Receivable

Question 1

10 jan

Answer 1

The balance for trade receivables is usually a significant amount in a company’s statement of financial position. Therefore, a substantial amount of audit work is required to ensure the reliability of this balance. Here are the key points and practical examples:

Principal Risks of Misstatement:

1. Irrecoverable Receivables (Valuation Assertion):
   
   • Risk: Some receivables may not be collectible.
   • Example: A customer who has declared bankruptcy may not be able to pay their outstanding balance.
2. Contested Receivables (Existence and Rights and Obligations Assertions):
   
   • Risk: Customers may dispute the amounts owed.
   • Example: A customer claims they returned goods and should not be charged.
3. Incorrect Cut-Off (Cut-Off Assertion):
   
   • Risk: Sales and receivables may be recorded in the wrong period.
   • Example: Goods shipped on December 31st are recorded as a sale in January.

Direct Confirmation of Balances (Circularization):

Direct confirmation involves asking customers to provide written confirmation of their account balance with the client entity. This is a strong source of external audit evidence. However, its reliability depends on:

1. Customer Response Rate:
   
   • Challenge: Not all customers may respond.
   • Solution: Follow up with non-responding customers to increase the response rate.
2. Accuracy of Customer Responses:
   
   • Challenge: Some customers may confirm balances without proper verification.
   • Solution: Cross-check customer confirmations with the company’s records.

Assertions Checked by Direct Confirmation:

1. Existence Assertion:
   
   • Objective: Ensure receivables exist and are not overstated.
   • Example: Confirming a $10,000 balance with Customer A to verify it exists.
2. Rights and Obligations Assertion:
   
   • Objective: Ensure the company has the legal right to the receivables.
   • Example: Confirming that the $10,000 balance is owed to the company and not to a third party.
3. Accuracy, Valuation, and Allocation Assertion:
   
   • Objective: Ensure receivables are stated at their appropriate amount.
   • Example: Confirming that the $10,000 balance is accurate and not subject to any disputes or adjustments.

Scenario:
ABC Ltd. has a trade receivables balance of $500,000. The auditor decides to send confirmation requests to a sample of customers.

Steps:

1. Select Sample:
   
   • Audit Step: Select a sample of 50 customers with balances totaling $200,000.
   • Example: Customers A, B, and C with balances of $10,000, $15,000, and $20,000, respectively.
2. Send Confirmation Requests:
   
   • Audit Step: Send confirmation letters to the selected customers.
   • Example: Request Customer A to confirm their $10,000 balance.
3. Follow Up:
   
   • Audit Step: Follow up with non-responding customers.
   • Example: Send a reminder to Customer B if no response is received within two weeks.
4. Analyze Responses:
   
   • Audit Step: Compare customer responses with the company’s records.
   • Example: Customer A confirms the $10,000 balance, but Customer C disputes the $20,000 balance, claiming it should be $18,000.
5. Investigate Discrepancies:
   
   • Audit Step: Investigate any discrepancies reported by customers.
   • Example: Review sales invoices and shipping documents to resolve Customer C’s dispute.

By following these steps, auditors can obtain reliable evidence to support the trade receivables balance in the financial statements, ensuring accuracy and completeness. If you have any more questions or need further clarification, feel free to ask!

ISA 505 covers the process of obtaining external confirmations, which are considered highly reliable audit evidence. Here’s a breakdown of the key requirements and procedures:

1. Control Over External Confirmation Requests:
- Deciding Information to Confirm: The auditor decides what information needs to be confirmed, such as account balances or specific transactions.
- Selecting the Confirming Party: The auditor selects the appropriate party to confirm the information, such as the financial director or controller at the entity.
- Designing Confirmation Requests: The auditor designs the confirmation requests, ensuring they include instructions for responses to be sent directly to the auditor.
- Follow-Up Requests: The auditor follows up on confirmation requests to ensure a high response rate.

2. Authorization from Client’s Management:
- The confirmation letter must include authorization from the client’s management, allowing customers to provide the required information directly to the auditor.

3. Reliability of Responses:
- Doubts About Reliability: If there are doubts about the reliability of any response, the auditor should obtain further evidence. Doubts may arise if:
- The response was received indirectly.
- The response did not come from the originally intended confirming party.
- The response was received electronically, making it difficult to establish the origin and authority of the respondent.
- Further Evidence: The auditor may:
- Request direct confirmation from management.
- Contact the confirming party directly if the response was received via email.
- Use encryption and other information transmission technologies.
- Verify responses from third parties to ensure they are from the proper source, the respondent is authorized, and the integrity of the transmission is maintained.

4. Non-Responses and Exceptions:
- Non-Responses: For non-responses, the auditor should perform alternative audit procedures. If a vital positive confirmation request is not responded to, the auditor must consider the implications for the audit report.
- Investigating Exceptions: The auditor should investigate all exceptions to determine if they indicate misstatements, fraud, or internal control breakdowns, or if they are due to timing differences.

5. Evaluating Results:
- The auditor should evaluate the results of the confirmation process as a whole to determine if they provide relevant and reliable audit evidence or if further evidence is needed.

Scenario:
ABC Ltd. has a trade receivables balance of $500,000. The auditor sends confirmation requests to a sample of customers.

Steps:

1. Design Confirmation Requests:
   
   • Audit Step: Design confirmation requests for 50 customers with balances totaling $200,000.
   • Example: Request Customer A to confirm their $10,000 balance.
2. Send Requests with Authorization:
   
   • Audit Step: Send confirmation letters with management’s authorization.
   • Example: Include a statement from ABC Ltd.’s management authorizing Customer A to provide the balance information directly to the auditor.
3. Follow Up on Non-Responses:
   
   • Audit Step: Follow up with non-responding customers.
   • Example: Send a reminder to Customer B if no response is received within two weeks.
4. Verify Reliability of Responses:
   
   • Audit Step: Verify the reliability of responses.
   • Example: If Customer C’s response is received via email, contact Customer C directly to confirm the response’s authenticity.
5. Investigate Exceptions:
   
   • Audit Step: Investigate any discrepancies reported by customers.
   • Example: Customer D disputes a $20,000 balance, claiming it should be $18,000. Review sales invoices and shipping documents to resolve the dispute.
6. Evaluate Results:
   
   • Audit Step: Evaluate the overall results of the confirmation process.
   • Example: Determine if the confirmation responses provide sufficient and reliable evidence for the trade receivables balance.

By following these steps, auditors can ensure the accuracy and reliability of trade receivables balances in the financial statements, providing assurance to stakeholders. If you have any more questions or need further clarification, feel free to ask! 😊

If management refuses to allow the auditor to send a confirmation request, the auditor should follow these steps as outlined in ISA 505:

1. Inquire About Reasons:
- Audit Step: Inquire as to management’s reasons for the refusal.
- Objective: Seek audit evidence to validate and assess the reasonableness of those reasons.
- Example: Management may cite confidentiality concerns or ongoing disputes with customers.

2. Evaluate Implications:
- Audit Step: Evaluate the implications of management’s refusal on the auditor’s assessment of the relevant risks of material misstatement, including the risk of fraud.
- Objective: Determine how the refusal affects the nature, timing, and extent of other audit procedures.
- Example: If management’s refusal raises suspicion of fraud, the auditor may need to increase the extent of substantive testing.

3. Perform Alternative Audit Procedures:
- Audit Step: Perform alternative audit procedures to obtain relevant and reliable audit evidence.
- Objective: Compensate for the lack of direct confirmation.
- Example: Review subsequent cash receipts, inspect supporting documents for sales transactions, or verify shipping documents.

4. Communicate with Governance:
- Audit Step: If the refusal is deemed unreasonable or alternative procedures do not provide sufficient evidence, communicate with those charged with governance in accordance with ISA 260.
- Objective: Inform the governance body of the limitation and its potential impact on the audit.
- Example: Discuss the issue with the audit committee or board of directors.

5. Determine Implications for Audit Opinion:
- Audit Step: Determine the implications for the audit and the auditor’s opinion in accordance with ISA 705.
- Objective: Assess whether the limitation on scope affects the auditor’s ability to form an opinion.
- Example: If the limitation is significant, the auditor may need to issue a qualified opinion or a disclaimer of opinion.

Scenario:
ABC Ltd.’s management refuses to allow the auditor to send confirmation requests to customers, citing confidentiality concerns.

Steps:

1. Inquire About Reasons:
   
   • Audit Step: Discuss with management to understand their confidentiality concerns.
   • Example: Management explains that customer contracts include confidentiality clauses.
2. Evaluate Implications:
   
   • Audit Step: Assess the impact of the refusal on the risk of material misstatement.
   • Example: Consider whether the refusal indicates potential fraud or other issues.
3. Perform Alternative Procedures:
   
   • Audit Step: Review subsequent cash receipts for the receivables balance.
   • Example: Verify that payments received after year-end match the outstanding receivables.
4. Communicate with Governance:
   
   • Audit Step: Inform the audit committee about the refusal and its implications.
   • Example: Discuss the potential impact on the audit opinion with the audit committee.
5. Determine Audit Opinion Implications:
   
   • Audit Step: Assess whether the alternative procedures provide sufficient evidence.
   • Example: If alternative procedures are insufficient, consider issuing a qualified opinion due to the limitation on scope.

By following these steps, auditors can address management’s refusal to send confirmation requests and ensure they obtain sufficient and appropriate audit evidence. If you have any more questions or need further clarification, feel free to ask!

When auditing receivables, the auditor can choose between positive and negative confirmation requests. Here’s a detailed look at both types:

Positive Confirmation:

A positive confirmation request asks the customer to reply to the auditor whether they agree or disagree with the balance on their account as recorded in the client company’s accounting records. There are two methods to obtain positive confirmation:

1. Method 1:
   
   • Description: Provide the customer with details of the balance and ask them to confirm its accuracy or indicate any discrepancies.
   • Example: “Dear Customer, our records show that your balance as of December 31, 2024, is $10,000. Please confirm if this is correct or indicate any discrepancies.”
2. Method 2:
   
   • Description: Ask the customer to provide details of their balance at the selected date without providing the balance from the client’s records.
   • Example: “Dear Customer, please provide the balance of your account with us as of December 31, 2024.”

Advantages and Disadvantages:
- Method 1: Easier for customers to respond but may lead to unverified confirmations.
- Method 2: Provides more reliable evidence but may result in a lower response rate due to the additional effort required from customers.

Negative Confirmation:

A negative confirmation request asks the customer to reply only if they disagree with the balance recorded by the company. If no reply is received, it is assumed that the customer agrees with the balance.

Example:
- “Dear Customer, our records show that your balance as of December 31, 2024, is $10,000. Please reply only if you disagree with this balance.”

Advantages and Disadvantages:
- Advantage: Easier for customers as they only need to respond if there is a disagreement.
- Disadvantage: Provides less reliable audit evidence since no response could mean either agreement or no verification by the customer.

ISA 505 permits the sole use of negative confirmation only if all the following conditions are met:

1. Low Risk of Material Misstatement:
   
   • The risk of material misstatement has been assessed as low, and controls have been tested.
2. Large Number of Small Balances:
   
   • The population consists of a large number of small account balances or transactions.
3. Low Exception Rate:
   
   • A very low exception rate is expected.
4. No Ignored Requests:
   
   • The auditor is not aware of circumstances that would cause the respondent to ignore the request for confirmation.

Scenario:
ABC Ltd. has a trade receivables balance of $500,000. The auditor decides to use positive confirmation for significant balances and negative confirmation for smaller balances.

Steps:

1. Positive Confirmation:
   
   • Method 1: Send confirmation requests to customers with balances over $10,000.
   • Example: “Dear Customer, our records show that your balance as of December 31, 2024, is $15,000. Please confirm if this is correct or indicate any discrepancies.”
2. Negative Confirmation:
   
   • Criteria: Use for customers with balances under $1,000.
   • Example: “Dear Customer, our records show that your balance as of December 31, 2024, is $500. Please reply only if you disagree with this balance.”

By choosing the appropriate type of confirmation based on the circumstances, auditors can obtain reliable audit evidence to support the trade receivables balance in the financial statements. If you have any more questions or need further clarification, feel free to ask! 😊