ACREV 426 – AUDIT OF RECEIVABLES AP-02

INTERNAL CONTROL OF SALES TRANSACTIONS, ACCOUNTS RECEIVABLE AND

NOTES RECEIVABLE
When internal controls over sales on account are inadequate, the following situations may arise:

1. Merchandise may be shipped to customers whose credit standing has not been approved.
2. Shipments may be made to customers without notice being given to the billing department;
consequently, no sales invoice is prepared.
3. Sales invoices may contain errors in prices and quantities.
4. If sales invoices are not controlled by serial numbers, some may be lost and never recorded as
accounts receivable.

Internal controls are strengthened by the following control measures:

1. The following functions should be segregated from each other: credit and collection; cashier;
accounting and sales.
2. Subsidiary ledgers should be balanced regularly with the controlling accounts.
3. Monthly statements should be sent to all customers so that errors may be reported by the
debtors.
4. Receivables should be confirmed periodically by the internal auditing department.
5. There should be sufficient control over the granting of credit and their collection
6. Accounts should be aged periodically.
7. Bad debt write off should be approved in writing by a responsible independent official.
8. The acceptance, renewal or write off of notes should be authorized by an independent,
responsible official.

AUDIT WORKING PAPERS

1. Lead schedule
2. Aged trial balance of accounts receivable
3. Analysis of notes receivable and related interest
4. Summary of results of confirmation of receivable
5. Analysis of allowance for bad debts

AUDIT PROCEDURES FOR RECEIVABLES

Existence or Occurrence/Rights and Obligations

 Obtain schedule of aged trade accounts receivable and notes receivable schedule and reconcile
to ledgers.
 Confirm receivables with debtors
 Inspect notes on hand.
 Perform analytical procedures to determine reasonability of recorded sales and receivables.

Completeness

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 Test cut-off of sales and sales returns to determine whether receivables are recorded in the
proper accounting period.

Valuation

 Review collectability of receivables and determine the adequacy of allowance for doubtful
accounts
 Recalculate the interest income from notes receivable.

Presentation and Disclosure

 Evaluate financial statement presentation and disclosure of receivables

 Obtain written client representations regarding pledge, discount or assignment or receivables.

MULTIPLE CHOICE- THEORY

1. When the allowance method of recognizing bad debt expense is used, the entry to record the
write-off of a specific uncollectible account would decrease
A. Working capital
B. Net realizable value of accounts receivable
C. Net income
D. Allowance for bad debt
2. On July 1, 2022, a company received a one-year note receivable bearing interest at the market
rate. The face amount of the note receivable and entire amount of the interest are due on June
30, 2023. The interest receivable account would show a balance on
A. July 1, 2022 but not on December 31, 2022
B. July 1, 2022 and December 31, 2022
C. December 31, 2022 but not on July 1, 2023
D. Neither July 1, 2022 nor on December 31, 2022
3. The balance of accounts receivable is reduced in recording all of the following financing
arrangements except
A. Assignment of specific accounts receivable
B. Pledging of accounts receivable
C. Sale of accounts receivable
D. Accounts receivable factoring
4. An auditor’s purpose in reviewing credit ratings of customers with delinquent accounts
receivable most likely is to obtain evidence concerning management’ assertion about
A. Presentation and Disclosure
B. Existence or Occurrence
C. Rights and obligations
D. Valuation or allocation
5. Positive accounts receivable confirmations are appropriate when
A. Confirmations are mailed during an interim period
B. Accounts receivable consists of many small balances.
C. Control risk is low

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D. There is reason to believe that a substantial number of accounts may be in dispute

6. Which of the following might be detected by sales cut-off tests?
A. Kiting
B. Understated inventory
C. Overstated receivables
D. Overstated sales

PROBLEM SOLVING
Problem 1. Account Classification

Classify each of the items listed below as (A) Accounts Receivable, (B) Notes Receivable, (C) Trade
Receivable, (D)Nontrade Receivable, or (‘E) Other-Indicate the nature of item. Since the classifications
are not mutually exclusive, more than one classification may be appropriate. Also indicate whether the
item would normally be reported as a current or noncurrent asset assuming a 6-month operating cycle.

1. Overpayment to supplier for inventory purchases on account

2. Insurance claim on automobile accident
3. Charge sale to regular customer
4. Advances to sales manager
5. Interest due on 5-year note from company president, interest payable annually
6. Acceptance of 3-year note on sale of land held as investment
7. Acceptance of 6-month note for past due account arising from the sale of inventory
8. Claim for a tax refund from last year
9. Prepaid insurance -four months remaining in the policy period
10. Overpayment by customer of an accounts receivable

Problem 2. Accounts Receivable Balance

Chicken Company started operations on January 1, 2022. Following data are available as of June 30,
2022:

Purchase of merchandise P9,000,000

Inventory, June 30, 2022 1,500,000
Goods were sold at 50% above cost; 75% of sales were on account
Estimated bad debts 1% of credit sales
Collections from charge customers 6,300,000
Allowance for doubtful accounts, June 30, after write-off of 78,075
uncollectible accounts

The outstanding accounts receivable on June 30, 2022 is

A. P2,200,000 B. P2,137,500 C. P2,131,200 D. not given

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Problem 3. Test for Proper Sales Cut-off

You are engaged to perform an audit of the accounts of the Butterfly Corporation for the year ended
December 31, 2022, and have observed the taking of the physical inventory of the company on
December 30, 2022. Only merchandise shipped by Butterfly to customers up to and including December
30, 2022 have been eliminated from inventory.

The inventory as determined by physical inventory count has been recorded on the books by the
company’s controller. No perpetual inventory records are maintained. All sales are made on an FOB
Shipping point basis. You are to assume that all purchase invoices have been correctly recorded.

The following lists of sales invoices are entered in the sales books for the months of December 2022 and
January 2023, respectively.

Sales Inv. Sales Inv. Date Cost of Mdse. Date Shipped

Amount Sold
December 2022
(a) P30,000 Dec. 21 P20,000 Dec 31
(b) 20,000 Dec. 31 8,000 Nov. 3
(‘c) 10,000 Dec. 29 6,000 Dec. 30
(d) 40,000 Dec. 31 24,000 Jan. 3
(‘f) 100,000 Dec. 30 56,000 Dec. 29 ( shipped to
consignee)
January 2023
(f) 60,000 Dec 31 40,000 Dec. 30
(g) 40,000 Jan. 2 23,000 Jan. 2
(h) 80,000 Jan. 3 55,000 Dec. 31

Requirement: Prepare the necessary adjusting journal entries at December 31, 2022.

Problem 4. Receivable Financing

During the second year of operations, Rabbit Company found itself in financial difficulties. The entity
decided to use the accounts receivable as a means of obtaining cash to continue operation.

On July 1, 2022, the entity sold P1,500,000 of accounts receivable for cash proceeds of P1,400,000. No
allowance for doubtful accounts was associated with these accounts.

On December 15, 2022, the entity assigned the remainder of its accounts receivable, P5,000,000 as of
that date, as collateral on a P2,500,000, 12% annual interest rate loan from Finance Company. The entity
received P2,500,000 less a 2% finance charge.

None of the assigned accounts have been collected by the end of the year. It is estimated that 10% of
accounts receivable would be uncollectible.

The entity revealed the following data on December 31, 2022.

Accounts Receivable, excluding factored and assigned 1,000,000

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accounts
Accounts receivable -assigned 5,000,000
Accounts receivable – factored 1,500,000
Allowance for doubtful accounts before adjustment 100,000

1. What total amount was received from the financing of accounts receivable?
A. 3,900,000 B. 3,850,000 C. 3,950,000 D. 4,000,000

2. What amount should be reported as net realizable value of accounts receivable on December
31, 2022?
A. 4,500,000 B. 5,400,000 C. 6,000,000 D. 5,000,000

3. What amount should be recognized as doubtful accounts expense for 2022?

A. 600,000 B. 500,000 C. 650,000 D. 0

Problem 5. Notes Receivable

Presented below are unrelated situations. Answer the questions relating to each situation.

A. On January 1, 2022, Cat Corporation sold goods to Rat Company. Rat Company signed a non-
interest-bearing note requiring payment of P600,000 annually for seven years. The first payment
was made on January 1, 2022. The prevailing rate of interest for this type of note at date of
issuance was 10%.
PV of an ordinary annuity of 1 at 10% for 6 periods 4.36
PV of an ordinary annuity of 1 at 10% for 7 periods 4.87

1. What is the amount of Sales Revenue credited on January 1, 2022?

2. What is the carrying amount of note receivable on December 31, 2022?

B. On January 1, 2022, Parrot Company sold equipment with a carrying amount of P4,800,000 in
exchange for a P6,000,000 noninterest-bearing note due January 1, 2025. There was no
established exchange price for the equipment. The prevailing rate of interest for a similar note
was 10% and the present value of 1 at 10% for three periods is 0.75.

1. How much is the Loss on Sale of equipment on January 1, 2022?

2. What is the interest income on December 31, 2023?

C. 120- day note of P100,000 dated October 1, non-interest bearing, and with a market rate of 9%
interest, discounted at the bank on November 30 at 12%. This note was received from the sale
of the equipment.

Determine the proceeds from discounting of notes receivable.