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Chapter 16
Accounts Receivable
Concept Checks
P. 537
1. Auditors perform substantive analytical procedures for the entire sales
and collection cycle, including accounts receivable. This is necessary
procedures relate to the comparison of current year sales, gross margins,
and sales returns and allowances to prior year amounts and at
accounts that also may affect accounts receivable.
Other substantive analytical procedures in the sales and collection
cycle relate to the comparison of customer accounts receivable balances
expense as a percentage of sales, the number of days in accounts
receivable, or aging categories as a percentage of accounts receivable
with those of prior years.
2. The most important objectives satisfied by confirmations are existence,
P. 546
1. There are two common types of confirmations used for confirming accounts
receivable: “positive” confirmations and “negative” confirmations. A
requests a response only if the recipient disagrees with the amount of the
stated account balance. A positive confirmation is more reliable evidence
because
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Concept Check, P. 546 (continued)
the confirmation request.
Offsetting the reliability disadvantage, negative confirmations are
less expensive to send than positive confirmations, and thus more of
circumstances are present:
1. The auditor has assessed the risk of material misstatement as low
and has obtained sufficient appropriate evidence regarding
the design and operating effectiveness of controls relevant to the
assertion being tested by the confirmation procedure.
2. The population of items subject to negative confirmation
account balances, transactions, or other items.
3. The auditor expects a low exception rate.
public. In these cases, far more assurance is obtained from tests of controls
and substantive tests of transactions than from confirmations.
Even with these efforts, some customers do not return the confirmations, so
it is necessary to follow up with alternative procedures. The objective of
accuracy of amounts making up the ending balance in accounts receivable:
1. Subsequent cash receipts Evidence of the receipt of cash
subsequent to the confirmation date includes examining remittance
advice,
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Concept Check, P. 546 (continued)
that a customer would not make a payment unless it was a valid
receivable. On the other hand, the fact of payment does not
for disputes or disagreements over individual outstanding
invoices.
4. Correspondence with the client Usually it is unnecessary to
review correspondence as a part of alternative procedures, but it
can be used to disclose disputed and questionable receivables not
uncovered by other means.
The extent and nature of the alternative procedures depends primarily
upon the materiality of the unconfirmed accounts, the nature and extent of
the misstatements discovered in the confirmed responses, the subsequent
Review Questions
16–1 Tests of details of balances are designed to determine the
reasonableness of the balances in sales, accounts receivable, and other
Tests of controls and substantive tests of transactions for the sales and
of credit.
The results of the tests of controls and substantive tests of transactions
affect the procedures, sample size, timing, and items selected for the tests
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16–1 (continued)
controls).
16–2 The negative form requests the recipient to respond only if he or she
when:
account balances, transactions, or other items.
3. The auditor expects a low exception rate.
4. The auditor reasonably believes that recipients of negative
appropriate where the internal controls of the sales and collection cycle are
effective is violated by Cynthia Roberts’ approach. Not only is her
approach questionable from the standpoint that nonresponses have not
necessarily proved the existence of the receivable, but her confirmation at an
assumption.
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16–3 The following are analytical procedures for the sales and collection
cycle, and potential misstatements uncovered by each test. Each ratio
should be compared to previous years.
ANALYTICAL PROCEDURE
POTENTIAL MISSTATEMENT
1. Gross margin by product line
Sales cutoff errors or other misstatements
involving sales; purchase cutoff errors or
other misstatements involving inventory or
purchases.
2. Sales returns and allowances
as a percentage of gross
sales by product line or
segment
All returns were not recorded, or shipments to
customers were not in accordance with
specifications and were returned (this could
result in significant operating problems).
3. Trade discounts taken as a
percentage of net sales
Discounts that were taken by customers and
allowed by the company were not recorded.
4. Bad debts as a percentage
of gross sales
Misstatement in determining the allowance for
uncollectible accounts.
5. Days sales in receivables
outstanding
A problem with collections, potentially causing
an understatement of bad debts and
allowance for uncollectible accounts.
6. Aging categories as a
percentage of accounts
receivables
Collection problems and understatement of
allowance for uncollectible accounts.
7. Allowance for uncollectible
accounts as a percentage
of accounts receivable
Misstatement in determining the allowance for
uncollectible accounts.
8. Comparison of the balances
in individual customers’
accounts over a stated
amount with their balances
in the previous year
A problem with collections and therefore a
misstatement of the allowance for
uncollectible accounts, or cutoff errors or
other misstatements in customer accounts.
16–4 In most audits it is more important to carefully test the cutoff for sales
than for cash receipts because sales cutoff misstatements are more likely to
To perform a cutoff test for sales, the auditor should obtain the
number of the last shipping document issued before year–end and examine
The propriety of the cash receipts cutoff is determined through tests of
16–4 (continued)
traced to the subsequent bank statement. Any delays in crediting deposits by
16–5 The following are balance–related audit objectives and related audit
procedures for the audit of accounts receivable.
BALANCE–RELATED
AUDIT OBJECTIVE
AUDIT PROCEDURE
Accounts receivable in the aged
trial balance agree with related
master file amounts; the total is
correctly added and agrees with
the general ledger (detail tie–in).
Trace twenty accounts from the trial
balance to the related accounts in the
master file.
Use audit software to foot the aged trial
balance, and trace the total to the
general ledger.
The accounts receivable in the
aged trial balance exist
(existence).
Confirm accounts receivable using positive
confirmations. Confirm all amounts over
$15,000 and a statistical sample of the
remainder.
Existing accounts receivable are
included in the aged trial balance
(completeness).
Trace ten accounts from the accounts
receivable master file to the aged trial
balance.
Accounts receivable in the trial
balance are accurately recorded
(accuracy).
Confirm accounts receivable using positive
confirmations. Confirm all amounts over
$15,000 and a statistical sample of the
remainder.
Accounts receivable in the aged
trial balance are properly
classified (classification).
Review the receivables listed on the aged
trial balance for notes and related party
receivables.
Transactions in the sales and
collection cycle are recorded in
the proper period (cutoff).
Select the last 10 sales transactions from the
current year’s sales journal and the first 10
from the subsequent year’s and trace each
one to the related shipping documents,
checking for the date of actual shipment and
the correct recording.
Accounts receivable in the trial
balance are owned (rights).
Review the minutes of the board of directors
for any indication of pledged or factored
accounts receivable.
Accounts receivable in the trial
balance are stated at realizable
value (realizable value).
Discuss with the credit manager the
likelihood of collecting older accounts.
Examine subsequent cash receipts and the
credit file on older accounts to evaluate
whether receivables are collectible.
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16–6 Accounting standards require that sales returns and allowances be
matched with related sales if the amounts are material. For most companies,
however, sales returns and allowances are recorded in the accounting period in
which they occur, under the assumption of approximately equal, offsetting
amounts at the beginning and end of each accounting period. This approach is
acceptable as long as the amounts are not material.
When the auditor is confident that the client records all sales returns and
allowances promptly, the cutoff tests are simple and straightforward. The auditor
can examine supporting documentation for a sample of sales returns and
allowances recorded during several weeks subsequent to the closing date to
consider an adjustment.
16–7 A necessary audit procedure is to test the information on the client’s
trial balance for detail tie–in. The footing in the total column and the columns
depicting the aging must be checked and the total on the trial balance
the listing.
The master file records are the tie–in between tests of controls,
substantive tests of transactions, and tests of details of balances. The aged trial
balance is the listing of the master file. Since the auditor uses the aged trial
balance in tests of details, he or she must be sure that information is the same
and it is determined that reliance cannot be place upon the trial balance with
less than 100% testing.
16–8 The purpose of the accuracy tests of gross accounts receivable is to
customers.
The purpose of the test of the realizable value of receivables is to
estimate the amount of the accounts receivable balance that will not be
collected. To estimate this amount, the auditor normally reviews the aging of
the accounts receivable, analyzes subsequent cash payments by customers,
customers.
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16–9 The value of accounts receivable confirmation as evidence can be
visualized more clearly by relating it to tests of controls and substantive tests of
transactions. If the beginning balance in accounts receivable can be assumed
to be correct and careful tests of the controls have been performed, the auditor
should be in an excellent position to evaluate the fairness of the ending balance
in accounts receivable.
Confirmations are typically more effective than tests of controls and
substantive tests of transactions for discovering certain types of misstatements.
These include invalid accounts, disputed amounts, and uncollectible accounts
resulting from the inability to locate the customer. Although confirmations
independent sources.
There are two instances in which confirmations are less likely to
uncover omitted transactions and amounts than tests of controls and
substantive tests of transactions. First, in order to send a confirmation, it is
necessary to have a list of accounts receivable from which to select. Naturally,
Clerical errors in billing customers and recording the amounts in the
accounts can be effectively discovered by confirmation, tests of controls,
or substantive tests of transactions. Confirmations are typically more
effective in uncovering overstatement of accounts receivable than
presentation of sales, sales returns and allowances, and accounts receivable
than can result from either type considered separately. The strengths of tests of
controls and substantive tests of transactions combined with the strengths of
confirmation result in a highly useful combination. The two types of evidence
receivable.
The extent to which the auditor should rely upon the tests of controls
and substantive tests of transactions is dependent upon his or her evaluation
of the effectiveness of internal controls. If the auditor has carefully evaluated
internal control, tested internal controls for effectiveness, and concluded that
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16–9 (continued)
reduce the confirmation of accounts receivable. On the other hand, it would
be inappropriate to bypass confirmation altogether.
used.
16–10 It is common to use a combination of negative and positive confirmations
by sending the positives to accounts with large balances and negatives to those
with small balances. This allows the auditor to focus the confirmation testing
16–11 It is acceptable to confirm accounts receivable prior to the balance
sheet date if the internal controls are adequate and can provide reasonable
assurance that sales, cash receipts, and other credits are properly recorded
between the date of the confirmation and the end of the accounting period.
analytical procedures at year–end.
16–12 The most important factors affecting the sample size in confirmations of
accounts receivable are:
Performance materiality
Control risk
Achieved detection risk from other substantive tests (extent and
results of substantive tests of transactions, substantive analytical
procedures, and other tests of details)
Type of confirmation (negatives normally require a larger
sample size)
master file if the client has adequate controls over the master file. Email 16–1
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16–13 (continued)
domain of the email address.
16–14 An auditor might choose to confirm information such as the right of
return or sales terms when they suspect aggressive revenue recognition
techniques like channel–stuffing or bill–and–hold sales. The auditor may have
for confirmations.
16–15 Confirmation of accounts receivable is normally performed on only a
sample of the total population. The purpose of the confirmation is to obtain
outside verification of the balance of the account and to obtain an indication of
controls over the accounts receivable.
16–16 Three differences that may be observed in the confirmation of accounts
receivable that do not constitute misstatements, and an audit procedure that
would verify each difference are as follows:
to the confirmation date.
3. Merchandise has been returned, but has not been received by the
client at the confirmation date. Receiving documents and the
credit memo should be examined.
an initial assessment of control risk based on the controls which are present in
the accounting cycle as documented in the flowcharts, and would plan the tests