CHAPTER 14

AUDITING THE REVENUE CYCLE

Learning Check
14-1. a. The revenue cycle includes the activities involved in the exchange of goods and
services with customers and the realization of the revenue in cash.
b. The classes of transactions in this cycle for a merchandising company are sales, sales
adjustments, and cash receipts. The primary accounts affected by these transactions
are sales, accounts receivable, cost of sales, inventory, cash, sales discounts, sales
returns and allowances, bad debts expense, and allowance for uncollectible accounts
14-. a. !pecific audit objectives for the revenue cycle are derived from the five categories of
management"s financial statement assertions.
b. !pecific audit objectives for credit sales transactions include the following#
$ecorded sales transactions represent goods shipped during the period %existence
or occurrence&.
'll sales transactions that occurred during the period have been recorded
%completeness&.
The entity has the rights to receivables resulting from recorded credit sales
transactions %rights and obligations&.
'll sales transactions are correctly journalized, summarized, and posted
%valuation or allocation&.
The details of sales transactions support their presentation in the financial
statements including their classification and related disclosures %presentation and
disclosure&.
14-(. )t may be appropriate to allocate a proportionately larger share of tolerable misstatement to
accounts receivable because of high ris* of misstatements in this account and the high costs
of applying certain procedures used in auditing receivables %such as sending and processing
confirmation re+uests&. This simply means that the auditor chooses to allow relatively more
of the total tolerable misstatement %financial statement materiality& remain undetected in
accounts receivable where they are more costly to detect than misstatements in some other
accounts. ,evertheless, tolerable misstatement must still be sensitive to the amount of
misstatement that might influence the decisions of financial statement users.
14-4. -actors that might motivate management to deliberately misstate revenue cycle assertions
include#
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3ressures to overstate revenues in order to report achieving announced revenue or
profitability targets or industry norms that were not achieved in reality owing to such
factors as global, national, or regional economic conditions, the impact of technological
developments on the entity"s competitiveness, or poor management.
3ressures to overstate cash and gross receivables or understate the allowance for
doubtful accounts in order to report a higher level of wor*ing capital in the face of
li+uidity problems or going concern doubts.
-actors that might contribute to unintentional misstatements in revenue cycle assertions include#
The volume of sales, cash receipts, and sales adjustments transactions is often high,
resulting in numerous opportunities for errors to occur.
The timing and amount of revenue to be recognized may be contentious owing to factors
such as ambiguous accounting standards, the need to ma*e estimates, the complexity of
the calculations involved, and purchasers" rights of return.
14-4. a. -ollowing are example analytical procedures that the auditor might use to estimate
total revenue for a household appliance manufacturer and for an airline.
Industry Possible Analytical Procedures
5ousehold 'ppliance .fg. 6se past ratio of net sales to capacity with
adjustments for capacity changes.
6se a combination of past ratios of mar*et
share with adjustments of current changes in
mar*et share. $e+uires *nowledge of the
total mar*et size in the industry.
'irline 7stimate net revenues using information on
utilization of capacity %airline seat miles& and
average revenue per seat.
b. Two analytical procedures that the auditor might use to estimate gross margin for
company might include.
Analytic Procedure Audit Significance
/ompare historical trends in
mar*et share and gross margin
with current unaudited data.
/ompanies with commanding mar*et shares
often are able to obtain larger gross margins.
7valuate the percentage of
revenues coming from new
products.
/ompanies with a high proportion of revenues
from new products may earn premium gross
margins due to the ability to innovate.
c. Two analytical procedures that the auditor might use to estimate net receivables and
the allowance for doubtful accounts for company might include.
Analytic Procedure Audit Significance
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'ccounts receivable turn days 6nderstanding a company8s history of accounts
and sales volume can assist the auditor in
evaluating net receivables and the ade+uacy of
the allowance for doubtful accounts.
7valuate the entities history of
uncollectible accounts expense
to net credit sales, with
adjustment for economic
conditions
This procedure is primarily related to the
ade+uacy of the allowance for uncollectible
accounts. The above history of accounts
receivable turn days would be most useful for
evaluating estimating gross receivables given
sales.
14-9. !everal control environment factors and their applicability to revenue cycle assertions are#
Integrity and ethical values - reduction of ris* of overstatement of revenues
and receivables by eliminating incentives to dishonest reporting.
/ommitment to competence - by chief financial officers and accounting
personnel.
Management's philosophy and operating style - conservatism in developing
such accounting estimates as the allowance for uncollectible accounts and
allowance for sales returns.
Human resource policies and practices - bonding of employees who handle
cash
14.:. The following table summarizes the functions that apply to credit sales transactions, the
department that performs the functions, and the principal documents or records produced in
performing the function.
Function
Department that
performs function
Principal documents and records
produced in performing the function.
)nitiating credit
sales
!ales department
/redit department
;ocuments
/ustomer <rder
!ales <rder
/omputer -iles and $ecords
/ustomer .aster -ile %with credit
information& and 'ccounts $eceivable
.aster -ile.
3erpetual )nventory
'uthorized 3rice =ist
<pen <rder -ile
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Function
Department that
performs function
Principal documents and records
produced in performing the function.
;elivering good
and services
2arehousing and shipping
department for goods.
=ine operating departments
for services.
;ocuments
!hipping documents
$eports of unfilled orders and bac* orders
/omputer -iles and $ecords
<pen <rder -ile
3erpetual )nventory
!hipping -ile
$ecording sales 'ccounting %>illing& ;ocuments
!ales )nvoice
!ales $eports and !ales 1ournal
?arious 7xception $eports
.onthly /ustomer !tatements
/omputer -iles and $ecords
!ales Transaction -ile
'ccounts $eceivable .aster -ile
14-@. )n order to assess control ris* as low based on programmed control procedures the auditor
should test the following.
Control Importance to Control Risk Assessment
3rogrammed control procedures )f a programmed control procedure in critical to a low
control ris* assessment then the auditor should directly
test the control procedure.
/omputer general control
procedures
)n order to obtain assurance that the programmed
control procedure functions effectively throughout the
period the auditor also needs to these the effectiveness
of computer general control procedures.
.anual follow-up procedures. 3rogrammed controls usually report exceptions noted
when performing the control. 's a result auditors also
need to test the effectiveness of manual controls that
follow-up on reported exceptions.
14-A. The following tables describes programmed controls for a typical manufacturing company.
Potential
isstatement
Programmed Control CAA!s "Assuming !est Data#
a. !ales invoices may
not be recorded.
The computer compares
entries in the sales journal
with underlying shipping
information. 'll shipping
documents must be matched
with a sales invoice.
!ubmit test data for a
transaction that has shipping
information, both with and
without a supporting sales
invoice.
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Potential
isstatement
Programmed Control CAA!s "Assuming !est Data#
b. !ales invoice may
be recorded in the
wrong accounting
period.
The computer compares
dates on the sales invoice
with dates on shipping
documents.
!ubmit test data with dates on
sales invoices that both do and
do not match with dates on
related shipping files.
c. ' fictitious sales
invoice, or a sales
transaction for
which revenue
should not be
recognized, is
recorded.
The computer will not
prepare a sale invoice
without underlying
information on shipping
files.
!ubmit test data with sales
invoice information that both is
and is not supported by
underlying shipping
information.
d. !ales are made
without credit
approval.
The computer searches a
field for appropriate credit
authorization before an order
is placed on an open order
file.
!ubmit test data for sales orders
that both are and are not
supported by appropriate credit
authorization.
e. ' sales invoice has
incorrect +uantities
or prices.
The computer matches
+uantities on a sales invoices
with underlying shipping
information and matches
prices with an authorized
price list.
!ubmit test data for sales
invoices that both do and do not
match underlying shipping
information and authorized
price lists.
f. !ales invoices may
not be posted or
may not be
journalized
The computer chec*s run-to-
run totals of beginning
accounts receivable balances,
plus sales transactions, with
the ending receivable
balances.
!ubmit test data for batches that
with complete and incomplete
data sets in terms of completed
transactions.
g. !ales invoices may
be posted to the
wrong customer8s
accounts.
The computer matches
customer information on the
sales invoice with the master
customer file, the sales order,
and the shipping documents.
!ubmit test data with underlying
information that both does and
does not match with information
on previously created sales
order and shipping files.
14-10. ' common management control involves having managers with responsibility for sales to
review daily or wee*ly sales reports to assess the reasonableness of recorded sales. -urther
management responsible for warehousing and shipping should review daily or wee*ly sales
and inventory movement reports to assess the reasonableness of recorded sales and
inventory removed from the perpetual inventory.
14-11. The sub-functions involved in cash receipts include %1& receiving cash receipts, %&
depositing cash in ban*, and %(& recording the cash receipts.
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14-1. a. Two important controls pertaining to cash sales and the transaction class audit
objectives to which they relate are#
The customer"s expectation of a printed receipt and supervisory surveillance of
over the counter sales transactions helps to ensure that all cash sales are
processed through the cash registers or terminals - completeness.
)ndependent chec* by supervisor on the accuracy of cash count sheets, and
verification of agreement of cash on hand with totals printed by a cash register or
terminal - existence or occurrence and valuation or allocation.
b. Two important controls pertaining to the initial handling of mail receipts are %1&
immediate restrictive endorsement of chec*s received and %& preparation of a multi-
copy listing %prelist& of mail receipts.
14-1(. a. ' lockbox is a post office box that is controlled by the company"s ban*. The ban*
pic*s up the mail daily, credits the company for the cash, and sends the remittance
advices to the company for use in updating accounts receivable. This system
eliminates the ris* of diversion of the receipts by company employees and failure to
record the receipts.
b. ;epositing receipts intact daily means that all receipts are depositedB that is, cash
disbursements should not be made out of undeposited receipts. This control reduces
the ris* that receipts will not be recorded %completeness&, and the resulting ban*
deposit record establishes the existence or occurrence of the transactions.
14-14. -our controls that can aid in preventing or detecting errors or irregularities in recording cash
receipts are summarized below along with potential tests of controls#
Control !est of Control
)ndependent chec* of agreement of
validated deposit slip with daily cash
summary.
)nspect a sample of daily cash summaries and
examine evidence of agreement with validated
deposit slip by responsible employee.
/omputer chec* of information
included in the cash receipts journal
with information from prelist.
6se /''Ts to test computer matching of
information from cash receipts journal with
electronic prelist. 'lso follow-up on how
exceptions are reported and examine evidence or
correction of errors reported on exception
reports.
3reparation of periodic independent
ban* reconciliations.
7xamine a sample of periodic ban*
reconciliations. .a*e in+uiries about ban*
reconciliation procedures and test accuracy on a
sample basis.
.ailing of monthly statements to
customers.
<bserve the mailing of monthly statements to
customers. .a*e in+uiries about procedures to
follow-up on issues raised by customers, and
examine reports or other evidence of follow-up.
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14-14. a. The functions pertaining to sales adjustments transactions are# granting cash
discountsB granting sales returns and allowancesB and determining uncollectible
accounts.
b. The following three types of controls pertaining to sales adjustments transactions
have as their common focus establishing the validity, or existence of occurrence, of
such transactions#
3roper authorization of all sales adjustments transactions.
The use of appropriate documents and records, particularly the use of an
approved credit memo for granting credit for returned or damaged goods, and an
approved write-off authorization memo for writing off uncollectible customer
accounts.
!egregation of duties for authorizing sales adjustment transactions and handling
and recording cash receipts.
14-19. a. The transaction classes that should be considered in assessing control ris* for
accounts receivable assertions are# credit sales, cash receipts, and sales adjustments.
b. )n assessing control ris* for the existence or occurrence account balance assertion for
accounts receivable, the following transaction class control ris* assessments should
be considered#
7xistence or occurrence for sales transactions that increase accounts receivable.
/ompleteness for cash receipts and sales adjustments transactions that decrease
accounts receivable.
c. ' revised acceptable level of detection ris* for tests of details and a revised level of
substantive tests must be determined for an assertion when the relevant final or
actual inherent ris* assessments, control ris* assessments, and analytical procedure
ris* assessments, differ from the planned assessed levels.
14-1:. )n vouching recorded accounts receivable transactions to supporting documentation, a
sample of debits to customers" accounts is compared to data on supporting sales invoices and
matching shipping documents, sales orders, and customer orders. The evidence obtained
pertains primarily to specific audit objectives derived from the existence or occurrence,
rights and obligations, and valuation or allocation assertions for accounts receivable.
14-1@. >oth the sales cutoff test and the cash receipts cutoff test pertain to accounts receivable. The
sales cutoff test involves#
7xamining shipping documents for several days before and after the cutoff date to
determine the date and terms of shipment.
Tracing shipping documents to sales and inventory records to establish that the entries
were made in the correct accounting period.
)nspecting invoices for a period of time before and after the cutoff date to ascertain the
validity and propriety of the shipments and corresponding entries.
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)n+uiring of management about any direct shipments by outside suppliers to customers
and determining the appropriateness of related entries.
)n performing a cash receipts cutoff test, the auditor may be present at the balance sheet date
to personally observe the promptness of the cutoff. )n particular, the auditor determines that
all collections received prior to the close of business are included in cash on hand or in
deposits in transit and are credited to accounts receivable. 'lternatively, the auditor may
review the daily cash summary and validated deposit slip for the last day of the year.
>oth cutoff tests relate to the existence or occurrence and completeness assertions for
accounts receivable.
14-1A. a. )t may not be necessary to confirm accounts receivable when#
The balance is immaterial to the financial statements.
The use of confirmations would be ineffective as an audit procedure.
The auditor"s combined assessment of inherent ris* and control ris* is low, and
that assessment, made in conjunction with the evidence expected to be provided
by analytical procedures or other substantive tests of details, is sufficient to
reduce audit ris* to an acceptably low level for the applicable financial statement
assertions.
b. -actors to be considered in choosing the form of confirmation re+uest are %1& the
acceptable level of detection ris* and %& the composition of the customer balances.
The positive form is used when detection ris* is low or individual customer balances
are relatively large. The negative form should be used only when all three of the
following conditions apply#
The acceptable level of detection ris* for the related assertions is moderate or
high.
' large number of small balances is involved.
The auditor has no reason to believe that the recipients of the re+uests are
unli*ely to give them consideration.
c. 2hen no response is received after the second or third positive confirmation re+uest
to a customer, the auditor should apply such alternative procedures as %1& examining
subse+uent collections and %& vouching open invoices comprising the customer"s
balance. 'lternate procedures may be omitted when both of the following conditions
apply#
There are no unusual +ualitative factors or systematic characteristics related to
the nonresponses, such as that all nonresponses pertain to year-end transactions.
The nonresponses, projected as 100C misstatements to the population and added
to the sum of all other unadjusted differences, would not affect the auditor"s
decision about whether the financial statements are materially misstated
14-0. a. The aged trial balance is used primarily in assessing the ade+uacy of the allowance
for uncollectible accounts.
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b. 3rocedures applied to the aged trial balance include %1& footing and crossfooting the
aged trial balance and comparing the total to the general ledger balance for accounts
receivable and %& testing the aging of the amounts shown in the aging categories by
examining supporting documentation such as dated sales invoices.
c. 'fter testing the accuracy of the aged trial balance the auditor should perform the
following procedures to draw a conclusion about the fair presentation of the
allowance for doubtful accounts.
7xamine past due accounts for evidence of collectability such as correspondence
with customers and outside collection agencies, credit reports, and customers8
financial statements.
;iscuss collectability of accounts with appropriate management personnel.
7valuated management8s process for estimated the allowance for doubtful
accounts using hindsight.
7valuate the ade+uacy of the allowance given information about industry trends,
aging trends, and collection history for specific customers.
d. 5indsight allows auditors to evaluate the reasonableness of management8s process
for estimating the allowance for doubtful accounts. The reliability of management8s
process for developing this accounting estimate can be gauged by evaluating
estimates in prior periods and the degree to which those estimates accurately
estimated subse+uent uncollectible accounts.
14-1. D''3 disclosure for accounts receivable include#
;isclosure of receivables from employees, officers, affiliated companies and other
related parties.
'ppropriate classification of material credit balances.
'ppropriate classification of current and noncurrent receivables.
;isclosure of pledging, assigning, or factoring receivables.
$b%ecti&e 'uestions
14-. 1.c .d (.a 4.d
14-(. 1.c .d (.a 4.d 4.b
14-4. 1.a .b (.c 4.d 4.b
14-4. 1.d .a (.a 4.d 4.b
Comprehensi&e 'uestions
14-9. %7stimated Time# 14 .inutes&
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The auditor should consider separately audit the revenues associated with the : owned
properties and the 40 managed properties.
$evenues for the : owned properties represent direct revenues of the motel chain. The auditor
might consider evaluating the summer season separate from the balance of the year as the auditor
will expect occupancy to be high during that time of year and the auditor will also expect that
revenues should reflect higher rates. The auditor would also expect that for the balance of the year
occupancy should be lower and revenues per night will be reduced due to significant price
competition. Enowledge of the industry will be particularly helpful in gauging the reasonableness
of occupancy rates and revenues per unit.
$evenues for the 40 managed hotels will li*ely be related to management fees based on
revenues earned for absentee owners. The auditor needs to consider the same issues as
above, but also need to determine the appropriateness of the management fee based on the
contract with absentee owners.
14-:. 3$<>=7. 14-: 2'! ),/=6;7; ), T57 T7FT ), 7$$<$. T57 -=<2/5'$T
<, 3'D7 4@4 ;<7! ,<T D< 2)T5 T5)! 3$<>=7.. ),G;7G6'T7
),-<$.'T)<, )! '?')='>=7 -<$ !T6;7,T! T< !<=?7 T57 3$<>=7.. T57
'6T5<$8! ',; 1<5, 2)=7H 7FT7,; T57)$ '33<=<D)7!.
14-@. %7stimated time - 0 minutes&
Internal Control 'uestionnaire
'uestion (es )o
1. 're cash registers or point-of-sale devices used for over-the-counter salesI
. )s there periodic surveillance of cash sales proceduresI
(. 're customers who pay by chec* re+uired to provide identificationI
4. 're chec*s restrictively endorsed on receiptI
4. )s a receipt produced by the cash register given to each customerI
9. )s an independent chec* made of agreement of cash and chec*s on hand with
cash count sheets and cash register readingsI
:. )s cash deposited intact dailyI
@. )s an independent chec* made of agreement of daily cash register summaries
with validated deposit slipsI
A. )s an independent chec* made of agreement of amounts journalized with daily
cash register summaries and validated deposit slipsI
10. 're periodic independent ban* reconciliations madeI
11. 're employees who handle cash bondedI
14-A. %7stimate Time# (0 .inutes&
*eakness Recommended Impro&ement
-inancial secretary exercises too much
control over collections.
To extent possible, financial secretary"s
responsibilities should be confined to record
*eeping.
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*eakness Recommended Impro&ement
-inance committee is not exercising its
assigned responsibility for collections.
-inance committee should assume a more
active supervisory role.
The auditing function has been assigned to
the finance committee, which also has
responsibility for the administration of the
cash function. .oreover, the finance
committee has not performed the auditing
function.
'n audit committee should be appointed to
perform periodic auditing procedures or
engage outside auditors to perform the
procedures.
The head usher has sole access to cash
during the period of the count. <ne person
should not be left alone with the cash until
the amount has been recorded or control
established in some other way.
The number of counters should be increased
to at least two, and cash should remain under
joint surveillance until counted and recorded
so that any discrepancy will be brought to
attention.
The collection is vulnerable to robbery
while it is being counted and from the
church safe prior to its deposit in the ban*.
The collection should be deposited in the
ban*"s night depository immediately after the
count. 3hysical safeguards, such as loc*ing
and bolting the door during the period of the
count, should be instituted. ?ulnerability to
robbery will also be reduced by increasing
the number of counters.
The head usher"s count lac*s usefulness
from a control standpoint because he
surrenders custody of both the cash and the
record of the count.
The financial secretary should receive a copy
of the collection report for posting to the
financial records. The head usher should
maintain a copy of the report for use by the
audit committee.
/ontributions are not deposited intact.
There is no assurance that amounts
withheld by the financial secretary for
expenditures will be properly accounted
for.
/ontributions should be deposited intact. )f it
is considered necessary for the financial
secretary to ma*e cash expenditures, she
should be provided with a cash wor*ing
fund. The fund should be replenished by
chec* based upon a properly approved
reimbursement re+uest and satisfactory
support.
.embers are as*ed to draw chec*s to
JcashJ, thus ma*ing the chec*s completely
negotiable and vulnerable to
misappropriation.
.embers should be as*ed to ma*e chec*s
payable to the church. 't the time of the
count, ushers should stamp the church"s
restrictive endorsement %-or ;eposit <nly&
on the bac* of the chec*.
,o mention is made of bonding. Eey employees and members involved in
receiving and disbursing cash should be
bonded.
2ritten instructions for handling cash >ecause much of the wor* in cash
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*eakness Recommended Impro&ement
collections apparently have not been
prepared.
collections is performed by unpaid,
untrained church members, often on a short-
term basis, detailed written instructions
should be prepared.
14-(0. %7stimated Time# (0 minutes&
a. Consolidated +lectricity Company, Cash Receipts Flo-chart
;ocumentary Eey $eports /omputer 3rograms and -iles
'udit Trail
b. Hes, the new cash receipts procedures have created some systems and internal
control problems. These problems include the following#
There are some potential control problems in the data entry procedures. The /$T
operator should be restricted to cash receipts processing activities. There should
be safeguards to detect or prevent unauthorized entries to the system.
The old master file records are destroyed in the update process. The company
should *eep a bac*up of the accounts receivable file in case the file is destroyed.
This can be accomplished by periodically dumping the accounts receivable file
on magnetic tape or another dis*
There is no assurance that all cash receipts have been entered correctly into the
system. There should be some independent computation of batch andKor hash
totals involving the remittance advices and the number of transactions so that a
comparison at the conclusion of processing would reveal omissions or errors
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/ustomer
3ayment
$emittance
'dvice
;ata
7ntry
at
/$T
/'!5 $7/7)3T!
3$<D$'.#
6pdates '$ .aster
-ile and ;aily
Transaction Tape.
'lso 3roduces
;eposit !lip for
/ash $eceived
'ccounts
$eceivable
-ile
rece
/ash
$eceipts
Transactio
n -ile
;eposit
!lip
The remittance advices The remittance advices are destroyed the next day, which
probably is too soon. 'ny errors or operator alterations not discovered by the end
of the next business day would be difficult to trace and correct.
14-(1. %7stimated Time L 4 .inutes&
a. Substanti&e !est b. Financial Statement
Assertion
c. !ype of +&idence
?ouch aged trial balance to
supporting documentation
?aluation or allocation ;ocumentary
'pply analytical procedures 7xistence or occurrence,
completeness, valuation or
allocation
'nalytical
?ouch recorded receivables to
supporting documentation
7xistence or occurrence,
rights and obligations,
valuation or allocation
;ocumentary
3erform sales cutoff test 7xistence or occurrence,
completeness
;ocumentary
/onfirm accounts receivable 'll except presentation and
disclosure.
/onfirmation
?ouch aged trial
balance to supporting
documentation
?aluation or allocation ;ocumentary
?ouch recorded receivables to
supporting documentation
7xistence or occurrence,
rights and obligations,
valuation or allocation
;ocumentary
?erify accuracy of accounts
receivable trial balance and
agreement with general ledger
control
?aluation or allocation .athematical
7xamine subse+uent
collections or allocation
7xistence or occurrence,
completeness, valuation
;ocumentary
/onfirm accounts receivable 'll except presentation and
disclosure
/onfirmation
/ompare statement
presentation with D''3
3resentation and
disclosure
;ocumentary
3erform cash receipts cutoff
test
7xistence or occurrence,
completeness
;ocumentary
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14-(. %7stimated Time L 0 minutes&
!chedule of 'djustments
Sales
Cost of
.oods Sold
!ransaction /nder $&er /nder
$&er
' ,000
; 4,000 4,900
7 10,000
- 9,000
5 @,000 4,400
Total 14,000 14,000 :,400 4,900
'djusting 7ntry
1,A00
/ost of Doods !old
)nventory
1,A00
14-((. %7stimated time - 14 minutes&
a. Eing might justify omitting the confirmation of /ycle"s accounts receivable when#
The balance is immaterial to the financial statements.
The use of confirmations would be ineffective as an audit procedure.
The auditor"s combined assessment of inherent ris* and control ris* is low, and
that assessment, made in conjunction with the evidence expected to be provided by
analytical procedures or other substantive tests of details, is sufficient to reduce
audit ris* to an acceptably low level for the applicable financial statement
assertions.
b. )n designing confirmation re+uests, the auditor considers the acceptable level of
detection ris* needed to be achieved, the composition of the client"s customer balances,
and the li*elihood that the customers will conscientiously respond. The positive form is
used when detection ris* is low or individual customer balances are relatively large.
The negative form should be used only when all three of the following conditions
apply#
The acceptable level of detection ris* for the related assertions is moderate or
high.
' large number of small balances is involved.
The auditor has no reason to believe that the recipients of the re+uests are
unli*ely to give them consideration.
c. 2hen no response is received after the second or third positive confirmation re+uest
to a customer, the auditor should apply such alternative procedures as %1& examining
subse+uent collections and %& vouching open invoices comprising the customer"s
balance. 'lternate procedures may be omitted when both of the following conditions
apply#
!olutions .anual to Modern Auditing: /opyright 000, 1ohn 2iley and !ons, )nc. 14-14
There are no unusual +ualitative factors or systematic characteristics related to
the nonresponses, such as that all nonresponses pertain to year-end transactions.
The nonresponses, projected as 100C misstatements to the population and added
to the sum of all other unadjusted differences, would not affect the auditor"s
decision about whether the financial statements are materially misstated.
14.(4. %7stimated Time L 4 .inutes&
a. There are two forms of accounts receivable confirmation re+uestsB the positive form
and the negative form. ' positive form as*s the debtor to respond whether or not the
debtor is in agreement with the information on the confirmation re+uest. ' negative
form as*s the debtor to respond only if the debtor disagrees with the information on
the confirmation re+uest. The negative form generally re+uires follow-up by the
auditor in the form of practicable alternative procedures that are used to obtain
necessary evidence. The use of the positive form is preferable when individual
account balances are relatively large, when there is reason to believe that there may
be a substantial number of accounts in dispute or with inaccuracies or irregularities.
The negative form is useful when internal control surrounding accounts receivable is
considered to be effective, a large number of small balances is involved, and the auditor
has no reason to believe that persons receiving the re+uests are unli*ely to give them
consideration.
b. ' debtor"s ac*nowledgement of indebtedness does not indicate whether the
indebtedness is collectible. ' good indicator of collectability is an aging schedule.
Denerally, the older an account is, the less li*ely it will be collected. 'n aging
schedule should segregate past due and current accounts. ;odge should review,
analyze, and interpret the aging schedule to determine whether the client"s allowance
for uncollectible accounts is ade+uate. .aterial differences, if any, should be
adjusted by the client. )n connection with the aging review and interpretation, ;odge
should investigate all accounts receivable losses of preceding periods and the amounts
of uncollectible accounts charged off in the current period to determine if the bad
debt rate is increasing and if charge-offs because of uncollectability are properly
approved. 'fter a review of correspondence, minutes, and collection procedures, and
after discussions with the appropriate client credit and collection officials, ;odge
should prepare an estimate of the possible collection losses and compare the estimate
to the amount of the recorded allowance. 2here necessary ;odge should review
client credit files as well as reports of external credit agencies. ;odge should also
examine subse+uent cash receipts to ascertain what portion of amounts owing at the
balance sheet date have actually been collected in the subse+uent period.
!olutions .anual to Modern Auditing: /opyright 000, 1ohn 2iley and !ons, )nc. 14-14
14-(4. %7stimated Time L (0 .inutes&
0asic Recei&able Audit
!est
1o- .eneral2Purpose Computer
Soft-are Package and !ape of Accounts Recei&able
Data ight be /seful
Test the mathematical
accuracy of the accounts
receivable subsidiary ledger.
.athematically compute the total amount owed by each
customer. The total is the sum of all unpaid items less
cash receipts during the current month.
!elect individual customer
accounts for confirmation.
The selection of individual accounts for confirmation
may be made either by ma*ing a simple random sample
or a stratified sample. )ndividual customers with
balances in excess of a specified dollar amount may be
selected. ' random sample of other accounts may be
selected. 'ccounts with past-due, outstanding balances
may be selected, as well as accounts with any other
characteristics of interest to the auditor.
7xamine cash receipts and
sales cutoff.
=isting a sample of items on the accounts receivable file
for which the date of last sale and the date of last cash
receipt are immediately prior to the confirmation date.
'nalyze accounts receivable
for slow paying customers
and past due accounts.
=isting of customers and open items on the accounts
receivable file for which the date of last payment or ratio
of month"s payments to balance owed indicates a slow-
paying customer or past-due amounts.
'ge the accounts receivable. The open, or unpaid, invoices in the accounts receivable
file may be aged by current, (0 days, 90 days, and other
time periods for which the items are past due.
3rint confirmation re+uest. >y utilizing especially prepared, preprinted forms, the
confirmation re+uest may be printed, together with the
envelope in which it is to be mailed. !econd re+uest and
control copies may be printed simultaneously.
)dentify credit balances. 'ccounts having credit balances in accounts receivable
may be listed.
!elect individual sales
transactions and cash receipt
transactions for additional
audit procedures.
-or selected accounts, the auditor may have listing
prepared of individual items composing the accounts
receivable balance. This information is useful, for
instance, in following up on Jno-repliesJ to confirmation
re+uests.
!olutions .anual to Modern Auditing: /opyright 000, 1ohn 2iley and !ons, )nc. 14-19
Cases
14-(9. %7stimated Time L (0 .inutes&
Year 5 Yar 4 Year 3 Year 2 Year 1
Unaudited Unaudited Unaudited Unaudited Unaudited
Accounts Receivable Gross 535,000 295,000 265,000 207,500 175,000
Allowance or Uncollectable Accounts !"14,500# !"6,400# !"5,275# !"5,900# !"5,400#
$et Receivables 520,500 2%%,600 259,725 201,600 169,600
&otal Assets 2,200,000 1,%00,000 1,500,000 1,200,000 1,000,000
&otal Revenues 2,700,000 2,050,000 1,750,000 1,400,000 1,200,000
Uncollectable Accounts '()ense 33,750 25,625 21,%75 17,500 15,000
*riteo o Accounts Receivable 22,600 24,500 22,500 17,000 14,000
a. Selected Ratios
+ales to avera,e total assets 1-35 1-24 1-30 1-27
.ndustr/ 0edian 1-25 1-23 1-29 1-26
1ierence 0-10 0-01 0-01 0-01
AR Growt2 to +ales Growt2 2-53 0-65 1-15 1-13
AR collection )eriod 55 49 4% 4%
.ndustr/ 0edian 47 4% 47 47
1ierence % 1 1 1
Uncollectable account e()ense to net credit sales 1-253 1-253 1-253 1-253
.ndustr/ 0edian 1-503 1-303 1-253 1-253
1ierence 40-253 40-053 0-003 0-003
Uncollectable account e()ense to bad debt writeos 1-493 1-046 0-972 1-029

b. The unaudited figures for 'urora .anufacturing, )nc. show the following#
There was a significant increase in sales compared to total assets, particularly when
compared to industry averages. This is an indication of possible existence and
occurrence problems as past history of the ratio of total assets to sales would predict
lower sales levels. The auditor should expand the scope of accounts receivable
confirmations.
The collection period is increasing relative to industry averages and past history.
-urther, accounts receivable are growing faster than sales. The 'urora continues to use
a historical rate of 1.4C of credit sales to provide for uncollectable accounts while
industry trends show an increase in the rate of bad debts to credit sales. The is an
indication of possible problems of associated with the net realizable value of receivables.
The auditor needs to expand the scope of tests of collection of current receivables, the
allowance for uncollectable accounts, and the provision for bad debt expense.
!olutions .anual to Modern Auditing: /opyright 000, 1ohn 2iley and !ons, )nc. 14-1:
14-(:. !ee separate file with answers to the comprehensive case related to the audit of .t. 5ood
-urniture that is included with this chapter.
14-(@. !ee separate file with answers to the comprehensive case related to the audit of .t. 5ood
-urniture that is included with this chapter.
14-(A. !ee separate file with answers to the comprehensive case related to the audit of .t. 5ood
-urniture that is included with this chapter.
Research 'uestions
-or the reasons specified in the introduction to this manual, solutions are not provided for this
category of +uestions.
!olutions .anual to Modern Auditing: /opyright 000, 1ohn 2iley and !ons, )nc. 14-1@