Receivables

The main audit objectives that should be addressed when auditing assertions in respect of
receivables are:

Verifying that the receivables exist at the financial statements date;

Verifying that receivables are accurately recorded at the correct value and provisions are
made for bad and doubtful debts;

Verifying completeness of receivables and cutoff.

It will normally be necessary to test a sample of sales ledger balances to verify their existence
and this could be done by using a variety of procedures. A common and effective procedure is
that of tracing and agreeing the balances selected to after date cash received. When a
judgemental method of selection is used older and larger balances should be covered.
When the auditor knows that the amount of after date cash received will be limited due to the
level of receivable days, which may stretch beyond the audit engagement completion date, other
procedures should be considered, like circularisation of balances on an earlier period with roll
forward of the amounts, substantive analytical procedures or obtaining evidence that goods sold
were received by or dispatched to the customer before the year end.
It is also important to appreciate that a debt that has been confirmed to exist will not necessarily
be recovered, and therefore the valuation objective is not met simply by a debtor confirming to
the auditor that the debt existed at the year end. Testing selected items against after date cash
receipts is a procedure that is also relevant in verifying recoverability of receivables; however the
objective is normally achieved by using a combination of procedures. In particular the use of
analytical procedures can provide evidence to compound the results of the tests on after date cash
receipts. For example, comparing the bad debt expense as a percentage of sales and the
provisions for unrecoverable accounts as a percentage of receivables to the data of the previous
year may corroborate the receivables valuation. Similar evidence may be derived by comparing
receivables turnover and receivables days to the previous year or by examining large customer
accounts individually and comparing them to the previous years balances. Another procedure to
verify valuation of receivables is the examination of credit notes issued after the year end for
provisions that should be made against current year balances.
Completeness and cutoff of receivables is normally tested in conjunction with sales and
inventory. The objective is to verify that sales and receivables are completely and accurately
recorded and are accounted for in the correct period, and that the inventory treatment is
consistent with the timing of the sale. A procedure for verifying completeness is that of tracing a
sample of dispatch documentation to sales invoices and into the sales and receivables ledgers.
Cutoff testing may be performed by selecting a sample of sales invoices around the year end
(before and after), inspecting the dates and comparing them with the dates of dispatch of goods
in the relevant documentation and with the dates recorded in the ledger for application of correct

cutoff. Another cutoff procedure is that of reviewing material after-date invoices and credit notes
and ensuring that they are recorded in the correct period. It has to be noted that cutoff testing
should not be performed by reference to invoices only, as sales should be recognised in
accordance with the applicable revenue recognition policies that would often refer to the date
when goods are dispatched; there could be in fact a discrepancy between the date of the invoice
and the date the sale should be recognised. Analytical procedures, for instance comparing the
gross profit percentage by product line to the previous year, may also provide evidence of
completeness and cutoff for sales and receivables.

1. positive: sent to customer of client by auditor requesting a response directly as to

whether the stated amount owed is correct or incorrect. Provides reliable evidence.
Costly.
2. negative: sent to customer of client by auditor requesting a response only if the customer
disagrees with the amount stated on the confirmation. Less reliable information than
positive. Less expensive than positive. Auditor can use negative confirmation only in the
following circumstances: receivables is comprised of a large number of small accounts;
inherent and control risk is very low; no reason to expect customers not to respond to the
request.

II. Auditing Procedures - Accounts Receivable

A. Existence/occurrence - Are accounts receivable valid? Did sales actually occur?
1.
interim.

Confirm receivables (SAS 67). Best evidence when sent at year end rather than

a. Use confirmations unless: 1. receivables are immaterial 2. confirming would

not provide useful information 3. control risk is so low that other procedures will reduce audit
risk to acceptable level.
b. Types of confirmations: (common to use a combination of positive and
negative)
1. positive: sent to customer of client by auditor requesting a response
directly as to whether the stated amount owed is correct or incorrect. Provides reliable
evidence. Costly.
2. negative: sent to customer of client by auditor requesting a response only
if the customer disagrees with the amount stated on the confirmation. Less reliable information
than positive. Less expensive than positive. Auditor can use negative confirmation only in the
following circumstances: receivables is comprised of a large number of small accounts; inherent
and control risk is very low; no reason to expect customers not to respond to the request.
c.

If not confirming receivables, auditor must document how this decision was

d.

Confirming is good procedure to detect lapping.

e.

Confirming may detect improper sales cutoff. (customers show smaller

made.

balances).
f. When customers do not respond to requests, other procedures should be
employed, such as examining subsequent cash receipts, shipping documents, sales invoices, bank
deposits.

2. Vouch receivables to shipping documents.

3. Vouch sample of recorded sales transactions to customer orders and shipping
documents. Focus on large or unusual sales.
B. Completeness. Do the balances of sales and receivables contain all transactions for the
period?
1.

Reconcile sub ledger to control account for receivables.

2. Sales cutoff test. Trace shipping documents immediately prior and just after accounting
period to the accounting records. Focus on FOB shipping point and FOB destination.
3. Cash receipts cutoff test. Trace daily remittance of payments to accounts receivable
credits.
4. Trace shipping documents to sales invoices and accounting entries to determine if sales
were recorded appropriately.
5. Account for numerical of numbered documents.
6. Apply analytical procedures. Compare ratios of this period to prior periods, budgets,
and industry averages.
C. Rights and Obligations. Does the client company have the right to collect the
receivables?
1.

Inquire of management. Discuss factoring and pledging.

2. Track cash receipts to determine if collections match deposits in the company's bank
accounts.
3. Examine return policy. Evaluate expected/actual returns before and after year-end.
Evaluate past returns at this time period.
D. Valuation/Allocation. Are receivables valued at GAAP, i.e., net realizable value?
1.

Perform or evaluate clients aging schedule.

2. Trace cash receipts early in subsequent period. Cash receipts in subsequent period
provide best evidence of collectibility.

3.

Evaluate delinquent customers credit histories.

E. Presentation/Disclosure. Are sales and receivables appropriately presented and is their

appropriate note disclosures?
1.

Evaluate the balance sheet and income statement for proper classification.

2. Read footnotes. Disclosures about factoring and pledging and related party
transactions.
3. Obtain and evaluate the management representation letter concerning the
revenue/receipt cycle.
III.

Other Related Revenue/Receipt Accounts.

A. Sales Returns and Allowances. Were returns properly authorized? Were goods returned?
Auditor examines receiving reports, credit memos, and entries in the accounting records.
B. Bad Debt Expense. Are writeoffs properly authorized? Evaluate allowance account and
estimating procedures for determining size of allowance. Evaluate accounts that have been
written off and examine aging schedule for potential additional writeoffs. Mail confirmation
requests to customers that have been written off (there should not be a response).

Substantive Audit Procedures for Accounts

Receivable
Accounts receivable is part of the "current assets" section on a company's balance sheet. It
represents the balance owed by customers for products sold or services rendered. For small
businesses that sell on credit, this account can represent a large portion of its current assets. In
many companies, individual transactions are small and frequent. As such, there is ample
opportunity for errors in prices and dates that could leave accounts receivable misstated. Audits
can help clear up these errors. Auditors typically follow a standard set of procedures when it
comes to auditing accounts receivable.

Confirmation
The most common audit procedure involving the accounts receivable balance is confirmation. To
test that accounts receivable exist, the auditor will send letters to a sample of the client's
customers asking to verify the amount that is owed to the company being audited. The customer
is then asked to return the letter to verify the balance. Small business owners should be aware
that the auditor must send and receive confirmation letters under the auditor's own control. The
auditor will ask you to prepare the letter, but he will be responsible for delivery and receipt.

Subsequent Cash Receipts

For confirmation requests that are not returned by customers, auditors must perform alternative
procedures to verify the accounts receivable balance. To do so, the auditor will request proof that
the customer balances selected for confirmation have been paid since the company's fiscal year
end. This will require the client to provide bank records showing the receipt of payment. If the
balances have not yet been paid by the customer, the auditor might be forced to contact the
customer and verify the balance over the phone.

Allowance Testing
Generally accepted accounting principles (GAAP) require that the accounts receivable balance is
shown "net" on the balance sheet. This means that accounts receivable should be reduced by an
allowance for accounts that are deemed to be uncollectible. Under accrual accounting, this
requires the client to make an estimate of the current dollar amount of debt that will ultimately
remain uncollected. The auditor will review this estimate, usually with respect to historical
trends, and determine if the amount is reasonable. Small business owners can make this process
go smoothly by ensuring that they employ a consistent methodology when assessing bad debt
from year to year. Or, if the company changes methodology, it should be able to justify the
change.

Factoring
Some small businesses do not have the personnel to bother with collecting past-due accounts. As
such, they sometimes sell or "factor" their accounts receivable to a third party. In these cases, a
company outsources the collection of these accounts to a party that specializes in collection. An
auditor will examine the agreements between the client and the company that has purchased the
accounts, known as the factor. The auditor will then determine who has legal title to the accounts
recievable and assess whether the client has any responsibility to reimburse the factor for an
excessive number of uncollectible accounts. This responsibility is known as recourse.

Substantive Audit Procedures for Accounts

Receivable
Substantive audit procedures are the activities that auditors perform to assess the risk of material
misstatements or instances of fraud at the assertion level. As opposed to the testing of controls,
substantive procedures focus on amounts and include detailed testing of classes of transactions,
account balances and disclosures. Substantive analytical procedures are also included.

Substantive Analytical Procedures

Auditors perform substantive analytical procedures at the planning and review stages of an audit.
These procedures include comparison of a company's financial information with comparable
financial information from past records; the company's anticipated results, such as forecast or
budgets; or financial information of another company from similar industry. Auditors conduct
these comparisons at the transaction's class level and the assertion level, and they generally ask
management about the availability and reliability of the comparable information. If there are
differences, then an investigation must follow.

Verification by Confirmation
To verify completeness, valuation and cut-off assertions, auditors send confirmation requests to
debtors and third parties. They first test the reconciliation of accounts receivable balances to the
general ledger. They then select relevant account balance items either on a judgmental basis or
using audit software, and prepare confirmation requests for these items. They ask the recipients
to respond with negative or positive confirmation and use the responses to verify the company's
information.

Performance of Alternative Procedures

External parties don't always respond to confirmation requests, and when they don't, auditors
must perform alternative audit procedures. This involves tracing subsequent cash receipt records
or invoices and supporting documentation. If the company didn't receive significant repayments
from debtors in a subsequent period, the auditors will address this concern with the
organization's managers. To verify the valuation assertions, validity, and recording and
presentation, auditors also perform tests of the journal entries in accounts receivable and the
subsidiary ledgers. They also perform aging analyses to check long outstanding debts.

GAAP Considerations
Companies must prepare and present their financial statements according to a financial reporting
framework, and in United States, when companies share their financial information with the
public, they must use generally accepted accounting principles, or GAAP, to prepare their
financial statements. Auditors, therefore, determine that the accounting policies and procedures
related to accounts receivables are appropriate and are applied consistently according to GAAP.
They also validate that the company presents and discloses its accounts receivable balances in
the balance sheet and its accompanying notes properly.