Completing the Tests

in the Sales and

Collection Cycle:
Accounts Receivable
Chapter 16

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 1

 Learning Objective 1

Describe the methodology for

designing tests of details of
balances using the audit
risk model.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 2

 Accounts Receivable Balance-
related Audit Objectives
1. Detail tie-in 5. Classification

2. Existence 6. Cutoff

3. Completeness 7. Realizable value

4. Accuracy 8. Rights

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 3

 Methodology for Designing Tests
of Details of Balances for A/R
Identify client business
risks affecting Phase I
accounts receivable

Set tolerable misstatement

and assess inherent risk Phase I
for accounts receivable

Assess control risk for

Phase I
sales and collection cycle
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 4
 Methodology for Designing Tests
of Details of Balances for A/R
Design and perform
tests of controls and
substantive tests
Phase II
of transactions
for the sales and
collection cycle

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 5

 Methodology for Designing Tests
of Details of Balances for A/R
Design and perform
analytical procedures
Phase III
for accounts
receivable balance
Design tests of Audit procedures
details of accounts
receivable balance Sample size
Phase III
to satisfy Items to select
balance-related
audit objectives Timing
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 6
 Relationship Between Sales
and Accounts Receivable
ACCOUNTS RECEIVABLE
BALANCE-RELATED

Completeness

Classification
AUDIT OBJECTIVES

Detail tie-in

Realizable
Existence

Accuracy
Translation-related

Rights
Cutoff

value
audit objectives
Sales
Occurrence ×
Completeness ×
Accuracy ×
Posting and
summarization ×
Classification ×
Timing ×
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 7
 Relationship Between Sales
and Accounts Receivable
ACCOUNTS RECEIVABLE
BALANCE-RELATED

Completeness

Classification
AUDIT OBJECTIVES

Detail tie-in

Realizable
Existence

Accuracy
Translation-related

Rights
Cutoff

value
audit objectives
Cash receipts
Occurrence ×
Completeness ×
Accuracy ×
Posting and
summarization ×
Classification ×
Timing ×
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 8
 Learning Objective 2

Design and perform analytical

procedures for accounts in the
sales and collection cycle.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 9

 Analytical Procedures for the
Sales and Collection Cycle
Compare by product line:
 Gross margin percentage with
previous years
 Sales by month over time
 Sales returns and allowances
as a percentage of gross sales
with previous years

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 10

 Analytical Procedures for the
Sales and Collection Cycle
Compare with previous years:
 Individual customer balances over
a stated amount
 Bad debt expense as a percentage
of gross sales
 Days that accounts receivable
are outstanding

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 11

 Analytical Procedures for the
Sales and Collection Cycle
Compare with previous years:
 Aging category as a percentage
of receivables
 Allowance for uncollectible accounts as
a percentage of accounts receivable
 Write-off of uncollectible accounts as a
percentage of total accounts receivable

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 12

 Selected Comparative
Information
Percent Percent
change change
12/31/07 2006- 12/31/06 2005- 12/31/05
($000) 2007 ($000) 2006 ($000)
Sales 144,328 9.0 132,421 7.0 123,737
Gross margin 39,845 9.6 36,350 7.0 33,961
Accounts receivable 20,197 7.3 18,827 14.1 16,505
Bad debt expense 3,323 (2.1) 3,394 7.3 3,162
Total current assets 51,027 14.0 44,779 6.6 41,989
Total assets 61,367 (7.0) 66,021 8.0 61,147
Net earnings 5,681 21.9 4,659 39.0 3,351
Number of accounts
receivable 258 16.7 221 5.7 209
Number of accts. rec. with
balances over $100,000 37 15.6 32 6.7 30

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 13

 Analytical Procedures: Sales
and Collection Cycle
12/31/07 12/31/06 12/31/05
Gross margin/net sales 27.85% 27.70% 27.68%
Sales returns and allowances/
gross sales 0.90% 0.90% 0.90%
Bad debt expense/net sales 2.30% 2.60% 2.60%
Allowance for uncollectible
accounts/accounts receivable 6.10% 7.50% 6.40%
Number of days receivables
outstanding 48.09 47.96 49.32
Net accounts receivable/
current assets 37.20% 32.50% 32.30%

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 14

 Design and Perform Tests of
Details of A/R Balance (Phase III)
 Planned detection risk for each
objective is an auditor decision

 Combining the factors that determine

planned detection risk is complex

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 15

 Analytical Procedures for
Gross Margin
Gross margin percent
2007 2006 2005
Great Great Great
Western Industry Western Industry Western Industry

Hardwood 36.3 32.4 36.4 32.5 36.0 32.3

Softwood 23.9 22.0 20.3 22.1 20.5 22.3
Plywood 40.3 50.1 44.2 54.3 45.4 55.6

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 16

 Learning Objective 3

Design and perform tests of

details of balances for accounts
receivable.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 17

 Designing Tests of Detail
of Balances
Accounts receivable are correctly added and
agree with the Master File and the General
Ledger (aged trial balance).

 Recorded accounts receivable exist

 Existing accounts receivable are included

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 18

 Designing Tests of Detail
of Balances
 Accounts receivable are accurate

 Accounts receivable are properly classified

 Cutoff for accounts receivable is correct

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 19

 Designing Tests of Detail
of Balances
 Accounts receivable is stated at
realizable value

 The client has rights to accounts receivable

 Accounts receivable presentation and

disclosure

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 20

 Learning Objective 4

Obtain and evaluate accounts

receivable confirmations.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 21

 Auditing Standards
Requirements
1. Accounts receivable are immaterial.
2. The auditor considers confirmations
ineffective evidence because response
rates will likely be inadequate or unreliable.
3. The combined level of inherent risk and
control risk is low and other substantive
evidence can be accumulated to provide
sufficient evidence.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 22

 Type of Confirmation
 Positive confirmation

 Blank confirmation form

 Invoice confirmation

 Negative confirmation

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 23

 Timing

The most reliable evidence from confirmations

is obtained when they are sent as close to the
balance sheet date as possible.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 24

 Sample Size
 Tolerable misstatement
 Inherent risk
 Control risk
 Achieved detection risk from
other substantive tests
 Type of confirmation

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 25

 Maintaining Control

After the items for confirmation have been

selected, the auditor must maintain control
of the confirmations until they are returned
from the customer.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 26

 Follow-up on Nonresponses

When positive confirmations are used,

SAS 67 requires follow-up procedures
for confirmations not returned by
he customer.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 27

 Subsequent Cash Receipts

Evidence of the receipt of cash subsequent

to the confirmation date includes examining
remittance advices, entries in the cash
receipts records, or perhaps even
subsequent credits in the accounts
receivable master file.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 28

 Duplicate Sales Invoices

These are useful in verifying the actual

issuance of a sales invoice and the
actual date of the billing.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 29

 Shipping Documents

These are important in establishing

whether the shipment was actually
made and as a test of cutoff.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 30

 Analysis of Difference
 Payment has already been made

 Goods have not been received

 The goods have been returned

 Clerical errors and disputed accounts

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 31

 Drawing Conclusions
 Reevaluate internal control

 Evaluate the qualitative nature of

misstatements

 Determine whether sufficient evidence

was obtained

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 32

 Learning Objective 5

Design audit procedures for the

audit of accounts receivable,
using an evidence planning
worksheet as a guide.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 33

 Source of Each Row in the
Evidence Planning Worksheet
 Tolerable misstatement
 Acceptable audit risk
 Inherent risk
 Control risk
 Substantive tests of
transactions results
 Analytical procedures
 Planned detection risk and
planned audit evidence

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 34

 End of Chapter 16

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 16 - 35