DIRE DAWA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING
Unit 3: Audit of Receivables and sales
Meaning of Receivables
The term “Receivable” refers to money owed (be in debt) to a firm that meets two requirements:
Firstly, the money is legally owed to the firm. Secondly, the firm has good reason to believe it
will actually receive the funds. The firm may expect the funds either in the short term, as with
"Accounts receivable," or in the long term, as with "Long term notes receivable."
Definition:
According to Business dictionary defined, receivables is nothing but it is an amount due from a
customer, employee, supplier (as a rebate or refund), or any other party.
What are receivables?
Receivable is an asset designation applicable to all debts, unsettled transactions or other
monetary obligations owed to a company by its debtors or customers. Receivables are recorded
by a company's accountants and reported on the balance sheet, and they include all debts owed
to the company, even if the debts are not currently due. Long-term receivables, which do not
come due for a significant length of time, are recorded as long-term assets on balance sheet;
most short-term receivables are considered part of a company's current assets.
For example, if a company sells car and sells 30% of them on credit, it means 30% of the
company's receipts are receivables. That is, the cash has not been received but is still recorded
on the books as revenue. Instead of an increase in cash, the company makes an increase to
accounts receivable. They are both considered an asset, but accounts receivable is not
considered cash until it gets paid off. If the customer pays the bill in six months, on the seventh
month the receivable is turned into cash and the same amount of cash received is deducted from
receivables.
Characteristic of receivable
• Payments are fixed or determinable
• They may or may not have a fixed term or maturity
• They are not traded in an active securities market
• The holder can recover significantly all of its investment except if there is credit
deterioration (make less value)
• The holder does not have a demonstrated intention and ability to control them until
maturity.
Classification of Receivables
Receivables are classified as Accounts receivable, Notes receivable, Trade receivable and other
receivable.
Meaning of Accounts receivable:
Accounts receivable refers to the outstanding invoices (a list of goods with price sent to a buyer)
a company has or the money the company is owed from its clients. The phrase refers to accounts
a business has a right to receive because it has delivered a product or service. Receivables
essentially represent a line of credit extended by a company and due within a relatively short
time period, ranging from a few days to a year.
Definition of Accounts receivable:
Sales made but not paid-for by the customers (trade debtors). Accounts receivables are shown as
current (short-term) assets in a balance sheet and are, in fact, unsecured promises by customers
to pay in the future.
These sums are a key factor in determining a firm's liquidity and may be discounted used in
raising a short-term bank loan, or sold to a factor. A provision is usually made in the accounts of
a firm to offset uncollectible accounts receivable (bad debts) as losses.
Accounts receivable are sales on credit made to customers that have not yet been collected in
cash. Accounts receivable are discounted based on:
1. Trade discount – discount based on sales volume
For example, Price per unit will be ETB 8.50 for sales of more than 200 units. 
The volume discount is ETB 1.50.
2. Terms of payment
For example, this means that a 2% discount will be given to a customer for the amount paid
within 15 days while the unpaid amount should be settled in 30 days.
3. Cash discount – Discount is given if full amount is paid within a normal credit period.
For example 1: Customers will be given 2% discount if they pay in cash at the time of sale.
For example 2: ETB 25 is the selling price per unit. 
Customers will be given 1% discount if they fully pay within 5 days.
Why Do Businesses Have Accounts Receivable?
Most companies operate by allowing some portion of their sales to be on credit. In some cases,
business offer this type of credit to frequent or special customers who are invoiced periodically.
The practice allows customers to avoid the hassle (disturb) of physically making payments as
each transaction occurs.
In other cases, businesses routinely offer all of their clients the ability to pay after receiving the
service. For example, electric companies typically bill their clients after the clients have received
the electricity. While the electricity company waits for its customers to pay their bills, the unpaid
invoices are considered accounts receivable.
Difference between Accounts Payable and Accounts Receivable?
Accounts payable are amounts a company owes because it purchased goods or services on
credit from a supplier or vendor. Accounts receivable are amounts a company has a right to
collect because it sold goods or services on credit to a customer. Accounts payable are
liabilities. Accounts receivable are assets.
Let's assume that Company “A” sells merchandise (goods/product) to Company “B” on credit.
(Perhaps the invoice states that the amount is due in 30 days.) Company “A” will record a sale
and will also record an account receivable. Company “B” will record the purchase (perhaps
as inventory) and will also record an account payable.
Similarly, when a company owes debts to its suppliers or other parties, these are known as
Accounts Payable. Accounts payable are the opposite of Accounts Receivable.
For example, imagine company “A” cleans company B's carpets and sends a bill for the
services. Company “B” owes the money, so it records the invoice in its accounts payable
column. Company “A” is waiting to receive the money, so it records the bill in its accounts
receivable column.
Internal control over accounts receivable:
• A customer order is received. May be by mail or over telephone or given directly to
company employees.
• On a pre-printed, pre-numbered sales order form, the sales department lists all relevant
information: Quantity, Description, Terms, Buyer address, Method of payment, etc.
• Credit department reviews credit file (which can hold credit report, references, financial
statements, payment history of client, etc.). Approval or disapproval of credit is then
indicated on the sales order form.
• If approved, sales order goes to finished goods warehouse where goods are gathered and
sent to shipping department. Separate departments are maintained so that goods being
removed must be documented. Since asset is being transferred, shipping department
should verify description and quantity against sales order form. Condition of goods
should also be checked. Shipping then signs and returns a copy of sales order which is
kept by warehouse as a receipt to prove that transfer was made.
• Shipping (delivery) department sends goods to customer and prepares a shipping
document, often known as a bill of lading. One copy goes with merchandise and a second
copy is sent directly to customer.
• Copy of bill of lading [or air way bill] sent to inventory accounting department which
should maintain a perpetual(continuous) listing of all inventory. An entry is made to
remove item from records.
• Entries are accumulated and forwarded to general accounting department for posting of
the overall reduction of Inventory account.
• Copies of all documents go to billings department. Comparison is made of quantity and
description. If all information agrees, a Sales Invoice is prepared and sent to client. It is
also recorded in sales journal. Summary of sales journal is forwarded to general
accounting for recording.
 • Copy of sales invoice is sent to accounts receivable department. Amount is recorded in
accounts receivable master file by customer name.
• Periodically, an aged accounts receivable trial balance is prepared which lists each
account by age. Old accounts are turned over to a collection department.
• If balance still proves to be uncollectible, both collection and accounts receivable
departments file documentation to indicate actions taken.
• Independent party reviews information before final write-off of balance is approved.
Notes receivable:
Notes receivable is an Asset of a company, bank or other organization that holds a written
promissory note from another party. For example, if a company lends one of its suppliers ETB
10,000 and the supplier signs a written promise to repay the amount, the company will enter the
amount in its asset account Notes Receivable. The supplier will also enter the amount in its
liability account Notes Payable.
The portion of the notes receivable which is to be received within one year of the balance sheet
date is reported in the current asset section of the lender's Balance sheet. The remaining portion
of the notes receivable will be reported in the noncurrent asset section Investments.
The maturity date of a note determines whether it is placed with current assets or long-
term assets on the balance sheet. Notes that are due in one year or less are considered current
assets, while notes that are due in more than one year are considered long-term assets.
Characteristics of Notes receivable:
• Promissory note – is a written promise to pay a sum of money on demand or at a definite
time.
• Payee – the person to whom the note is payable to
• Maker – one making the note and owing the money
• Due date – when the note is due
• Maturity value = principal + interest
Difference between Account receivable and Notes receivable?
A written promissory note is a note payable for the borrower and it is a note receivable for the
lender. Hence, the promissory note is a liability for the borrower and it is an asset for the lender.
For example, let's assume that Local Retailer borrows ETB 20,000 from its bank and signs a
promissory note. Local Retailer records ETB 20,000 in its liability account Notes Payable and
also records the ETB 20,000 in its Cash account. The bank records the ETB 20,000 promissory
note in its asset account Notes Receivable and it records the ETB 20,000 increase in its
customer's checking account (which is a liability account on the bank's balance sheet).
Since the promissory note is a contract to pay interest at a specified date, it requires Local
Retailer to report interest expense in each accounting period and to report interest payable for
any interest owed at the end of an accounting period.
The bank is required to report interest revenue in each accounting period and to report interest
receivable for any interest it has earned but has not received as of the end of each accounting
period. 
Notes receivable are promissory notes that company receive after providing product or services,
this is transferable, and the company can transfer it to the bank etc. to meet current financial
obligation, without asking payee. It might have %age of interest. Account receivables can’t be
transferred, you have to wait for the specific payee.
"Notes receivable" is when one party extends a line of credit to another party with the promise to
pay in future mentioned date or dates while "Accounts receivable" is when a party sells a good
or renders a service but has not yet received money for those goods or services.
Accounts Receivable: These are short term receivables raised through trading activities of the
Business where as notes Receivable: These are long term receivables raised through
investing/lending activities of the Business. 
Account receivable due to credit sale and note receivable a promissory note 
Internal control over notes receivable:
• The custodian (guardian) of notes receivable should not have access to cash or to the
general accounting records
• The acceptance and renewal of notes be authorized in writing by a responsible official
who does not have custody of notes
• The write-off of defaulted notes be approved in writing by responsible officials and
effective procedures adopted for subsequent follow-up of such defaulted notes
Trade receivable:
Trade receivables arise when a business makes sales or provides a service on credit. For
example, if Inigo sells goods on credit to Bethlaham, Bethlaham will take delivery of the goods
and receive an invoice from Inigo. This will state how much must be paid for the goods and the
deadline for payment, eg within 30 days. Inigo now has a trade receivable – the amount payable
to him by Bethlaham.
The total value of trade receivables for a business at any one time represents the amount of sales
which have not yet been paid for by customers. The trade receivables figure will depend on the
following:
• The value of credit sales: The greater the value of credit sales then, other things being
equal, the greater the total of trade receivables.
• The period of credit given: The longer the period of credit given to customers then, other
things being equal, the greater the total of trade receivables.
• The efficiency with which the business administers its trade receivables : The more
inefficient the business is in billing its customers and collecting overdue accounts then,
other things being equal, the greater the total of trade receivables.
Other receivable:
• Interest Receivable is interest earned on Notes Receivable or other assets are added to
the Interest Receivable account at the end of each accounting period.
• Other receivables include loans made to employees or other companies and advances on
wages paid to employees. If significant, these nontrade receivables are usually listed in
separate categories on the balance sheet because each type of nontrade receivable has
distinct risk factors and liquidity characteristics.
• Other receivables can be divided according to whether they are expected to be received
within the current accounting period or 12 months (current receivables), or received
greater than 12 months (non-current receivables).
Audit of Sales:
• Sales is activity related to selling or the amount of goods or services sold in a given time
period.
• The seller or the provider of the goods or services completes a sale in response to an
acquisition, appropriation, requisition or a direct interaction with the buyer at the point
of sale.
• There is a passing of title (property or ownership) of the item, and the settlement of a
price, in which agreement is reached on a price for which transfer of ownership of the
item will occur.
• The seller, generally executes the sale and it may be completed prior to the obligation of
payment. In the case of indirect interaction, a person who sells goods or service on
behalf of the owner is known as a salesman or saleswoman or salesperson.
Control objectives of sales system:
• One person is not responsible for taking orders, recording sales and receiving payment
• Recorded sales transactions represent goods shipped
• Goods and services are only supplied to customers with good credit rating
• Goods and services are provided at authorized prices and on authorized terms
• Customers are encouraged to pay promptly
• All revenue relating to goods dispatch is recorded
• All goods and services sold are correctly invoiced
• All sales and adjustments are correctly journalized summarized and posted to the correct
accounts
• Transactions have been recorded in the correct period
• All transactions are properly classified in accounts
What are the Controls that can be put in place in a Sales System?
• Segregation of duties
• Sales recorded only with approved sales order form and shipping documents
• Accounting for numerical sequences of invoices
• Monthly customer statements sent out and customer queries and complaints handled
independently
• Authorization of credit terms to customers
• Authorization by senior staff required for changes in standing data
 • Orders not accepted unless credit limits reviewed first
• Authorized price lists and specified terms of trade in place
• Shipping documentation is matched to sales invoices
• Sales invoices are reconciled to the daily sales report
• An open-order files is maintained and reviewed regularly
• Sales invoices and matching documents required for all entries
• All shipping documentation is forwarded to the invoicing section on a daily bases
• Daily invoicing of goods shipped
• Chart of accounts in place
• Codes in place for different types of products or services
What are the tests of controls for the Sales System?
• Observe and evaluate whether proper segregation of duties is operating
• Test a sample of sales invoices for authorized sales order form and shipping
documentation
• Examine application controls for authorization
• Review and test entity’s procedures for accounting for numerical sequences of invoices
• Review entity’s procedures for sending out monthly statements and dealing with customer
queries and complaints
• Review entity’s procedures for granting credit to customers
• Examine a sample of sales orders for evidence of proper credit approval by the
appropriate senior staff member
• Examine application controls for credit limits
• Review all new customer files to ensure satisfactory credit references have been obtained
• Compare prices and terms on a sample of sales invoices to the authorized price list and
terms of trade
• Examine application controls for authorized prices and terms
• Review and test entity’s procedures for accounting for numerical sequences of invoices
• Trace a sample of shipping documents to the sales invoices and ledger
• Review a sample of reconciliations performed
• Inspect the open-order file for unfilled orders
• Vouch recorded sales to supporting documents
• Compare dates on sales invoices with dates of corresponding shipping documentation
• Compare dates on sales invoices with dates recorded in the sales ledger
• Review sales ledger for proper classification
• Examine a sample of sales invoices for proper classification
• Test application controls for proper codes

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