OVERVIEW
Objective
¾
To determine areas of risk in the audit of trade receivables.¾
To describe the procedure of confirmation by direct communication.RISKS SOURCES OF
EVIDENCE ACCOUNTS LEDGER
¾ Accounting entries ¾ Control a/cs
¾ Control a/c reconciliations ¾ Individual customer a/cs
C A P E R
¾ “Ideas list” ¾ Examples
EXTERNAL CONFIRMATION
[ISA 505] ¾ Evidence ¾ Need for ¾ Reliability ¾ Risk assessment ¾ Design of request ¾ Confirmation process
¾ Examples
1
SOURCES OF EVIDENCE
Example 1
Complete the following ideas list.
1.1 “Ideas list”
1.2 Examples
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Accounting systems ⇒¾
Documentation ⇒¾
Tangible assets ⇒¾
Management and employees ⇒¾
Customers and suppliers ⇒¾
Other third parties ⇒¾
Analytical procedures ⇒2
RISKS
2.1
Examples
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Accounts receivable may not be recoverable if overdue liquidated/in receivership
disputed (e.g. over pricing/goods supplied).
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An accounts receivable analysis may not accurately reflect age of debtors (e.g. if items are not matched in “open-item” system).¾
Trade receivables will be overstated if estimate for bad and doubtful debtors is inadequate.Example 2
A Trade receivables’ ledger B C
$ $ $ $ $ $ B/f 100 B/f 80 B/f 170
Receipts $75 from A $80 from B $100 from C
Required:
Explain how the misappropriation of receipt A could be concealed with subsequent cash receipts.
Solution
(i) When $80 received from B – (ii) When $100 received from C –
3
LEDGER ACCOUNTS
Understanding the way in which transactions with customers are recorded is crucial to describing audit procedures.
3.1
Accounting entries
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Relevant transactions are usually posted twice In total to a control a/c Individually to trade receivables/trade payables ledger accounts.
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If control a/cs are maintained in the general ledger double-entries will includeDr Control a/c Cr Sales a/c
Being sales
Dr Cash a/c
Cr Control a/c
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If control a/cs are NOT maintained in the general double-entries will includeDr Individual customer a/c Cr Sales a/c
Dr Cash a/c
Cr Individual customer a/c
a control a/c should be kept in memorandum.
3.1.1
Books of prime entry
CASH BOOK RECEIPTS
GENERAL In memorandum
Books of prime entry
(Similar entries will be made from
the sales and purchases returns
books) CASH BOOK
PAYMENTS SALES DAY BOOK PURCHASES DAY BOOK JOURNAL
TRADE
RECEIVABLES PAYABLES TRADE
DOUBLE ENTRIES SINGLE ENTRIES
3.1.2
Detailed extract
SALES DAY BOOK
Totals Individual
memo entries
GENERAL LEDGER RECEIVABLES LEDGER
Revenue a/c Control a/c Anderson
TOTALS SHOULD
AGREE Cooper
Cash a/c
Individual
Totals memo entries
CASH BOOK
3.2
Control accounts
3.2.1
Purpose
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To provide an internal control (also called “internal check”) over the recording of credit transactions and their subsequent settlement. If all postings are correct both individually and in total ⇒ Σ individual balances in sub-ledger = balance on control a/c If errors in control a/c (kept in general ledger) ⇒ TB will not balance If errors in individual a/c (kept in memorandum) ⇒
3.2.2
Proforma
¾
A trade receivables ledger control account may contain any or all of the following totalsfor the period.
Trade receivables ledger control a/c
$ Balance b/f
(opening trade receivables) x Sales (credit) a/c
(sales day book) x
Cash a/c – dishonoured cheques
(cash book) x
__ x __
Bal b/f x
$
Cash a/c (cash book) x Discounts allowed a/c
(cash book) x
Sales returns a/c
(sales returns day book) x Bad debts expense a/c (journal) x Credit notes (journal) x Trade payables ledger contra
(journal) x
Balance c/f †
(closing trade receivables) __ x x __
† If there are not errors, this balance must be the same as the sum of the individual balances on the customers’ ledger a/cs. Any difference must be reconciled.
3.3
Control account reconciliations
3.3.1
Preliminary procedure
Step 1 Balance off individual a/cs (e.g. in the sub-ledger)
Step 2 Extract a list of a/c balances and sum it
Step 3 Balance control a/c (e.g. in general ledger)
3.3.2
Possible reasons for difference
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Casting error in a book of prime entry (affects total) will give rise to an error in the control a/c.¾
Omission or duplicate posting of individual transactions.¾
Transposition errors (in individual amounts or totals) will result in errors (in the individual and control a/cs respectively).¾
“Contra entries” (set-offs) in individual a/cs not recorded in control a/cs.Commentary
Contra entries may arise when a business has accounts in both the receivables and payables ledgers for the same party (i.e. the business obtains supplies from a customer). Instead of exchanging cheques, the accounts are settled by setting off the smaller balance to leave a net amount owing.
¾
Bad debts in individual a/cs not recorded in control a/c.¾
Casting error in balancing off a/cs (individual or total).¾
Errors in extracting individual balances (= list) omission
recording Cr balance † in trade receivables ledger as Dr recording Dr balance in trade payables ledger as Cr.
† It is easily assumed that all receivables should have debit (or nil) balances. However, a customer could have a credit balance (e.g. if they made an advance payment).
Commentary
Not all errors will give rise to a difference (e.g. omitting a transaction from a book of prime entry).
3.3.3
Procedure for agreeing
Step 1 Identify reasons for differences (above)
Step 2 Identify control a/c adjustments ⇒ adjust control a/c
3.3.4
Proforma reconciliation
Trade receivables ledger control a/c
$
Balance b/f x
Adjustments
eg dishonoured cheque x
__
x __
$ Adjustments
e.g. contra x
sales returns x
Balance c/f __ x
x __ Statement reconciling the control account to the list of balances
$
Balance per list of balances x
Add: eg balance omitted x
Less: eg balance posted twice (x) __
Balance per trade receivables ledger control account __ x
These do not agree therefore something has gone wrong
Balances now agree
3.4
Individual customer accounts
3.4.1
“Open-item”
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Keeps full details of all transactions that have been posted to an account.¾
There is a facility to clear (or delete) from the file all items which have been fullymatched, leaving details only of those items which are still not fully matched or “open”. Information is thereby retained for items requiring some processing.
¾
As an entry is made the user should specify whether this is a new transaction (e.g. invoice) or whether it is to be matched against an earlier transaction (e.g. cash receipt).¾
To preserve audit trails when matched items are cleared from the file, it is usual for3.4.2
“Balance (brought) forward”
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Usually keeps details only of the current month’s transactions. Those of previous months are amalgamated to form a single balance which is b/fwd.¾
Much less detail is kept in such a file and it may be impossible to obtain an accurate or meaningful aged analysis.¾
Items may be posted without specific matching to earlier transactions with a FIFO convention usually being adopted. Thus a cash receipt is set against the b/fwd (old) balance before being included in the latest period’s transactions.¾
It can become difficult to reconcile the balance on an account to separate transactions in the past.4
EXTERNAL CONFIRMATION [ISA 505]
ISA 505 External Confirmations supersedes the section in ISA 501 Additional Considerations for Specific Items relating to direct confirmation of accounts receivable.
The process of obtaining and evaluating a direct communication from a third party in response to a request for information affecting financial statement assertions.
Example 3
Suggest matters on which it may be appropriate to seek direct confirmation.
Solution
4.1
Need for
The factors to be considered when determining the need for external confirmations are:
¾
materiality;¾
the assessed risk; and¾
how other evidence will reduce audit risk to an acceptably low level.¾
The weaker internal controls (i.e. the higher control risk), the more important external confirmation.¾
Confirming balances (e.g. accounts receivable) on a test basis may reduce the scope of detailed tests on related transactions (e.g. sales).4.2
Reliability
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Received directly by the auditor from independent third parties, therefore relatively reliable.¾
However, the auditor must exercise control over confirmation requests and responses.¾
Restrictions imposed by management (e.g. not to request balances from certaincustomers) may impair reliability.
4.3
Risk assessments
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If assessed risk is high, the need for more substantive or persuasive evidence (e.g. through direct confirmation procedures) is greater.¾
If assessed as low (e.g. in respect of a loan being repaid in accordance with its terms) substantive procedures may be limited to tests of detail (e.g. of the payments made) rather than through confirmation (e.g. with the lender).Example 4
Identify the financial statement assertion(s) most relevant to the external confirmation of:
Solution
Account receivable
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¾
Goods held on consignment
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¾
Account payable
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4.4
Design of request
External confirmation requests should be tailored to the specific audit objective.
4.4.1
Factors to be considered
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Financial statements assertions¾
Prior experience¾
Respondents (competence, competence, independence, motivation, authority or willingness to provide information, knowledge of the matter being confirmed, and objectivity)¾
The type of information respondents will readily confirm. For example, single transactions (e.g. invoices) rather than overall account balance.4.4.2
Methods
Positive vs Negative
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Request to confirm agreement with balance shown or express disagreement.¾
Preferred when high assessed risk e.g. weak internal controls suspicion of irregularity or
amounts in dispute numerous bookkeeping
errors.
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Request to reply only in event of disagreement with recorded balance.¾
Appropriate when good internal controls , and
large number of small accounts
errors not expected.
4.4.3
Management’s request not to confirm certain information
If the auditor agrees to management’s request not to confirm certain information (on valid grounds) alternative procedures should be applied to obtain sufficient appropriate evidence.
If management’s request is not valid the possible impact on the auditor’s report of the limitation on scope should considered.
¾
Factors to be considered: the need for professional scepticism;
any implications regarding management’s integrity; the possible existence of fraud or error.
4.5
Confirmation process
The auditor should have control over:
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the selection process;¾
sending confirmation requests; and¾
receiving responses.¾
Results should be evaluated in the context of ISA 530 Audit Sampling and Other Selective Procedures.4.5.1
Constructing a sample
Receivables vs Payables
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If testing primarily forOVER-
statement, selectfrom receivables’ ledger (reconciled to control a/c in general ledger).
¾
If testing primarily for UNDER-statement, select from “reciprocal”population (e.g. suppliers identified by audit tests on purchases).
Special attention to be given to - old unpaid a/cs
- a/cs written off during period
- credit/debit balances in receivables/payables - nil balances
- a/cs paid by date of examination.
Audit sampling and other selective testing procedures are described in Session 19.
4.5.2
Request
Specially prepared form or letter or an attachment to the normal statement giving a copy of the customer’s ledger account. The latter is more likely to detect error or fraud.
To . . . Audit confirmation
Will you please return the enclosed slip to our auditors, Messrs Pears, Cross, Brannigan & Company, of 131/133 Dutchman Avenue, indicating whether or not you agree the enclosed account by deleting the line that does not apply.
To: Messrs Pears, Cross, Brannigan & Company 131/133 Dutchman Avenue
Audit confirmation of balance due to: Solti Potato Crisps Inc at 30 June 20X1
Please delete as necessary
We confirm that the balance due from us to the above company at the above date was $ . . .
According to our records the amount due from us to the above company was $ . . .
A reconciliation of these amounts is shown below.
Yours faithfully
4.5.3
Replies
¾
Agree or reconcile differences.4.5.4
Non-replies
Alternative audit procedures should be undertaken to provide equivalent evidence (i.e. about the same financial statement assertion).
¾
Alternative procedures are usually undertaken after a making a second request.Example 5
Suggest alternative procedures which may provide sufficient appropriate audit evidence of the existence and completion of accounts receivable.
Solution
4.6.5
Summary of results
An example of a standard schedule is set out in Appendix 3.
FOCUS
You should now be able to:
¾
explain risks of misstatement associated with trade receivables;¾
identify sources of audit evidence;¾
appreciate and explain the importance of control a/c reconciliations;¾
select appropriate audit procedures (including external confirmation) for inclusion in a work program (see also Appendix 3) relating to financial statement assertions concerning trade receivables.EXAMPLE SOLUTIONS
Solution 1 — Sources “Ideas list”
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Accounting systems ⇒ “Open-item” or “balance forward” ledger¾
Documentation ⇒ Sales orders, GDNs, invoices, credit notes, statements¾
Tangible assets ⇒ Cash receipts (confirm recoverability)¾
Management and employees ⇒ Sales director, Credit controller, cashier¾
Customers and suppliers ⇒ Customer remittance advices,Solution 2 — Teeming and lading
(i) When $80 received from B – allocate $75 to A and pocket difference ($5) (ii) When $100 received from C – allocate $80 to B and pocket difference ($20)
Solution 3 — Direct confirmation
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Account balances (receivable and payable) and their components¾
Terms of agreements¾
Transactions with third parties and terms thereof¾
Bank balances and other information from bankers¾
Inventories held by third parties (e.g. in warehouses or on consignment)¾
Loans from lenders¾
Title deeds to property held by lawyers or banks for safe custody or as security¾
Investments purchased from stockbrokers but not delivered by the end of the reporting period.Solution 4 — Financial statement assertions
Account receivable
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Existence of the account as at the date specified (and accuracy of recorded accounts balances)¾
Completeness (and cut-off between trade receivable/inventory) of recorded transactions (particularly receipts from customers).Evidence is also provided about the adequacy (or otherwise) of the system of internal controls over sales.
Goods held on consignment
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Existence¾
RightsAccount payable
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Obligation¾
Completeness (i.e. that there is no material unrecorded liability)Solution 5 — Alternative procedures (trade receivables)
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After-date cash receipts¾
Shipping documentation or other proof of delivery of goods to the customer¾
Cutoff tests (on sales invoices, goods despatch and cash receipts)