©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Completing the Tests in the Sales and Collection Cycle: Accounts Receivable Chapter 16

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 1 Describe the methodology for designing tests of details of balances using the audit risk model.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Accounts Receivable Balance- Related Audit Objectives Detail tie-in Realizablevalue ClassificationAccuracy Existence Rights Completeness Completeness Cutoff Presentation and disclosure

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Identify client business risks affecting accounts receivable. Methodology for Designing Tests of Details of Balances for A/R Phase I Set tolerable misstatement and assess inherent risk for accounts receivable. Assess control risk for sales and collection cycle.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Methodology for Designing Tests of Details of Balances for A/R Design and perform tests of controls and substantive tests of transactions for the sales and collection cycle. Phase II

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Timing Items to selectSamplesizeAuditprocedures Methodology for Designing Tests of Details of Balances for A/R Design and perform analytical procedures for accounts receivable balance. Phase III Design tests of details of accounts receivable balance to satisfy balance-related audit objectives.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Relationship Between Sales and Accounts Receivable Presentation and disclosure Detail tie-in ExistenceCompletenessAccuracyClassificationCutoffRealizablevalueRights Accounts receivable balance-related audit objectives Translation-related audit objectives Sales Existence Completeness Accuracy Classification Timing Posting/Summary × × × × × ×

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Relationship Between Sales and Accounts Receivable Presentation and disclosure Detail tie-in ExistenceCompletenessAccuracyClassificationCutoffRealizablevalueRights Accounts receivable balance-related audit objectives Translation-related audit objectives Cash receipts Existence Completeness Accuracy Classification Timing Posting/Summary × × × × × ×

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 2 Design and perform analytical procedures for accounts in the sales and collection cycle.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Selected Comparative Information Sales Gross margin Accounts receivable Bad debt expense Total current assets Total assets Net earnings Number of accounts receivable receivable Number of accts. rec. with balances over $100,000 balances over $100,000144,328 39,845 39,845 20,197 20,197 3,323 3,323 51,027 51,027 61,367 61,367 5,681 5, (2.1) (2.1)14.0 (7.0) (7.0) ,421 36,350 36,350 18,827 18,827 3,394 3,394 44,779 44,779 66,021 66,021 4,659 4, ,737 33,961 33,961 16,505 16,505 3,162 3,162 41,989 41,989 61,147 61,147 3,351 3, /31/04($000)Percentchange /31/03($000)Percentchange /31/02($000)

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Analytical Procedures: Sales and Collection Cycle Gross margin/net sales Sales returns and allowances/ gross sales gross sales Bad debt expense/net sales Allowance for uncollectible accounts/accounts receivable accounts/accounts receivable Number of days receivables outstanding outstanding Net accounts receivable/ current assets current assets27.85% 0.90% 0.90% 2.30% 2.30% 6.10% 6.10% %27.70% 0.90% 0.90% 2.60% 2.60% 7.50% 7.50% %27.68% 0.90% 0.90% 2.60% 2.60% 6.40% 6.40% %12/31/0412/31/0312/31/02

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Design and Perform Tests of Details of A/R Balance (Phase III) Planned detection risk for each objective is an auditor decision. Combining the factors that determine planned detection risk is complex.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Analytical Procedures for Gross Margin HardwoodSoftwoodPlywood Gross margin percent GreatWesternIndustryGreatWesternIndustryGreatWesternIndustry

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 3 Design and perform tests of details of balances for accounts receivable for each balance- related audit objective.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Designing Tests of Detail of Balances Accounts receivable are correctly added and agree with the Master File and the General Ledger (aged trial balance). Recorded accounts receivable exist Existing accounts receivable are included

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Designing Tests of Detail of Balances Accounts receivable are accurate Accounts receivable are properly classified Cutoff for accounts receivable is correct

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Designing Tests of Detail of Balances Accounts receivable is stated at realizable value The client has rights to accounts receivable Accounts receivable presentation and disclosures are proper

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 4 Obtain and evaluate accounts receivable confirmations.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Type of Confirmation Positive confirmation Blank confirmation form Invoice confirmation Negative confirmation

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Sample Size Tolerable misstatement Inherent risk Control risk Achieved detection risk from other substantive tests Type of confirmation

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Selection of the Items for Testing When selecting a sample of accounts receivable for confirmation, the auditor should be careful to avoid being influenced by the client.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Selection of Items for Testing If a client tries to discourage the auditor from sending confirmations to certain customers, the auditor should consider the possibility that the client is attempting to conceal fictitious or known misstatements of accounts receivable.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Maintaining Control After the items for confirmation have been selected, the auditor must maintain control of the confirmations until they are returned from the customer.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Follow-up on Nonresponses When positive confirmations are used, SAS 67 requires follow-up procedures for confirmations not returned by he customer.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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 file.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Duplicate Sales Invoices These are useful in verifying the actual issuance of a sales invoice and the actual date of the billing.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Shipping Documents These are important in establishing whether the shipment was actually made and as a test of cutoff.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Analysis of Difference Payment has already been made Goods have not been received The goods have been returned Clerical errors and disputed accounts

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Drawing Conclusions Reevaluate internal control. Evaluate the qualitative nature of misstatements. Determine whether sufficient evidence was obtained.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 5 Design audit procedures for the audit of accounts receivable, using an evidence planning worksheet as a guide.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Source of Each Row in the Evidence Planning Worksheet  Tolerable misstatement  Acceptable audit risk  Inherent risk  Control risk  Substantive tests of transactions results transactions results  Analytical procedures  Planned detection risk and planned audit evidence planned audit evidence

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder End of Chapter 16