SUBSTANTIVE TESTS OF RECEIVABLES AND SALES

Audit Objectives and Procedures for accounts and notes receivable:

Assertions
I. Existence or Occurrence
II. Rights and Obligations
Audit Objectives
To determine that receivables
exist and represent bona fide
obligations owed to the
company as of the balance
sheet date.
Audit Procedures
1. Obtain schedule of aged
trade accounts receivable and
notes receivable schedule and
reconcile to ledgers.
2. Confirm receivables with
debtors.

3. Inspect notes on hand.

4. Perform analytical
procedures to determine
whether recorded sales and
receivables balances appear
reasonable.

III. Completeness To determine that all 5. Test cutoff of sales and sales
transactions relative to returns to determine whether
receivables have been recorded receivables are recorded in the
in the proper accounting period. proper accounting period.
IV. Valuation or Allocation To determine that receivables 6. Review collectability of
are recorded and presented at receivables and determine the
proper amounts in accordance adequacy of allowance for
with financial reporting doubtful accounts.
framework.
7. Recalculate the interest
income from the notes
receivable.

V. Presentation and Disclosure To determine that the 8. Evaluate financial statement

receivables are properly presentation and disclosure of
presented and classified in the receivables.
balance sheet.
9. Obtain written client
representations regarding
pledge, discount or assignment
of receivable, and about
receivables from officers,
directors, affiliates or other
related parties.

Audit Procedure 1
 ● Commonly prepared by the employees of the client.
● It may be designed for the aging of customers’ accounts, the estimating of probable credit
lossess and the controlling of confirmation request.
● The auditor should test footings, crossfootings and agings especially those accounts classified as
current, as well as those shown as past due. These selected accounts should be traced to the
subsidiary ledgers.

Audit Procedure 2
● Direct communication with debtor is the most essential and conclusive step in the verification of
the existence of accounts receivable.
st
1 Step: Determine the method, timing and the number of confirmation to be requested.
a. Methods of confirmation

When to use Positive Request Method

1. Individual account balances are relatively large.
2. There is reason to believe that there may be a substantial number of accounts in dispute
or with inaccuracies or irregularities.
3. Internal substantiating evidences are not adequate.
4. Internal control system is weak.

Negative Request Method is useful when:

1. Internal control surrounding accounts receivable is considered to be effective.
2. A large number of small balances are involved.
3. The auditor has no reason to believe that persons receiving the requests are unlikely to
give them consideration.

In many situations, a combination of two forms may be appropriate with the positive form used
for large balances and the negative form for small balances.

b. Timing of confirmation
Accounts may be confirmed either at year-end or at an interim date near year-end. If
confirmation procedures are carried prior to the year-end work, it is necessary for the auditor to
review the intervening transactions in the receivables control accounts between the date of
confirmation and the balance sheet date and to consider confirming any accounts with large
balance or any accounts he or she considers to be unusual that remains open at year-end.

c. Extent of confirmation
In the audit of companies with reasonably adequate systems of internal control, the
confirmation process is limited to a sample of the accounts receivable. The sample should be
sufficiently large to account for most of the peso amount of the receivables or it should be
sufficiently representative to deter the drawing of invalid inferences about the entire population
of receivables. The size of the sample will depend upon:
1. The materiality of accounts receivable in comparison with total assets. The size of the
sample should be relatively large if accounts receivable are a relatively large asset.
2. The auditor’s evaluation of the system of internal control. Weaknesses in internal
control call for larger samples than when internal control is strong.
3. The result of confirmation tests in prior year. Significant exceptions in prior year’s
confirmations signals the need for extensive confirmation of this year’s receivables.
 4. The choice between the positive and negative form of confirmation request. The
number of confirmations is usually increased when the negative form is used.

2nd step: Sending the confirmation letters to the debtors.

3rd step: Investigate any exceptions noted by customers to recorded balances.

The auditor should resolve unusual or significant differences reported by customers. Other exception
may be turned over to employee of the client with the request that investigation be made and
explanation furnished to the auditors. When replies are not received on accounts with substantial
balances, the auditors should verify the existence, location and credit standing of the debtor by
reference to credit agencies or other sources independent of the client as well as establish the
authenticity of the underlying transactions by examination of supporting document such as contracts,
customer purchase orders and copies of sales invoices and shipping advices.

4th step: Prepare the summary of the results of confirmation.

5th step: Perform alternative procedures for any confirmation which are not returned.
The auditor may perform the following procedures:
1. Examine collections made subsequent to the confirmation date by inspection of incoming
checks or remittance advices.
2. Trace invoice number and amounts collected to the individual customer’s account and to the
record of cash receipts and to the bank deposit.
3. Examine the customer’s purchase order, the client’s shipping records, and the sales invoice.
4. Perform analytical procedures for accounts receivable.

Audit Procedure 3
The auditor should generally inspect all of the actual notes and any collateral for the notes, preferably
simultaneous with the counting of cash and examination of securities. However, if there are a great
number of notes receivable, the auditor might consider examining only a sample of the notes. Also, if
some of the notes are held by some other party, the auditor should send a confirmation to the holder of
the note.

Audit Procedure 4
The auditor should compare significant statistics related to accounts and notes receivable with those of
the prior year. This procedure can highlight potential weakness in the client’s collection efforts that may
affect the overall collectability of accounts receivable. This procedure may be used also to evaluate the
overall reasonableness of accounts receivable. These statistics include:
1. Ratio of accounts receivable to sales
2. Ratio of overdue accounts to total accounts receivable
3. Number of average day’s sales in accounts receivable
4. Average annual accounts receivable turnover
5. Percentage of bad-debts expense to the total sales
6. Ratio of the valuation allowance to accounts receivable
7. Ratio of interest revenue to notes receivable

Audit Procedure 5
The auditor usually tests the sales cutoff by examining invoices and shipping documents for several days
both before and after the year-end and by tracing such documents to the sales and account receivable
records for the appropriate period. This test of sales cutoff may occasionally be made at an interim date
to check the adequacy of the company’s procedures. All substantial sales returns after the balance sheet
date should also be reviewed carefully as they may represent fictitious sales recorded at year-end.

Audit Procedure 6
The auditors may take the following steps:
1. Verify the past due accounts receivable listed in the aging schedule that have not been paid
subsequent to the balance sheet date.
2. Determine credit ratings for delinquent and usually large accounts.
3. Evaluate confirmation exceptions for indication of amounts in dispute or other clues as to
possible uncollectible account.
4. Summarize in a working paper those accounts considered to be doubtful of collection based on
the preceding procedures. List customer names, doubtful amounts and reasons, considered
doubtful.
5. Confer with the credit manager the current status of each doubtful account ascertaining the
collection action taken and the opinion of the credit manager as to ultimate collectability.
Provide for the estimated losses on accounts considered by the auditors to be uncollectible.
Confer with client’s legal counsel.

Audit Procedure 7
The most effective verification of the interest earned account consists of an independent computation
by the auditors of the interest earned during the year on notes receivable. The interest section of
working paper consists of four columns showing for each note receivable owned during the year the
following information:
1. Accrued interest receivable at the beginning of the year
2. Interest collected during the year
3. Accrued interest receivable at the end of the year
4. Interest earned during the year.

Audit Procedure 8 and 9

In addition to the foregoing audit procedures mentioned, the auditors should also review of the minutes
of director’s meeting and confirm with banks of any selling or assigning of accounts receivable.