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 Balancerelated 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
accounts receivable
Phase I
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
Sample size
receivable balance
to satisfy
Items to select
balance-related
Timing
audit objectives
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder
Phase III
16 - 6
Occurrence
Completeness
Accuracy
Posting and
summarization
Classification
Timing
Rights
Realizable
value
Cutoff
Classification
Accuracy
Sales
Completeness
Translation-related
audit objectives
Existence
ACCOUNTS RECEIVABLE
BALANCE-RELATED
AUDIT OBJECTIVES
Detail tie-in
Relationship Between Sales
and Accounts Receivable
×
×
×
×
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder
×
×
16 - 7
Occurrence
Completeness
Accuracy
Posting and
summarization
Classification
Timing
Rights
Realizable
value
Cutoff
Classification
Accuracy
Cash receipts
Completeness
Translation-related
audit objectives
Existence
ACCOUNTS RECEIVABLE
BALANCE-RELATED
AUDIT OBJECTIVES
Detail tie-in
Relationship Between Sales
and Accounts Receivable
×
×
×
×
©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
Sales
Gross margin
Accounts receivable
Bad debt expense
Total current assets
Total assets
Net earnings
Number of accounts
receivable
Number of accts. rec. with
balances over $100,000
Percent
Percent
change
change
12/31/07 2006- 12/31/06 2005($000)
2007
($000)
2006
12/31/05
($000)
144,328
39,845
20,197
3,323
51,027
61,367
5,681
9.0
9.6
7.3
(2.1)
14.0
(7.0)
21.9
132,421
36,350
18,827
3,394
44,779
66,021
4,659
7.0
7.0
14.1
7.3
6.6
8.0
39.0
123,737
33,961
16,505
3,162
41,989
61,147
3,351
258
16.7
221
5.7
209
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
Sales returns and allowances/
gross sales
Bad debt expense/net sales
Allowance for uncollectible
accounts/accounts receivable
Number of days receivables
outstanding
Net accounts receivable/
current assets
27.85%
27.70%
27.68%
0.90%
2.30%
0.90%
2.60%
0.90%
2.60%
6.10%
7.50%
6.40%
48.09
47.96
49.32
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
Softwood
Plywood
36.3
23.9
40.3
32.4
22.0
50.1
36.4
20.3
44.2
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder
32.5
22.1
54.3
36.0
20.5
45.4
32.3
22.3
55.6
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
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16 - 23
Timing
The most reliable evidence from confirmations
is obtained when they are sent as close to the
balance sheet date as possible.
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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.
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16 - 26
Follow-up on Nonresponses
When positive confirmations are used,
SAS 67 requires follow-up procedures
for confirmations not returned by
he customer.
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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