually made to customers

For a sample of entries in the sales journal, compare sales invoice copy, customer order and
sales invoice.

Completeness: Sales transactions that occurred are recorded

For a sample of shipping documents, trace sales invoice and entry into sales journal and
accounts receivable subsidiary ledger. Perform cutoff tests.

Classification: Sales and accounts receivable transactions have been recorded in the proper accounts.

For a sample of entries in the sales journal, verify the accuracy of account coding.

Accuracy (Valuation): Sales are correctly billed and recorded.

 For a sample of entries in the sales journal, examine sales invoice, shipping document, and
customer for consistency of descriptions and quantities; examine sales order for credit approval; and
check prices and extensions. Foot sales journal and general ledger account.
Potential Misstatements - Revenue
Misstatement
1. Recording unearned
revenue
2. Early or late recognition
of revenue – “cutoff
problems)
3. Recording revenue
when significant
uncertainties exist
Examples
Fraud – Recording fictitious
sales without receiving a
customer order or shipping the
goods
Error – Recording sales based
on the receipt of orders from
customers rather than the
shipment of goods.
- Inaccurate billing and
recording of sales
Fraud – Holding the sales
journal open to record next
year’s sales as having occurred
in the current year
Error – Recording sales in the
wrong period based on
incorrect shipping information
Fraud – recording sales when
the customer is likely to return
the goods
Error – recording sales when
the customer’s payment is
contingent upon the customer
receiving financing or selling the
goods to another party (e.g.,
Internal control weaknesses
or factors that increase the
risk of misstatement
Ineffective board of directors,
audit committee, or internal
audit function;
Ineffective billing process in
which billing is not tied to
shipping information.
Ineffective controls for testing
invoices or ineffective input
validation checks and
computer reconciliation to
ensure the accuracy of
databases.
Ineffective board of directors,
audit committee, or internal
audit function;
Ineffective cutoff procedures
in the shipping department
Ineffective board of directors,
audit committee, or internal
audit function;
Aggressive attitude of
management toward financial
reporting; incompetent chief
accounting officer
 consignment sales)

4. Recording revenue Fraud – Recording franchise Ineffective board of directors,

when significant revenue when the franchise are
services still must be sold even though an bligation to
performed by seller perform significant service still
exists
Error – amount of revenue
earned on franchise is
miscalculated
5. Overestimation of the Fraud – misstating the
amount of revenue percentage of completion of
earned several projects by a
construction company using the
percentage of completion
method of revenue recognition
audit committee, or internal
audit function.
Aggressive attitude of
management toward financial
reporting; incompetent chief
accounting officer
Ineffective board of directors,
audit committee, or internal
audit function.

Illustrative cases:

Case No.1

You have been asked to audit the records of XYZ Manufacturing Company, a small manufacturer
of precision tools and machines, for the year ended December 31, 2019. Your examination of sales
transaction received among others the following:

1. Some machines have been shipped on consignment to XYZ’s regular dealers. These transactions
have been recorded as ordinary sales and billed as such. As of December 31, 2019 the machines
billed and in the hands of consignees amounted to P130,000. Sales price was determined by
adding 30% to cost.

2. On December 31, 2019, two machines were shipped to a customer on FOB shipping point basis.
The sale was entered in the records on January 5, 2020 when cash was received in the amount
of P13,000.

3. The inventory as of December 31, 2019 included goods sold during November 2019 for P6,500
but returned on December 15, 2019. No entry has been made to adjust the customer’s account
for the goods returned. The goods were included at selling price which was 130% of cost.

The Accounts Receivable on December 31, 2019 is P450,000 and Sales account has P1,250,000
as of December 31, 2019.

A. As auditor of XYZ Manufacturing Company, what adjusting journal entries would you
recommend relative to the above findings?

B. How much is the Accounts Receivable adjusted balance?

 C. How much is the Adjusted Sales of XYZ Company on December 31, 2019?

Answer:

A. For Audit finding No.1

Sales P130,000
Accounts Receivable P130,000
To reverse the entry made to record deliveries
to consignees which are still unsold as of 12/31/2019

Inventory P100,000
Cost of Sales (P130,000/130%) P100,000
To include goods in the hands of consignees

For Audit Finding No. 2

Accounts Receivable P13,000

Sales P13,000
To record the sale of machines shipped
on 12/31/2019, FOB Shipping point

For Audit Finding No. 3

Sales return and allowances P6,500

Accounts Receivable P6,500
To record goods returned by customer

Cost of Sales [P6,500 - (P6,500/30%)] P1,500

Inventory P1,500
To correct overstatement of inventories

B. Unadjusted Accounts Receivable 12/31/2019 P450,000

Add: Record sale of two machines, FOB shipping point 13,000

Less: Items on consignment, unsold 130,000

Sales return on December 15, 2019 6,500

Adjusted Accounts Receivable, 12/31/2019 P326,500

C. Unadjusted Sales, 12/31/2019 P1,250,000

Add: Record sale of two machines, FOB shipping point 13,000

Less: Items on consignment, unsold 130,000

Sales return on December 15, 2019 6,500

 Adjusted Sales, 12/31/2019 P1,126,500

Case No. 2

You have been appointed as external auditor of Orange Corporation. Orange Corporation
operates in an industry that has a high rate of bad debts. On December 31, 2019, before any year-end
adjustments, Orange’s Accounts Receivable balance was P600,000 and its Allowance for Doubtful
Accounts balance was P25,000. The year-end balance reported in the statement of financial position for
the Allowance for Doubtful Accounts will be based on the aging schedule shown as follows:

Time Outstanding Amount of Accounts Receivable Probability of Collection

Under 15 days P300,000 0.98

16-30 days 200,000 0.90

31-45 days 50,000 0.80

46-60 days 30,000 0.70

61-75 days 10,000 0.65

Over 75 days 10,000 0.00

Required: As an auditor, you have to determine:

A. The appropriate balance for the Allowance for Doubtful Accounts on December 31, 2019.

B. How Accounts Receivable would be presented on the balance sheet on December 31, 2019.

Solutions:

A. Allowance for Doubtful Accounts on December 31, 2019 is P 48,500.

Time Outstanding Amount of Accounts Expected Percentage of Estimated

Receivable Uncollectible Uncollectible

Under 15 days P300,000 0.02 P 6,000

16-30 days 200,000 0.10 20,000

31-45 days 50,000 0.20 10,000

46-60 days 30,000 0.30 9,000
61-75 days 10,000 0.35 3,500
TOTAL P600,000 P 48,500

Note: The P10,000 Accounts Receivable outstanding for over 75 days should be written off since there is
no possibility of collecting the amount hence, should not be considered when determining the adjusted
balance of Allowance for Doubtful Accounts.

B.

Accounts Receivable Unadjusted, 12/31/2019 P600,000

Less: Accounts written off (over 75 days) 10,000

Allowance for doubtful accounts 48,500

Net Accounts Receivable P541,500

Case No. 3

During the course of the audit of the financial statements of Crome, Inc., for the year ended
December 31, 2019, you examined the notes receivable represented by the following items:

1) A four-month note dated November 10, 2019, from the Aeon Company, P10,000; interest
rate 16%; discounted on November 31, 2019, at 6%.

2) A draft drawn payable 30 days after date for P45,000 by the Benton Company on the Dodge
Company in favour of the Gerrard Company, endorsed to Crome, Inc., on December 2, 2019,
and accepted on December 4, 2019.

3) A 90-day note dated November 1, 2019 from J.C. Cruz of P25,000; interest at 16%; the note
is for subscriptions to 250 preference shares of Crome, Inc., at P100 per share.

4) A 60-day note dated May 3, 2019, from the Naional Investment Company, P30,000; interest
rate 16%; dishonoured at maturity; judgment obtained on October 10, 2019. Collection
doubtful. (No interest after maturity)

5) A 90-day note dated January 14, 2019 from Romeo Paz, president of Crome, P8,000; no
interest; not renewed; president confirmed.

6) A 120-day note September 14, 2019, from Samson Company, P6,000; interest rate 16%;
note is held by bank as collateral.

When the company discounted a note, Interest Expense was debited for the discount cost and
Interest Income was credited for the revenue.

Prepare working paper for the Notes Receivable as of December 31, 2019 and determine the adjusted
balance of Notes Receivable as of December 31, 2019.
 CROME, INC.,

Notes Receivable 12/31/2019

Maker Date Interest Amount Interest Remarks

Of Note Due Rate Receive Accrued Earned

d

Aeon 11/30/201 03/30/202 16% P10,000 P533 P133 Discounted

Company 9 0 on
11/30/2019
at 16%

Benton 12/2/2019 01/2/2020 - P45,000 Accepted by

Company Dodge on
12/14/2019
J.C Cruz 11/1/2019 1/30/2019 16% P25,000 P667 P667 Subscription
Receivable
on
preference
shares

National 05/3/2019 07/2/2019 16% P30,000 P800 P800 Dishonored

Investmen at maturity;
t Co. collection
doubtful

Romeo Paz 01/4/2019 04/4/2019 - P8,000 Maker is

President of
Crome; not
paid at
maturity nor
renewed;
confirmed
Samson 9/14/2019 1/12/2020 16% P6,000 P280 P280 Note held by
Company bank as
collateral

Balance P124,000 P533 P1,747 P1,880

per ledger

Balance per ledger P124,000

Deduct: Reclassify subscription receivable 25,000

Reclassify past due note 30,000

 Reclassify note due from president 8,000

Adjusted Balance of Notes Receivable P61,000

Computation of Interests:

Aeon Company Interest Received on Nov. 30, 2019 (P10,000 x 16% x 4/12) - P 533.33

Interest Earned -December 2019 (P533.33 / 4) - P 133.33

J.C Cruz Interest Earned – Nov and Dec [(P25,000 x 16% x 90/360) x2/3] - P 667

National Investment Co. Interest Earned in 2019 (P30,000 x 16% x 60/360) - P 800

Samson Company Interest Earned – Oct to Dec [(P6,000 x 16% x 120/360) x3.5/4] - P 280