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Methodology for Designing Tests of

Balances: Accounts Receivable

Topic 8

Phase I

Completing the
Tests in the Sales
and Collection
Cycle:
Accounts
Receivable

Phase II

Identify Client
Design and perform
business risks affecting tests of control and
Accounts Receivable
substantive tests of
transaction for Sales
and Collection Cycle

Audit Objectives

Auditor should make additional inquiries of

management

Managements responses should be critically

evaluated.

Rights

Realisable
Value

When analytical procedures in the sales and

collection cycle uncover unusual fluctuations:

Cut Off

Before tests of details of balances.

Posting and
Summarisation

Classification

After balance date

Accuracy

Accuracy

Most analytical procedures performed during the

detailed testing phase:

Completeness

Completeness

Occurrence

Existence

Designing and Performing Analytical Procedures

Cash Receipts

Timing

Detail Tie In

Rights

Realisable
Value

Cut Off

Classification

Accounts Receivable

Accuracy

Completeness

Completeness

Existence

Detail Tie In

Sales

Occurrence

Classification

Audit Procedures
Sample Size
Items to Select
Timing

Audit Objectives
Accounts Receivable

Design tests of detail

of Accounts Receivable
balance to satisfy
balance-related
account objectives

Assess Control Risk for

Sales and Collection
cycle

PowerPoint to accompany:

Posting and
Summarisation

Design and perform

analytical procedures
for Accounts
Receivable

Set Tolerable error and

assess inherent risk for
Accounts Receivable

(Chapter 13)

Accuracy

Phase III

Classification
Timing

Analytical Procedures for the

Sales and Collection Cycle
Compare by product line:

Gross margin percentage with previous years

Sales returns and allowances as a percentage of gross

sales with previous years.

Sales by month over time

Compare with previous years:

Individual customer balances over a stated amount

Days that accounts receivable are outstanding.

Bad debt expense as a percentage of gross sales

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Analytical Procedures for the

Sales and Collection Cycle (cont.)

Compare with previous years:

Ageing categories as a percentage of accounts

receivable

Allowance for doubtful debts as a percentage of

accounts receivable

Write-off of uncollectible accounts as a percentage of

total accounts receivable.

Designing Tests of Details of Balances (cont)

Accounts receivable are properly classified.

Cutoff for accounts receivable is correct.

Accounts receivable are stated at realisable

value:
o

Allowance for doubtful debts

Bad debts expense.

The client has rights to accounts receivable.

Designing Tests of Details of Balances

Accounts receivable are correctly added and agree with:

o

Recorded accounts receivable exist:

o

Positive confirmation:

Requests the debtor to confirm whether the balance

on the confirmation request is correct or incorrect.

Invoice confirmation:

Individual invoice is confirmed, rather than the

customers entire balance.

Negative confirmation:

Requests the debtor to respond only when there is

disagreement with the stated amount.

Confirmation of customer balances.

Existing accounts receivable are included.

Accounts receivable are accurate.

Confirmation of Accounts Receivable

Confirmations are commonly used in practice, except
where:

Accounts receivable presentation and disclosure.

Types of Confirmation

The master file (subsidiary ledger) and general

ledger.

Accounts receivable are immaterial

Auditor considers confirmations ineffective evidence

because response rates may be inadequate or
unreliable

Combined level of inherent risk and control risk is low

and other substantive evidence can be accumulated
to provide sufficient evidence.

Confirmations - Timing
Most reliable evidence from confirmations is obtained
when:

They are sent as close to the balance sheet date as

possible.

Often necessary to confirm the accounts at an interim

date:

Permissible if internal controls are adequate.

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Confirmation - Sample Size

Selection of Items for Testing

Main factors affecting sample size:

Audit focus is on overstatement of receivables, so

stratification is desirable:

Tolerable error

Inherent risk

Control risk

Achieved detection risk from other substantive tests

Type of confirmation.

Analysis of differences:

Must ensure independent communication between

auditor and customer.

Payment has already been made

Second and third requests.

Goods have been returned

Goods havent been received

Clerical errors and disputed amounts.

Drawing conclusions

Alternative procedures:

(cont.)

Follow-up of non-responses:

Auditor should be careful to avoid being influenced by the

client.

Other Issues

Maintaining control:

Age of balance.

When selecting a sample of accounts receivable for

confirmation:

Other Issues

Dollar value

Subsequent cash receipts

Re-evaluate internal control

Shipping documents

Determine if sufficient evidence was obtained.

Duplicate sales invoices

Correspondence with the client.

Evidence Planning Worksheet

(Fig 13.7)

Evaluate the qualitative nature of errors

Lecture Example

Activity 13.27 (Arens et al., 2013)

(a)

(b)

Identify which procedures are tests of details of

balances, which are tests of controls, and which are
substantive tests of transactions

Identify one test of details and one test of control or

substantive test of transactions that will partially
satisfy each balance related audit objective.

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What Next ???

Topic 8:

Review Chapter 13

Ensure understand key terms and concepts

Review seminar slides & examples

Assigned Questions: 13.11, 13.23,13.25,13.26

Next Week:

Chapter 15: Audit of Transaction Cycles (Part 2).

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