Ch 11 Flashcards
Sources of Accounts Receivable
Claims against customers from sale of goods or services.
Loans to officers or employees.
Loans to subsidiaries.
Claims against various other refunds.
Claims for tax refunds.
Advances to suppliers.
AR is shown on the balance sheet at
Net realizable value
What is the nature/what is contained in notes receivables?
Substantial loans to individuals or companies.
Installment note or contract can allow seller to hold lien on goods. Examples:
Sale of industrial machinery, or farm equipment.
Loans to subsidiaries or other types of related companies.
Loans to officers, employees.
Audit risk is significant for receivables because:
Many incidences of fraud have involved overstatement of receivables and revenue.
Revenue recognition may be based on complex accounting rules.
Examples—long term contract accounting
multiple element arrangements
Receivables and revenues are usually subject to valuation using significant accounting estimates.
What are the three “steps” to audit receivables and revenue?
- Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to receivables and revenues.
- Obtain an understanding of internal control over receivables and revenues.
- Assess the risks of material misstatement and design tests of controls and substantive procedures that:
Assess the risks of material misstatement and design tests of controls and substantive procedures that:
a. Substantiate the existence of receivables and the occurrence of revenue transactions.
b. Establish the completeness of receivables and revenue transactions.
c. Verify the cutoff of revenue transactions.
d. Determine that the client has rights to recorded receivables.
e. Establish the proper valuation of receivables and the accuracy of revenue transactions.
f. Determine that the presentation and disclosure of receivables and revenue are appropriate.
In the control environment, internal control over AR and revenue is important because:
Important because of risk of intentional misstatement of revenue.
Commitment to integrity and ethical behavior.
Are estimates of allowance for doubtful accounts developed in a conscientious manner?
Independence of board and audit committee.
Appropriate structure and lines of responsibility.
Commitment to recruit, develop, and retain competent. employees.
Holding employees accountable.
Risk assessment is important within internal control over AR and revenue because:
Risk of misstatement of revenue may be high based on its nature and complex rules regarding revenue recognition.
Give examples of control activities:
Prepare sales order.
Approve credit.
Issue merchandise from stock.
Shipment.
Billing.
Invoice verification.
Maintenance of control accounts.
Maintenance of customers’ ledgers.
Approval of sales returns and allowances.
Authorization of write-offs of uncollectible accounts.
Two examples of monitoring controls:
Management review controls.
Internal audits.
Match each revenue cycle to its’ corresponding document: Customer purchasing
Purchase order
Match each revenue cycle to its’ corresponding document: Sales
Sales order
Match each revenue cycle to its’ corresponding document: Shipping
Bill of lading
Match each revenue cycle to its’ corresponding document: Billing
Invoice
Match each revenue cycle to its’ corresponding document: Receiving cash receipts.
Control listing
Match each revenue cycle to its’ corresponding document: Authorizing adjustments to accounts receivable
Credit memo
Match each revenue cycle to its’ corresponding control: Sales and collections
Segregation of duties
Match each revenue cycle to its’ corresponding control: Matching of sales invoices and
shipping documents
Match each revenue cycle to its’ corresponding control: clerical accuracy checks on
invoices
Match each revenue cycle to its’ corresponding control: Credit approval for
sales transactions
Match each revenue cycle to its’ corresponding control: mailing of
monthly statements
Match each revenue cycle to its’ corresponding control: reconciliation of
bank accounts
Match each revenue cycle to its’ corresponding control: use of control listing of
cash receipts
Match each revenue cycle to its’ corresponding control: use of budgets and analysis of
variances
Match each revenue cycle to its’ corresponding control: control over shipping and
billing documents
Match each revenue cycle to its’ corresponding control: use of authorized
credit memoranda
Match each revenue cycle to its’ corresponding control: use of chart of accounts and review of
account codings
The custodian of notes receivable should not
have access to cash or to the general accounting records.
The acceptance and renewal of notes are
authorized in writing by a responsible official who does not have custody of notes.
The write-off of defaulted notes are
approved in writing by responsible officials and effective procedures adopted for subsequent follow-up of such defaulted notes.
3 audit steps of AR
A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to receivables and revenue.
B. Obtain an understanding of internal control over receivables and revenue.
C. Assess the risks of material misstatement and design further audit procedures.
Details on Understanding the Client Business
The types of products and services sold.
The classes and categories of the client’s customers.
Whether the business is affected by seasonal or cyclical demand.
Typical marketing policies for the client and its industry.
Policies regarding pricing, sales returns, discounts, extension of credit, and normal delivery and payment terms.
Compensation arrangements that are based on recorded revenue.
Typical revenue recognition principles used in the industry and their methods of application.
Understand controls established by
management to control risks.
Determine controls have been
implemented
Response to risks. (as an auditor) 3
An overall effect on audit.
Alter the design of audit procedures.
Performing procedures to address risk of material misstatement due to management override of internal control.
Go over the red and pink information on slides 15-16!
D. Perform further audit procedures—tests of controls. Give examples
a. Test the controls over sales transactions by examining the process of recording the transactions.
b. Trace details of shipping documents to related sales invoices.
c. Review the use and authorization of credit memoranda.
d. Test controls over over-the-counter sales by reconciling cash register tapes or sales tickets with sales journals.
e. Test management review controls.
f. Test controls over accounting estimates related to revenues and receivables.
Perform further audit procedures—substantive procedures for receivables and revenue.
Obtain an aged trial balance of trade accounts receivable and analyses of other accounts receivable and reconcile to ledgers.
Obtain analyses of notes receivable and related interest.
Inspect notes on hand and confirm those with holders.
Confirm receivables with debtors.
Review the year-end cutoff of sales transactions.
Perform analytical procedures for accounts receivable, notes receivable, and revenue.
Review significant year-end sales contracts for unusual terms.
Test the valuation of notes receivable, computation of interest income, interest receivable, and amortization of discount or premium.
Evaluate the propriety of the client’s accounting methods for receivables and revenue.
Evaluate accounting estimates related to revenue recognition.
Determine the adequacy of the client’s allowance for uncollectible accounts.
Ascertain whether any receivables have been pledged.
Investigate any transactions with or receivables from related parties.
Evaluate the business purpose of significant and unusual sales transactions.
Evaluate financial statement presentation and disclosure of receivables and revenue.
Obtain aged listing of receivables and reconcile to ledgers.
Obtain analyses of notes receivable and related interest.
Valuation and accuracy
Inspect notes on hand and confirm those not on hand.
Existence, occurrence, and rights
Confirm receivables with debtors.
Existence, occurrence, and rights
Valuation and accuracy
Perform analytical procedures or data analytics.
Review significant year-end sales contracts.
Existence, occurrence, and rights
Cutoff
Valuation and accuracy
Review the year-end cutoff of sales transactions.
Existence, occurrence, and rights
Cutoff
Verify interest earned on notes receivable.
Completeness
Evaluate the propriety of client’s accounting for transactions. Evaluate accounting estimates related to revenues and receivables.
Valuation and accuracy
Determine adequacy of allowance for uncollectible accounts.
Valuation
Ascertain the existence of pledged receivables.
Investigate receivables from related parties.
Presentation and disclosure
Evaluate the business purpose of significant and unusual sales transactions.
Valuation and accuracy Presentation and disclosure
Evaluate financial statement presentation and disclosure.
Presentation and disclosure
Receivables should be confirmed, unless:
Accounts receivable are immaterial,
The use of confirmations would be ineffective, or,
The auditors’ combined assessment of inherent and control risk is low, and audit risk can be reduced to acceptably low level with substantive tests,
if client refuses to allow auditors to send confirmations to Customers —
could lead to qualified opinion or disclaimer of opinion
Same result could occur if auditors cannot get written responses
Two methods of confirmation of receivables:
Positive confirmations – request addressed to the debtor asking for a reply.
- Ordinarily sent with balances due on them.
- Blank forms – leave amount blank (used less frequently).
Negative confirmations – ask debtor to advise the auditors only if the balance shown is incorrect.
- Low level of assessed risk of material misstatement.
- Large number of small balances.
- A low error rate is expected.
- No reason to believe the respondent will ignore the request.
Make the flowchart for the confirmation sequence:
- Develop audit objectives
- Choose appropriate confirmation form
- determine the timing and extent
- Identify the information to be confirmed
- Select the accounts for confirmation
- Prepare and mail the requests
- send 2nd requests for positive confirmations
- perform alternative procedures for non-respondents
- resolve exceptions
- document the procedures and results
Steps for recognition of revenue
Step 1: Identify the Contract. Step 2: Identify the Performance Obligations.
Step 3: Determine the Transaction Price.
Step 4: Allocate the Transaction Price to the Performance Obligations.
Step 5: Recognize Revenue When the Performance Obligations Are Satisfied.
Potential Revenue Recognition Problems
Services/items that would have complex/unsual revenue stuff happening
Sales with unusual right to return.
Side agreements.
Franchise fees.
Bill and hold transactions.
Sales using notes with unusual interest rates.
Long-term construction contracts.
Multiple element agreements.
Revenue recognition may involve significant accounting estimates.
Auditors can evaluate these estimates by:
Reviewing and testing management’s method of developing the estimates,
Developing their own estimates, or,
Reviewing subsequent transactions and other events that provide evidence about the accuracy of the estimates.
The auditors are required to perform a retrospective review of the prior year’s significant
accounting estimates to determine whether they indicate bias on the part of management.
Construction industry: compare prior year estimates of costs to ____. This may show ____. Use this information for ___.
complete projects with the actual costs incurred
may show bias on the part of management
use this information for current year audit of estimates
What are the steps to audit of allowance for doubtful accounts
Review collections in subsequent period.
Develop estimate and evaluate reasonableness of management estimate.
Compare the details of the aging of accounts receivable to prior years’ aging.
Investigate the credit ratings for delinquent and unusually large accounts.
Review confirmation exceptions for an indication of amounts in dispute or other clues as to possible uncollectible accounts.
Summarize in a working paper those accounts whose collectability is doubtful based on the preceding procedures. List customer names, doubtful amounts, and reasons for considering these accounts doubtful.
Review with the credit manager the current status of significant doubtful accounts.
Compute relationships, such as the number-of-days’-sales in accounts receivable and the relationship of the valuation allowance to (1) accounts receivable and (2) net credit sales.
Audit of Allowance for Doubtful Accounts: Review collections in
subsequent period
Audit of Allowance for Doubtful Accounts: develop estimate and evaluate reasonableness of
management estimate
Audit of Allowance for Doubtful Accounts: compare the details of the aging of AR to
prior years’ aging
Audit of Allowance for Doubtful Accounts: investigate the credit ratings for
deliquent and unsually large accounts
Audit of Allowance for Doubtful Accounts: review confirmation exceptions for an
indication of amounts in dispute or other clues as to possible uncollectible accounts
Audit of Allowance for Doubtful Accounts: summarize in a wp those accounts whose
collectability is doubtful based on the preceding procedures. List customer names, doubtful amounts, and reasons for considering these accounts doubtful.
Audit of Allowance for Doubtful Accounts: review with the credit management the current status of
significant doubtful accounts
Audit of Allowance for Doubtful Accounts: compute relationships, such as the
number of days’ sales in AR and the relationship of the valuation allowance to 1. AR and 2. net credit sales
To identify related party transactions, auditors should review:
Proxy and other filings with S E C or other regulatory agencies.
conflict-of-interest statements by management.
Transactions with unusual terms.
Accounting records for unusual balances or transactions particularly near year-end.
Determine that related party transactions are appropriately ____.
disclosed
Lead schedules for receivables and net revenue and Working papers. Give examples (generally know these)
Aged trial balance of A/R.
Analyses of other accounts receivable.
Analysis of notes receivable and related interest.
Analysis of allowance for doubtful accounts and notes.
Comparative analyses of revenue.
Documentation of internal control.
Risk analyses and audit plan (program).
