Completing the Tests in the

Sales and Collection Cycle:

Accounts Receivable

Chapter 15

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 Learning Objective 1

Describe the methodology

for designing tests of details
of balances using the
audit risk model.

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 Accounts Receivable Balance-
Related Audit Objectives

Realizable
Detail tie-in Accuracy value

Rights and
Existence Classification obligations

Presentation
Completeness Cutoff and disclosure

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 3
 Methodology for Designing Tests of
Balances – Accounts Receivable
Identify client business risks
affecting accounts receivable.

Set tolerable misstatement

and assess inherent risk
for accounts receivable.

Assess control risk for sales

and collection cycle.
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 4
 Methodology for Designing Tests of
Balances – Accounts Receivable
Design and perform tests of
controls and substantive tests
of transactions for sales and
collection cycle.

Design and perform analytical

procedures for accounts
receivable balance.
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 5
 Methodology for Designing Tests of
Balances – Accounts Receivable

Design tests of details of Audit procedures

accounts receivable balance Sample size
to satisfy balance-related Items to select
audit objectives. Timing

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 6
 Relationship Between Sales
and Accounts Receivable
Accounts Receivable

and disclosure
Completeness

Classification

Presentation
Balance-Related

Detail tie-in

Realizable
Audit Objectives

Existence

Accuracy
Translation-Related

Rights
Cutoff

value
Audit Objectives
Sales
Existence ×
Completeness ×
Accuracy ×
Classification ×
Timing ×
Posting/Summary ×
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 7
 Relationship Between Sales
and Accounts Receivable
Accounts Receivable

and disclosure
Completeness

Classification

Presentation
Balance-Related

Detail tie-in

Realizable
Audit Objectives

Existence

Accuracy
Translation-Related

Rights
Cutoff

value
Audit Objectives
Cash receipts
Existence ×
Completeness ×
Accuracy ×
Classification ×
Timing ×
Posting/Summary ×
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 8
 Learning Objective 2

Design and perform analytical

procedures for accounts in the
sales and collection cycle.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 9
 Analytical Procedures for the
Sales and Collection Cycle

Gross margin percentage with previous years

Sales by month over time
Sales returns and allowances as a percentage
of gross sales with previous years

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 Analytical Procedures for the
Sales and Collection Cycle

Individual customer balances over a stated amount

Bad debt expense as a percentage of gross sales
Days that accounts receivable are outstanding

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 Analytical Procedures for the
Sales and Collection Cycle

Aging category as a percentage of receivables

Allowance for uncollectible accounts
as a percentage of accounts receivable
Charge-off of uncollectible accounts
as a percentage of total accounts receivable

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 Selected Comparative
Information
Percent
2002 Change 2001 Chan
(000) 02-01 (000) 00-01
Sales 144.3 9.4 132.0 6
Gross margin 39.8 9.3 36.4 7.1
Accounts receivable 20.2 7.4 18.8 13.9
Bad debt expense 3.3 (2.9) 3.4 9.7
Total assets 61.4 (7.0) 66.0 8.0
Net earnings 5.7 21.3 4.7 38.2
Number of accounts
receivable 258 16.7 221 5
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 13
 Analytical Procedures
Sales and Collection Cycle
2002 2001 20
Gross margin/net sales 27.8% 27.7% 27
Sales R&A/gross sales .9% .9%
Bad debt expense/net sales 2.3% 2.6% 2.4%
Allowance for uncollectible
accounts/accounts receivable 6.1% 8.2% 8.4%
Number of days receivables
outstanding 51.5 52.3 51
Net accounts receivable/
current assets 37.2% 38.6% 36.0%
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 Design and Perform Tests of Details
of A/R Balance (Phase III)

Planned detection risk for each

objective is an auditor’s decision.

Combining the factors that determine

planned detection risk is complex.

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 Analytical Procedures for
Gross Margin

Gross Margin Percent

2002 2001
Client Industry Client Industry
Hardwood 36.3 32.4 36.4 32.5
Softwood 23.9 22.0 20.3 22.1
Plywood 40.3 50.1 44.2 54.3

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 16
 Learning Objective 3

Design and perform tests of

details of balances for accounts
receivable for each balance-
related audit objective.

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 Designing Tests of
Detail of Balances

Aged trial balance

Recorded accounts receivable exist
Existing accounts receivable are included
Accounts receivable are accurate
Accounts receivable are properly classified

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 18
 Designing Tests of
Detail of Balances

Cutoff for accounts receivable is correct

Accounts receivable is stated at realizable value
The client has rights to accounts receivable
Accounts receivable presentation
and disclosures are proper

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 Learning Objective 4

Obtain and evaluate accounts

receivable confirmations.

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 AICPA Requirements
1. Accounts receivable are immaterial.
2. The auditor considers confirmations
ineffective evidence because response
rates will likely be inadequate or unreliable.
3. The combined level of inherent risk and
control risk is low and other substantive
evidence can be accumulated to provide
sufficient evidence.
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 21
 Type of Confirmation

Positive
Positive confirmation
confirmation

Blank
Blank confirmation
confirmation form
form

Invoice
Invoice confirmation
confirmation

Negative
Negative confirmation
confirmation

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 Timing

The most reliable evidence from

confirmations is obtained when
they are sent as close to the balance
sheet date as possible, as opposed
to confirming the accounts several
months before year-end.

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 Sample Size

Tolerable misstatement
Inherent risk
Control risk
Achieved detection risk from
other substantive tests
Type of confirmation

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 Selection of Items
for Testing

When selecting a sample of accounts receivable

for confirmation, the auditor should be careful
to avoid being influenced by the client.

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 Selection of Items
for Testing

If a client tries to discourage the auditor from

sending confirmation to certain customers,
the auditor should consider the possibility
that the client is attempting to conceal
fictitious or known misstatements of
accounts receivable.

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 Subsequent Cash Receipts

Evidence of the receipt of cash subsequent

to the confirmation date includes examining
remittance advices, entries in the cash receipts
records, or perhaps even subsequent credits in
the accounts receivable master files.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 27
 Duplicate Sales Invoices

These are useful in verifying

the actual issuance of a sales
invoice and the actual date
of the billing.

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 Shipping Documents

These are important in establishing

whether the shipment was actually
made and as a test of cutoff.

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 Correspondence
With the Client

Usually, the auditor does not need to review

correspondence as a part of alternative
procedures, but correspondence can
be used to disclose disputed and
questionable receivables not
uncovered by other means.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 30
 Analysis of Difference

Payment
Payment has
has already
already been
been made
made

Goods
Goods have
have not
not been
been received
received

The
The goods
goods have
have been
been returned
returned

Clerical
Clerical errors
errors and
and disputed
disputed accounts
accounts

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 Drawing Conclusions

Reevaluate internal control.

Evaluate the qualitative nature of misstatements.

Determine whether sufficient evidence was obtained.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 32
 Learning Objective 5

Design audit procedures for the

audit of accounts receivable,
using an evidence planning
worksheet as a guide.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 33
 Source of Each Row in the
Evidence Planning Worksheet
Tolerable Substantive tests
misstatement of transactions
Acceptable results
audit risk
Planned detection
Inherent risk
risk and planned
Control risk audit evidence

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 End of Chapter 15

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 35