12 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Bea Completing the Tests in the Sales and Collection Cycle: Accounts Receivable Chapter 12
12 - 1©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Completing the Tests in theSales and Collection Cycle:
Accounts Receivable
Chapter 12
12 - 2©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Learning Objective 1
Describe the methodology
for designing tests of details
of balances using the
audit risk model.
12 - 3©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Accounts Receivable Balance-Related Audit Objectives
Detail tie-in
Completeness
ClassificationExistence
Accuracy
Cutoff
Realizablevalue
Rights andobligations
Presentationand disclosure
12 - 4©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Methodology for Designing Tests ofBalances – Accounts Receivable
Identify client business risksaffecting accounts receivable.
Set tolerable misstatementand assess inherent riskfor accounts receivable.
Assess control risk for salesand collection cycle.
12 - 5©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Methodology for Designing Tests ofBalances – Accounts Receivable
Design and perform tests ofcontrols and substantive testsof transactions for sales and
collection cycle.
Design and perform analyticalprocedures for accounts
receivable balance.
12 - 6©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Methodology for Designing Tests ofBalances – Accounts Receivable
Design tests of details ofaccounts receivable balance
to satisfy balance-relatedaudit objectives.
Audit proceduresSample size
Items to selectTiming
12 - 7©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Relationship Between Sales and Accounts Receivable
ExistenceCompletenessAccuracyClassificationTiming
Pre
sen
tati
onan
d d
iscl
osu
re
×
Det
ail t
ie-i
n
Exi
sten
ce
Com
ple
ten
ess
Acc
ura
cy
Cla
ssif
icat
ion
Cu
toff
Rea
liza
ble
valu
e
Rig
hts
Posting/Summary
Accounts ReceivableBalance-RelatedAudit Objectives
Translation-RelatedAudit Objectives
Sales
××
×
××
12 - 8©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Relationship Between Sales and Accounts Receivable
ExistenceCompletenessAccuracyClassificationTiming
Pre
sen
tati
onan
d d
iscl
osu
re
Det
ail t
ie-i
n
Exi
sten
ce
Com
ple
ten
ess
Acc
ura
cy
Cla
ssif
icat
ion
Cu
toff
Rea
liza
ble
valu
e
Rig
hts
Posting/Summary
Accounts ReceivableBalance-RelatedAudit Objectives
Translation-RelatedAudit Objectives
Cash receipts
××
××
××
12 - 9©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Learning Objective 2
Design and perform analytical
procedures for accounts in the
sales and collection cycle.
12 - 10©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
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 percentageof gross sales with previous years
12 - 11©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
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
12 - 12©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Analytical Procedures for the Sales and Collection Cycle
Aging category as a percentage of receivables
Allowance for uncollectible accountsas a percentage of accounts receivable
Charge-off of uncollectible accountsas a percentage of total accounts receivable
12 - 13©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Selected Comparative Information
Percent Percent2002 Change 2001 Change 2000
(000) 02-01 (000) 00-01 (000)Sales 144.3 9.3 132.0 6.5 124.0Gross margin 39.8 9.3 36.4 7.1 34.0Accounts receivable 20.2 7.4 18.8 13.9 16.5Bad debt expense 3.3 (2.9) 3.4 9.7 3.1Total assets 61.4 (7.0) 66.0 8.0 61.1Net earnings 5.7 21.3 4.7 38.2 3.4Number of accounts receivable 258 16.7 221 5.7 209
12 - 14©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Analytical ProceduresSales and Collection Cycle
2002 2001 2000Gross 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 51.2Net accounts receivable/ current assets 37.2% 38.6% 36.0%
12 - 15©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Design and Perform Tests of Detailsof A/R Balance (Phase III)
Planned detection risk for eachobjective is an auditor’s decision.
Combining the factors that determineplanned detection risk is complex.
12 - 16©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Analytical Proceduresfor Gross Margin
Gross Margin Percent 2002 2001
Client Industry Client IndustryHardwood 36.3 32.4 36.4 32.5Softwood 23.9 22.0 20.3 22.1Plywood 40.3 50.1 44.2 54.3
12 - 17©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Learning Objective 3
Design and perform tests of
details of balances for accounts
receivable for each balance-
related audit objective.
12 - 18©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Designing Tests ofDetail of Balances
Aged trial balance
Recorded accounts receivable exist
Existing accounts receivable are included
Accounts receivable are accurate
Accounts receivable are properly classified
12 - 19©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Designing Tests ofDetail of Balances
Cutoff for accounts receivable is correct
Accounts receivable is stated at realizable value
The client has rights to accounts receivable
Accounts receivable presentationand disclosures are proper
12 - 20©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Learning Objective 4
Obtain and evaluate accounts
receivable confirmations.
12 - 21©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
AICPA Requirements
1. Accounts receivable are immaterial.
2. The auditor considers confirmationsineffective evidence because responserates will likely be inadequate or unreliable.
3. The combined level of inherent risk andcontrol risk is low and other substantiveevidence can be accumulated to providesufficient evidence.
12 - 22©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Type of Confirmation
Positive confirmationPositive confirmation
Blank confirmation formBlank confirmation form
Invoice confirmationInvoice confirmation
Negative confirmationNegative confirmation
12 - 23©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Timing
The most reliable evidence fromconfirmations is obtained when
they are sent as close to the balancesheet date as possible, as opposedto confirming the accounts several
months before year-end.
12 - 24©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Sample Size
Tolerable misstatement
Inherent risk
Control risk
Achieved detection risk fromother substantive tests
Type of confirmation
12 - 25©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Selection of Itemsfor Testing
When selecting a sample of accounts receivablefor confirmation, the auditor should be careful
to avoid being influenced by the client.
12 - 26©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Selection of Itemsfor Testing
If a client tries to discourage the auditor fromsending confirmation to certain customers,the auditor should consider the possibility
that the client is attempting to concealfictitious or known misstatements of
accounts receivable.
12 - 27©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Subsequent Cash Receipts
Evidence of the receipt of cash subsequentto the confirmation date includes examining
remittance advices, entries in the cash receiptsrecords, or perhaps even subsequent credits in
the accounts receivable master files.
12 - 28©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Duplicate Sales Invoices
These are useful in verifyingthe actual issuance of a salesinvoice and the actual date
of the billing.
12 - 29©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Shipping Documents
These are important in establishingwhether the shipment was actually
made and as a test of cutoff.
12 - 30©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
CorrespondenceWith the Client
Usually, the auditor does not need to reviewcorrespondence as a part of alternative
procedures, but correspondence canbe used to disclose disputed and
questionable receivables notuncovered by other means.
12 - 31©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Analysis of Difference
Payment has already been madePayment has already been made
Goods have not been receivedGoods have not been received
The goods have been returnedThe goods have been returned
Clerical errors and disputed accountsClerical errors and disputed accounts
12 - 32©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Drawing Conclusions
Reevaluate internal control.
Evaluate the qualitative nature of misstatements.
Determine whether sufficient evidence was obtained.
12 - 33©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Learning Objective 5
Design audit procedures for the
audit of accounts receivable,
using an evidence planning
worksheet as a guide.
12 - 34©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Source of Each Row in the Evidence Planning Worksheet
Tolerablemisstatement
Acceptableaudit risk
Inherent risk
Control risk
Substantive testsof transactions
results
Planned detectionrisk and plannedaudit evidence
12 - 35©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Developing Tests of DetailsAudit Program
The development of audit programprocedures for tests of details in thesales and collection cycle is based
on the results of the analyticalprocedures, tests of controls, andsubstantive tests of transactions.
12 - 36©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
End of Chapter 12