CHAPTER 4 – RECEIVABLES

 Daily totals of sales invoices processed

- Should be transmitted to the accounting dept. for the proper journal entries in the sales
journal and posting to the general ledger and subsidiary ledger of accounts receivable
- Any adjustments to sales (e.g. sales discounts and sales returns and sales allowances)
o Must be properly approved before they are recorded in the books
 Daily totals of cash receipts from customers must be transmitted to the accounting dept.
- For proper posting to the subsidiary ledger accounts

NOTE: At least once a month, the total of subsidiary ledger balances should be reconciled with the
controlling account in the general ledger by an employee from the internal audit or operations control
group.

 Statement of accounts should be sent to customers, at least once a month.

 Dormant accounts should be reviewed and tested for impairment.
 Approval shall be made for writing off of receivables assessed to be uncollectible.
 Accounts written off should be transferred to a separate ledger and control account, for proper
control.
 Subsequent collections may be abstracted without the necessity of manipulating the accounting
records.

Audit Objectives

- Auditor’s principal objectives in the audit of accounts receivable & sales are to:
o Consider internal control over receivables and revenue transactions
o Determine the existence of receivables, that the client has rights to these assets,
and the occurrence of revenue transactions
o Establish the completeness of recorded receivables and revenue transactions
o Determine that the receivables are measured at appropriate amortized cost
o Establish the presentation and disclosure of receivables and revenues are
appropriate

Audit procedures

- Auditor has to update info. on client business risk & analyze potential motivations to or
circumstances that misstate revenues
- Must understand client operations and identify the proper revenue recognition principle
applicable to business operations
- Understanding of the entity’s operations and its environment will assist the auditor in
developing
o An expectation of total revenues by understanding the company’s products,
markets and its maximum sales volume
o Understanding of gross margin by understanding products, market share and
competitive advantage
o Expectation of receivable levels based on average collection periods for the client
and the industry as a whole
 Because of normal cutoff errors or misapplication of the appropriate revenue recognition
principle
o There is rebuttable presumption that the amount of revenue recorded by the enterprise
contains some misstatements
o Presence of any of the ff. increases inherent risk and probability of material
misstatement
 Unusual credit terms
 Unusually large amounts of revenue recorded towards the end of the reporting
period
 Sales made with recourse or that have significant returns
 Unusual concentration of sales made to particular customers
 Shipments to customers w/o corresponding sales orders
 Substantive tests of revenue for existence, occurrence and valuation include vouching of
recorded sales transaction back to customer order and shipping document.
o Quantities on customer’s order – must be compared w/ quantities shipped & billed
o Cutoff test – provides evidence whether transactions are recorded in the proper
reporting period
 Cutoff period – usually several days before and after the end of reporting period
 Extent of cutoff tests – depends on the strength or effectiveness of client
controls over the revenue cycle
 Sales cutoff test
 Auditor selects sample of sales recorded during the last few days of the
year and first few days subsequent to the year under audit
 Recorded sales in the sales journal – vouched back to sales invoice and
shipping documents to determine whether sales are recorded in the
proper period
 Sales return cutoff test
 Auditor selects a sample of receiving reports issued during the last few
days of the year (or the last month of the year) and during the first few
days during the subsequent year (or the first month of the subsequent
year)
 Purpose: determine whether credit memorandum is recorded during
the correct reporting period
 Cash receipts cutoff test
 Auditor selects sample of credits to the accounts receivable in the cash
receipts journal & vouch them to the copies of official receipts issued
during the cutoff period and the copies of sales invoices issued to the
customer
 Purpose: determine whether collection is recorded on time and
whether any adjustment in the original invoice price, if any, is properly
accounted for
 Examination of cash sales is linked to examination of cash receipts from such sales.
o Random samples of cash sales, based on sales invoice, can be traced to the cash receipts
records and reconciled with bank deposits
 o Pricing must be checked to inventory records
o To test reasonableness of the recorded cash sales, expectations are set for change in
sales figures in comparison w/ previous year’s sales.
 Amount beyond expectations – require further analysis and investigation
 Similar attention must be given to credit sales.
o Sample of sales invoices must be traced to the order slips (or similar documents),
reconciled to pricing information, warehouse requisitions and delivery receipts
o Obtain reasonable assurance was recorded in the proper reporting period, that is when
the sale is actually made
o To obtain assurance that all shipments are billed
 Auditor should obtain a sample of shipping documents issued during the year
and compare them to sales invoices
 To establish correctness of the balance of the accounts receivable in the GL
o Necessary for the auditor to obtain a list of the AR from the subsidiary ledgers and
reconcile the total to the balance in the GL
o Standard procedure: AR must be confirmed
 Provides assurance that no lapping or any other form of manipulation has been
resorted to by any employee of the entity
 Auditing firm must mail directly the confirmation request w/ attached business
reply envelope to the client’s customers
 Provide reliable external evidence about the existence of recorded AR,
completeness and correctness of recorded cash collections, sales discounts and
sales returns and allowances
 Auditor has to evaluate whether to use the positive/negative form of confirmation.
o Positive form of confirmation – requests the customer to reply whether or not the
customer agrees w/ the amount indicated in the confirmation request
o Negative confirmation – requests the debtor to reply only when the balance shown is
incorrect
- Positive confirmations provide more competent evidence because some customers may not
give due considerations to negative confirmation
o Thus non-reply does not necessarily mean that the customer agrees with the
balance indicated
- Because positive confirmation requires response, it may be necessary to mail a second
request if customer does not respond to the first confirmation request
- Repeated non-reply
o Means that the auditor has to use alternative procedures to verify the existence and
correctness of the balance to the customer’s account.
o Such procedures include:
 Tracing subsequent cash receipts to determine that payments relate to the
year-end accounts receivable balance
 Reviewing shipping documents to determine that AR balances relate to
goods ordered by customers which have been shipped
 Matching these collections w/ year-end receivables addresses the
assertions of existence, validity and collectability of these
 receivables, while reviewing shipping documents addresses the
assertions of completeness, existence and validity
- Negative confirmation
o Less expensive because non-response is assumed to mean agreement with the bal.
in the confirmation request
o May only be used when all of the ff. conditions are present;
 Account consists of a large no. of small balances
 Inherent and control risk for AR is low
 Auditors have no reason to believe that the customer will not disregard the
confirmation request
 Exceptions
- Non-agreement by the customer on amount indicated in the confirmation request
- May be due to timing differences in the execution and recording of transaction, disputed
item of goods, customer errors or client errors
- Auditor must determine the reason for this otherwise,
o Unexplained differences noted by the customers and significant time lag between
the record of the customer and the record of the client for cash remittances
 May lead to conclusion that fraud exists in the collection process
 To establish collectability of the receivables, auditor has to review credit collection policies and
procedures and measure expected credit losses
o Expected credit losses are recognized
 By setting up an allowance account at an amount equal to 12-month expected
credit losses and lifetime expected credit losses
o Lifetime credit losses and the related loss allowance are recognized for receivables
whose credit risk increased significantly from the date of initial recognition.
 Indicators of lifetime credit losses on the receivables
 Difficulty by the client in making collections on time
 Repeated defaults by client customers
 Subsequent declaration of customers’ bankruptcy
o For all other receivables w/ no such indicators of lifetime credit risk
 Allowance for credit losses is measured at an amount equal to 12-month
expected credit risk
o Measurement of expected credit risk
 Normally involves classification of receivables by age
 Client prepares an aging schedule (manually or from a computerized system)
 Auditor uses this and group receivables according to age to evaluate the
adequacy of the client’s allowance for uncollectible accounts
 If aging schedule is generated by client
 Auditor has to test it for mathematical & age classification accuracy
 Aging schedule can also be used to validate the control account balance, select
customer accounts for confirmation, and identify amounts due from related
parties (for disclosure purposes)
  Auditor may also examine credit files for large accounts, review subsequent collection of
accounts and perform analytical procedures useful in evaluating the appropriateness of the
balance of the allowance for uncollectible accounts
 Substantive tests on NR and related interest revenue include:
o Inspection of the notes
- Notes must be examined as to date of maturity, interest rate and payee
- Most effective verification of interest revenue account consists of test of reasonableness of
interest earned during the year on notes receivable
o Ratios and trend can be used as indicators of reasonableness of amounts
o Independent computation of interest earned
o analytical review procedures
 Receivables from related parties
- Separately disclosed
- Audit procedures that identify related party transactions include:
o Reviewing the AR subsidiary ledger and trial balance
o Inquiries from management
- Names of related parties
o Must be communicated to all the members of the audit team so that they are
alerted for related party transactions
 Receivables that are sold w/ recourse, discounted or pledged as collateral
o Can be identified through management inquiry, scanning cash receipts journal for large
inflows from unusual sources, bank confirmations, w/c include information on
obligations and terms and reviewing the minutes of the meetings of the BOD
EXAMPLES OF NONTRADE RECEIVABLES
A. Advances to or receivables from shareholders, directors, officers or employees
> If collectible in one year - advances/receivables should be classified as current assets.
Otherwise, advances or receivables are classified as noncurrent assets.
B. Advances to affiliates - long-term investments
C. Advances to supplier for the acquisition of merchandise - current assets
D. Subscriptions receivable - current assets if collectible within one year. Otherwise,
subscriptions receivable should be shown preferably as a deduction from subscribed share
capital
E. Creditor’s accounts may have debit balances as a result of overpayment or returns and
allowances - current assets
> If debit balances are not material - an offset may be made against the creditor’s accounts with
credit balances and only the net accounts payable may be presented
F. Special deposits on contract bids - classified as noncurrent assets because such deposits are
likely to remain outstanding for a considerable long period of time
- deposits that are collectible currently (current assets)
G. Accrued income - dividend receivable, accrued rent receivable, accrued royalties receivable
and accrued interest receivable on bond investment
H. Claims receivable - claims against common carriers for losses or damages, claim for rebates,
tax refunds, claim from insurance entity (current assets)
CUSTOMERS’ CREDIT BALANCES
- credit balances in accounts receivable resulting from overpayments, returns and allowances
and advance payments from customers
- classified as current liabilities and are not offset against the debit balances in other customers’
accounts, except when the same is not material in w/c case only the net AR may be presented

INITIAL MEASUREMENT OF ACCOUNTS RECEIVABLE

- recognized initially at fair value plus transaction costs that are directly attributable to the
acquisition
- FV of a financial asset - transaction price (fair value of the consideration given)
- short-term receivables - FV is equal to the face amount or original invoice amount

SUBSEQUENT MEASUREMENT
- After initial recognition, AR shall be measured at amortized cost
- amortized cost = net realizable value of accounts receivable