Completing the Tests

in the Sales and

Collection Cycle:
Accounts Receivable

Chapter 16

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 1

 Learning Objective 1

Describe the methodology for

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

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 2

 Accounts Receivable Balance-
Related Audit Objectives

Detail
Detailtie-in
tie-in Existence
Existence Completeness
Completeness

Accuracy
Accuracy Classification
Classification Cutoff
Cutoff

Realizable
Realizable Presentation
Presentation
Rights
Rights
value
value and
anddisclosure
disclosure

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 3

 Methodology for Designing Tests
of Details of Balances for A/R
Phase
PhaseII

Identify
Identifyclient
clientbusiness
businessrisks
risksaffecting
affectingaccounts
accounts
receivable.
receivable.

Set
Settolerable
tolerablemisstatement
misstatementandandassess
assessinherent
inherent
risk
riskfor
foraccounts
accountsreceivable.
receivable.

Assess
Assesscontrol
controlrisk
riskfor
forsales
salesand
andcollection
collectioncycle.
cycle.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 4
 Methodology for Designing Tests
of Details of Balances for A/R
Phase
PhaseIIII

Design
Designand
andperform
performtests
testsof
ofcontrols
controlsand
and
substantive
substantivetests
testsof
oftransactions
transactionsfor
forthe
the
sales
salesand
andcollection
collectioncycle.
cycle.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 5

 Methodology for Designing Tests
of Details of Balances for A/R
Phase
PhaseIII
III

Design
Designand
andperform
performanalytical
analyticalprocedures
proceduresfor
for
accounts
accountsreceivable
receivablebalance.
balance.

Design
Designtests
testsof
ofdetails
detailsof
ofaccounts
accountsreceivable
receivable
balance
balanceto
tosatisfy
satisfybalance-related
balance-relatedaudit
auditobjectives.
objectives.
Audit
Audit Sample
Sample Items
Itemstoto Timing
Timing
procedures
procedures size
size select
select
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 6
 Relationship Between Sales and
Accounts Receivable
Accounts receivable balance-related audit objectives
Accounts receivable balance-related audit objectives

and disclosure
Completeness

Classification

Presentation
Detail tie-in

Realizable
Existence

Accuracy
Translation-related

Rights
Cutoff

value
audit objectives
Sales
Existence ×
Completeness ×
Accuracy ×
Classification ×
Timing ×
Posting/Summary ×
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 7
 Relationship Between Sales and
Accounts Receivable
Accounts receivable balance-related audit objectives
Accounts receivable balance-related audit objectives

and disclosure
Completeness

Classification

Presentation
Detail tie-in

Realizable
Existence

Accuracy
Translation-related

Rights
Cutoff

value
audit objectives
Cash receipts
Existence ×
Completeness ×
Accuracy ×
Classification ×
Timing ×
Posting/Summary ×
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 8
 Learning Objective 2

Design and perform analytical

procedures for accounts in the
sales and collection cycle.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 9

 Analytical Procedures for the
Sales and Collection Cycle

Gross
Grossmargin
marginpercentage
percentagewith
withprevious
previousyears
years

Sales
Salesby
bymonth
monthover
overtime
time

Sales
Salesreturns
returnsand
andallowances
allowancesas
asaapercentage
percentageof
of
gross
grosssales
saleswith
withprevious
previousyears
years

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 10

 Analytical Procedures for the
Sales and Collection Cycle

Individual
Individualcustomer
customerbalances
balancesover
overaastated
statedamount
amount

Bad
Baddebt
debtexpense
expenseas
asaapercentage
percentageof
ofgross
grosssales
sales

Days
Daysthat
thataccounts
accountsreceivable
receivableare
areoutstanding
outstanding

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 11

 Analytical Procedures for the
Sales and Collection Cycle

Aging
Agingcategory
categoryas
asaapercentage
percentageof
ofreceivables
receivables

Allowance
Allowancefor
foruncollectible
uncollectibleaccounts
accountsas
asaa
percentage
percentageof
ofaccounts
accountsreceivable
receivable

Charge-off
Charge-offof
ofuncollectible
uncollectibleaccounts
accountsas
asaa
percentage
percentageofoftotal
totalaccounts
accountsreceivable
receivable
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 12
 Selected Comparative Information
Percent Percent
change change
12/31/04 2003- 12/31/03 2002- 12/31/02
($000) 2004 ($000) 2003 ($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

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 13

 Analytical Procedures: Sales and
Collection Cycle
12/31/04 12/31/03 12/31/02
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%

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 14

 Design and Perform Tests of
Details of A/R Balance (Phase III)

Planned
Planneddetection
detectionrisk
riskfor
foreach
eachobjective
objective
isisan
anauditor
auditordecision.
decision.

Combining
Combiningthe
thefactors
factorsthat
thatdetermine
determine
planned
planneddetection
detectionrisk
riskisiscomplex.
complex.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 15

 Analytical Procedures for Gross
Margin
Gross margin percent
2005 2004 2003
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

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 16

 Learning Objective 3

Design and perform tests of

details of balances for accounts
receivable for each balance-
related audit objective.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 17

 Designing Tests of Detail
of Balances

Accounts
Accountsreceivable
receivableare
arecorrectly
correctlyadded
addedand
and
agree
agreewith
withthe
theMaster
MasterFile
Fileand
andthe
theGeneral
General
Ledger
Ledger((aged
agedtrial
trialbalance
balance).).

Recorded
Recordedaccounts
accountsreceivable
receivableexist
exist

Existing
Existingaccounts
accountsreceivable
receivableare
areincluded
included

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 18

 Designing Tests of Detail
of Balances
Accounts
Accountsreceivable
receivableare
areaccurate
accurate

Accounts
Accountsreceivable
receivableare
areproperly
properlyclassified
classified

Cutoff
Cutofffor
foraccounts
accountsreceivable
receivableisiscorrect
correct

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 19

 Designing Tests of Detail
of Balances
Accounts
Accountsreceivable
receivableisisstated
statedat
atrealizable
realizablevalue
value

The
Theclient
clienthas
hasrights
rightsto
toaccounts
accountsreceivable
receivable

Accounts
Accountsreceivable
receivablepresentation
presentationand
and
disclosures
disclosuresare
areproper
proper

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 20

 Learning Objective 4

Obtain and evaluate accounts

receivable confirmations.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 21

 AICPA Requirements
1.
1.Accounts
Accountsreceivable
receivableare
areimmaterial.
immaterial.

2.
2.The
Theauditor
auditorconsiders
considersconfirmations
confirmations
ineffective
ineffectiveevidence
evidencebecause
becauseresponse
response
rates
rateswill
willlikely
likelybe
beinadequate
inadequateor
orunreliable.
unreliable.

3.
3.The
Thecombined
combinedlevellevelof
ofinherent
inherentrisk
riskand
and
control
controlrisk
riskisislow
lowand
andother
othersubstantive
substantive
evidence
evidencecancanbe beaccumulated
accumulatedto toprovide
provide
sufficient
sufficientevidence.
evidence.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 22
 Type of Confirmation

Positive
Positiveconfirmation
confirmation

Blank
Blankconfirmation
confirmationform
form

Invoice
Invoiceconfirmation
confirmation

Negative
Negativeconfirmation
confirmation

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 23

 Timing

The
Themost
mostreliable
reliableevidence
evidencefrom
fromconfirmations
confirmations
isisobtained
obtainedwhen
whenthey
theyare
aresent
sentasasclose
closeto
tothe
the
balance
balancesheet
sheetdate
dateas
aspossible,
possible,as
asopposed
opposed
totoconfirming
confirmingthe
theaccounts
accountsseveral
severalmonths
months
before
beforeyear-end.
year-end.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 24

 Sample Size

Tolerable
Tolerablemisstatement
misstatement

Inherent
Inherentrisk
risk

Control
Controlrisk
risk

Achieved
Achieveddetection
detectionrisk
riskfrom
from
other
othersubstantive
substantivetests
tests

Type
Typeof
ofconfirmation
confirmation

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 25

 Selection of the Items for Testing

When
Whenselecting
selectingaasample
sampleofofaccounts
accountsreceivable
receivable
for
forconfirmation,
confirmation,the
theauditor
auditorshould
shouldbebecareful
careful
to
toavoid
avoidbeing
beinginfluenced
influencedbybythe
theclient.
client.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 26

 Selection of Items for Testing

IfIfaaclient
clienttries
triestotodiscourage
discouragethetheauditor
auditorfrom
from
sending
sendingconfirmations
confirmationsto tocertain
certaincustomers,
customers,
the
theauditor
auditorshould
shouldconsider
considerthe
thepossibility
possibility
that
thatthetheclient
clientisisattempting
attemptingtotoconceal
conceal
fictitious
fictitiousororknown
knownmisstatements
misstatements
ofofaccounts
accountsreceivable.
receivable.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 27

 Maintaining Control

After
Afterthe
theitems
itemsfor
forconfirmation
confirmationhave
havebeen
been
selected,
selected,the
theauditor
auditormust
mustmaintain
maintaincontrol
control
of
ofthe
theconfirmations
confirmationsuntil
untilthey
theyare
arereturned
returned
from
fromthe
thecustomer.
customer.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 28

 Follow-up on Nonresponses

When
Whenpositive
positiveconfirmations
confirmationsare
areused,
used,
SAS
SAS67 67requires
requiresfollow-up
follow-upprocedures
procedures
for
forconfirmations
confirmationsnot
notreturned
returnedby
by
he
hecustomer.
customer.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 29

 Subsequent Cash Receipts

Evidence
Evidenceofofthe
thereceipt
receiptof ofcash
cashsubsequent
subsequent
to
tothe
theconfirmation
confirmationdate
dateincludes
includesexamining
examining
remittance
remittanceadvices,
advices,entries
entriesininthe
thecash
cash
receipts
receiptsrecords,
records,or
orperhaps
perhapseveneven
subsequent
subsequentcredits
creditsininthe
theaccounts
accounts
receivable
receivablemaster
masterfile.
file.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 30

 Duplicate Sales Invoices

These
Theseare
areuseful
usefulininverifying
verifyingthe
theactual
actual
issuance
issuanceofofaasales
salesinvoice
invoiceand
andthe
the
actual
actualdate
dateof
ofthe
thebilling.
billing.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 31

 Shipping Documents

These
Theseare
areimportant
importantininestablishing
establishing
whether
whetherthe
theshipment
shipmentwaswasactually
actually
made
madeand
andasasaatest
testof
ofcutoff.
cutoff.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 32

 Correspondence With the Client

Usually,
Usually,the
theauditor
auditordoes
doesnot
notneed
needtotoreview
review
correspondence
correspondenceas asaapart
partof
ofalternative
alternative
procedures,
procedures,but
butcorrespondence
correspondencecan can
be
beused
usedtotodisclose
disclosedisputed
disputedand
and
questionable
questionablereceivables
receivablesnot
not
uncovered
uncoveredby byother
othermeans.
means.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 33

 Analysis of Difference

Payment
Paymenthas
hasalready
alreadybeen
beenmade
made

Goods
Goodshave
havenot
notbeen
beenreceived
received

The
Thegoods
goodshave
havebeen
beenreturned
returned

Clerical
Clericalerrors
errorsand
anddisputed
disputedaccounts
accounts

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 34

 Drawing Conclusions

Reevaluate
Reevaluateinternal
internalcontrol.
control.

Evaluate
Evaluatethe
thequalitative
qualitativenature
natureof
of
misstatements.
misstatements.

Determine
Determinewhether
whethersufficient
sufficientevidence
evidence
was
wasobtained.
obtained.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 35

 Learning Objective 5

Design audit procedures for the

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

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 36

 Source of Each Row in the
Evidence Planning Worksheet
Tolerable misstatement
Tolerable misstatement
Acceptable audit risk
Acceptable audit risk
Inherent risk
Inherent risk
Control risk
Control risk
Substantive tests of
Substantive tests of
transactions
transactionsresults
results
Analytical procedures
Analytical procedures
Planned detection risk and
Planned detection risk and
planned
plannedaudit
auditevidence
evidence
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 37
 End of Chapter 16

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 16 - 38