Audit Data Analytics for Accuracy of Accounts Receivable
Aged accounts receivable trial balance—a listing of the balances in the accounts receivable master file at a particular date (such as the balance sheet date), broken down according to the amount of time elapsed between the date of sale and the effective date of the report.
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439 Accounts Receivable Subledger
#1
#2
#3
#4
$ 100 000 250 000 150 000 500 000 Customer
Customer Customer Customer
A/R balance = $1 000 000 Balance Sheet Company XYZ, Inc.
Accounts Receivable $1 000 000
Existence Valuation
Audit Procedures Audit Procedures
To verify the existence of accounts receivable, the auditor can:
• Select a sample of accounts receivable balances from the accounts receivable subledger and mail an accounts receivable balance confirmation to each selected customer.
• Vouch the balance from the confirmation (when it is returned) with the balance according to the accounts receivable subledger.
• Alternatively, review the bank statements subsequent to year-end for proof of payment received from Company XYZ’s customers. For example, if Company XYZ received a payment of $250 000 from Customer #2 subsequent to year-end, this payment would be reflected on Company XYZ’s bank statement and would give comfort to the auditor that the outstanding A/R balance at year-end of $250 000 existed.
The alternative procedure described above can be used by the auditor in situations where a reply to the A/R confirmation was not received.
Note that under certain circumstances (based on risk assessment) the auditor may also be concerned with the assertion of rights and obligations. For example, Company XYZ could have “factored”
(sold) its account receivable. The auditor would verify company’s rights to the A/R balance through management inquiry and review of documents such as board of directors’ meeting minutes. Keep in mind that just because the A/R balance exists and it’s valued correctly, Company XYZ might have factored its A/R and it no longer has the rights to this asset.
To verify the valuation of accounts receivable the auditor can:
• Obtain an accounts receivable aging schedule.
This schedule shows how long A/R balances for specific customers have been outstanding. The longer a balance has been outstanding, the higher is the likelihood that it will not be collected in full or at all. Therefore, even though the balance exists, as the likelihood that it will not be collected in full or at all, it should be valued at what the company reasonably can expect to collect.
• Obtain and review documentation that supports how management determined the amount that it deems uncollectible.
(Management is required to assess the likelihood of collecting each A/R balance and make a provision for the estimate that it deems uncollectible.) The auditor will assess the reasonableness of the method used and the amount deemed as uncollectible that was recorded by management in the allowance for doubtful accounts.
Note that the risk of the A/R balance being incomplete (completeness assertion) is low, as it is unlikely management would be inclined to understate the A/R balance (an asset). In most situations, the auditor would not be concerned with the “completeness” of the A/R balance.
The auditor needs to verify that the receivable of $1 000 000 is collectible. What if some customers can’t or won’t pay?
Keep in mind that although a receivable exists, this does not guarantee that the company can collect the full amount. The auditor needs to gain comfort regarding the amount that Company XYZ can reasonably expect to collect.
The auditor needs to verify that these custom- ers and the balance receivable from each customer actually exist.
The key risk associated with assets is that they are overstated (they don’t exist).
Figure 12-10 Substantive Tests of Details for Accounts Receivable
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• Identify unusual transactions using the auditor’s criteria. For example, balances that exceed their credit limits, or outstanding transactions over a certain size, or extremely old outstanding transactions could be listed. This can be used to help assess the reasonableness of the allowance for doubtful accounts.
• Evaluate the classification of accounts receivable by reviewing the aged trial balance for material receivables from affiliates, officers, directors, or other related parties.
• Identify credit balances, which if significant should be reclassified as accounts payable.
To identify unusual accounts or related-party transactions, the auditor may also run exception tests using GAS against the customer master file at the balance sheet date to determine which accounts should be investigated further.
Accounts Receivable Confirmations
One of the most important audit procedures is the external confirmation of accounts receivable. Confirmations, which can be in multiple forms (paper or electronic), are used to satisfy the existence, accuracy, and allocation (cutoff aspect) assertions.
The use of external confirmations is not required. However, if the auditor did not confirm receivables, he or she would gain the required assurance by other means such as review of subsequent payments or examination of documentation supporting the receivable balance. CAS 505 points out that confirmations may be more relevant to certain assertions (such as existence), and leaves the use of confirmations up to the auditor. Generally, the auditor will send confirmations unless the following are true:
• Accounts receivable are immaterial. This is common for companies such as retail stores with primarily cash or credit card sales.
Hillsburg Hardware Limited Accounts Receivable Aged Trial Balance 30/06/2020
Schedule Date Prepared by Client 15/07/2020 Approved by
Aging, Based on Invoice Date
101011 101044 101100 101191 101270 101301
109733 109742 109810 109907
Adams Supply Ltd.
Argonaut, Inc.
Atwater Brothers Beekman Bearings Corp.
Brown and Phillips Christopher Plumbing Ltd.
Travellers Equipment Ltd.
Underhill Parts and Maintenance UJW Co. Ltd.
Zephyr Plastics Corp.
73 290 1 542 85 518 14 176 13 952 105 231
29 765 8 963 15 832 74 300 20 196 800
57 966 1 542 85 518 12 676 104 656
29 765 8 963 60 085 10 334 169
15 324
9 832 14 215 5 598 762
13 952 200
1 589 654 1 500
150
6 000 2 598 746
100
75 469 Account
Number Customer
Balance
31/12/18 0–30 days 31–60 days 61–90 days 91–120 days over 120 days
125
Figure 12-11 Aged Accounts Receivable Trial Balance Summary for Hillsburg Hardware Limited
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441
• The auditor considers confirmations ineffective evidence because response rates will likely be inadequate or unreliable. In certain industries, such as hospitals, rates of response to confirmations are very low.
• The combined level of inherent risk and control risk is low, and other substan- tive evidence can be accumulated to provide sufficient evidence. If a client has effective internal controls and low inherent risk for the revenue cycle, the auditor should be able to satisfy the evidence requirements by tests of controls, substan- tive tests of transactions, and analytical procedures.
An auditor makes two assumptions when accepting an external confirmation from a third party as evidence:
1. The person returning the confirmation is independent of the company being audited and will provide an unbiased response. If this assumption is invalid, as would be the case if the confirmation of a fraudulent account receivable were sent to a company owned by an associate of the person committing the fraud, the value of the returned confirmation becomes zero.
2. The person returning the confirmation has knowledge of the account and the intent of the confirmation and has carefully checked the balance in his or her records to ensure that the confirmation is in agreement. However, this second assumption may also not always be valid.
Research has shown that some people return confirmations without really check- ing the balance; such a confirmation would not be valid. If the auditor has any doubts about the quality of the confirmation, then the auditor should apply professional skep- ticism and perform additional audit procedures.
The auditor must make several decisions about the confirmation that will be sought, including type of confirmation, timing, sample size, and sample selection of the items for testing.
Type of Confirmation Two common types of confirmations are used for confirm- ing accounts receivable: positive and negative. A positive (accounts receivable) confirmation is a communication addressed to the debtor requesting him or her to confirm directly with the auditor whether the balance as stated on the confirmation request is correct or incorrect. Figure 12-12 illustrates a positive confirmation in the audit of Island Hardware Ltd.
A variation of the first type of confirmation includes a listing of outstanding invoices making up the balance or a copy of the client customer statement attached by the auditor to the confirmation request. The listing of invoices is useful when the debtor uses a voucher system for accounts payable; attaching the statement makes it easier for the debtor to respond. If the client has unusual or complex sales agreements, the auditor could also request confirmation of terms of sale—such as bill-and-hold transactions, or extended payment terms.
A second type of positive confirmation, often called a blank confirmation form, does not state the amount on the confirmation but requests that the recipient fill in the balance or furnish other information. Because blank forms require the recipient to determine the information requested before signing and returning the confirmation, they are considered more reliable than confirmations that include the information.
Research shows, however, that response rates are usually lower for blank confirmation forms. These forms are preferred for accounts payable confirmations when the auditor is searching for understatement of accounts payable.
A negative confirmation is also addressed to the debtor but requests a response only when the debtor disagrees with the stated amount. Figure 12-13 illustrates a negative confirmation in the audit of Island Hardware Ltd. It is a gummed label and would be attached to a customer’s monthly statement. Often, the client can print the auditor’s negative confirmation request directly onto the customer statements.
A positive confirmation is more reliable evidence because the auditor can perform follow-up procedures if a response is not received from the debtor. With a negative
Positive (accounts receivable) confirmation—a letter, addressed to the debtor, requesting that the recipient indicate directly on the letter whether the stated account balance is correct or incorrect and, if incorrect, by what amount.
Blank confirmation form—a letter, addressed to the debtor, requesting the recipient to fill in the amount of the accounts receivable balance; considered a positive confirmation.
Negative confirmation—a letter, addressed to the debtor, requesting a response only if the recipient disagrees with the amount of the stated account balance.
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confirmation, failure to reply cannot be regarded as a correct response because the debtor may have ignored the confirmation request. This explains why CAS 505 states that negative confirmation should be used only when risks of material misstatement are low and when the following are true:
• The items to be confirmed are homogeneous (i.e., similar in nature) and com- prise small account balances.
• No or few exceptions are likely.
• There is an expectation that the negative confirmations will be read and considered.
Offsetting the reliability disadvantage, negative confirmations are less expensive to send than positive confirmations, and thus more can be distributed for the same total cost. Negative confirmations cost less because there are no second requests and no follow-ups of nonresponses.
Positive confirmations are more effective when the following exist:
• Individual balances of relatively large amounts
• Few debtors or account balances
• No suspicions or evidence of fraud or serious error Cockburn, Pedlar & Co.
Chartered Accountants Cabot Bldg.
P.O. Box 123 3 King Street North St. John’s, Newfoundland A1C 3R5 Gamer Hardware
80 Main Street
Corner Brook, Newfoundland A2H 1C8
August 15, 2020
To Whom It May Concern:
Re: Island Hardware Ltd.
In connection with our audit of the financial statements of the above company, we would appreciate receiving from you confirmation of your account. The company’s records show an amount receivable from you of $175.00 on June 30, 2020.
Do you agree with this amount? If you do, please sign this letter in the space below.
However, if you do not, please note at the foot of this letter or on the reverse side the details of any differences. Please return this letter directly to us in the envelope enclosed for your convenience.
Sincerely,
Cockburn, Pedlar & Co.
Per:
Please provide Cockburn, Pedlar & Co. with this information.
_____________________________________
J. Doe, Accountant, Island Hardware Ltd.
The above amount, owed by me (us) at the date mentioned.
_____________________________________
Figure 12-12 Example Positive Confirmation
CAS
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443 Typically, when negative confirmations are used, the auditor puts consider-
able emphasis on the effectiveness of internal control as evidence of the fairness of accounts receivable. Negative confirmations are often used for audits of municipal- ities, retail stores, banks, and other industries in which the receivables are due from the general public. In these cases, more weight is placed on tests of controls than on confirmations.
The primary factors affecting the confirmation decision are the materiality of total accounts receivable, the number and size of individual accounts, control risk, inher- ent risk, the effectiveness of confirmations as audit evidence, and the availability of other audit evidence.
Timing The most reliable evidence from confirmations is obtained when they are sent as close to the balance sheet date as possible, as opposed to confirming the accounts several months before year-end. This permits the auditor to test the accounts receivable balance on the financial statements directly without making any inferences about the transactions taking place between the confirmation date and the balance sheet date. However, as a means of completing the audit on a timely basis, it is fre- quently convenient to confirm the accounts at an interim date. This works well if internal controls are adequate and can provide reasonable assurance that sales, cash receipts, and other credits are properly recorded between the date of the confirmation and the end of the accounting period.
If the decision is made to confirm accounts receivable prior to year-end, it will be necessary to test the transactions occurring between the confirmation date and the balance sheet date. The nature of testing depends upon the length of time between the confirmation date and the year-end and the quality of internal controls. Testing could include examining such internal documents as duplicate sales invoices, ship- ping documents, and evidence of cash receipts, in addition to performing internal control testing, or analytical procedures of the intervening period.
Sample Size The main considerations affecting the number of confirmations to send include the following:
• Performance materiality;
• Inherent risk and risk of material misstatement (relative size of total accounts receivable, number of accounts, prior-year results, and expected misstatements);
• Assessed control risk;
• Achieved detection risk from other substantive tests (extent and results of analyti- cal procedures as substantive tests and other tests of details); and
• Type of confirmation (negatives normally require a larger sample size) AUDITOR’S ACCOUNT CONFIRMATION
Please examine this statement carefully. If it does NOT agree with your records, please report any exceptions directly to our auditors
Cockburn, Pedlar & Co.
Cabot Bldg.
P.O. Box 123 3 King Street North St. John’s, Newfoundland A1C 3R5
who are making an examination of our financial statements. A stamped, addressed envelope is enclosed for your convenience in replying.
Do not send your remittance to our auditors.
Figure 12-13 Example Negative Confirmation
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Sample Selection of the Items for Testing Some type of stratification is desirable with most confirmations. A typical approach to stratification is to consider both the size of the outstanding balance and the length of time an account has been outstanding as a basis for selecting the balances for confirmation. In most audits, the emphasis should be on confirming larger and older balances, because these are most likely to include a significant misstatement. However, it is also important to sample some items from every material stratum of the population. In many cases, the auditor selects all accounts above a certain dollar amount and selects a statistical sample (MUS) from the remainder.
Refusal to Permit Confirmation Management may refuse the auditor permission to send certain confirmations, perhaps because there is a dispute about the account. In such cases, CAS 505 requires the auditor to corroborate management’s statements and to conduct alternative audit procedures (which would be similar to procedures conducted for nonresponses, discussed below). For example, if an account were under dispute, the auditor would examine correspondence with the client and con- sider whether the account is still collectible. The auditor needs to consider whether management’s reasons for not confirming the account are reasonable and how this fits in to other assessed risks.
Maintaining Control After the items for confirmation have been selected, the auditor must maintain control of the confirmations until they are returned from the debtor. If the client’s assistance is obtained in preparing the confirmations—
enclosing them in envelopes or putting stamps on the envelopes—close supervision by the auditor is required. The public accounting firm’s return address must be included on all envelopes to make sure that undelivered mail is received by the public accounting firm. Similarly, self-addressed return envelopes accompanying the confirmations must be addressed for delivery to the public accounting firm’s office. It is even important to mail the confirmations outside the client’s office. All these steps are necessary to ensure independent communication between the audi- tor and the customer.
Follow-Up on Nonresponses Nonresponses to positive confirmations do not provide audit evidence. Similarly, for negative confirmations, the auditor cannot conclude that the recipient received the confirmation request and verified the information requested. Negative confirmations do, however, provide some evidence of the exis- tence assertion. For example, if the address does not exist, the envelope will be returned to the auditor’s offices.
It is common when the auditor does not receive a response to a positive confir- mation request to send a second and even a third request for confirmation. Even with these efforts, some debtors will not return the confirmation. The auditor can then (1) perform alternative procedures or (2) treat the nonresponse as an error to be projected from the sample to the population in order to assess its materiality. The objective of the following alternative procedures, listed below, is to determine by a means other than confirmation whether the nonconfirmed account existed and was properly stated at the confirmation date.
Subsequent Cash ReceiptsEvidence of the receipt of cash subsequent to the con- firmation date includes remittance advices, entries in the cash receipts records, or perhaps even subsequent credits in the supporting records. On the one hand, the examination of evidence of subsequent cash receipts is a highly useful alternative procedure because it is reasonable to assume that a customer would not make a pay- ment unless it were for an existing receivable. On the other hand, the fact of payment does not establish whether there was an obligation on the date of the confirmation, because the payment could pertain to sales after the confirmation date. This is why care should be taken to specifically match each unpaid sales transaction with evi- dence of its payment as a test for disputes or disagreements over individual outstand- ing invoices, as well as for matching to the correct period.
Alternative procedures—for confirmations, the follow-up of a positive confirmation not returned by the debtor with the use of documentation evidence to determine whether the recorded receivable exists and is collectible.
CAS
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