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Completing the Tests in the Sales and Collection Cycle: Accounts Receivable Chapter 16 Learning Objective 1 Describe the methodology for designing tests of details of balances using the audit risk model. Accounts Receivable Balance-Related Audit Objectives Detail tie-in Accuracy

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Completing the tests in the sales and collection cycle accounts receivable l.jpg

Completing the Tests in theSales and Collection Cycle:Accounts Receivable

Chapter 16


Learning objective 1 l.jpg
Learning Objective 1

Describe the methodology

for designing tests of details

of balances using the

audit risk model.


Accounts receivable balance related audit objectives l.jpg
Accounts Receivable Balance-Related Audit Objectives

Detail tie-in

Accuracy

Realizable

value

Existence

Classification

Rights and

obligations

Completeness

Cutoff


Methodology for designing tests of balances accounts receivable l.jpg
Methodology for Designing Tests ofBalances – Accounts Receivable

Identify client business risks

affecting sales and collection

cycle and set audit risk (ch. 8).

Set tolerable misstatement for A/R and assess

inherent risk for sales and collection cycle (ch. 9).

Potential FR – improper rev recognition (ch. 11)

Assess control risk for sales

and collection cycle (ch. 10).


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Methodology for Designing Tests ofBalances – Accounts Receivable

Design and perform tests of

controls and substantive tests

of transactions for sales and

collection cycle (ch.13, 14 and 15).

Design and perform analytical

procedures for sales and collection

cycle balances (e.g., sales, BDE) (ch. 8, 13 and 16).


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Methodology for Designing Tests ofBalances – Accounts Receivable

Design tests of details of

accounts receivable balance

to satisfy balance-related

audit objectives.

Audit procedures/staffing

Sample size/budget

Items to select

Timing


Relationship between sales and accounts receivable dr a r inc cr sales inc l.jpg
Relationship Between Sales and Accounts Receivable: dr. A/R (inc), cr. Sales (inc)

Accounts Receivable

Balance-Related

Audit Objectives →

Detail tie-in

Existence

Accuracy

Cutoff

Completeness

Classification

Realizable

value

Rights

Transaction-Related

Audit Objectives

Sales ↓

Occurrence

×

Completeness

×

Accuracy

×

Classification

×

Timing

×

Posting/Summary

×


Relationship between collections and accounts receivable dr cash inc cr a r dec l.jpg
Relationship Between Collections and Accounts Receivable: dr. cash (inc), cr. A/R (dec)

Accounts Receivable

Balance-Related

Audit Objectives

Detail tie-in

Existence

Accuracy

Cutoff

Completeness

Classification

Realizable

value

Rights

Transaction-Related

Audit Objectives

Cash receipts

Occurrence

×

Completeness

×

Accuracy

×

Classification

×

Timing

×

Posting/Summary

×


Say what l.jpg
Say what??? dr. cash (inc), cr. A/R (dec)

  • Recording a cash receipt that did not occur (cash – occurrence violation) violates completeness objective for A/R – there is an open A/R not in the accounting records (A/R reduced with false j/e). Cash is overstated and AR is understated

  • Failure to record a cash receipt (cash – completeness violation) means violation of existence for A/R – A/R should be reduced – does not exist. Cash is understated and AR is overstated


Learning objective 2 l.jpg
Learning Objective 2 dr. cash (inc), cr. A/R (dec)

Design and perform analytical

procedures for accounts in the

sales and collection cycle.


Analytical procedures for the sales and collection cycle l.jpg
Analytical Procedures for the Sales and Collection Cycle dr. cash (inc), cr. A/R (dec)

Compare

Gross margin percentage with previous years

Sales by month over time

Sales returns and allowances as a percentage

of gross sales with previous years

Sales growth vs. related NFM growth

by product line


Analytical procedures for the sales and collection cycle12 l.jpg
Analytical Procedures for the Sales and Collection Cycle dr. cash (inc), cr. A/R (dec)

Compare

Individual customer A/R balances over a stated amount

Bad debt expense as a percentage of gross sales

Days that accounts receivable are outstanding

with previous years


Analytical procedures for the sales and collection cycle13 l.jpg
Analytical Procedures for the Sales and Collection Cycle dr. cash (inc), cr. A/R (dec)

Compare

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

with previous years


Selected comparative information l.jpg
Selected Comparative Information dr. cash (inc), cr. A/R (dec)

Percent Percent

2008 Change 2007 Change 2006

(000) 08-07 (000) 07-06 (000)

Sales 144.39.4 132.0 6.5 124.0

Gross margin 39.8 9.3 36.4 7.1 34.0

Accounts receivable 20.2 7.4 18.8 13.9 16.5

Bad debt expense 3.3 (2.9) 3.4 9.7 3.1

Total assets 61.4(7.0) 66.0 8.0 61.1

Net earnings 5.7 21.3 4.7 38.2 3.4

Number of accounts

receivable 258 16.7 221 5.7 209


Analytical procedures sales and collection cycle l.jpg
Analytical Procedures dr. cash (inc), cr. A/R (dec)Sales and Collection Cycle

200820072006

Gross margin/net sales 27.8% 27.7% 27.5%

Sales R&A/gross sales .9% .9% .8%

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 51.2

Net accounts receivable/

current assets 37.2% 38.6% 36.0%


Analytical procedures for gross margin sales cgs sales l.jpg
Analytical Procedures for Gross Margin: Sales – CGS / Sales

Gross Margin Percent

20082007

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


Learning objective 3 l.jpg
Learning Objective 3 Sales

Design and perform tests of

details of balances for accounts

receivable for each balance-

related audit objective.


Design and perform tests of details of a r balance phase iii l.jpg
Design and Perform Tests of Details Salesof A/R Balance (Phase III)

Planned detection risk for each

objective is an auditor’s decision.

Combining the factors that determine

planned detection risk and reacting to DR is complex.

Research – better at assessment than response


Designing tests of detail of balances l.jpg
Designing Tests of SalesDetail of Balances

Aged A/R master file / subsidiary ledger

(realizable value): BDE and Allowance

Recorded accounts receivable exist (confirm)

Existing accounts receivable are included

(completeness) – Less of a concern – covered w/

Sales (cash) ToT of completeness (existence).

Accounts receivable are accurate (confirm and ToT)

Accounts receivable are properly classified – reclassify

notes receivable, credits, plus ToT


Designing tests of detail of balances20 l.jpg
Designing Tests of SalesDetail of Balances

Cutoff for accounts receivable is correct – ToT (timing)

The client has rights to accounts receivable:

factoring? discussions, BOD minutes

Extra: Accounts receivable and Sales presentation and

disclosures are proper – SOX: exec loans, more than

5%, Rev Recognition policy


Learning objective 4 l.jpg
Learning Objective 4 Sales

Obtain and evaluate accounts

receivable confirmations.


Aicpa requirements when confirmation not required l.jpg
AICPA Requirements: When confirmation NOT required Sales

1. Accounts receivable are immaterial. OR

2. The auditor considers confirmations

ineffective evidence because response

rates will likely be inadequate or unreliable. OR

3. The combined level of inherent risk and

control risk is low (DR high) and other

substantive evidence can be accumulated to

provide sufficient evidence (ToT and AP).

MUST DOCUMENT – story time, did not / could not

document #2 above. #1 and #3 not an option.


Type of confirmation l.jpg
Type of Confirmation Sales

Positive confirmation: non responses

must be followed up.

Negative confirmation:

all: (1) many small balances (coverage) (B2C) AND

(2) IR and CR are low AND (3) high response rate to

positive confirms in PY


Timing l.jpg
Timing Sales

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.

Consider earnings release dates in

light of risks – can you get it done??

SEC / LAFs : 90 → 60 days


Sample size firm specific l.jpg
Sample Size (firm specific) Sales

AUDIT SOFTWARE COMBINES ALL THIS

Tolerable misstatement - indirect

Inherent risk - direct

Control risk - direct

Assurance re: objectives from

other substantive tests (ToT, AP) - indirect

Type of confirmation – more with negative

Dollar A/R balance – Not “large” so typically

part of process - direct


Selection of items for testing l.jpg
Selection of Items Salesfor Testing

When selectinga sample of accounts receivable

for confirmation, the auditor should be careful

to avoid being influenced by the client.


Selection of items for testing27 l.jpg
Selection of Items Salesfor 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.

Scope limitation???? Disclaimer of opinion???

Parmalat and cash confirms, Satyam


Subsequent cash receipts l.jpg
Subsequent Cash Receipts Sales

Follow up: 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.

Monday Morning QB: Evaluate 12/31 balance with

Post 12/31 info


Duplicate sales invoices l.jpg
Duplicate Sales Invoices Sales

These are useful in verifying

the actual issuance of a sales

invoice and the actual date

of the billing: Cutoff


Shipping documents l.jpg
Shipping Documents Sales

These are important in establishing

whether the shipment was actually

made (existence and completeness) and

as a test of cutoff.



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