Audit of Receivables

Department of Professional & Continuing Education

(Kingston Campus)

In Partial Fulfillment of the Course

ACCT 242 – Auditing

THE AUDIT OF RECEIVABLES

Group Members:

DATE: February 04, 2018

 Audit of Receivables

Introduction

What are accounts receivables?

Accounts receivables are amounts due from debtors from sales of merchandise, services, or other
assets, or as a result of a loan.

3 types of receivables
1. Trade - Trade receivables include open accounts, notes, and installment contracts
representing claims for goods and services sold in the ordinary course of business.
2. Non Trade - Nontrade receivables may include tax refund claims, sale of plant or
equipment, or dividends receivable.
3. related party - Related-party receivables could be due from employees, stockholders,
officers, management, or affiliates.

The audit objective

Audit objectives are associated with the audit of financial statements. They cover the following topics:
● To obtain reasonable assurance that the financial statements are free of material misstatements;
and
● To issue a report on those financial statements based on the findings resulting from the audit.

They are broad statements developed by auditors and define intended audit accomplishments.
The audit objective forms the basis of the audit. The objective states the subject matter under examination
and how performance will be assessed. Once the objective is determined, the scope, criteria, and approach
can be developed.

For example, The objective of this audit was to determine whether Environment Canada adequately
enforced compliance with the Canadian Environmental Protection Act.

The audit objective of Accounts Receivable

The overall objective of the audit of accounts receivable and sales is to determine if they are fairly
presented in the context of the financial statements as a whole. The sales account is closely tied to
accounts receivable; therefore, evidence supporting accounts receivable tends to support sales. For
example, having determined that an account receivable is valid, the auditor has thereby supported the
validity of the sale.
 Audit of Receivables

The primary objectives for the auditors' substantive tests of receivables and revenue are to:

(a) substantiate the existence of receivables and the occurrence of revenue transactions, e.g., accounts
receivable are authentic obligations owed to the company at the date of the balance sheet.

(b) establish the completeness of receivables and revenue, e.g., accounts receivable include all
amounts owed to the company at the date of the balance sheet.

(c) determine that the client has rights and obligation to the recorded receivables, - e.g., pledged,
discounted, or assigned accounts receivable are properly disclosed

(d ) determine that the valuation and allocation of receivables and revenue is at an appropriate net
realizable value e.g., allowance for doubtful accounts is adequate but not excessive

(e) establish that the presentation and disclosure of receivables and revenue are appropriate.e.g.,
accounts receivable are appropriately classified in the balance sheet, and required disclosures are
made.
(f) cut off- ensure that transactions occurring near year-end are recorded in the financial
statements in the proper period.- e.g., accounts receivable are recorded in the proper period;

The audit procedures used to achieve the objectives of the audit of receivables

(a) substantiate the existence of receivables and the occurrence of revenue transactions, e.g., accounts
receivable are authentic obligations owed to the company at the date of the balance sheet.

Procedures that can be used:

● Perform a receivables’ circularization on a sample of year-end trade receivables.
A letter signed by a company officer (but mailed by the auditor) to customers selected by the
auditors from the company's accounts receivable aging report. The letter requests that customers
contact the auditors directly with the total amount of accounts receivable from the company that
was on their books as of the date specified in the confirmation letter.
The auditor typically selects customers for confirmation that have large outstanding receivable
balances, with secondary consideration given to overdue receivables, followed by a random
selection of customers having smaller receivable balances.

Two types of Receivable circularization

A positive confirmation request asks that a customer sign and mail the form back to you either
attesting to the fact that the figure owed is correct or correcting it. A positive confirmation
 Audit of Receivables

request can also show the dollar amount owed as blank, requiring the customer to fill it in
according to its records.

Negative confirmation. This is a request to contact the auditor only if the customer has an issue
with the accounts receivable information contained within the confirmation. This is a less robust
form of evidence, since there is an inclination by customers to not contact the auditor, which
leads to the presumption by the auditor that customers agree with the presented accounts
receivable information.

N.B if customers do not return confirmations to the auditor, the auditor may go to considerable
lengths to obtain the confirmations, given the high quality of this form of evidence. If there is no way
to obtain a confirmation, then the auditor's next step is to investigate subsequent cash receipts, to see
if customers have paid for those invoices that were not confirmed. This is a strong secondary form of
evidence that the accounts receivable outstanding at the end of the reporting period being audited
were in existence at that time.

If the information received from a customer varies from the receivable amount listed in the
company's receivable report, the auditor usually asks the company to reconcile the difference, which
the auditor can then take further action on, as necessary.

● Follow up all the balance disagreements and non-replies to the receivables’ confirmation.
● Perform alternative procedures for any exceptions and nonreplies to the receivables’
confirmation, such as: Review after-date cash receipts by inspecting bank statements and
cash receipts documentation.
● Examine the customer’s account and customer correspondence to assess whether the
balance outstanding represents specific invoices and confirm their validity.
● Examine the underlying documentation (purchase order, dispatch documentation,
duplicate sales invoices etc).
● Inquire from management explanations for invoices remaining unpaid after subsequent
ones have been paid.
● Observe whether the balance on the account is growing and if so, find out why by
discussing with management.

(b) establish the completeness of receivables and revenue, e.g., accounts receivable include all
amounts owed to the company at the date of the balance sheet.
● Agree the balance from the individual sales ledger accounts to the aged receivables’
listing and vice versa.
● Match the total of the aged receivables’ listing to the sales ledger control account.
 Audit of Receivables

● Cast and cross-cast of the aged trial balances before selecting any samples to test.
● Complete the disclosure checklist to ensure that all the disclosures relevant to receivables
have been made.
● Compare the gross profit % by product line with the previous year and industry data.
● Compare the level of prepayments to the previous year to ensure the figure is materially
correct and complete.
● Review detailed statement of financial position to ensure all likely prepayments have
been included

(c) determine that the client has rights and obligation to the recorded receivables, - e.g., pledged,
discounted, or assigned accounts receivable are properly disclosed
● Make inquiries of management, review loan agreements and review board minutes for
any evidence of receivables being sold (e.g. to factors).

(d ) determine that the valuation and allocation of receivables and revenue is at an appropriate net
realizable value e.g., allowance for doubtful accounts is adequate but not excessive.

● Compare receivables’ turnover and receivables’ days to the previous year and/or to
industry data.
● Compare the aged analysis of receivables from the aged trial balance to the previous year.
● Review the adequacy of the allowance for uncollectible accounts through discussion with
management.
● Compare the bad debt expense as a % of sales to the previous year and/or to industry
data. Compare the allowance for uncollectible accounts as a % of receivables or credit
sales to the previous year and/or to industry data.
● Confirm adequacy of allowance by reviewing correspondence with customers and
solicitors.
● Examine credit notes issued after year-end for allowances that should be made against
current period balances.
● Examine large customer accounts individually and compare them to the previous year’s
balances.
● For a sample of old debts on the aged trial balance, obtain further information regarding
their recoverability by discussions with management and review of customer
correspondence.
● For a sample of prepayments from the prepayments’ listing, recalculate the amount
prepaid to ensure that it has been accurately calculated.
 Audit of Receivables

(e) establish that the presentation and disclosure of receivables and revenue are appropriate.e.g.,
accounts receivable are appropriately classified in the balance sheet, and required disclosures are
made.
● Take a sample of sales invoices and examine for proper classification into revenue
accounts.
● Review the aged analysis of receivables for any large credits, non-trade receivables and
long-term receivables and consider whether such items require separate disclosure.
● Read the disclosure notes relevant to receivables in the draft financial statements and
review for understandability.

(f) cut off- ensure that transactions occurring near year-end are recorded in the financial
statements in the proper period.- e.g., accounts receivable are recorded in the proper period.
● For a sample of sales invoices around the year-end, inspect the dates and compare with
the dates of dispatch and the dates recorded in the ledger for application of correct
cut-off.
● For sales returns, select a sample of returns documentation around the year-end credit
entries.
● Perform analytical procedures on sales returns, comparing the ratio of sales returns to
sales.
● Review material after-date invoices, credit notes and adjustments and ensure that they are
recorded correctly in the line relevant financial period.

International examples of objectives and procedures for audit receivables

The Audit plan of Accounts Receivables

The effect accounts receivable has on the financial statements

Statement of comprehensive income
Accounts receivable are listed as revenue on the statement of comprehensive income.
Receivables have a purely positive effect on income statements, as they directly contribute to
current-period revenue. Accounts receivable represents a portion of sales volume, which may or
 Audit of Receivables

may not be recorded as a sale right away, depending on which accounting convention (cash or
accrual) you use. Regardless of your accounting convention or your payment arrangements with
your customers, every sale does eventually count as revenue.

Sales volume = Cash Sales + Credit Sales(Accounts Receivables)

The accrual method of accounting records a transaction as a sale regardless of when the customer
pays. Accounts receivable amounts, which represent transactions you have made for which
payment has not been received, count as sales once you have provided the product or service to
the customer. They increase your net profit by contributing to your reported sales revenue.

⬆ accounts Receivables = ⬆ net profit

Statement of cash flow

An increase in accounts receivable hurts cash flow; a decrease helps cash flow.
To provide products and services to your customers, you must pay for inventory and labor. If you
are not paid promptly, you might find yourself short of money. As a result, your net worth might
look good on paper, but you could still run into difficulties covering day-to-day expenses.
If you are chronically short of cash because you have financed sales that have not yet brought in
returns, you would be forced to take out loans and incur finance charges. If you don't have
sufficient cash flow to buy inventory and pay employees to generate future sales, then your
long-term revenue would decline.

If it's too high, the company may be lax in collecting what's owed to it and may soon be
struggling to find the cash to pay the bills; if it's too low, the company may be unwisely harming
customer relationships or not offering competitive payment terms. In general, accounts
receivable levels correspond to changes in sales levels.
When accounts receivable go down, this is considered a source of cash on the company's cash
flow statement, and as such, it increases the company's working capital(defined as current assets
minus current liabilities). When accounts receivable goes up, this is considered a use of cash on
the company's cash flow statement because the company is "stretching out" the time it takes to
receive money owed to it and thus is using cash more quickly.

⬆ accounts Receivables = ⬇ working capital (vice versa)

Let's assume that Company XYZ sells $1 million of widget parts to a widget manufacturer and
gives that customer 60 days to pay for those parts. Once Company XYZ receives the order
and/or sends the parts and/or sends the customer an invoice, it will decrease its inventory account
 Audit of Receivables

by $1 million and increase its accounts receivable by $1 million. When 60 days has passed and
Company XYZ is paid, it will increase cash by $1 million and reduce its accounts receivable by
$1 million.

Statement of Financial Position

It appears on the "assets" side of your balance sheet. When you list the sum of your company's
accounts receivable on the assets side of your balance sheet, you add to the dollar value of the
entries in that column. When calculating your net worth, the amounts that are owed to you for
products and services that have already been provided to customers are added to the total value
of other assets such as your bank balance, cash on hand, and the value of property that your
business owns.
because accounts receivables appear on the assets column of your balance sheet, it works to
offset the items that appear in the liabilities column. For example, if the liabilities section of your
balance sheet reflects the fact that you carry an accounts payable balance of $1,000 for inventory
that you have purchased but not yet paid for, an accounts receivable balance of $1,000 would act
to offset this amount, making your net worth the same as it would be without either of these
financial items.
 Audit of Receivables

Reference

Sample-Substantive-Procedures-All.pdf. (n.d.). Retrieved February 09, 2018, from

http://students.asalamjan.com/uploads/Sample-Substantive-Procedures-All.pdf

Auditing Accounts Receivables . (2015). Retrieved February 9, 2018, from

https://apps.apbcpa.com/rdweb/pages/en-us/pics/Auditing%20Accounts%20receivable/review_m
aterials.pdf

Gartenstein, %. (2018). The Effects of Accounts Receivable on a Balance Sheet. Retrieved

February 09, 2018, from
http://smallbusiness.chron.com/effects-accounts-receivable-balance-sheet-57389.html

Loughran, M. (n.d.). Confirming Accounts Receivable During an Audit. Retrieved February 09,
2018, from
http://www.dummies.com/business/accounting/auditing/confirming-accounts-receivable-during-a
n-audit/

Bragg, S. (2011, March 11). The accounts receivable confirmation. Retrieved February 09, 2018,
from
https://www.accountingtools.com/articles/what-is-an-accounts-receivable-confirmation.html

Witthington, & Pany. (n.d.). Accounts Receivable, Notes Receivable, and Revenue. Retrieved
February 09, 2018, from
http://highered.mheducation.com/sites/0073010847/student_view0/chapter11/index.html

ACCA paper F8 (SGP): audit and assurance: complete text. (2012). Singapore: Kaplan Financial
(S) Pte Ltd.