chapter 8 - Cash and Cash Equivalents ‘4 2. How much is the total payment for merchant purch; 500,000. “4! 203) a. P360,000 b. P380,000 d. P620,000 3, How much is the cost of goods sold in 2021? a. 380,000 c. P500,000 b. P420,000 4. P560,000 4, How much is the total sales in 2021? a. 440,000 c. P560, b. 528,000 a. Seen nee 5. How much is the amount of cash shortage as of Decemby = ui ‘00 c. P118,000 er 31, 20217 . PTAA d. P155,000 ‘ 222Yr Chapter 9 ~ Substantive Test of Receivables and Sales CHAPTER 9 SUBSTANTIVE TEST OF RECEIVABLES AND SALES TOPIC OVERVIEW: ‘This chapter discusses the audit of receivables and sales, its objectives and procedures as well as the management assertions relating to receivables and sales. LEARNING OBJECTIVES: After studying this chapter, you should be able to: 4, Identify the audit objectives for receivables, sales and related accounts. 2. Describe the primary substantive audit procedures for receivables, sales and related ac 3. Identify assertions addressed by audit procedures for receivables, sales and related accounts, ee Introduction The audit of receivables and revenue (e.g, sales) represents significant audit risk because: (a) many incidences of financial statement fraud have involved the overstatement of receivables and revenue; (b) revenue recognition may be based on complex accounting rules; and (0) receivables and revenue are usually subject to valuation using significant accounting estimates. It is also noteworthy that under PSA_240, the auditor shall, based on a presumption that there arg‘isks of fraudin revenue recognition, evaluate which types of revenue, révenuie transactions or assertions give rise to such risks. If the auditor has concluded that this presumption is not applicable, the auditor shall document the reasons for that conclusion. Companies should establish effective high-level controls over the financial reporting of these accounts, including (a) anaudit committee to oversee the reliability of reporting of revenue; (b) an internal audit department to monitor compliance with other revenue cycle controls; (c) human resource policies and practices to ensure that competent personnel are involved in determining revenue and receivables estimates; and (@) effective monitoring policies and procedures. In addition, a sound accounting system and effective control activities should be established for the revenue cycle. 223Chapter 9 - Substantive Test of Receivables and Sales Because of the close relationship between revenue and receivable, the tyo can be best considered jointly. The determination of the amount of revenue to be recognized for a particular period is integrally related to a number of financial statement accounts, including sales and accounts receivable, adjustment to sales and accounts receivable, service revenue, deferred revenues and cash. Audit Objectives When auditing accounts receivable and sales, the principal objective for the substantive tests is to determine the following: “Assertion Category Audit Objectives Existence or Occurrence All receivables on the SFP are authentic claims of the entity and all sales have really occurred and pertain to the entity. Completeness ‘All authentic claims of the entity for amounts receivable are included on the SFP and all sales have been included in the SCI. Cut-off Sales have been recorded in the proper accounting period. Valuation and Allocation Receivables are carried at their net realizable (collectable) value (i.e., the gross receivables are properly stated with appropriate allowances provided for doubtful accounts, discounts, returns, warranties and similar items). Sales have been accurately recorded in the SCI. ‘Accuracy Rights and The entity owns, or has a legal right to all the receivables on the SFP at the reporting date. Obligations Presentation and Disclosure & Classification Receivables and sales are properly classified, described, and disclosed in the financial statements, including notes, in accordance with PERS. Pledged, discounted, or assigned accounts receivable are properly disclosed. Related party receivables and sales are properly disclosed. Audit Procedures for Receivables and Sales The auditor's primary substantive procedures for receivable balance and sales transactions will typically include the following: 1. Reconciliation of Subsidiary Ledger (SL) with General Ledger (GL); 2. Confirming receivables and reviewing subsequent cash receipts; 3, Test of details for occurrence, accuracy and classification of sales 4, Analyzing notes receivable and related interest; 224Yr chapter 9 - Substantive Test of Receivables and Sales 5, Evaluating the adequacy of the allowance for doubtful accounts, including the appropriateness of the methodology used to calculate the allowance; 6, Performing accounts receivable and sales cutoff; 7, Test of details for completeness of sales; g. Checking the appropriate valuation of accounts receivables denominated in foreign currencies; g, Investigating any transactions with or related party receivables; 40. Analyzing credit balances and unusual items; 11. Ascertaining whether any receivables have been pledged or assigned; and 42. Performing analytical procedures Audit procedures presented in this textbook merely illustrate typical audit procedures (i.e, primary substantive procedures) for audits of merchandising and manufacturing entities. It is also primarily designed for audits of corporation; however, some discussions are made for partnership and sole proprietorship businesses. In actual practice, audit programs must be tailored to each client's risk and internal control. The audit procedures comprising audit programs may substantially vary from engagement to the next. Assertions mentioned in this textbook relate to primary assertion addressed by the audit procedures discussed. However, some other assertions may also be addressed. Reconciliation of Subsidiary Ledger with General Ledger Primary Audit | First step in the audit of receivable is to obtain an aged |_Objectives: _| trial balance of receivable. After obtaining an aged trial oe balance, the auditor should test the clerical accuracy (eg, footing, cross-footing) of the schedule and briefly inquire of management as to steps taken to ensure the trial balance is complete (i.e. that all receivables due to the company are included on the trial balance). If the client processes their transaction manually, the auditor then would obtain and review the reconciliation prepared by the entity between the receivables sub-ledger and the control account (ie, general ledger), and investigate reconciling items, particularly any unusual non-standard journal entries. Ifthe client uses automated processing, the auditor would request the client to generate the subsidiary ledger of receivable and then compare it with the balance in the general ledger. 225Chapter 9 - Substantive Test of Receivables and Sales Confirmation of Receivables & Review of Subsequent Cash Receipt Primary Audit | The primary audit procedure to verify the existence ang Objectives: _| gross valuation of receivable is through confirmation Existence Note that confirmation should only be performed once Saateal the auditor has already reconciled the subsidiary ledger acemaey with the general ledger. Ordinarily, confirmation is use Rights unless: 1. Receivables are immaterial; 2. Confirming would not provide useful information; and 3. Control risk is so low that other procedures will reduce audit risk to an acceptable level. In accordance with PSA 505 Revised and Redrafted, when using confirmation, the auditor can use either the positive or negative confirmation, or a combination of the two methods to produce more effective procedure. , \ ¢ deve /wo' Positive Confirmation. It is sent to customer of the client by the auditor requesting a response directly as to whether the stated amount owed is correct or incorrect, or to request the customer to provide specific information, such as their account balance with the entity (referred to asa blank form). This type of confirmation is specifically used when: 1. The information available to corroborate management's assertion(s) is only available outside the entity; 2. The entity's information systems and internal controls are unreliable or ineffective (the assessed level of the risk of material misstatement is HIGH); 3. Specific fraud risk factors, such as risk of management override of internal controls, prevent the auditor from relying on evidence from the entity; and 4. The account balances comprise of small number of large accounts. \ Positive confirmation is considered to provide more reliable audit evidence. ry Negative confirmation. It is sent to customer of the client by auditor requesting a response only if the customer disagrees with the amount stated on the confirmation. This type of confirmation is used in the following circumstances: 1. The auditor has no reason to believe that recipients of negative confirmation requests will disregard such confirmation requests; 2. The auditor has assessed the risk of material misstatement as LOW and has obtained sufficient appropriate audit evidence regarding the operating effectiveness of controls relevant to the assertion; 3. Very few or no exceptions expected; and 226Yr 1 | chapter 9 - Substantive Test of Receivables and Sales ! The receivables comprise a large number of small, homogenous, account balances, transactions or conditions. Negative confirmation provides audit evidence that is less reliable compared to positive confirmation, Non-response of the customer may either indicate that the customer agrees with the information in the confirmation request or the customers just ignore the confirmation letter. When customers do not respond to requests, other procedures should be employed, such as examining subsequent cash receipts, shipping documents and sales invoices. ‘Although the main objective of confirmation is to verify the existence of such receivables, confirmation also can be used to detect lapping and || improper sales cutoff (such as those customers that show smaller balances). Other Audit Considerations When Using Confirmation 4, The confirmation should be prepared by the audit client and signed by the appropriate management; 2. The confirmation request should describe that it is not a request for payment, but merely to confirm the account; 3. The confirmation request should be sent to the client's customer under the control of the auditor; 4, The auditor may include in the confirmation request the details of the transactions, such as customer's purchase order numbers to improve the response rate; 5, The confirmation request should be mailed in envelopes bearing the audit firm’s return address to ensure that all confirmation requests that are undeliverable by the post office are returned directly to the audit firm; and 6. Receipt of reply to confirmation request should be under the control of the auditor. Discrepancies in Customers’ Replies The auditor should resolve differences reported by client's customers. Majority of such reported discrepancies arise because of normal lags and in- transit items (e.g, payments made but not received, goods shipped but not received), disputed sales terms, credits allowed but not reflected in the records, and clerical errors. Alternative Audit Procedures for Non-responses When using positive confirmation request, the auditor should generally follow up through email or a telephone call to illicit replies. Traditionally, second or even third confirmation request can be used but nowadays, sending second or third confirmation is impractical because the auditor can track the status or location of the request via the website of the courier. When replies are still not received, the auditor should apply the following 227Chapter 9 - Substantive Test of Receivables and Sales alternative procedures (unless the amount of nonresponse is insignificant and there are no unusual characteristics related to the nonresponses): 1. Examine of subsequent cash receipts in payment of receivables, 2. Examine of charges and credits to accounts receivables, and 3. Examine of related shipping documents, purchase orders or sales invoices for the sales transactions making up the receivable. Management's Refusal to Allow the Auditor to Send a Confirmation Request A refusal by management to allow the auditor to send a confirmation ie, scope limitation) on the audit evidence the auditor may wish to obtain. The auditor is therefore required to inquire as to the reasons for the limitation. A common reason advanced is the existence of a legal dispute or ongoing negotiation with the intended confirming party, the resolution of which may be affected by an untimely confirmation request. The auditor is required to seek audit evidence as to the validity and reasonableness of the reasons because of the risk that management may be attempting to deny the auditor access to audit evidence that may reveal fraud or error. Intercompany receivable Intercompany receivable can be verified by sending confirmation to the client's related party. If the auditor also audits that related party, the auditor may simply cross-examine the records of the related parties. Kindly refer to Exhibit 2 at the end of this chapter for sample Positive Form of Receivable Confirmation. Test of Details for Occurrence, Accuracy and Classification of Sales Primary Audit | To satisfy the objectives of the auditor on the occurrence, Objectives:_| accuracy and classification of sales, the auditor commonly Cire erforms test of details by selecting items from the ‘Accura p y ae: * Cheitztion | Population of recorded sales during the audit period. This test is intended to verify if the amounts recognized as revenue really did occur, are accurate and are appropriately classified. Audit procedures to perform this test may include the following: 1. Obtain the related sales information (e.g, subsidiary ledger of sales, sales transaction details) for the period under audit. 2. Using the related sales information as population, select items for evaluation and obtain the executed sales agreement (e.g., master service agreement, sales contract, customer purchase order, etc.) and validate the actuality of a contract with the customer. 3. Obtain the invoice issued to the customer to vouch the agreed transaction price and compare it with the amounts recorded in the related sales information and audit evidence obtained in Step 2. 228re Chapter 9 - Substantive Test of Receivables and Sales 4, Request for the evidence of delivery (eg, bill of lading or proof of delivery), and agree the quantity of items shipped to the quantity charged to the customer as per invoice. 5. Check if the revenue has been recorded on or after the entity transferred the control of goods to customers based on the agreed shipping terms which can be verified in the audit evidences obtained on Steps 2 to 4. Note: The appropriate timing of revenue recognition would vary depending on the specific circumstances surrounding the sales transaction and on the nature of business operations of the audit client. Related guidance for revenue recognition can be found on PFRS 15 Revenue from Contracts with Customers. 6. Verify the appropriateness of classification of the transaction (e.g, sales, refund, return) and the related classification depending on the classifications found on the entity's financial statement disclosure of sales. 7. Evaluate and conclude on the occurrence, accuracy and classification of sales under audit. Analysis of notes receivable and related interest Primary Audit | An analysis of notes receivable supporting the general Objectives: ledger control account may be prepared for the auditor Existence by client's staff. The information in the analysis ordinarily Re ued includes the name of maker, date, maturity, amount and valuation interest rate. In addition to identifying the accuracy of the Accuracy analysis prepared by the client, the auditors should trace Completeness | items to the accounting records and to the notes Presentation themselves, and disclosure After ensuring the accuracy of the items included in the analysis of notes receivable, the auditor should check the accuracy of the interest by performing independent calculation. The working paper typically includes four columns, which show for each note receivable owned during the year the following information: 1. Accrued interest receivable at the beginning of the year (taken from the prior year’s audit working papers); 2, Interest earned during the year (computed from the terms of the notes); 3. Interest collected during the year (traced to cash receipts records); and 4, Accrued interest receivable at the end of the year (computed by the auditor). Ifthe interest earned for the year as computed by the auditor does not agree with interest earned as shown in the accounting records, the auditor should 229Chapter 9 - Substantive Test of Receivables and Sales investigate any difference as there may be unrecorded interest receipt or notes that was not included in the analysis prepared by the client. Noncurrent Notes Receivable For notes receivable with maturities greater than one year, the auditor should perform the following procedures: i. Evaluate whether the interest and contractual principal payments will be collected in accordance with their contractual terms; and 2. If either interest or principal payments will not be collected in accordance with their contractual terms, determine whether an allowance for credit loss (ie., allowance for impairment) has been computed using one of the following methods: a. The present value of expected future cash flows discounted at the receivable’s original effective interest rate; or b. The fair value of the collateral (if the receivable is collateral dependent). Evaluation of Allowance for Doubtful Accounts Primary Audit | As part of risk in conducting a business, some customers Objectives:_| may default from their payment. Since receivables need Naloation! to be valued at amortized cost (e.g, net realizable value), the company needs to make a reliable estimate of bad debts or doubtful accounts in its financial statements. In some circumstances, receivables are proven to be worthless are written off. An important part of obtaining evidence about the proper valuation of accounts receivable is the auditor’s evaluation of the adequacy of the allowance for uncollectible accounts. Since this account is a management estimate, it is typically audited by one or a combination of the following procedures: 1. Evaluating management process of developing the estimate. The auditor's ) evaluation ordinarily includes: a. Obtaining a general understanding of the process used in developing the estimate; b. Considering the reasonableness of the entity's policies regarding additions to the allowance and write-offs of doubtful accounts; c. Discussing with management the key assumptions regarding collectability and evaluating the reasonableness of the assumptions; d. Considering the effectiveness of the controls over the data used in the process; and e, Evaluating the entity's method of calculating the allowance (i.e., of applying its policies). 2. Reviewing subsequent transactions, Since the best evidence of collectability of receivable is payment by the debtors subsequent to the 230PP I chapter 9 - Substantive Test of Receivables and Sales reporting date, the auditor may review subsequent collection and ascertain the appropriateness of the provisions for bad debts recorded. | 3, Developing auditor's independent estimate. Based on the knowledge gained by the auditor regarding the credit and collection process and management process in developing the estimate, the auditor may come up with its independent estimate and compare it with the management estimate. Any significant difference should be investigated and resolved with the management (eg,, credit manager). Write-offs ‘The main concern of auditor is whether write-offs are properly authorized. Ifthere is inadequate internal control on making write-off, an employee may write-off a receivable even though it is not proven to be worthless and will misappropriate subsequent collection. Ordinarily, the auditor would perform the following procedures: 1. Evaluate the accounts that have been written off and examine aging schedule for potential additional write-offs; 2. Determine whether significant amounts written off during the year have been approved by a responsible official independent of the cash receipts, sales and receivables functions; and 3. Mail confirmation requests to customers that have been written off (there should not be a response). Note: In auditing impairment loss of debt securities (i.e, credit loss), the accounting and disclosure requirements of PFRS 9 should be considered specially for public interest entities. Accounts Receivable and Sales Cutoff. Primary Audit | As discussed in the previous chapter, one way to show Objectives:_| more favorable financial position and performance ene (termed as window dressing) is to inflate sales and cash by Rights holding open the sales journal and cash journal beyond Completeness the reporting date. Cutoff To detect such misstatements due to inaccurate cutoff of | sales records (whether accidental or intentional), the auditor should | perform analytical procedures to identify peaks in sales volume in the last few days or weeks of the year and test cutoff by inspecting sales register, +H billings, shipping documents and other supporting documents before and i after the year end date. | The auditor should ordinarily perform the following cutoff procedures: 1. Obtain cutoff information such as numbers on last shipping documents, invoices, credit memos and cash receipts, for a period on or before the cutoff date and check whether this was recorded in the proper accounting period; 231Chapter 9 - Substantive Test of Receivables and Sales 2. ae the summaries of activity for the month before and after year end; 3, Inspect a sample of transactions from the activity listing before ang after cutoff date and related supporting documentation to ensure that the transactions were recorded in the proper period; and 4, Compare the receivables cutoff with cutoffs in related areas, eg, sales and cash. Kindly refer to Exhibit 1 at the end of this chapter for sample Accounts Receivable (Sales) Cut-off. Test of Details for Completeness of Sales Primary Audit | To test the completeness of the recorded sales during the Objectives:_| audit period, the auditor shall determine an appropriate [Completeness _| reciprocal population. A reciprocal population is a population of items that are expected to be recorded in the population of audit interest (ie, sales). The determination of the appropriate reciprocal population is dependent on the proper understanding of the revenue business process of the audit client. As an example, the shipping lag which contains the shipping information of the client of its goods may serve as an appropriate reciprocal population. Audit procedures to perform this test may include the following: 1, Obtain from the client the appropriate reciprocal population (eg, shipping log) and related sales records (e.g, sales transaction details). 2. Select shipment transactions from the reciprocal population for testing and obtain audit evidences such as proof of delivery or bill of lading (BOL). 3, Trace and agree the quantity from the reciprocal population to the quantity in the related sales records. 4, Evaluate and conclude whether the shipments selected are appropriately recorded as sales transactions for period under audit. Receivables Denominated in Foreign Currencies PrimaryAudit] Portion of the receivables of an entity may be _iuiestives:_| denominated in foreign currency as a result of sales, loan [Valuation _] or other transaction in that foreign currency. As required by PAS 21 The Effects of Changes in Foreign Exchange Rates, these receivables (i.e, monetary asset) should be translated using the closing rate at the reporting date. The auditor ordinarily obtains the closing rate and re- performs the translation of the foreign currency denominated receivable. ‘The auditor should also ensure that any foreign currency transaction gain or loss should be reported as part of profit or loss. 232\ a chapter 9 ~ Substantive Test of Receivables and Sales ate Any Transactions with or Related Party Receivables Transactions between the corporation and its directors, | officers, employees, stockholders, and other affiliated i] parties require particular attention from the auditors presentation | because these related party transactions are not result of and Disclosure _} 2 +17s-Jength bargaining by parties of opposing interest. If related party receivables are material, the auditor should prepare or obtain analysis of advances to directors, officers, employees, stockholders, and ater affiliated parties and perform the following steps: "1, Recalculate the total balance and determine that it agrees with the ” balance in the general ledger or the detailed trial balance; Review the list for potential problem accounts or large amounts; Identify the purpose for advances and their potential collectability. Determine if such advances should be reflected as dividends or salary; Hi If the balances are significant, consider confirmation of several selected individual balances with the employees or affiliated parties and reconcile replies; 6. Determine that such advances have been properly approved by individuals appropriate under the by-laws of the company. 7. Determine the nature of any accounts receivable from such parties i that were written off during the audit period but subsequently reinstated to the general ledger; and 8. Determine the adequacy of disclosure in the notes of the transaction, q balance of receivable and any amount written-off. | Valuation yeep Credit Balances and Unusual Items | Primary Audit | Accounts receivable is an asset; therefore, the normal balance is on the debit side. However, it may have a credit balance due to overpayment by customers, or in some cases, it can be caused by errors or irregularities. The auditor should obtain and review the listings of credit transactions together | ‘with receivable balances with large or unusual items, and test the 1 completeness of the listing, The auditor should investigate why major credit \ balances have arisen and should consider their impact on year-end | receivables. The auditor should consider that credit balance of receivables | should be presented under the liabilities section and not presented as a | deduction to those receivables with a debit balance. This is ordinarily j included as part of reclassification entries in the auditor's working paper. and Disclosure Ascertain Whether Any Receivables Have Been Pledged or Assigned | Primary Audit] The main objective of audit procedures to verify the Objectives: | presentation and disclosure assertion is whether sales Presentation and receivables appropriately presented and has and Disclosure_] appropriate note disclosures. For financial statement 233Chapter 9 - Substantive Test of Receivables and Sales presentation, the auditor should ensure that trade receivable and curren, non-trade receivable is presented under one line item “trade and other receivables” as provided by PAS 01 Presentation of Financial Statements, Receivables that were pledged or assigned should be properly disclosed in the notes to inform the reader of financial statements that there js contingent liability attached with the receivable. Ordinarily, the following are the procedures performed by the auditor: 1, Evaluate the statement of financial position and statement of comprehensive income for proper classification; 2. Read footnotes regarding disclosures about factoring, assigning pledging, special sale transaction and related party transactions; and 3. Obtain and evaluate the management representation letter concerning the revenue/receipt cycle during the completion phase. Evidence of receivables pledged may also be disclosed through confirmation (banks and other financial institutions) requests, which specifically call fora description of the collateral securing bank loan. ical Procedures To evaluate the reasonableness of amounts reported in the financial statement, the auditor should perform analytical procedures. Typical analytical procedures for sales include the following: 1. Compare sales for the last month of the fiscal year to sales for the rest of the year and the first month after year end; and 2. Compare monthly sales returns and credit memos for the last few months of the fiscal year to the first few months following year end. For accounts receivable, apply analytical procedures by determining the following and comparing to percentages in previous period: 1, Trade receivables divided by current assets; 2, Trade receivables divided by total assets; 3. Receivable turnover (net sales divided by average trade receivables); and 4. Average collection period or days sales outstanding (trade receivables divided by receivable turnover). Perform Anal. Primary Audit Objectives: ‘Completeness Existence Valuation Presentation and disclosure For any significant differences or fluctuations noted, investigate the nature and cause of the differences and consider whether additional procedures are needed to test sales cutoff. It may be clarified that the foregoing is only an illustrative list of analytical review procedures which an auditor may employ in carrying out an audit of receivables and sales. The exact nature of analytical review procedures to be 234yy 7 Chapter 9 - Substantive Test of Receivables and Sales applied in a specific situation is a matter of professional judgment of the | auditor. ‘Audit documentation When performing analytical procedures, the auditor should document 1. The expectation and the factors considered in its development (unless readily determinable from the work performed); | 2. The results of the comparison between the expectation and recorded amounts; and 3, Any additional procedures performed in response to significant unexpected differences and the results of those procedures. Other Audit Considerations 1 Sales Returns and Allowances, When auditing receivables and sales, the auditor should also check the related accounts such as sales return and allowances. For returns and allowances, the following are the main concern of the auditor: 1. Were returns properly authorized? 2. Were goods returned? Ensuring that recorded sales adjustments actually occurred is important because a diversion of cash from an account receivable collection could be covered up by a fictitious sales return or allowance. Audit procedures to check whether returns were properly authorized and if goods are actually returned include examining receiving reports, credit memos and entries in the accounting records. | Imputed Interest ‘The auditor should review accounts and notes receivable to determine if any interest should be imputed for significant balances that are due in excess of one year from the reporting date. Also, proper statement of | financial position classification of such receivables must be considered. Employee Travel Advances \ The auditor should obtain or prepare a schedule of the detailed balances \ included in employee travel advances and perform the following steps: 1. Recalculate the schedule to determine the clerical accuracy and determine that the total balance agrees with the general ledger; 2. Compare individual information with the source records on a test basis. Document the items tested; 3. Confirm account balances with individual employees if the total amount is significant (this is very rarely the case) and reconcile replies, Retain copies of all confirmations in the working papers; and 4, Determine whether there is a proper cutoff of expense advances with the last payroll for year end. 235Chapter 9 - Substantive Test of Receivables and Sales Summary of audit procedures classified per assertion Applicable to Receivables Assertion Category Existence v S Primary audit Procedures Confirmation of receivables to co review of subsequent cash receipes "nee Inspect notes on hand and confirr, on hand those Performing receivable and sales cyt, Perform analytical procedures Completeness. NINN NS Reconciliation of subsidiary eq general ledger BR Analysis of notes receivable ang interest Telatg Performing receivable and sales cutogy Perform analytical procedures Valuation and Allocation NS NAS < Confirmation of receivables to custome Analysis of notes receivable ang interest lateg Evaluating the adequacy of allowaneg uncollectible accounts. for Testing valuation of receivables denom; in foreign currencies Examining sales returns and allowances Ascertaining authorization of write-off Perform analytical procedures atey Rights and Obligations ISSN < Confirmation of receivables to customers g review of subsequent cash receipts. Inspect notes on hand and confirm those nop on hand Performing receivable and sales cutoff. Presentation and Disclosure SNOSIN < Analysis of notes receivable and related interest Investigate receivables from related parties, Investigate any credit balances and unusual items Ascertain the existence of pledged receivables, Applicable to Sales and Other Income Statement Related Item Assertion Category. Primary audit procedures Occurrence SN Confirmation of receivables to customers Analysis of notes receivable and related interest Performing receivable and sales cutoff Test of details of recorded sales 236EE" 7 ' | Test of Receivables and Sales _ | ¥ Examining sales returns and allowances | Y¥_Ascertaining authorization of write-off | ¥ Analysis of notes receivable and related| | interest | ¥ Performing receivable and sales cutoff i v Test of details for completeness of sales | v_Perform analytical procedures er | Y Confirmation of receivables to customers | ‘Accuracy v Analysis of notes receivable and related interest ¥_ Test of details of recorded sales | ¥_ Test of details of recorded sales ¥_ Performing receivable and sales cutoff 1] pit 1; Accounts Receivable (Sales) Cut-off Expibit ‘Accounts Receivable (Sales) Cut-off Classification ‘ent: Ray Sibabol Reference: AR.01 Period endy December 31, 2021 | Sale Invoice DateinAR | Delivery | recordedin | Customer Number Ledger Date the proper period? | ‘Transactions recorded before December 31 \ faring ‘ABS14344__| 12/29/2021 _[ 12/28/2021 Yes | Bising ‘ABS14345 | 12/29/2021 | 12/28/2021 Yes Crising ‘ABS14346__| 12/30/2021 _| 12/29/2021 Yes | Dante ‘ABS14347__| 12/30/2021 _| 01/05/2022 No Emong ‘ABS14348 | 12/30/2021 _| 12/29/2021 Yes Fabian ‘Bs14349___| 12/30/2021 | 12/29/2021 Yes ‘Transactions recorded after December 31 | Gorio ‘ABS14351__| 01/03/2022 _| 01/03/2022 Yes \ Huaning ‘ABS14352__| 01/05/2022_| 01/04/2022 Yes Isang ‘ABS14353__| 01/06/2022 _| 12/29/2022 No. Jolina ‘ABs14354__| 01/05/2022 | 01/04/2022 No } Kiko ‘ABS14355 | 01/06/2022 _| 01/05/2022 Yes | Lannie ‘ABS14356 | 01/04/2022 | 01/03/2022 Yes \) Traced to bill of lading/delivery receipt and sales invoice. | 237Chapter 9 - Substantive Test of Receivables and Sales | e Form of Receivable Confirmation SAD asi Form fest Conan 5, Dear Sir(s): 2023 Please confirm directly to our auditors Asuncion, Escala, Ngina & Co, P.O, Box 14344, 2600 Baguio City the correctness of the balance of your account payable to us as shown ; bel enclosed statement at December 31, 2021 for their use in conneer i . Mection yu, the examination of our accounts, Ifthe amount is correct, please sign this letter , Mth i provided below. If not correct, please list on the remarks portion fy) dete the Shae difference. tals oft Areturn envelope is enclosed for your reply. No postage stamps are required PLEASE NOTE THE DATE as of which we request confirmation, Tra with us or payments to us between that date and the date you receive this letae tit ' to be considered. arene Thank you for your cooperation. Please fax an advance copy of your Very truly yours, reply at 143-14344, Attention of Mr. Darrell Escala, Partner- RFE in-Charge. Raymund Joe Controller RFE Company ‘THIS IS NOT A REQUEST FOR PAYMENT, BUT MERELY FOR CONFIRMATION OF YOUR ACCOUNT. ‘THE FOLLOWING BALANCE DUE FROM US IS CORRECT: Due to: RFE Company _ As of: December 31, 2021 Amount: P1,430,440.17 Remarks: None i i Signature: Francine Ray Position: 7, Posounls Pa tment 238 !chapter 9 ~ Substantive Test of Receivables and Sales CHAPTER : REVIEW QUESTIONS - THEORETICAL 1 5. ‘An auditor most likely would limit substantive audit tests of sales transactions when control risk is assessed as low for the existence or occurrence assertion concerning sales transactions and the auditor has already gathered evidence supporting: a. Shipping and receiving activities. b. Opening and closing inventory balances. c. Cutoffs of sales and purchases. d. Cash receipts and accounts receivable. Which of the following areas would ordinarily be expected to require the most time when performing an audit of a continuing client? a. Accounts receivable. b. Common stock. c. Retained earnings. d. Revenues. Which of the following is a procedure to verify the existence of receivables and/or occurrence of sales? a. Vouching receivables to shipping documents. b. Vouching recorded sales transactions to customer orders and shipping documents. c. Tracing the shipping documents to recorded sales transaction and receivable. 4. Confirmation of receivables to customers. Of the two forms of confirmation request, which is considered more reliable source of evidence? a. Positive confirmation b. Negative confirmation c. Bothare equally reliable d, None of the two is considered more reliable Which of the following scenario would positive confirmation be appropriate? a. The assessed level of inherent and control risk for receivable and sales isvery low. Very few or no exceptions expected. c. The auditor has a reason to believe that recipients of negative confirmation requests will disregard such confirmation requests. 4. The receivable comprises a large number of small, homogenous, account balances. JChapter 9 - Substantive Test of Receivables and Sales Which of the following is the best argument against the use of negative accounts receivable confirmations? a. The cost per response is excessively high. b. There is no way of knowing if the intended recipients received them, Recipients are likely to feel that in reality the confirmation is a subtle request for payment. The inference drawn from drawn from receiving no reply may not be 6. c d. correct. Which of the following would be least likely to diminish the validity of evidence obtained through confirmation of accounts receivable? ‘The confirmations are sent on the client's letterhead. a ‘The confirmations are mailed to customers by the internal auditors. b. ¢. The client's mailroom personnel closely monitor and inspect confirmations during mailing, d. The return address on the envelope used to send the confirmation request is that of the client. What is the primary assertion being addressed by confirmation of receivables? a. Completeness b. Gross valuation c. Existence d. Accuracy To test the existence assertion for recorded receivables, an auditor would select a sample from the. a. Sales orders file. b. Customer purchase orders. Accounts receivable subsidiary ledger. d._ Shipping documents (bills of lading) file. During the process of confirming receivables as of December 31, 2021, a positive confirmation was returned indicating the “balance owed as of December 31 was paid on January 9, 2022.” The auditor would most likely Determine whether there were any changes in the account between January 1 and January 9, 2022. b. Determine whether a customary trade discount was taken by the 10. a, customer. c. Reconfirm the zero balance as of January 10, 2022. d. Verify that the amount was received. 240gr Chapter 9 - Substantive Test of Receivables and Sales 1. 2 8, 14. 18. An auditor confirms a representative number of open accounts receivable as of December 31, and investigates respondents’ exceptions and comments. By this procedure the auditor would be most likely to learn of which of the following? a, One of the cashiers has been covering a personal embezzlement by lapping. b. One of the sales clerks has not been preparing charge slips for credit sales to family and friends. c. One of the computer control clerks has been removing all sales invoices applicable to his account from the data file. d. The credit manager has misappropriated remittances from customers whose accounts have been written off. Which of the following is least likely to be typically considered to be an alternate procedure for handling nonreplies to positive accounts receivable confirmations? a, Examine bills of lading. b. Physically examine items sold. c. Examine correspondence. d. Examine subsequent cash receipts. Which of the following types of misstatements is least likely a concern of the auditor when verifying the occurrence of sales? a. Recorded sale with no shipment b. Sale recorded more than once c. Shipments in transit to customer at year end 4. Shipments made to nonexistent customers Which of the following is the best audit procedure to detect recorded sale with no shipment? a. Trace from sales journal entry to shipping document. b. Check cancellation of shipping documentation. c. Review segregation of duties and ensure the person recording sales should not authorize shipments. d. Trace from shipping documents to recorded sales transaction, Tracing recorded sales transactions in the sales journal to the shipping documents (bills of lading) provides evidence about the: a. Completeness of recording of sales transactions. b. Occurrence of sales transactions. c. Billing of all sales transactions. d. Presentation of payables. If the objective of a test of details is to detect overstatements of sales, the auditor should trace transactions from the a. Cash receipts journal to the sales journal. b. Sales journal to the cash receipts journal. c. Source documents to the accounting records. d. Accounting records to the source documents. 241 SSEChapter 9 - Substantive Test of Receivables and Sales 17. Which of the following procedures is least likely to help auditors to assese the adequacy of management's accounting estimate of the allowance fe doubtful accounts? a. Investigate confirmation exceptions for indication of amounts ix dispute, b. Review accounts which have been written off as uncollectible prior ts year-end. Investigate credit ratings for large accounts receivable. d. Discuss with the credit manager the current status of doubtiy accounts. 18. Which of the following is considered the best audit procedure to obtaix evidence regarding the collectability of a receivable? a. Analysis of the allowance for doubtful accounts. b._ Sending confirmation request to customers. Reviewing subsequent payment of customers subsequent to the reporting date. 4. Cross-footing the aging schedule of receivables. 48, Cutoff tests designed to detect credit sales made before the end of the year that have been recorded in the subsequent year provide assurance about management's assertion of a. Presentation. b. Completeness. Rights. d. Existence. 2. Your client left the cash receipts journal open after 12/31/2021 for an extra day and included January 1, 2022 cash receipts in the 12/31/2021 totals. All of those cash receipts were due to cash sales. Assuming the client uses2 periodic inventory system with a 12/31/2021 count of the physical inventory, which of the following is most likely to be true relating to the year 2021 financial statements? a, Sales are understated. b, Accounts receivable are understated. ¢. Inventory is overstated. d, Net income is overstated. 21. What type of error is the CPA most likely to discover when he/she examines all shipping reports dated in January of 2022, shipped FOB shipping point, which were recorded in December of 2021 as credit sales? a. Accounts receivable are overstated at December 31, 2021. b. Accounts receivable are understated at December 31, 2021. c. Operating expenses are overstated for the 12 months ended December 31,2021. 4. Sales returns and allowance are overstated at December 31, 2021. 242Chapter 9 - Substantive Test of Receivables and Sales 2 2. a 25. A client might overstate December 31 accounts receivable balances by dating and recording January transactions in December. Such entries recorded in which journal are most likely to achieve this end? a. Cash receipts. b. Payroll. c. Purchases. d._ Sales. To obtain the best evidence regarding the completeness of recorded accounts receivable, the auditors: a. Trace a sample of the bills of lading to sales invoices. b. Confirm a sample of accounts payable. c. Review the aging of accounts receivable. d._ Trace a sample of recorded sales to shipping documents. An auditor's analytical procedures have revealed that the accounts receivable of a client have doubled since the end of the prior year. However, the allowance for doubtful accounts, as a percentage of accounts receivable remained about the same. Which of the following client explanations most likely would satisfy the auditor? a. Credit standards were liberalized in the current year. b. Twice as many accounts receivable were written off in the prior year as compared to this year. c. A greater percentage of accounts were currently listed in the "more than 90 days overdue" category than in the prior year. d. The client opened a second retail outlet in the current year and its credit sales approximately equaled the older, established outlet. Which of the following generally provides the least evidence regarding the valuation of accounts receivable? a. Reviewing an aging of accounts receivable. b. Examination of cash receipts subsequent to the balance sheet date. c. Confirming current (0-30 day) year-end accounts receivable. d. Reviewing credit files for selected account. 243